Perspectives



Economic Review & Outlook: Implications for the US

In the third quarter of 2012 the US economy continued its trend of modest growth, outperforming the previous quarter as well as the same period in 2011. However, the growth has not been so strong as to provide a sense of economic security. Many key economic indicators continue to move in an encouraging direction: the unemployment rate is finally below eight percent, while consumer spending and inflation remain stable.

The other encouraging news is that home prices appear to be increasing. The Case–Shiller index, a composite index of the home price index for 20 major US metropolitan statistical areas, has begun to rise as has real private residential investment. Unfortunately, the rate at which jobs are created continues to fluctuate.

Third Quarter Growth and Economic Components

US real GDP fluctuated through the first three quarters of 2012 from 2.0 percent seasonally adjusted annual rate (SAAR1) in the first quarter, slowing to 1.3 percent in the second quarter, and rebounding to 2.7 percent in the third quarter. An overview of the four components of GDP—consumer spending, fixed investment, government spending, and net exports—provides a deeper look into the drivers of GDP.

Consumer Spending

Consumer spending appears to be outperforming overall real GDP. For example, while the overall economy fell to 1.3 percent growth in the second quarter, consumer spending tracked slightly ahead, at 1.5 percent growth. In the third quarter, consumer spending grew by 1.4 percent.

Within consumer spending, major growth categories in the third quarter include recreational goods and vehicles (13.4 percent), furnishing and durable household equipment (8.2 percent), and motor vehicles and parts (7.2 percent). Only two sectors did not see positive growth in between the second and third quarter: health care (-1.4 percent) and financial services and insurance (-1.9 percent).

Fixed Investment

Business investment has pulled back since the end of 2011 when it posted 33.9 percent growth in the fourth quarter of that year. In 2012, first quarter business investment growth was 6.1 percent. It continued to slow further down to 0.7 percent in the second quarter, but rebounded in the third quarter growing by 6.7 percent.

The majority of the business investment increase in the most recent quarter is attributable to an increase in residential investment, which grew by 14.2 percent. Industrial capacity is another key indicator of business activity.

Historically, a healthy industrial capacity utilization rate for the US has been between 80 and 85 percent; however, while the country has been trending in that direction, in recent months industrial capacity utilization has leveled off and even dipped slightly to 77.8 percent. It is barely up year-over–year (0.2 percentage points) and it fell by 0.4 percentage points between September and October of 2012. Furthermore, while capacity utilization may be approaching what are considered normal or healthy levels, employment has not bounced back to the same degree.

The housing market, which has been at the center of the economic downturn, is finally starting to show signs of a recovery. Real private residential investment has grown for the past six quarters, something that has not happened since 2004/2005. Furthermore, since this most recent growth trend began in the second quarter of 2011, private residential investment has grown by 14.2 percent.The Case–Shiller Index has also finally started to show signs of growth. Since reaching its low in January of 2012, the Case–Shiller 20-city composite index has grown by 4.7 percent—levels last seen in the fall of 2010.

Government Spending

All levels of government spending grew by 3.5 percent on the third quarter, marking the first quarterly growth in government spending since the second quarter of 2010. Much of the increase comes from defense spending, which rose by 12.9 percent. State and local spending held almost steady, falling by only 0.4 percent, its smallest decrease since it began to fall in the fourth quarter of 2009.

Net Exports

Net exports, which includes goods and services, decreased slightly falling to 0.14 percent in the third quarter of 2011.

Projections

Using a weighted average of International Monetary Fund, Congressional Budget Office, and Moody’s, US GDP growth is expected to remain unchanged between 2012 and 2013 staying around 2.6 percent.2 Growth is expected to pick up beginning in 2014, peaking in 2015 at around 4.5 percent, and then falling back to 3.5 percent in 2017 settling into a long-term growth rate of approximately 3.2 percent starting around 2019. The consensus among economists is that higher growth than this will be needed relative to future population growth in order to effectively reduce unemployment.

Employment

The employment picture has been somewhat optimistic, as unemployment has trended downward over the past 14 months. The October 2012 unemployment rate was 7.9 percent—the lowest since January of 2009. While this is up slightly from 7.8 percent the month before, some of this increase may be attributed to previously discouraged workers rejoining the labor force; in October the number of unemployed was stable while the civilian labor force rose by 578,000.

 Inflation

The economy gained 171,000 jobs in October,3 marking the 25th straight month of job gains.The economy began shedding jobs in February of 2008. Over the next 31 months a net of 8.2 million jobs were lost. The recent streak of job growth that started in October 2010 has added 3.9 million jobs. If job growth continues at that pace it will take an additional 28 months to regain the lost jobs (February 2015). In order to reduce unemployment there would need to be additional job growth to accommodate new workers entering the labor force.

The Federal Reserve continues to hold the federal funds rate—the interest rate at which depository institutions actively trade balances held at the Federal Reserve with each other, usually overnight—on an uncollateralized basis, at near zero levels. For the month of October it stood at 0.16 percent, near the middle of the official target range of zero to 0.25 percent. The 10-year US Treasury bond continues to trade at very low rates; July of this year saw its historic monthly low of 1.53 percent. After that, rates increased slightly to 1.72 percent in September and 1.75 percent in October. Despite this there has been no significant inflation; year over core inflation, which does not include food or energy, was 2.0 percent (October to October), which is easily below the historic three to four percent range and well within the comfort zone of the Federal Reserve. Headline inflation over that same time period saw similar levels at 2.2 percent.

Regional Employment

On a state-by-state basis, recent employment gains and losses are dispersed throughout the country. Twenty-eight states saw unemployment rates rise between the second and third quarter. Fortunately, most of these increases were less than one percent. However, Washington saw a 1.1 percentage-point increase in unemployment and Tennessee a 1.7 percentage-point increase. Neither state ranks in the top 10 in terms of unemployment rate; both stand at 8.2 percent, and are ranked 17th and 18th overall.

The states which saw the largest decreases in unemployment in the third quarter were Rhode Island (-1.60 points), South Dakota (-1.43 points), the District of Columbia (-0.6 points), New Mexico (-0.4 points), and Utah (-0.4 points).

A more coherent picture emerges at the regional level. The Great Plains states and parts of the Midwest continue to do better than the national average; Oklahoma, Wyoming, and Iowa all had unemployment rates of less than 5.5 percent. Furthermore, Nebraska, South and North Dakota all had unemployment rates under five percent: 3.8, 4.5, and 3.1 percent, respectively. Most of the states of the upper Great Plains and Central Mountain areas are doing relatively well compared to the US average, fueled largely or in part by their energy sector growth. Unfortunately for the national averages, these are primarily low population states.

Conditions outside of those states remain spotty, with a few of the hard hit Midwest industrial states such as Ohio and Wisconsin now at or below the national average in unemployment. The Southeast continues to have high unemployment almost across the board, and the Northeast has higher than average unemployment as well. California, the largest economy state economy in the US, continues to struggle mightily, with unemployment well above the national average at 10.2 percent; its neighbor, Nevada, is worse off with an 11.8 unemployment rate, the highest in the nation.

On the brighter side, a significant number of states, including those mentioned earlier such as Rhode Island, New Mexico, and South Dakota, have seen improvements over the past year. The Sun Belt—the engine of the US economy during the 2000s and an area most hard hit thereafter by the recession—has started to catch up with the rest of the country.

Special Section: Focus on State and Local Finances

The economic recession severely compromised the fiscal health of many states and local governments. With declining federal resources now and almost certainly moving forward, the ability of states and locales to finance investment without creative use of new revenue sources, tolling and other user fees, and private sector participation is in question. This is hardly news. But even when supplemented by these creative measures, significant new investment will still require reasonably healthy state and local finances as a foundation.

In this section we review some of the major trends in state and local finance and consider how these are distributed geographically across the US. We then provide some suggestions for what it means for the infrastructure industry in general and for transportation. 

Budgets

In general, data suggest that state and local fiscal conditions have recovered to a degree from the recession, as has the economy. However, even with an overall bottoming out and a slow climb back, many states continue to face serious fiscal stress. 

And while a majority of states are seeing slow improvement, many local governments, including some major cities and their surrounding counties, remain in deep financial trouble. Trends suggest continuing and possibly mounting problems, on both the revenue and cost sides.

Economic Conditions

State and local government finances depend above all on the state of the underlying economy. As noted previously, overall employment gains and losses are dispersed throughout the country, with about half showing small increases in unemployment and another half showing small reductions. Still, while conditions are generally improving, unemployment remains persistently high in many states and regions.

Revenue Trends

While the worst appears over, the trends here still give rise to concern. According to the latest data from the Rockefeller Institute, overall state tax collections in the second quarter of 2012 were up 3.2 percent year-over-year. While this is good news, inflation adjusted revenue remains at $49 billion or roughly five percent lower than its peak in the third quarter of 2008. Local taxes have started to grow year-over-year averaging 1.1 percent over the past four quarters. While not a strongly optimistic improvement, it is better than the -2.2 percent seen in 2010.

 

The story is more complex when considering individual revenue sources. State and local sales and personal incometaxes swung dramatically downward with the recession. Personal income taxes then took a sharp upward turn beginning around 2010, and remain above three percent real growth (i.e., after inflation). Sales tax revenues rebounded some too, and reached into positive real growth for over a year beginning in mid-2010. However, sales taxes have gradually fallen back since then. Whether the recent increases in personal income tax revenues can be sustained into the future is the question, as the uptick has occurred while real GDP has stood still. That cannot continue indefinitely. Personal income taxes are a volatile source of revenue—not the best for planning and investment purposes. There is also a long-term downward spiral in property taxes, a major part of the tax base of local governments, especially smaller locales and counties. The decline reflects the housing crash, but the trend began before that, in part due to legislated efforts to limit property tax growth. Transportation revenue sources, which are most closely linked to motor fuel taxes, are also declining steadily in real terms as the vehicle fleet becomes more fuel efficient and as inflation erodes the tax base, which is based on volume and not fuel price.

Expenses

The major financial threats on the expenditure side are employee and citizen health care costs, employee pension obligations, reductions in federal and state aid, and mounting debt which even after recovery will continue to constrain states and locales from investing. Since 2001, forxample, annual required pension contributions as a percentage of state and local payrolls increased from about six percent to over 15 percent, and states and locales are now only paying about 75 percent of their required pension obligations; virtually all of these pensions were being fully funded in 2001.4 The US Government Accountability Office forecasts that state and local government health care costs (including employee health care and Medicare and Medicaid reimbursements) could rise dramatically relative to all spending if no policy changes are implemented.

Debt

Although states are required to balance their budgets, state debt burdens have increased moderately since 2001. Currently, the average debt-to-GDP ratio for all states is 

16 percent, compared with the US average of 14.5 percent. There is a great deal of variability here among the states with many showing debt-to-state GDP ratios well below the national average, and many above—the standard deviation for all 50 states is about nine percent. New Jersey’s debt ratio is 33 percent while Nebraska’s is 3.8 percent. Alaska, a state with substantial natural resources, has a debt-to-GDP ratio of 31 percent according to the Congressional Research Service.

Cities also vary across the board. Bond ratings for a few major cities are still low. Philadelphia, for example, is rated below “A” grade by Standard and Poor’s, although S&P raised its long-term rating to “BBB+” in April 2012 with a positive outlook.5 Detroit, New Orleans, and Pittsburgh are also below “A” grade. But in looking at the top cities around the country, it is surprising that most are in decent or good shape in terms of access to capital markets, with ratings consistently at “AA” or ”AAA” grades. There is pressure from many directions for rating agencies to give good marks, however. Overall, these major cities ratings mask deeper fiscal problems, especially on the part of small to mid-size cities, a significant number of whom have had to go so far as to hand over their financial affairs to state commissions or overseers. Many cities have had to shed public employees and teachers.

Long-Term Threats

On the revenue side, tax collections are simply not growing in real terms. On the expense side, growth in health care costs may be the single largest long-term threat.  In addition, there may be some concerns related to the long-term status of federal tax preferences for state and local interest as well as state and local taxes. The extent of this threat is contingent on politics moving into the future. 

What This Means for the Infrastructure Industry

Clearly, until the economy rebounds to rates of economic growth commensurate with growth in the labor force, state and local fiscal conditions will be in a perilous state, although this will be unevenly distributed across the country. At the same time, uncertainties, until resolved with more clarity, will continue to constrain state and local governments who are likely to proceed with caution.
 

In addition, new infrastructure investment is likely to continue to stand at the back of the line compared with asset management and preservation of existing assets. Opportunities, on the other hand, exist for increased private-sector participation and greater use of tolling. Moreover, states and locales will be looking to replace old forms of taxation, including sales and motor fuel taxes, both of which are likely to grow slowly or decline, with newer and perhaps more efficient revenue sources such as mileage and carbon-based taxes and fees linked to private sector benefits.
 


Notes:
  1. All growth rates reported as seasonally adjusted annual rate (SAAR) unless otherwise indicated
  2. This edition of EFR discontinues the use of GDP indicators as reported by IHS Global Insight
  3. Jobs numbers refers to the BUreau of Labor Statistics (BLS) Current Emplotment Statistics household survey , which excludes the self-employed and farm workers. The number of unemployed and labor force figure are from BLS Current Population Survey, and includes farm workers and the self-employed. 
  4. Wall Street Journal. Hard Times Spread for Cities (11/12/2012)
  5. US Census Bureau, Philadelphia. State and Local Government Finances and Employment.

 

Image Header Source: Quinn Dombrowski (Creative Commons)

 

 

 


Geographies: United States
Sectors: Other
Topics: Economics