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 Forget the underemployed hotel desk clerk on Shelter Island for a moment. The question of whether the United States economy would escape a recession was settled when the National Bureau of Economic Research, the official arbiter and dater of recessions, announced the recession started last March. Will the national downturn push our local economy into a recession? To answer that, we need to look at the causes of the national recession. Before Sept. 11, most people identified declines in manufacturing output and business investment as initiators of the economic downturn. Ugly Face Of The Recession The weakest sector of the economy is manufacturing. The first to turn, it slipped into recession during the fall of 2000. Most economists use the National Association of Purchasing Managers index as an indicator of manufacturing health. This index fell from a high of about 57 in the fall of 2000 to a low of 40 in October 2001, a decline of 43 percent over the year. Nationally, manufacturing employment has declined 5 percent during 2001. Locally, however, manufacturing employment has declined by 2.3 percent, about half as much as the nation. Locally, manufacturing jobs make up about 9 percent of total jobs, whereas nationally they account for 14 percent of the total. San Diego is not a major manufacturing region and was therefore buffered from this sector’s worst recession in the past two decades. Nationally, manufacturing remains mired in a recession. Orders for durable goods, for example, still are sliding. Excess capacity is killing manufacturing profits and in turn investment spending. Manufacturing is shot through with global excess capacity. In the United States, retail and telecommunications are overbuilt — remember all of the dot-com and Internet venture capital investment between 1996 and 2000? The leisure and airline industries, which were on the verge of over capacity, have been pushed over the edge by nervous conventioneers and vacationers. With no bright spot, the situation in manufacturing is likely to get worse before it gets better, but it is cyclical rather than permanent. So much for the “death of the business cycle” argument that arose during the 1990s. The business cycle is very much alive, so much so that it is leading the national economy into a recession. Declining business investments are a co-leader in this current recession. Orders for capital goods and anything related to computers are still showing double-digit, year-over-year declines. Spending on computers and related products may not regain its previous high until 2006. Businesses need to see increasing sales and profits before they step up spending on new equipment and buildings. And, with nearly 80 percent of business investment spending for replacement, some spending likely will be delayed. The rise and fall in the availability of venture capital also has played a role in the recession. The availability of venture capital nationally doubled between 1995 and 1996, increasing to $11.6 billion from $5.8 billion in one year. The rapid growth continued through 2000, rising to more than $102 billion, nearly an 18-fold increase in five years. Venture capital availability also improved in San Diego, rising to $2.2 billion in 2000 from $235 million in 1995, a nine-fold increase in five years. Despite the rapid rise locally, it is only about half the national rate of increase. The benefit to San Diego of not participating at a level higher than the national average is only now apparent. We are not participating in the precipitous declines associated with the unsustainable levels of economic activity. These setbacks were generated by the expenditure of venture capital investment funds, especially the implosion impacting Internet and other dot-com companies. Unlike the recession of the early 1990s that was concentrated in Southern California and devastated the defense and aerospace industries, this recession is concentrated in Northern California and has had a devastating impact on high-technology companies. After Sept. 11 By undermining consumer confidence, the attacks of Sept. 11 hit directly one of the two remaining main pillars of support. Consumer spending represents about two-thirds of overall demand for goods and services. Consumers and government kept the national and local economy from sinking in the first quarter of 2001, but consumers have been withdrawing their support ever since, and were expected to continue to withdraw during the fourth quarter, leaving only government to prop up demand. More on this later. One of the clearest monthly measures of our economic performance is employment, and for the nation the news is grim. During October and November, employment fell by more than 1 million jobs and the unemployment rate jumped from 4.9 percent to 5.7 percent. Changes of this magnitude have not occurred in more than 15 years. A majority of these job losses are concentrated in the travel and visitor related industries. Locally, our employment and unemployment numbers do not reflect the same impacts. Total employment has increased since Sept. 11, rising 3,300 jobs, and our unemployment rate has increased to only 3.6 percent from 3.5 percent, hardly the type of numbers that would characterize a recession. Only the airline industry has recorded substantial declines in employment since September, falling 18 percent. But the numbers are somewhat misleading. Some of San Diego County’s statistical strength can be explained by a cutback in work hours for employees in the impacted industries. Reducing hours keeps the employee from being counted as unemployed. Also, many of the employees in the travel and visitor related industries are Mexican citizens working in San Diego. Laying off Mexican citizens would not register in San Diego’s unemployment rate. Time Heals All Wounds? Some view the early dating of the national recession as good news. Their logic is that the average recession since World War II lasted 11 months: it is now some 10 months after the peak, so there are probably only one or two months to go. Unfortunately, there is nothing magic about this 11-month rule. Recessions are not healed by time but by policy actions and the playing out of negative cycles in inventories and confidence. Inventories and business investment have been cut dramatically, and both monetary and some fiscal policies are expected to continue to be quite stimulative. But other business sector cycles are not so advanced. The normal downturn in housing and autos has yet to materialize, and consumer confidence appears to be slipping. Don’t look for an immediate economic turnaround after the first of the year; the shape of this downturn may be more like a “U” than a “V.” Did Santa Bring Recession’s End? Policy actions are important to ending recessions. The Federal Reserve has cut short-term interest rates 11 times since January 2001; the federal funds rate now stands at 1.75 percent. The federal government has sent tax rebate checks to us and has enacted emergency spending programs after the Sept. 11 attacks. Additional wish lists submitted to Washington from special interest groups are not encouraging, pushing for favorite spending programs, tax breaks or subsidies. Some of Santa’s helpers—call them Keynesian elves—argue that during periods of low demand, increases in government spending or tax cuts can revive demand, putting unemployed resources back to work. This is based on the idea that as the private sector increases its precautionary savings, pulling money out of the economy, the government can offset the lost demand by lowering its own saving; that is, spending the surplus or deficit spending. Other helpers—call them supply side elves—argue that tax policy affects the economy primarily by altering incentives to work and take entrepreneurial risks. The idea is lower marginal tax means workers keep a larger portion of the last dollar earned. The larger portion increases the incentive to work, and to pursue endeavors that are riskier, but may offer a higher return. Because the elves could not agree on the wrapping paper, no additional stimulus package was delivered before the holidays and a new year began with legislative uncertainty. I did not let this stalemate deter me from thinking about what may be best for the American economy. In my letter to Santa, I recommended mixing some demand and supply policies together. First, spending on security infrastructure makes sense, because it injects money into the economy and addresses fragile consumer confidence. This includes additional resources for our border area communities. Second, a temporary investment tax credit would help, because it would encourage investment now, before the credit runs out and would provide a nudge to one of the sources affecting productivity and standard of living. Last, a stocking stuffer like accelerating the already enacted cut in the 28 percent tax rate to 25 percent, because it would make Santa very popular without much harm to the long-run budget deficit. No Recession Locally, But… The local economy’s rate of growth cooled significantly during 2001. Employment growth, for example, is on a pace that is about half of what occurred during 2000. This slower pace will create about 23,000 jobs during 2001.
This cooling trend is expected to continue into 2002, limiting employment growth to 19,000 jobs. The slower pace reflects:
The Sun Will Come Out Tomorrow At the forefront of the San Diego economy’s turnaround are export-oriented employment clusters. These industries hold the key to both holding off the recession and also much of our future prosperity. All employment categories contribute to the region’s output of goods and services. However, it is important to distinguish between those sectors that primarily serve the local economy and those that sell their products and services nationally or internationally. Employment clusters that compete nationally and internationally have a far greater potential for growth. Opportunities for growth in these clusters are not constrained by the size of the local market, and can expand far beyond it. As the corresponding table shows, export clusters grew slower last year than total employment, a clear indication of a weak regional economy. Although the 2002 growth rate for total employment is expected to be lower than 2001, I expect the growth rate for export clusters to outpace total employment. That’s because those interest rate cuts are finally going to take hold and investment will pick up. Also, although it appears a federal stimulus package won’t be available, many other post-Sept. 11 programs already approved by Congress are taking effect, and those that favor defense should be especially beneficial to San Diego. Combined, this will set the stage for prosperous economic growth that should begin during the second half of 2002. So, know that all of your glasses were at least half full as you toasted this new year. Marney Cox is the chief economist and director of regional economic planning and research for the San Diego Association of Governments.
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