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Connecticut Economic Digest: January 2007 issue

Connecticut Economic Outlook for 2007
By Stanley McMillen, Ph.D., Managing Economist, DECD

The Big Picture

The Federal Reserve increased interest rates several times in the past year to dampen what it sees as increasing inflation. The fallout is predictable given historic, low interest rates of the past few years: attenuated residential construction and investment spending. As such, the housing market - nationally and locally - continues to undergo a correction that will reduce employment in the construction sector, reduce house prices as supplies catch up with demand, and reduce consumer spending as the wealth effect mitigates the extraction of cash from housing assets. The good news is that inflation and interest rates will not get out of hand in the foreseeable future. Low inflation, stable prices and interest rates are ingredients for economic growth.

The Nation

Moody's Economy.com national forecast sees the recent expansion dipping below potential GDP growth (the growth rate if the economy were at full employment) in 2007 and recovering to just about potential growth in 2008.

The Fed's current policy should have the desired effect with inflation moderating to about 2.4% by 2008 after experiencing a small spike to almost 3% in 2007.

This should be placed against the backdrop of robust corporate profits and broad-based, global growth (consequences include mitigating the housing wealth effect for high-income earners and increased tax receipts for the federal and state governments).

Threats to national and regional growth include additional monetary tightening if inflation does not quell, increased protectionism if the trade deficit does not moderate, and higher energy prices due to increased destabilization in the Middle East, Africa and South America. Large and growing federal deficits portend higher interest rates in the face of reduced domestic savings rates and the possible reluctance of foreigners to absorb additional U.S. debt.

Connecticut

Connecticut will experience slow job and population growth, as well as slower growth in median income and gross state product (compared with 2005), while average incomes will experience respectable gains in 2007. The first three growth issues are due to a variety of factors that have been exhibiting downward trends regionally and nationally for some time (excepting Connecticut's top income decile). However, current and foreseeable Fed monetary policy may lead to greater housing affordability in Connecticut as house prices attenuate relative to average income (not the median Connecticut income necessarily, which has experienced no real gains in several years).

The New England Economic Partnership (NEEP) forecasts that Connecticut's non-agricultural employment will grow from an estimated 1,673,000 in 2006 to 1,683,000 (+0.6%) in 2007.

The NEEP manufacturing employment forecast for Connecticut calls for a decline of 2,200 jobs from an estimated 192,900 in 2006 to 190,700 in 2007 (-1.14%). Moody's Economy.com estimates the changes in non-agricultural and manufacturing employment are almost identical to the NEEP forecast. NEEP predicts Connecticut's labor force will grow by 8,000 workers from an estimated 1,829,000 in 2006 to 1,837,000 next year (0.44%). The statewide unemployment rate will remain steady at 4.5% in 2007. The NEEP population estimate for 2006 is 3,531,000 while for 2007 it is 3,549,000, an increase of 18,000 people.

To augment the above outlooks, I simply forecast1 the Connecticut coincident and leading employment indicators that have appeared in this journal for several years (charts below). These indicators suggest current and potential levels of employment in Connecticut.

The latest down cycle had its peak in September 2000 and its trough in April 2003. Fifteen months of forecast (October 2006 through December 2007) appear to the right of the vertical line. The coincident employment indicator forecast suggests a flattening of the recent employment growth consistent with other forecasts for New England and Connecticut. The leading indicator forecast is more optimistic and shows continued growth consistent with recent trends. There is in fact disagreement about employment growth in the state, but my take is, absent significant public and private investment in education and infrastructure, Connecticut will experience lack-luster employment and median wage growth. 2

Why Slow Growth?

Connecticut's slow employment growth derives in part from continuing declines in manufacturing employment even while manufacturing productivity and output (value of shipments) continue to climb. This phenomenon is national in scope as the U.S. economy (and others) experience similar declines.

In addition, Connecticut's ingenuity produces manufacturing processes, once requiring high-skill labor, to become routinized and automated, therefore requiring less labor per unit of output and lower-skilled labor. Such processes are then moved to areas with lower labor costs such as the southern U.S. and Mexico and China.

Overall, payroll employment for Connecticut and the northeast lags the U.S. not because of layoffs and discharges, but because of comparatively soft hiring. More specifically, Connecticut does not offer the job (wage) growth potential of other areas of the U.S. As Connecticut firms downsize and outsource, as housing affordability lags and as urban amenities elsewhere sparkle in contrast to those in Connecticut, we lose working age population. New Jersey faces similar challenges.3 Thus, we see an exodus of 25 to 44 year olds and an influx of Hispanics and a higher birth rate among this group.

These two observations suggest a lower-skilled Connecticut workforce in the future and a greater willingness of Connecticut firms to expand or relocate elsewhere (Coelen and Berger, 2006).4

Beyond 2007

What is Connecticut's likely labor force composition in 2007 and beyond? Given that the workforce is our most valuable asset in that it is what firms consider first when pondering expansion or relocation, we look closer at this aspect of future growth. Professors Coelen and Berger make the case that:

1) "The out-migration of the region's white population in the 1990s and the in-migration of minority populations have played out differently in each state. For example, the white exodus from Massachusetts in the 1990s was more than matched by a minority influx. In fact, the state's minority population, comprising just 16.4% of the Commonwealth's total population, is responsible for an inflow of residents that was almost twice (193%) the size of the state's outflow of residents;"

2) "On the other hand, Connecticut's white exodus was so large that even a substantial minority influx was not enough to make migration a net positive force for population growth;"

3) "By 2020 more than a quarter of Massachusetts (28%) and Connecticut's (28%) working-age population will be composed of minority populations;"

4) "Connecticut and Massachusetts, the most developed states in the region, will suffer the largest losses of four-year degree holders. Among the young, the number of those that will hold a baccalaureate or degree will shrink by 3%. Connecticut's forecast call[s] for a decline from 34% in 1993 to 30.5% in 2020."

5) "Connecticut and Massachusetts suffer persistent out-migration of their mid-life and older working-age populations. In Connecticut, the loss of 40- to 64- year olds (between 1990 and 2000) was significant-an 85,000-person loss. The loss in this age group represents 3.92% of the state's working-age population."

Coelen and Berger and others5 argue that massive investment in education from preschool through university is necessary to create the workforce Connecticut (and this country) needs to compete in the global, high-tech economy.

Connecticut's near-term economic outlook is partly sunny, but there are storm clouds on the horizon five to ten years out unless we address the growing wage gap, housing affordability and our transportation infrastructure. Our workforce development strategy needs adjustment as well with focused investment in postsecondary and preschool education.6

1 Using Holt-Winters exponential smoothing with no seasonals.

2 Examples of investment/innovation initiatives are: Strengthening the Mid-Atlantic Region for Tomorrow (SMART) [www.smartstates.com], Connecticut Innovations (http://www.ctinnovations.com/about/about.php), and the Business Innovation Factory (BIF) [http://www.businessinnovationfactory.com]. For an assessment of Connecticut's position, see "Benchmarking Connecticut 2006: The Determinants of Economic Growth," http://www.cerc.com/benchmarks.html.

3 Hughes, J. and J. J. Seneca (2006). "New Jersey's New Economy Growth Challenges," Rutgers Regional Report, Edward J. Bloustein School of Planning and Public Policy, Issue Paper Number 25, July.

4 Coelen, S. and Joseph B. Berger (2006). "New England 2020, A Forecast of Educational Attainment and Its Implications for the Workforce of the New England States," www.nmefdn.org.

5 See "Benchmarking Growth In Demand-Driven Labor Markets - 2006," forthcoming, and the CT child care industry study at http://ccea.uconn.edu/studies/Child%20Care%20Report.pdf, and the 2006 CED study, "The Economic Promise of Investing in High-Quality Preschool," at http://www.ced.org/docs/report/report_prek_econpromise.pdf.

6 Christopher Mazzeo, et al. (2006). "Working Together: Aligning State Systems and Policies for Individual and Regional Prosperity," www.workforcestrategy.org.

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Last Updated: January 2, 2007