Economic Forecast for 2012

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It looks as if the economic recovery is continuing, although at a slow pace. Arizona State University economists Robert Mittelstaedt and Dennis Hoffman and economist Elliott Pollack will take a look back at the 2011 economy and a look forward at the 2012 outlook.

Ted Simons: Tonight on "Horizon," the nation and the state slog through another tough economic year. Will things improve in 2012? Three local economists will look back at 2011 and look forward to the next year, that's next on "Horizon."

Ted Simons: Good evening, and welcome to "Horizon," I'm Ted Simons. The Federal Reserve announced it'll not take any action to stimulate the economy, citing job growth and increased consumer spending as signs of an improving economy. As for Arizona, more than 23,000 jobs were added in 2011, and it appears as if that growth will continue. Here with a year-end review of the economy and a look toward what we can expect in 2012 is Robert Mittelstaedt, dean of the Arizona State University W.P. Carey School of Business. Economist Elliott Pollack of Elliott D. Pollack and Company, and ASU economist Dennis Hoffman. Good to have you here, thanks for joining us. Let's get it started. One by one, the biggest economic story of this year.

Robert Mittelstaedt: Well, I'm tempted to say that it was Europe, but I think the biggest economic story of the year was the recovery that didn't happen, when you had so many economists predicting that we would come out of this fairly smoothly, especially the government. It was dishonest on the part of the the government I think to gloss over a lot of real evidence there that this was going to be a particularly extended recovery.

Ted Simons: The biggest story of the past year.

Elliot Pollack: I think two, one that the economy took a lot of rights to the jaw and kept on going. Two, the story was how bad the economy was. It's like a patient getting out of intensive care but he's on a walker, and we're just crawling our way out. Again, as the dean said, most people believed it would be stronger than it was.

Ted Simons: Dennis, biggest story of the past year.

Dennis Hoffman: You got me here with the two grinches. Debt, I would say, would be the biggest story. It plays out in Europe big-time and Europe is a huge issue, a big cloud of uncertainty I think for the U.S. economy and for the world economy. And of course in the states with the battle over the debt ceiling and some of the residual issues. The apparent inability or the obvious inability, I guess, and we have it proven to us now, the inability of Congress to really grapple with that issue.

Ted Simons: Okay. Let's get to some of the finer points here. Now I'd like to start with job growth and the idea that Arizona ranked around the seventh year over year. What's going on in Arizona, compared to the rest of the country? What's happening in America with job growth?

Robert Mittelstaedt: Well, I'll look at the national piece and let Dennis talk about the Arizona piece. Nationally, you know, we've seen job growth that has disappointed almost every month until recently. In fact, two years ago at one of our economic lunches Lee McPheeters said Arizona is not producing jobs but at least they are still producing jobs in health care and government. And at that time I said we should start cheering when government jobs decrease. That's what we saw this year. We finally began to see private sector jobs created toward the end of the year, and government jobs decreasing. Not by a lot and almost all the decreases have been state and local. The net has been that we've had very modest job growth in the last few months. The good news that is we're cutting down on government jobs, and that gets to the whole issue of what's the appropriate balance. But that's not good news overall because those people still become unemployed, as well.

Ted Simons: I think some eyebrows are raised when we hear "government jobs are cut, hooray."

Dennis Hoffman: Well, that's not my opinion, but the issue around government and government employment is really complex. I think really, Ted, what do we do with the Raytheon and a Boeing; is that a private sector job or a government job? They are private sector firms, but completely beholding to the Department of Defense. When I think of Arizona I think of our defense industry and about the dependence upon government. Now, look, government has to get smaller, I agree with Bob in that regard. Government has to get smaller over the longer term. But the private sector has gone through massive deleveraging over the last five years, clearly. Government has not, until very recently -- Well, arguably the federal government still has not begun. But at the state and local level, the dean is absolutely right, we've seen cuts, job reductions. So now it's government's turn to endure some of that deleveraging. You know, the private sector's going have to pick up this void that government filled for some time.

Ted Simons: What do you think?

Elliot Pollack: The private sector is going to pick up the void when there's demand to pick up the void and Washington comes up with consistent policy so they know what the hell is going on. This is crazy. The fact is, there is excess capacity so there's no need to add plant; when you use that up they will start to add plant, and that's when jobs will really take off. In terms of the issues, the issues are not just -- they need to, there's got to be demand and consistant policies from Washington. Right now with health care, with taxes, with regulation, the average businessman doesn't know what's going on. I have a small business, I have 14 employees, my health care costs went up 35% last year. A lot of these mandates are crossing business money and it is terribly inconsistent. If there were consistent policies and you got enough demand to use up the excess capacity, the economy would be better. But the big problem is deleveraging on the part of the consumer. The consumer's about halfway there. It's another two to three years before consumers get back to the way they were. That would coincide with housing prices starting to take off again. The combination of those things will put us on the right footing but there's no quick fix.

Ted Simons: I'm seeing a circle here. Business sits on cash, not going anything until they know what's going to be done. Some of the things that are going to be done are some regulation, maybe some taxation gets business nervous so they're not going to do anything which means no money goes into consumers' hands, no demand, and we're right back at the start again.

Elliot Pollack: Well, no Consumers are getting money in their hands but it's modest. They are using more of it to pay down debt and to save. The result is they are spending less than they otherwise would. That's part of the deleveraging process. They have too much debt and they have got to pay it down. This cycle will take few more years.

Robert Mittelstaedt: I think we forget there are some basic laws of economics that take place here. One of them is that part of the reason -- let's ignore the whole inappropriate behaviors relative to mortgages and everything else. If you go back to the history of bubbles, all the way back to the pepper bubble in the 1500s, 1600s, people get all excited about something, they go overboard. The economy crashes and lots of folks get wiped out and then you recover. As Elliott says, you don't recover instantly and the demand has to be there. In the process, everybody else becomes more conservative because they are afraid of the loss. A lot of companies are doing extremely well, but they have learned how to do it with less capital on the human capital side than in the past. Productivity has increased. That's the other aspect of economics we all forget. Competitively over time every business has to increase productivity. You can't do those things until somebody forces you to do it easily. Whether you're talking about the private sector or government, we have been in a situation where we've increased productivity massively over the last two decades. And all of a sudden we found out we could go even further when there was a crisis. That's a horrible problem for employment but it's real. And as Elliot says It's going take a while for it to straighten out.

Ted Simons: How do we get it to straighten out?

Dennis Hoffman: We do, I agree with Elliott that the primary driver is uncertainty. But I think he leaves out a lot of uncertainty. I think There's uncertainty around when the next consumer is going walk in the front door and where that next order is going to come from. For all those firms worrying about health care costs and regulation, they are worrying about losing their next government contract. Think about this state. Since World War II the state has been highly, highly dependent upon government contracts through the Department of Defense.

Robert Mittlestaedt: I would argue we are less dependent now than we were in the past. We look at Intel and Petsmart and USAA and Vanguard and a bunch of other employers that are core private sector.

Dennis Hoffman: Motorola is not here without the Department of Defense. They chased defense dollars when they came here originally. We have $12 billion of procurement from the department of defense per year that rolls into this state. As a share of the State's economy, it's one of the biggest shares in the economy in the nation.

Elliott Pollack: By that logic, why don't we turn our money over to Washington and let them spend it.

Ted Simons: Come on, Elliott.

Elliott Pollack: Fact is that that plays a part in it, but that's not the issue. That's not the issue with the decline in government employment. The issue with the decline in government employment has to do with productivity of public sector workers and whether they are dealing -- whether labor unions are dealing with people, especially at the local level, who on the other side of the table can really represent the voters, instead of the unions who give them money to run.

Dennis Hoffman: I think that's a big problem in many states across this nation, I don't think it's a big problem here.

Elliott Pollack: I would suggest in the city of Phoenix it is.

Robert Mittlestaedt: I hit one of Dennis' hot buttons obviously. When I said decline in government employment is good I didn't mean that would hurt employers dependent on government funds. You might say it would be better if those employers could get those funds allocated to places of private employment more efficiently and have fewer government employees doing it.

Dennis Hoffman: That's going take time.

Elliot Pollack: The bulk of the issue is getting consumers to feel comfortable where they will spend again, and that is more than -- it's more than government and I will be the first to admit, that that has to do with basically businesses feeling comfortable enough that the demand will continue to increase, at a strong enough rate so they start to hire people again. And they don't need to right now, they will I think by the end of this year. The best way to describe the economy is a patient who's really sick and getting better. But because he's getting better doesn't mean he's cured.

Dennis Hoffman: I think the economy is clearly warming in Arizona. We see in that retail sales and jobs. This is a pretty good story. We had a 6% holiday season last year, we will put another five to 6% this year. And go into the spring with some growth behind us.

Ted Simons: Before we go into job growth though, What kind of jobs are we talking about here? What's happening to personal income? What kind of employment are we looking at, seeing as -- if everyone's just answering a phone or cold-calling --

Dennis Hoffman: Absolutely. Bob's got great data on this, with respect to the growing service component. I think it's a worry. We're not growing great jobs. We're an increasingly service-oriented economy Nationwide and to some degree in Arizona.

Rebert Mittelstaedt In fact, I saw some data recently that said net-net for the last 20 years, all the jobs created in the United States were service jobs. There's been ups and downs. The net of it is, The net job creation in this country has been service jobs. By the way, that includes government. And so the problem is that when you look at the decline in construction, and obviously Arizona's more dependent on construction than many other states -- the decline in construction and manufacturing jobs, those are the two big sectors where the middle class jobs that everybody claims are disappearing are in fact disappearing. You replace those with service jobs at lower rates of pay, and net incomes, that's part of the reason net incomes haven't grown.

Elliott Pollack: The standard of living in this country has grown for literally centuries, and especially since the end of World War II. At the end of WWII 45% of all jobs were manufacturing jobs and now it's 8%, 9% nationally; so it's a long going thing. It has to do with productivity growth, and there has been in the service sector which is why The standard of living has been growing. A lot of people in the service industry, whether you're an economic consultant or a doctor or a lawyer are a accountant or work for American Express, they are all service jobs and they are doing just fine.

Dennis Hoffman: What Percent of total service jobs that is group that you just described?

Elliott Pollack: Enough so that the standard of living continues to increase. And per capita personal income in Arizona relative to the US remains flat. It takes as you know an awful lot to change the economy one way or the other. Except for one five-year glitch at the end of the 1970s, early 1980s, we've been steady ever since. Yes, it's a problem. If it was a real problem standards of living wouldn't have gone up the way they have.

Robert Mittelstaedt: The real employment problem and the reason we have occupy wall street and all those things, is that the people that have been displaced from the sectors that traditionally paid good middle class wages are not able to go and become doctors, lawyers and accountants in the service sector. And so they either end up at the lower end of the service sector, or they end up no place at all. And again, I'll go back to history on this. If you look at every major shift in economies over the last 200 years, there were people that got displaced and it's horrible. And if you're one of those persons and you're in that class that gets displaced, it's terrible. But the economy goes on and grows, as Elliott says, at a higher level with higher standards of living doing different things than they did before. Unfortunately we're at one of those points.

Ted Simons: Was outsourcing to different countries part of that equation?

Robert Mittelstaedt: Sure. What was the lowest wage country that was devastating western Europe 200 years ago?

Ted Simons: Ireland.

Robert Mittelstaedt: The United States. We started manufacturing clothing less expensively than they could in Britain.

Ted Simons: We get letters and e-mails, it's outsourcing is a major problem. The jobs that were here are now over in China and India.

Elliot Pollack: That's nonsense, okay? And it's comparative advantage, which I don't have to talk to these gentlemen about. Anyone who took freshman economics knows about, and that is you're better off at producing the things you're good at producing and importing the things you're not good at producing essentially is the concept. We are importing things we can't produce effectively and exporting things we can produce effectively. That means our resources are properly utilized. And that southeast Asia's resources are being properly utilized.

Robert Mittelstaedt So I've told people for a long time, you're going to lose manufacturing jobs in this country even if there's no outsourcing. The reason is because companies have to improve productivity to compete and technology helps them do that. One of the boards I'm on, a smaller avionics company, over the 25 years since we founded that company, they don't have any more employees than they had 20 years ago. And it's because there's been continuous increases in manufacturing technology that have allowed them to grow and grow and grow without adding any other people.

Ted Simons: Do you agree with this?

Dennis Hoffman: I do. China's lost 10 manufacturing jobs for every one we've lost as they churn through? I absolutely agree with it.

Ted Simons: From job growth, let's get to housing. How much is housing situation affected by job situation?

Elliot Pollack: Well, it's affected by two things: One, there's too many excess vacant units according to ASU. There's about 50, 55,000 excess vacant units, which is a lot. Down from 80,000 excess units. Two, population growth has slowed and so not as many people are buying houses. And as you pointed out before the show This doubling up impact,basically household sizes are getting larger, because especially people between 25 and 34 are staying home when they'd usually be out, it's a big factor. So It's a combination of too much supply, not enough demand. That will ultimately equalize but not until jobs pick up.

Ted Simons: We've got 50% of valley homes underwater, 27 some odd percent of existing home sales in foreclosure, that's over half the market distressed.

Elliot Pollack: I'll use this example, and then these guys can take over. If you were a retailer or a manufacturer and had much too much for product, you put it on sale and keep on cutting the prices until it was gone. What would happen to the price of the commodity soon the excess supply was gone? Prices go up. That's exactly what's going to happen on housing. Right now houses are on sale. When the sale ends, the sale ends and you've got to pay the real price.

Dennis Hoffman: I just want to reinforce this. If you look at these national prognosticators here in terms of the housing market, you know, it's 2013, 2014, but it really accelerates. Some big double-digit numbers nationally, and I suspect that Arizona will be a big piece of that.

Robert Mittelstaedt: When you have two competing factors here, I think in addition to all the units on the market as excess inventory, you have a huge shadow inventory. Plenty of people say, I can afford to hold on, but I'd sell my house if I could if the prices come up. You will have more inventory coming onto the market, and it's just a question of if it moderates out. The other side, the positive side, the reason for some of these high projections, all the young people living at home that haven't found -- you know, become a house, an entity yet, will begin to do that as they can afford to.

Ted Simons: Quickly, has the idea of buying a home, considering everything that's happened in the past, has that idea been stained?

Elliot Pollack: Well, clearly, The home ownership rate is going down because people who probably never should have been in a home in the first place thanks to Bernie Frank's got into a house. Essentially they found out they shouldn't have been homeowners when reality set in. People who shouldn't have been in houses who bought in 2004, 2005, and 2006, are basically going to be mailing in keys. So there'll be a transfer of people People going from home ownership to home rental. Three quarters to 90% rent to single-family homes because they're being foreclosed on or they have to send the keys in, rent the single family home, because You've got two kids and a dog, you're not going to an apartment.

Ted Simons: So basically, Rental market right now: hot?

Elliott Pollack: Yes, very. Probably the one bright sector in the valley.

Dennis Hoffman: A lot of debate about how we got into this. It would be nice to get back to a stable housing market where you buy the house as a consumption good, not as an investment good, and not betting on big housing inflation.

Ted Simons: All right, that's a good question, though. A good point, at least. Investors still dominating the market?

Elliott Pollack: 42% is nonowner occupants and the bulk of those is investors.

Ted Simons: Last time I heard that kind of activity was right before the bubble burst. Is this a good thing or a bad thing?

Elliott Pollack: Right now it's a good thing, because it's providing rental housing for the people losing their homes.

Ted Simons: Good things or bad thing, all the investor activity?

Robert Mittelstaedt: I've said, the biggest problem is we don't have enough Canadians. It helps to stabilize the market. That's what investors do in any market. They come in and soak up excess inventory when that needs to happen. But long term, that isn't healthy.

Ted Simons: Is it whistling past the graveyard a little bit here?

Dennis Hoffman: You know, it's demand. It's not overly speculative like it was in five and six where they are chasing everything, clearly.

Ted Simons: Quickly here, GDP growth, what are you thinking and looking at and why?

Robert Mittelstaedt: I'm not a professional forecaster. I'm a practitioner who looks at signals out there. I see lots of signals that things are getting better. For a long time I've said you will see specific sectors do very well and others that aren't. Construction will be a problem for a while but you're seeing lots of other sectors doing very well. The way that adds up from a gdp standpoint, it's not the kind of growth that is yet high enough to generate the job creation levels we need to get anywhere close growing back. For different reasons, whether you're looking at housing or individual sectors, I think we're still looking at another two or three years of a very slow economy.

Ted Simons: so does that mean Two to 3%, somewhere along those lines?

Probably 2 to 2.5%, I think in GDP, which I think is not enough to bring down the unemployment rate a lot, assuming people don't leave the labor force. But I think Dennis has the numbers of a bunch of forecasters.

Dennis Hoffman: I have some. These guys are on the mark with respect to consistency with some of these national guys. Sluggish, two or slightly less, say, going forward. Although there's some interesting banter about the fourth quarter. Some people are thinking 3, 3.5, although with retail sales recently, who knows? But I'd say sluggish growth. But then if you get to the 13, 14, 15, if we all make it that long, you know, people are talking 3, 3.5.

Elliott Pollack: And this European problem is nontrivial. The economies are very interlocked.

Ted Simons: Talk more about that, because I think People are trying to figure out why problems in Portugal and Italy are affecting me in Mill Avenue or wherever I live. Explain that for those kind of trying to figure this out.

Robert Mittelstaedt: It's pretty simple. What would happen if we hadn't created a somewhat viable federal system 200 years ago, and we are all still individual countries sitting here, and we'd be asking all of our friends whether they want to bail out California. How much help would you want to give them? Not much. But globally our economies have become so interlocked that you can't ignore it. You go back to when the Fukushima nuclear accident happened, and all of a sudden, within a week, Ford quit producing black cars because their only supplier of the kind of specific black paint they used had just shut down. That's a global economy.

Ted Simons: Before we go, the biggest story of the past year we started with. What will be the biggest story of 2012?

Elliott Pollack: Assuming that Europe doesn't crumble, and that's an interesting assumption, assuming they muddle through and I believe they will, it'll be whether or not you get employment growth that starts to be substantial. In Arizona most forecasts are 1.5 '02% for next year, pretty slim and not enough to get the unemployment rate down.

Ted Simons: Quickly Dennis, big story of next year.

Dennis Hoffman: The big story is going to be the election but you're not going to get a forecast out of me on that. But it'll be the talk, it's worrisome to me that the banter around the political arena may be distracting to consumers and may erode confidence, that is a bit worrisome.

Robert Mittelstaedt: I think the big story is the dollar retains its strength as a global currency. We saw that today in the bond auction We had the 3.5 bid to cover ratio, a lot of it coming from foreign investors.

Ted Simons: Gentlemen, thank you so much. Good to have you here. That is it for now. I'm Ted Simons, thank you so much for joining us. You have a great evening.

Robert Mittelstaedt:ASU economist; Dennis Hoffman:ASU economist; Elliott Pollack:Economist;

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