In the fourth quarter, Southern California economists came out with bullish forecasts for the U.S. economy in 2001and predicted Orange County and the rest of the Golden State yet again would outpace the nation.
Since then, the U.S. economy has done an about-face that’s taken many by surprise. Five months later, local economists have tempered their views for the year.
“So much has changed since we came up with the forecast in October of 2000,” said Anil Puri, dean of business school at California State University, Fullerton, at a recent economists roundtable held by the Business Journal. “The slowdown is more severe than we had anticipated.”
Economists now are projecting slower-than-expected California job growth, softness in housing and lower growth in the state economy. Puri and others agreed that the national economy has come to a grinding halt, rather than the gradual slowdown predicted a few months back. Still, they are sticking to projections of local growth this year.
With a declining stock market, weak corporate earnings, layoffs and low consumer confidence, economists say there is a 40% chance that the U.S. economy may hit a recession this year. The Business Journal’s Rajiv Vyas and executive editor Rick Reiff discussed the economy and related issues with Puri and other local economists, including: Tom Lieser, senior economist at the University of California, Los Angeles; Rajeev Dhawan, the former director of econometric forecasting at UCLA who recently left to join Georgia State University; Lisa Grobar, director of the economic forecast project California State University, Long Beach; Gurd-Ulf Krueger, vice president of market research at Irvine-based real estate investment adviser Institutional Housing Partners; and real estate consultant Kenneth W. Agid of Newport Beach-based The Marketing Department.
I don’t know if you all plead guilty to this, but certainly the consensus late last year was that we were going to see continued growth in the U.S. and in California. In the light of what’s happening now, are you reconsidering your outlooks?
Puri: We predicted in October that the first half of 2001 will be slow, and that we will see a recovery in the second half. The numbers that we have seen so far through January,they verify or validate the general picture. The slowdown is more severe than we had anticipated. It came quicker. It hit us in November and December, rather than January, February and March.
Lieser: Our forecast was done in early December. The national economy is evolving the way we had expected. Nobody had foreseen how strongly and quickly the Federal Reserve would react to the slowdown, and that may shape the remainder of the year. So 2001 will be a little different than what we had supposed. We had expected the economy would gradually weaken through the middle of the year and the second and the third quarter would be modestly negative. Now many forecasters are saying that the economy could turn around by the second or the third quarter.
Dhawan: I have become more pessimistic, because five months ago things weren’t too bad. The economy has unexpectedly gone into a tailspin, which has been because of rising energy prices, the collapse of the dot-coms and falling consumer confidence.
So are we in the start of a recession, a slowdown, a hard landing or what?
Puri: If you stick with the technical recession definition of two quarters of negative GDP, we are still in a slowdown,perhaps a harder landing than we had anticipated, but certainly a slowdown. I think that we are going to see the slowdown persisting throughout the year.
So you’re not ready to say “oops” yet?
Dhawan: Not yet. Five months back, I was projecting a growth rate of 3% for the U.S. economy and right now we are forecasting a growth rate of 2%.
Puri: I think this quarter will be the determining quarter as to how deep and how long this slowdown is going to be.
Krueger: There is an interesting dichotomy emerging. We have seen a decline in investment spending in the most recent quarter. At the same time consumers still are spending. Everyone was looking for a sign of sharply dropping consumer confidence, which indeed occurred. But if you look at the numbers themselves, they still are relatively high. Spirits may be depressed, but the urge to splurge is strong. If consumers hold up, we will not have a sharp recession. It will be short and shallow, just as UCLA predicted, if there is one.
Lieser: One thing that concerns me is the turnaround in the equities market. Now there is a good chance that (a rebound) won’t happen at all this year. That could tend to put brakes on a recovery. So we could see a prolonged period of weakness but not particularly a deep cycle.
Have the recent earnings disappointments and layoffs caught you guys by surprise?
Lieser: We have been predicting a fairly poor outcome of earnings, so that was expected. But the stock market has not reacted to it well. There still is some level of optimism about the equities market, which I don’t see based on the realities of earnings. I would expect negative earnings to persist for a while.
Dhawan: That was expected. The dot-com companies never had earnings. So it’s just coming home to roost. The dot-com layoffs were expected. And, in fact, California has weathered this dot-com collapse well.
Grobar: We are downgrading our Cal State Long Beach forecast for the region, but only slightly. One point I want to make is that this region is going to slow less than the nation. That is going to put us on a relatively stronger footing. Our forecast calls for the nation to have two weak quarters of growth, starting with the first quarter. Of course, the fourth quarter also was weak, which puts us really close to recession. But we are not calling for recession as our baseline.
What about job growth?
Grobar: The nation is going to be generating jobs. Our benchmark, as far as measuring the regional economy, is to just look at job growth. Of course, it is closely related to GDP. But our basic perspective is that we think the U.S. economy is going to slow a lot. It is going to be kind of a bumpy landing. But we should narrowly avoid a recession. We’re now looking in the area of 2%, or slightly less than 2% (job growth) for the region. Our prior forecast for job growth was 2.4%.
Are any of you thinking we are in the start of a recession now, and not just a slowdown?
Grobar: To use an analogy, it’s almost as if the U.S. economy is a car speeding at 100 mph and someone slammed on the brakes. Now we are going at about 40 mph. It feels really slow, but we’re all moving forward.
Dhawan: A few months back we thought we were going to come down from 100 mph to 60 mph. Now we expect it to be 40 mph.
Agid: It’s a self-fulfilling prophecy. As the media and the economic forecasters state their positions on growth, relative to where it has been, we tend to fuel the negative fires. And the scary thing in all of this is consumer confidence.
Puri: There are things on the horizon that make it a lot worse than what it appears to be right now. The dollar exchange value is one issue. The Asian economy is slowing down. There is trouble in Europe. And the dollar falls when foreign investors lose confidence. The U.S. economy will continue to slow down more than what we see right now. There is some chance, not very high, of this turning into a much longer, deeper recession or slowdown, not only for us.
How would you define much deeper or much longer?
Puri: If for the year, on the whole, we have less than 2% growth, that’s very slow growth. Also, we don’t know what would reverse this investment slowdown that is taking place. And there still are doubts as to what kind of productivity growth this (investment) led to,whether it really lead to huge productivity increase or not. If you were to take the other side, if you want to take a pessimistic view, you can do that.
It sounded like you were doing that.
Puri: No, I am not doing that. I am still wondering about this lost investment in high tech. How deep is this going to be? In Orange County, most of the tech companies provide equipment and hardware, unlike Northern California. And if the investment slowdown continues, we are going to get hit. We may get hit more than the rest of the country or nation because our tech is concentrated.
Grobar: In many ways, this is shaping up to be a standard contractionary cycle. The auto industry is another area where you can see some real slowdown.
Puri: Auto, I think, is in serious trouble. Domestic auto producers can’t compete with the foreigners. There’s too many SUVs on the road. Auto sales have been a phenomenon. Seventeen million units or so? I think that for the next year or two, people can just sit back and drive their vehicles for another year. What’s the big deal? Just like computers,people don’t need the latest PC every year.
What is the probability we will be in a recession as classically defined?
Grobar: 40%
Krueger: I will agree with you. Forty percent is in the cards. The thing that will tip it over is if the consumer gets really cranky.
Puri: I could say close to 30%, with interest rates coming down and a tax cut likely. But on the other hand, we do not know for sure yet. There are reasons to believe that we could avoid two consecutive quarters of negative growth. I would be surprised if this quarter turns out to be a negative growth.
Lieser: For the national economy, it is better than fifty-fifty. Majority still is on the side of recession. In California, I will still say it is less likely. It is because we started this downturn at such a strong pace. We grew last year at twice the national rate.
Dhawan: There is always a chance of a recession. But there is a very low probability. I would say the probability is about 25%.
Agid: I don’t sense the same degree of downside risk in the California economy as perhaps exists nationally. I would rather classify this as a more classic correction than necessarily an out-and-out recession. The wild card is the consumer.
Grobar: A recession, if it occurs at all will be relatively mild by historical standards.
Why?
Grobar: Manufacturing has not been a major driver of growth in this region for a couple of years. We’re also diversified internationally in a couple of ways, which really helps us. We know California is more export-oriented than the other states. Also, our tourism industry, which is really important to Orange County, is export-oriented in that we sell hotel rooms to people around the world. And the advantage of having that orientation is almost like having a diversified portfolio.
For the past three years, consumers in the U.S. have been spending more than their disposable income. Now, with the correction in the stock market, how long will consumers keep spending more than their income?
Agid: What I’m hearing locally and anecdotally is there still are people out there buying houses. There is definitely going to be a shift away from pure discretionary spending to needs-based spending. There is a phenomenal number of young, moderately affluent consumers who are under-housed compared to their desires. There are a number of them that are waiting for an opportunity to step out to purchase a home.
How about the argument, in terms of Orange County, in which prices could stay up because there is a disconnect between supply and demand. Is there something to that?
Dhawan: The biggest problem with California is housing. No wonder the home prices in California are out of sync. They have not built.
Agid: Historically there is a classic lag factor in housing. The housing market tends to continue relatively strongly for as much as a year and a half. We were still strong in 1990 and 1991. So I think that we are still having the after-effect of a dramatic under-supply of adequate housing in California.
Puri: Regarding housing, I think it is an anomaly this year. Technically in the business cycle, housing goes down first before anything else. And we saw some evidence of that in the middle of last year when the economy started to slow.
Let’s turn to technology. Unexpected layoffs by Toshiba, Gateway. Broadcom and others see slower growth than expected. How does this affect Orange County and Southern California?
Puri: I have not seen major job cuts in Orange County or Southern California yet. But if this slowdown in national tech investment continues beyond what we know right now, there is no question that it would happen soon.
Is anyone thinking that California will have negative growth in the technology segment?
Agid: I’m reacting to the friends and contacts that I have in the computer industry. Six months ago, we were still lamenting that we could not find anyone to take a job, that we had all these job openings. And they had to offer all kinds of ridiculous relocations, benefits and bonuses, and there was a bounty being put out in all these companies for new employees. And what we are experiencing now is that the economy has turned so sharply, that there is no growth in the technology industry or there is a significant slowing from a level of growth that was again, unsustainable.
Krueger: One of the things that you watch is venture funding slipping in OC. What happens in that situation is that it prevents the current companies from getting funded.
What about dot-com layoffs in Northern California?
Krueger: Orange County is well positioned to steal some people from Silicon Valley. It feels pretty close to what the people in Silicon Valley have: nice suburban environment, low crime. There are things that are missing. Orange County needs to have some kind of similar rebellious spirit that you might see in places like Los Angeles, where the young enterprenuers just go ahead and do things.
Puri: Let’s look at the record here. Let’s compare ourselves to San Diego or Silicon Valley. Orange County can and should do better in terms of start-ups. The University of California, Irvine, is a great university. And it’s starting to take stuff finally that will hopefully lead in the future to a greater increase in new ideas and innovations. Look at venture capital firms. There are hardly any that are located in Orange County. There are one or two that you can name, but nowhere close to what Silicon Valley has, or even San Diego with biotechnology.
Krueger: The development in Orange County has been until recently over-determined by real estate. It’s starting to change, and it has to change. So it’s not going to be enough just to create a nice suburban environment. Eventually, all of this will be done and you will have to focus on the same thing that everyone else is doing. You have to focus on the cultural, infrastructure innovations that will guarantee that this will become or continue to be a very dynamic place.
Agid: What’s interesting is that Orange County has grown out and now needs to grow up. I don’t mean that just in the physical forms. More esoterically, we are going through a period of reaching our urban limits and growing out. We are probably within a decade of using up the buildable, readily available land. And the next stage of maturation in Orange County is how do we deal with this next trend?
Puri: The higher housing prices really reflect on what people get here for their money. The problem is, when prices increase too fast in a short period, it prices people out. Affordable housing is an important issue for the county. We have been growing at a much faster rate than our population for several years now. And that is the reason why we are so much better off economically. Because we import labor from the Inland Empire. We will continue to have to do that if we want to continue our rate of growth. Transportation becomes a critical issue for our continued economic growth.
We have on a list the issues facing us, transportation, affordable housing. I think the two are inter-related. What are some of Orange County’s challenges going to be?
Agid: To go back and look at Los Angeles. Los Angeles grew and continued to have this expansion. It’s now run out of the ability to depend on Orange County, Ventura County, San Bernardino County to pick up the need for housing and places for people to live. I think Orange County is in the early stages of dealing with the same issues. No one is talking about demographics. There is a major shift occurring in the demographics of California that Orange County is not immune to. It is something that is going to affect the way Orange County matures in the next 10 years. But by about 2010, we start to lose the boomers and their spending. What happens after that?
Lieser: We have been saying this for several years: We have a looming problem of housing supply. In the short run, it is not going to be a big consideration. The middle class has experienced a decline in affordability, which is going to make it harder for employers to locate here. This is just a limitation on how much growth we can achieve. The poster child for this would be the Bay area, which could be at some point at risk of a downturn in home prices. We are at a period now where housing has become a problem for growth and combined with concerns about electricity, we have got some problems.
Grobar: As the population ages, different types of housing will be demanded, favoring more urban high-density.
The public consensus now seems to be against developing the coast, more roads and an airport. That also extends to high-density housing. Yet all these demands are there. How will it play out?
Puri: I don’t see low-cost, high-density being built in Orange County. Maybe some city in the north of the county may permit that. I can’t see any of the coastal cities ever permitting extremely high-density housing. If you go inland, I don’t think that there will be any sentiment toward that, unless the economy is really hurting.
Krueger: It’s a bit like a Greek tragedy. The audience knows exactly the outcome. That is how I feel about the housing situation here in California. Everyone knows that eventually this will become a problem, but we don’t want it, and nothing will happen. There is an error in that thinking in the sense that if you don’t build it, they won’t come. They come anyway. They have come, and they will continue to come.
Simplistically then, what is the ramification of that? Just a higher cost of living?
Agid: It’s the Darwinian survival of the riches. There is no visionary leadership in Orange County right now saying, “Let’s get realistic and talk about Orange County’s needs.”
The higher cost of living will at some point curve the growth as businesses and individuals go elsewhere. But what about traffic?
Puri: One thing that the county is trying to do is move people around within the county. Ten years from now, if we don’t do something, whether it’s urban rail or buses, people who can afford to live here will not be able to drive. And just because they want to live here, they have to find a way to use urban transit. We have to find people to go to Disneyland to work, to go south, and to move up north, either way. And that seems obvious as something that we have to do within the next five to seven years.
I would like you to address the issue of moving people in Orange County and then in a broader regional context.
Puri: Urban transportation, especially rail, has never proven to be self-sufficient, even in highly congested urban areas. It has to be subsidized. So we just have to accept that. If we want rail here, we are just going to have to subsidize it. But is it worth it? Would people who want to drive their own car be willing to pay for other people who want to ride the bus or train? To be honest, I don’t see any way around it.
Agid: You are not going to like this but one of the best things that can happen to Orange County is if the price for gasoline goes up to international levels. The mayor of one Brazilian city said that there is no commuting. You have to use the buses. The arterial highway coming to town can only be used for public transportation. And he made it work.
Puri: That is an intriguing idea. People who are for an El Toro commercial airport, why aren’t they in favor or urban rail or some mass transportation system? If you want the airport to be a success and not impose a huge cost on everyone else, whether they fly out of there or not, I think one should have urban mass transit systems to move people in and out of the airport.
Ten years from now will Orange County have a significant light rail system?
Agid: I’m a pessimist politically that you can ever get one.
Puri: I think that there will be one, but I don’t know how big it will be.
Krueger: I’m not sure. I think there will be more freeways.
Let’s turn to El Toro. There’s talk now of an airport at Camp Pendleton and the need for increased air capacity. How important of an issue is it, and where do you see it heading?
Puri: It’s very important. Air traffic will continue to grow. You just need to have a big airport somewhere, whether Camp Pendelton or somewhere else.
Grobar: It is another element contributing to regional competitiveness, or lack there of.
Agid: If the economy is going to grow, that growth is based on exporting our expertise to other countries. I think that with continued growth in our airport system,as well as our education system,you’re talking about the basic foundation of growth.
What is the likelihood that this demand will be addressed in the region?
Agid: It has to happen, but it’s the question of how it’s going to happen. El Toro shows how strong and polarized the county is. There is going to be an irrational resistance to it being an airport in the south.
Krueger: I think that there is some resistance by the airline industry to stay within the confines of what has already been established. In the case of any airport within 50, 60 miles of Anaheim, you will clearly have the situation of the field of dreams. If you built it, they will come.
Agid: The problem is getting to an airport and away from it. I look at my neighbors who oppose the airport at El Toro. Their lifestyles, or the quality of their lives, would probably benefit from having an airport there. They are just opposed to it because of their irrational fear of the impact on our transportation network and their ability to get around. I think it would be good for high-end jobs. It would ultimately be easier for them to get in and out. In my mind, I believe in having another airport at El Toro, or reuse of that airport, and not a shameful waste of turning it into a park. That would be criminal to supporting the continued growth and health of Orange County.
Puri: The decision for El Toro is probably one of the most crucial decisions for this county. Having an airport or not having one is going to define the quality of life to a significant degree. It is going to have an impact on transportation, it is going to have impact on housing, and it is going to have impact on what kind of industry we have, or don’t have.
In short, what is the probability of an El Toro commercial airport?
Krueger: I think that it’s not very high.
Agid: As a cynic, I agree with you.
Puri: Fifty-fifty.
Krueger: There are places that want an airport. Ontario wants an airport, and so does Palmdale. Let them build an airport where people want them. At least you have something instead of fighting that will be dragged on for decades.
How serious do you think the state’s energy crisis is? How do you see it playing out?
Lieser: The energy situation started in California and has had some differential regional impact. And it now seems to be finding its way into a national concern over energy policy. It is going to weaken the outlook for California somewhat. We could lose some job growth because of this in the short run. Certainly there is a lot of concern about the summer.
Krueger: It is quite serious. It has impacted some industries, manufacturing in particular. It is a short-term problem and a medium-term issue. The short-term issue is that there are going to be rolling blackouts. In the medium term,in the next three years,plants are going to be built. Technology has changed in the way that you can build electric plants in a one- to three-year horizon rather than five to 10 years. Over the longer horizon, I don’t think that there will be any future problems. The reason for that: oil prices over the longer haul look pretty good worldwide. The energy situation in general would appear to be pretty benign in the forecast of that.
Agid: I agree. I think that it may be more severe short-term and it comes at a bad time because we are more vulnerable to bad news. And the shame is this is a by-product of the failure to look ahead. Everyone said, “No big deal, we have plenty of capacity.” We did. We had about 20 years of capacity. Then we ran out of it. Now we need to address it again. The shame is that the crisis had to happen in the first place.
Puri: We looked ahead. The best brains in the state got together from both sides and deregulation got unanimous approval. California was the pioneer. We saw that huge nuclear, hydroelectric plants no longer will dominate the electric industry. The future of electricity is smaller plants, and deregulation is the way to go. If anything, we were too far ahead. We made the mistake of creating a system that did not work. And there are problems, technical problems more than anything else. I’m not so sure that California cannot get together politically when the need is there. Look at water. When the need is critical, we get together and we make decisions and use the resources and erase all the problems. Look at transportation. We have billions of dollars at the state level. It is a democracy.
Playing devil’s advocate, some might say this energy crisis is not a long-term problem. The issue will come down to whether ratepayers pay for it, or if taxpayers help out. But it winds up getting paid for. Energy will cost more, and so what?
Agid: But it diverts dollars, just as this crisis is diverting dollars. Let’s take the money that we are about to spend to solve this problem. Just take the billions of dollars that we’re talking about and put it against the education. Let’s build some new institutions. Those dollars that could go toward improving the quality of our life are being deflected into a meaningless exercise of paying for a failed system.
Will this be resolved so that the lights stay on or are we in for a summer of rolling blackouts? What will the impact be on business?
Puri: What percentage of total cost is electricity of any business?
Agid: It is next to nothing.
Puri: And is somebody going to move for that reason? Reliability is an important factor. Not the cost necessarily. I wouldn’t be surprised if over the summer we have some tight spots.
Krueger: The creative part of what is driving the California economy is not going to move out when the lights go out. What is going to get hurt is manufacturing. There are looming doubts about having manufacturing facilities.
Is the power crunch a long-term problem?
Agid: This is the first of a whole series of crises that California will deal with. While they all probably are solvable, it would be a good idea to solve them in advance. But we’ll come through it. n
