How long can San Diego’s economy defy the gravity pulls of the national and state economic black holes? Most publications on this subject are dominated by the thoughts of street economists, who by their very nature let the manic-depressive short-term swings in business finances distort their forecast. And I admit, this dark side view of the economy is not without merit.

Seven Worries

• Holiday hangover: Much of the growth of the nation’s gross domestic product (4 percent) displayed during the third quarter of 2002 was a buildup in inventories. That is why we saw such early holiday discounting at retail outlets. Expect the inventory buildup to cut fourth-quarter GDP growth in half, and carry over to the first two quarters of 2003.
  
  
• War fears: Saber rattling affects the psychology and confidence of decision making, keeping new consumer purchases and business investment in check. Locally, any deployment of military personal stationed in San Diego will be an additional drag on the local economy.
  
  
• Housing fatigue: The national housing market is expected to slow, following the nation’s general trend in the economy and employment. Nationwide, the average price of a new home is 5 percent below its December 2001 peak. But housing markets are regional, and San Diego’s market is expected to remain strong.
  
  
• Jobless recovery: Jobs are what make our economy tick; the nation’s unemployment rate has risen to 6 percent, key leading employment sectors are weak and declining, as are the total hours worked. On the other hand, San Diego continues its record job growth and a low unemployment rate.
  
  
• State fiscal crisis: California’s budget deficit is larger than most all other states’ budgets. Recent reports put the deficit in excess of $34 billion, a 60 percent increase over previous estimates ($21 billion). It is no longer just the private sector that has a credibility problem.
  
  
• Running out of “ReFi” cash: Mortgage refinancing has been one source of consumer expenditures that has kept the national economy afloat. Mortgage rates would need to be lowered below the current low rates to maintain this source of cash.
  
  
• No “net” policy help: Any policy help Californians receive from the federal government (i.e. tax cuts) will likely be more than offset by state actions (i.e. tax hikes).

Make Your Stand

The nation and state seem one bad number away from declaring a double dip recession, especially if the number is a significant decline in jobs and a rise in the unemployment rate.

The condition of the tenuous national economic recovery can be described as a relay race, with sectors taking turns moving the economy forward. With the consumer sector looking winded, will business investment step up to take the baton?

The capabilities of business investment are clearer if the sector is divided into two parts: equipment and buildings. Good reasons exist to believe that equipment spending may be poised for a rebound. Because of rapid innovation, tech capital has an average life span of three years. The capital improvements to prepare for Y2K should now begin to be viewed as obsolete. Falling technology equipment prices should help this trend.

While equipment spending may be poised to rebound, the investment in buildings nationally seems to be headed in the opposite direction with farther to fall. Overbuilding and a sharp drop in demand for space have caused a very rapid increase in vacancy rates. And the construction cycle is much longer than the equipment cycle because buildings do not become obsolete for many decades and because buildings planned for the boom times are still in the process of being completed. A recovery in building construction will occur after the national economy begins to pick up and new jobs are created.

Policy actions are important to ending recessions and kick starting economies. The Federal Reserve has cut short-term interest rates 12 times since January 2001; the federal funds rate now stands at 1.25 percent, a 40-year low. Also, disposable incomes are benefiting from the tax cut in January 2002. But most national economic indicators point to continued economic weakness. With the Fed’s policy status designated as neutral, did the Fed declare victory prematurely after its most recent reduction in the federal funds rate? Yes, expect another rate reduction of 25 basis points during the first quarter of 2003. What other policies are available?

Higher deficit spending is a possible policy alternative. The Republican victory in the national elections suggests that the trend toward higher deficits will continue. While the administration talks about controlling spending, it has been aggressive in pursuing both tax cuts and defense related spending. After a $159 billion deficit last year, the 2003 deficit will likely climb to more than $200 billion.

Maybe Win One, Lose One

Predicting the outcome of the Iraqi crisis may be the most difficult issue of 2003. The administration continues to prepare for war, maybe during the first quarter of the new year. President Bush seems determined to eliminate the Iraqi threat and achieve a regime change.

The preparation for war is another drag on the already slow-footed U.S. economic recovery. The most obvious impact is high oil prices, recently near $30 per barrel. Models of the national economy suggest that a $10 hike in oil prices subtracts about 0.4 percentage points from GDP growth. GDP growth is expected to be between 1 percent and 2 percent during the fourth quarter of 2002 and first quarter of 2003. It would not take much to push GDP growth into negative territory. This could be the major trade-off for 2003, a double-dip recession in exchange for achieving the administration’s goals in Iraq.

Stock Market Salvation?

The stock market is expected to play an increasingly important role in helping determine the direction of the economy. Stock market participation swelled during the 1990s to more than 50 percent of U.S. households. Although participation is high and expanding, stock market assets are still heavily concentrated among the wealthy. In 2000 more than 80 percent of aggregate household equity market wealth (nearly $14 trillion) was owned by the top 20 percent of wage earners. By comparison, the aggregate value of all homes in the nation, while still skewed, is much more evenly distributed — the uppermost income quintile owns slightly less than half of the value of the housing stock.

The sharp decline in equity prices has hit this wealthy segment of the population hard, erasing about $2 trillion in wealth. Despite their relatively small numbers, this class accounts for a disproportionately large share of aggregate net worth, income and, most importantly, consumption expenditures. Families in the top 20 percent of income account for almost half of consumer spending. As a result, any reduction in their spending would have a significant effect on overall consumer expenditures and GDP.

The other half of the population that does not own stocks looks at the stock market as a barometer of the overall health of the economy. They view movements in stock prices as predictors, or leading indicators of the future growth in their take-home pay. A poorly performing stock market is a sign that economic times are bad, and therefore the likelihood of getting a raise or keeping a job is diminished.

Thus, while stock exposure is still concentrated among the wealthy, the impact of the declining market affects the behavior of a broad range of households, making daily market moves as important as the daily economic statistics. Makes one wonder about the rationale behind statements designed to pop the stock market bubble.

Such A Fine Sight To See

What about San Diego? Why is our economy succeeding while others falter?

Our region generated more than 20,000 industry jobs during 2002 and our unemployment rate hovered near 4 percent for most of the year. Construction in general and home prices specifically continued to rise, suggesting additional strength. Locally, we added more than 2,000 construction jobs and the median price of a single family unit is now more than $300,000. There are other signs, such as the redevelopment going on in downtowns, such as San Diego, El Cajon and Santee, and our expanding universities, with new buildings being constructed to accommodate a growing number of students.

We remain relatively more prosperous than many other regions because our economy is competitive and diversified. The driving forces behind our economy’s success are 15 export oriented employment clusters. These employment clusters produce a diversity of goods and services that can be sold outside of the local market and that can bring new money into the region. Export clusters are the region’s economic drivers because their markets are not limited by the size of the local economy and they can expand far beyond it. These export clusters include businesses from both the traditional and “modern” economy as well as both large and small companies.

The stellar performance of some of these export clusters since 1995 has helped our economy weather the current downturn better than many other areas in the nation. The diversity of our clusters has provided economic stability. When one cluster is struggling, another has been able to prosper, reducing the strain on the local economy. Recently, our telecommunications cluster has been faltering, with job losses in each of the past three years and more job losses forecast for 2003. At the same time, however, new jobs have been created in other clusters, such as services in software and computers, business, medical and tourism, more than offsetting the declines in the telecommunications cluster.

As the corresponding table shows, 2003 is expected to bring slower growth than we have been experiencing since 1995. We expect our economy to produce about 12,000 jobs during 2003, compared to 22,000 during 2002, a decline of 45 percent. Nearly half the decline in growth is because of the state’s fiscal problems. In recent years the state has been a consistent and significant contributor to job growth. We expect this trend to be at least curtailed if not reversed, with the state shedding jobs during 2003. The impact of the state’s fiscal problems will likely be a rise in our unemployment rate, topping out at 5 percent and averaging 4.5 percent for this year.

San Diego’s economy will be skating on thin ice during the first half of 2003, clearly deserving a yellow alert with a note to all to watch out for soft patches in the ice.

Marney Cox is the chief economist and director of regional economic planning and research for the San Diego Association of Governments.