Eight North Carolina economic headlines for 2017

[caption id="attachment_3309" align="alignleft" width="150"] Mike Walden[/caption]

by Dr. Mike Walden, NCSU Professor of Economics, January 4, 2016.

EIGHT NORTH CAROLINA ECONOMC HEADLINES FOR 2017

1. NATIONAL ECONOMIC GROWTH WILL ACCELERATE IN 2017 RESULTING PRIMARILY FROM AN EXPECTED FEDERAL ECONOMIC STIMULUS OF REDUCED TAX RATES

2. BOTH INFLATION RATES AND INTEREST RATES WILL TREND HIGHER IN 2017

3. NORTH CAROLINA’S AGGREGATE ECONOMIC MEASURES WILL ALSO TREND HIGHER IN 2017, WITH 100,000 NET NEW PAYROLL JOBS ADDED

4. NORTH CAROLINA’S AGGREGATE GROWTH WILL EXCEED NATIONAL AGGREGATE GROWTH IN 2017, REVERSING THE TREND DURING MUCH OF THE CURRENT ECONOMIC RECOVERY 

5. THE “HEADLINE” JOBLESS RATE WILL FALL TO UNDER 4% IN ASHEVILLE, DURHAM, AND RALEIGH, BUT THE RATE WILL REMAIN ABOVE 6% IN GOLDSBORO AND ROCKY MOUNT

6. IN NORTH CAROLINA, FASTEST JOB GROWTH WILL CONTINUE IN BOTH HIGHER-PAYING AND LOWER-PAYING JOBS, WITH SLOWEST GROWTH IN MIDDLE-PAYING JOBS; HOWEVER, THE DIFFERENCES WILL NOT BE AS GREAT AS IN RECENT YEARS

7. NORTH CAROLINA COULD BENEFIT FROM TRUMP ADMINISTRATION POLICIES EXPANDIND MILITARY SPENDING AND INCREASING OFF-SHORE ENERGY EXPLORATION

8. TO INCREASE AND SPREAD PROSPERITY, NORTH CAROLINA NEEDS TO FACILITATE MORE RAPID GROWTH IN HIGH-PRODUCTIVITY INDUSTRIES

The National Economy: Are Happy Days Here Again?

            What a difference a month made.   In the four weeks after the 2016 elections, the stock market (measured by the Dow-Jones Industrial Average) soared 7%, close to the milestone 20,000 level. To put this number in context, at the bottom of the Great Recession the Dow-Jones average was 6600, having lost over half its value during that historic downturn.

The stock market has always been viewed as a barometer of the economy, rising when economic fundamentals suggest improvement and falling when challenges pull the economy down. So has the outlook for the economy suddenly and dramatically improved, and if so, why?

A Look at 2016

Before answering these questions, a review of the economy’s track record in 2016 is presented.   Table 1 shows the national economy’s performance on several key variables.            Real GDP is the broadest measure of the economy, as it combines the output of all sectors of the economy – including goods and services – into one number.   It improved in 2016 and actually accelerated in the second half of the year.   Still, the growth rates in real GDP in both the years since the Great Recession (2009-2015) and in 2016 have been below the historical average (1960-2009).

There are similar conclusions for the four labor market (labor force, payroll jobs, labor productivity, real wage rate) measures. Each improved in 2016 but – with the exception of the

Table 1. Performance of Key National Economic Measures.

Source: U.S. Dept. of Commerce; Federal Reserve

¹ 2015III – 2016III; ² November 2015 – November 2016; ³1962 – 2009; ⁴ based on 2016 I, II, III; ⁵ 3-month Treasury bill rate; ⁶ 10-year Treasury note rate;  ⁷ through November

real wage rate - at rates below their long-run averages.   Of particular concern is the continuing slow growth in labor productivity, which has a long-run correlation with improvements in the standard of living. Economists debate the factors behind the sluggishness in worker productivity gains, with a focus on the contributions of demographics (younger inexperienced workers replacing older experienced workers), shortcomings in worker training and skill development, and even the potential for distractions in the workplace from the use of social media and personal tech devices.   The average real wage rate significantly improved in 2016 as a result of the tightening labor market, but there are questions about how far these gains can go without faster labor productivity improvements.

Business investment improved in 2016 but was still under its long-run average.   Both the all-item and core inflation rates continued their recent trend in 2016 of being historically low, and the same result occurred for short-term and long-term interest rates. Analysts question whether these low rates are a result of plentiful supply or weak demand.

An Attitude Shift

            For most of 2016 there was continuing concern over a slowly improving economy on the verge of stagnation. Then everything changed after the November election. As already noted, the stock market soared. The Federal Reserve raised their key short-term interest rate by 0.25 percentage points, and other short-term rates were poised to follow. Long-term interest rates, which are based on broader factors than just Federal Reserve policy, jumped almost a full percentage point. Even expectations for future inflation rose.   Most analysts interpreted these moves as resulting from a new optimism about the future economy.

So what happened to warrant such optimism?   The answer is the stock market is looking forward and anticipating changes in national public policy under the new Trump Administration that will improve economic growth and business earnings.   Specifically, the business world expects substantial tax reductions, major investments in public infrastructure, an overhaul of key financial, energy, and environmental regulations, and a strong pro-business attitude from the new president that will significantly increase domestic production, sales, and incomes from the trend set since the end of the Great Recession.

            This anticipated additional spending and economic activity is also expected to increase both public and private borrowing, which in turn led to the rise in interest rates at the end of 2016.   Also, the increase in interest rates in the private market could cause some of the $2 trillion in excess reserves banks have parked at the Federal Reserve to be withdrawn and invested in the economy. Higher interest rates will also motivate holders of money to spend that money faster.   Both of these changes could lead to higher inflation rates, which the financial markets already anticipate.

It is important to note the financial market changes in stocks, interest rates, and expected inflation happened at the end of 2016 occurred before Donald Trump was inaugurated as President and any specific proposals were sent to Congress.   Financial markets attempt to account for future changes and price those changes into current values.

Of course, expectations can be proven inaccurate, and there are still many questions about the content and impacts of the emerging Trump agenda. While a tax reduction and infrastructure spending package are almost certain to be sent to Congress, the final forms of the Trump plans are unknown. Nor do we know how Congress might change those plans. Tax plans are always contentious, with debates over rates, deductions and credits, and impacts for households of different income levels. The size of the infrastructure package, the designation of projects, and the speed of starting the projects will be debated both within the Trump Administration as well as between the Administration and the Congress.

There are also questions about the economic impact of the tax and spending proposals.   Will President-elect Trump’s goal of 4% annual growth be achieved?   In the 36 years since 1980, a 4% annual growth rate in GDP has occurred only nine times, and it has not happened at all since 2000.   Some say the reason is not economic policy, but rather is demographics.   Like most developed countries, the U.S. is aging.   Historically, older societies have slower rates of economic growth.

            President-elect Trump has also vowed to reduce regulations by changing recent legislative acts in health care (the Affordable Care Act), the financial system (Dodd-Frank Financial Reregulation Act), and the environment (several recent Environment Protection Agency rulings). The speed of making changes and the ultimate results are still unknown.

Perhaps the biggest question mark for the Trump Administration will be their proposals on international trade.   During the campaign, Mr. Trump forcefully talked about reducing the trade deficit by limiting imports and moving foreign production operations to the U.S.   He said he would renegotiate trade treaties, sue countries that are alleged to be violating provisions of the treaties, and possibly even impose tariffs (taxes on imports) on some products as high as 35%.

Certainly substituting increased domestic production for imports would contribute to faster economic growth in the U.S. The question is whether the tactics used to do this (law suits, tariffs) would invite retaliation by other countries to do the same and reduce their purchases of products made in the U.S. U.S. exports to foreign countries currently total $2.4 trillion annually, or 13% of the country’s total economic production.   Any significant reduction in U.S. exports would work against increasing the rate of economic growth.   Indeed, U.S. exports are already facing the headwind of a rising international value of the dollar that has occurred with the growing expectation of faster U.S. economic growth. A stronger valued dollar makes U.S. exports more expensive to foreign buyers and imports to the U.S. cheaper.

National Forecasts for 2017

The right column of Table 1 gives 2017 forecasts for the nation on the key economic measures. Most of the growth measures show improvement over 2016, suggesting an economic bump from the likely combination of tax cuts and increased federal spending.   However, “costs” of this program will be higher interest rates, higher inflation, and an increase in federal borrowing. These costs could be reduced or avoided if the economy grew sufficiently faster or if federal spending was re-arranged so as to not require additional borrowing.

The North Carolina Economy: Uneven Growth Continues

            Table 2 shows North Carolina enjoyed a positive year in 2016 for four top economic measures. There were gains in real GDP, the labor force, payroll jobs, and the real (inflation-adjusted) wage rate, and each of these gains exceeded their counterparts at the national level.

Although the state did perform better than the nation in 2016, there is concern over recent trends. Figure 1 shows North Carolina’s rebound from recessions has become progressively less robust during the last three business cycles. For example, 2016 is the seventh year of recovery from the Great Recession, and the state’s real GDP in 2016 was 8% higher than at the beginning of the recovery. But the comparable gain following the 2001 recession was 19%, and following the 1990-91 recession it was 36%.[1] Furthermore, Figure 2 shows the state’s recovery compared to the national recovery has narrowed over the last three recessions – indeed in the current recession it has been slower than the national recovery.

            A major reason for North Carolina’s relatively slower growth in the current economic recovery is shown in Table 3. Compared to the nation, North Carolina has had significantly slower growth in several high productivity sectors – including utilities, finance, nondurable manufacturing, and agriculture – and faster growth in low productivity sectors like arts/leisure/hospitality, personal services, and administrative services. In particular, the decline in the state’s non-durable manufacturing sector, once a mainstay of the North Carolina economy, has been more than four times greater than the sectors’ downsizing at the national level in the current economic expansion.   This contrast suggests the economic transformation in North

Table 2. Performance of Key North Carolina Economic Measures.

Source: U.S Dept. of Commerce; ¹ 2015 II – 2016 II; ² November 2015 – November 2016

Figure 1. North Carolina Real GDP Relative to Recession’s Trough Value (trough=100).^a

Source: U.S. Dept. of Commerce; ^a the recovery from the 2001 recession lasted six years

Figure 2.North Carolina’s Real GDP to Trough Value Relative to US Real GDP to Trough Value.

Source: U.S. Dept. of Commerce

Table 3. North Carolina and U.S. Real GDP Growth by Sector Ranked from High to Low Productivity, 2009-2015 (>> indicates significantly slower North Carolina Growth in High Productivity Sectors; > designates significantly faster North Carolina Growth in Low Productivity Sectors)

Source: U.S. Dept. of Commerce

Carolina’s economy, which has been on-going for several decades, is continuing.

Recent North Carolina economic growth has been characterized by two types of “unevenness.”   One is between workers, where those with more education and pay have done much better in the 21^st century economy than those without these characteristics. The recent labor market has been characterized by a “hallowing-out,” with slowest gains in middle-paying jobs. The second unevenness is between geographic regions of the state.   The state’s metropolitan counties, especially those around Charlotte and Raleigh, have raced ahead in the 21^st century, capitalizing on their college-educated workforce and new-age industries in technology, medicine, finance, and professional services. For many of the state’s small-town and rural counties, achieving economic growth is still a challenge.

These two types of unevenness did not abate in the state in 2016, with one exception.   Figure 3 shows the continuing trends of the fastest job growth in the higher and lower paying employment sectors, with the slowest growth in middle paying sectors. One “plus” for 2016 is that some job growth shifted from lower-paying to middle-paying sectors.   Figure 4 illustrates more rapid job growth in large and medium-sized metros especially compared to small metros. An exception in 2016 was the very strong job boost in non-metro (rural) areas – even greater than the job growth among large metros. This may mean that employers are motivated to extend their search for workers to rural counties as the economic recovery ages and unemployment rates approach low levels in large metropolitan regions.

As indicated in Table 2, the North Carolina economy is likely to expand in 2017 and – like the nation – at a slightly faster clip than in 2016.   One reason is faster population growth in the state compared to the nation.   U.S Census forecasts suggest North Carolina’s population will increase 30% faster than the nation’s population in 2017.

Of course, all the economic policies of the Trump Administration will have impacts on North Carolina, but two stand out. One is a possible increase in military spending. North Carolina is the home to the largest military base in the world, at Ft. Bragg, as well as several other major installations. If greater military spending results in significantly more military personnel, then North Carolina – and especially the Fayetteville area - could see a big boost in economic activity. However, if the added military spending is mainly allocated to equipment, then the economic impact in the state will be modest.

Figure 3.North Carolina Payroll Job Growth in High, Middle, and Low-Paying Sectors (annualized percentage change) ^a

Source: U.S. Dept. of Commerce; ^a high-paying sectors are financial services, information, and professional/business services; middle-paying sectors are manufacturing, government, construction, and education/health care; low-paying sectors are trade/transportation, leisure/hospitality, and other services 

Figure 4. North Carolina Payroll Job Growth in Large, Medium, and Small Metro Areas and in Non-Metro Areas (annualized percentage change) ^a

Source: U.S. Dept. of Commerce; ^a large metros are Charlotte, Durham-Chapel Hill, Greensboro, Raleigh, and Winston-Salem; medium metros include Asheville, Burlington, Fayetteville, Greenville, Hickory, and Wilmington; small metros are composed of Goldsboro, Jacksonville, New Bern, and Rocky Mount; and non-metros are counties not included in the large, medium, and small metro categories

            The other policy is energy exploration.   The Trump Administration is expected to push for an easing of regulations on accessing energy deposits in the nation, both on-shore and off-shore.   It is estimated the largest quantity of undersea oil deposits on the eastern seaboard are off the coast of North Carolina.   If these deposits were accessed and produced, I calculate the annual economic activity could generate $1.9 billion of income and 17,000 permanent jobs.[2]   Balanced against these potential benefits would have to be a consideration of potential costs to the environment and existing coastal industries (mainly tourism and fishing).

            Like other states, North Carolina will be affected by the expected debate about new international trade policies in 2017.   In 2015, 16% of the North Carolina economy was directly related to international trade ($81 billion of export and import activity combined from a total economy of $495 billion). If a “trade war” occurred that significantly reduced the state’s exports, then the state’s leading export sectors – including advanced manufacturing, agriculture, auto parts, and technology- could be adversely affected.

Once again, large and medium-sized metro areas in North Carolina will have the lowest unemployment rates at the end of 2017 (Table 3). However, with the labor market expected to further tighten in 2017 and with an economic stimulus likely from the federal level, all regions should see improvement in the labor market, and the state should see 100,000 net new jobs generated.

Table 3.   Regional Unemployment Rate Forecasts, % (not seasonally-adjusted)

Source: U.S. Dept. of Commerce; author’s forecasts

A Fascinating Year

            For the economy, 2017 should be a fascinating year, both nationally and in North Carolina. The Trump Administration is expected to be very active in recommending programs and policies to accelerate economic growth.   Although one party (Republican) will control both the Presidency and Congress, there will still be deliberations and debates about competing ideas and proposals.

North Carolina will again have divided government, with newly elected Governor Cooper, a Democrat, working with the Republican dominated General Assembly. This situation will likely lead to more strenuous debates over a wider range of items than has occurred in recent years.

            Still, both national and state policymakers, in their shared goal of improving the economy for more people, will be faced with forces beyond their control, including an aging society, a workforce requiring more cognitive skills, technologically-induced unemployment, faster growth in metropolitan regions, a world where economic competition is now global rather than local or national, and – as always – unexpected events (both positive and negative) that force forecasts and expectations to be tossed aside.

[1] The comparison to the 2001 recession is for the sixth year, the last year of that’s cycle’s recovery.

[2] Michael L. Walden, The Economic Potential from Developing North Carolina’s On-Shore and Off-shore Energy Resources, Dept. of Agricultural and Resource Economics, North Carolina State University, April 2013. The report also shows the economic impacts of on-shore energy development in the state would be minor. In late December 2016, President Obama permanently banned energy exploration in large parts of the Atlantic coast; however the ban does not include ocean areas off the coast of North Carolina.