Previously published March 22, 2011 in the California Economic Forecast
I mentioned in the United States Highlights essay that the fourth quarter consumption growth rate of 4.1 percent, the strongest in five years, was a surprise given weak economic fundamentals. I also discussed the evidence of significant heterogeneity across U.S. regions. I would argue that California has these incongruities even more than the United States does.
California has places like Santa Barbara and Monterey, places where politicians on both sides of the aisle embrace strong “slow-growth” principles. Not far from Monterey, California has the Silicon Valley, the world’s premier location for information technology businesses. In addition, California also has places, eight counties, that have an unemployment rate greater than twenty percent. California has 27 counties where the unemployment rate is greater than fifteen percent. Bill discusses in his California essay that its DURT’y policies are effectively driving businesses and people away noting that net domestic migration has been negative for the last 20 years.
The weak fundamentals that exist for the United States exist for California but more acutely. They include: a high revolving-credit debt level as a share of income, a high mortgage-debt level as a share of income, a high residential default rate and foreclosure rate, a high banking charge-off rate, a high long-term unemployment rate, a high home ownership rate, a low construction activity rate, a low small-business profit rate, a significant structural imbalance in the labor market (too many construction workers), and a low job creation rate.
Many of the 27 counties with high unemployment rates mentioned above are suffering from the weak fundamentals more than the state as an average. In addition, some of the 27 counties are located some distance from large job centers. Some of the counties in the San Joaquin valley have been negatively impacted by not just state regulations, but federal regulations as well, where a large number of farms experienced water supply restrictions by federal order, and have discontinued operations.
In this context I present our forecast.
California’s year-on-year job creation rate has been lower than that for the United States for most of the last 48 months. In addition, California has a much higher unemployment rate than the United States.
California’s rate of construction activity has dropped to a very low level due to an over-supply of housing. Because real estate markets are still adjusting to a lower level of home demand, driven by the weak fundamentals described above, we forecast weak construction activity for at least the next two years. The residential chart is shown here, the commercial forecast has a very similar pattern.
The lack of participation of the housing market in the recovery is partly what makes the recovery so weak. A new home has what economists call a large “multiplier” effect on the economy. I am referring to an Input-Output multiplier. This is where production in one industry has impacts on other industries due to the demand for intermediate products and materials. These products and materials create demand in other industries adding to total economic activity.
A new home has large impacts on other industries both when it is being built and right after it is sold. While it is being built the inter-industry demand for intermediate products and materials (furnaces, windows, carpet, cabinets, etc) creates significant stimulus. When sold, the new inhabitants often embark on a spending campaign lasting many months, one that brings in the desired furnishings, furniture, appliances, etc. Many of the purchases are large in dollar volume.
Because California’s housing market is in worse shape than the United States’ housing market our forecast of California building activity and job creation is weaker than it is for the United States. With slower GDP and with more of a construction worker over-supply, California’s job market will be weaker than the U.S.’s.
California’s somewhat slower economic and job growth implies that the unemployment rate will not decrease very quickly.