The National Economy
The New York State Economy
The national economy is now in its 96th month of expansion. In December 1998, the current expansion went on record as the second longest expansion of the postwar period. Only a few months ago, the nation was wondering whether a global financial meltdown would drag the U.S. economy into a recession despite the efforts of the Federal Reserve Board. Now, most of the world stands in awe of the tremendous strength and resiliency of an economy that just will not quit. The Ways and Means Committee staff projects that the national economy will see only moderately slower growth in 1999 than we saw in 1998, and that the current expansion will go on to become the longest since the end of the Second World War. The New York State economy will also experience only slightly slower growth in both employment and income in 1999 relative to last year.
The fundamentals of the U.S. economy remain sound, with the nation continuing to enjoy both low inflation and low unemployment. As measured by real U.S. GDP, the economy grew a robust 3.9 percent during 1998, matching its 1997 performance (see Figure 1). This was a much stronger performance than economists were predicting a year ago. At several points during the year, it appeared as if global economic conditions might stymie the economy’s momentum, a scenario which never occurred. Economic growth for 1999 is expected to slow, but only moderately, to a still healthy 3.3 percent.
Turmoil in the World Economy
The U.S. economy has not weathered the global crisis entirely without impact. A weakened Asian economy has meant reduced demand for U.S. exports, which until recently had been an important engine of growth. Moreover, devalued currencies have induced Asian producers to market their own exports even more aggressively by further reducing prices. The result has been a ballooning trade deficit accompanied by a loss of U.S. manufacturing jobs, as well as diminishing corporate profits. The uncertainty surrounding the future of the Brazilian economy presents a source of risk for 1999.
Consumption: The Nation’s Growth Engine
With the nation’s export sector in a depressed state, the national economy has found its growth engine in domestic consumption, which remained unusually strong throughout 1998. Strong employment growth, low interest rates, and high levels of consumer confidence all contributed to our domestic vigor. In fact, consumption growth was so strong that it appeared as if the U.S. household saving rate, as traditionally defined, had fallen to zero. However, we find that when the remarkable increase in the value of Americans’ net wealth is taken into account, U.S. households are not quite the spendthrifts they originally appear to be. We conclude that the strong stock market growth of the last four years has helped to fuel domestic consumption.
Low Inflation and Low Unemployment
Back in the late summer and early fall, the possibility that the U.S. economy would be drawn into the global crisis spurred the Federal Reserve Board to act. Its three interest rate reductions sent a clear signal to the financial markets that fending off the threat of recession was now its top concern, not inflation. However, with the national unemployment rate at a thirty-year low, it is no less than remarkable that the Federal Reserve would be able to consider such actions without fear of inflation.
The current environment presents a clear challenge to economists’ long-standing view that the rates of inflation and unemployment move in opposite directions. Before preparing ourselves to discard that view, we look carefully at what characteristics of the current environment might temporarily alter one of the bedrock relationships of economic theory. We find that developments within the international oil market, the global economy, and our domestic health care industry have all contributed to the fortuitous state we now find ourselves in. As the influence of these factors diminishes, the historically inverse relationship between inflation and unemployment can be expected to re-emerge.
The Millenium Bug
The industry contributing the most to national economic growth is by far the computer industry, and there is good reason to expect that the purchase of computers and computer-related equipment will remain robust throughout 1999. On January 1, 2000, information technology managers may be facing a computer glitch known as the "year 2000 problem," or Y2K problem. Because some computers are instructed to read the year as a two-digit number, unsuspecting computer software may interpret the new millenium coded "00" as 1900. Since this is a problem of almost universal dimension, Y2K is boosting expenditures for both computer hardware and software, as well as for the services of programmers who have been sifting through billions of lines of computer code in order to identify and correct the problem. Below we examine the possible impact of Y2K on the national economy during the period leading up to, around, and following January 1, 2000.
The Global Risk and Wall Street
How has the State economy been affected by international economic developments? The global turmoil in which we now find ourselves began in the financial sector. Weakness in the international banking system first revealed itself in Asia, and spread to Latin America and Russia, culminating in the collapse of Long Term Capital Management, the failed hedge fund. The speed with which all of this occurred demonstrated just how integrated global capital markets have become. These financial market woes were finally beginning to threaten the U.S. financial markets, as risk-weary investors, both foreign and domestic, began to flee even the highest quality corporate securities in favor of safer U.S. government debt.
As the home of the world’s financial capital, New York State stands to be deeply affected by global financial risk. The financial markets have not quite recovered from the events of the late summer, with the volumes of corporate debt and equity underwriting both down during the second half of 1998. Moreover, the increase in financial market volatility poses a threat to the high profit levels which the securities industry has enjoyed over the last four years. Indeed, a few financial services firms have announced the need for layoffs in light of their particularly poor profit performance in the third quarter. We can also expect to see a decline in bonus income earned by financial market employees during this bonus season, following three years of remarkable growth. Nevertheless, markets are still up relative to last year, and merger and acquisition activity appears to have picked up again following the September lull. All of these developments are pivotal to State income.
New York State Employment Trends
The New York State economy has lagged the nation in job growth since the end of the recession of the early 1990’s. This continues to be the case, despite the fact that the national economic expansion is well into its ninth year. New York employment growth is estimated at 2.0 percent for 1998. Although this represents the State economy’s best performance since the 1980’s, it is still significantly below the national rate of 2.6 percent. Below we examine employment and wage trends for each of the State’s ten regions. We find that there exist wide disparities in the distribution of gains from New York State’s strong job growth, both across and within regions. The three downstate regions combined, grew 2.2 percent during the first two quarters of 1998, compared with the same period of the previous year, while all the upstate regions together experienced a corresponding rate of only 1.1 percent.(1) Additionally, a significant proportion of the jobs created was in low-wage industries.
Early last year, the Asian crisis loomed like a storm cloud, the strength of which was uncertain. In fact, the impact of the Asian crisis on the U.S. economy has been even more profound than most forecasters were predicting only a year ago. A weaker Asian economy has meant weaker demand for both U.S. exports and the products of U.S. firms with direct investments in the affected areas. Moreover, devalued currencies have induced Asian producers to market their own exports even more aggressively by further reducing prices. The recent emergence of trade skirmishes within the steel and other international markets is evidence that global markets are substituting cheaper Asian goods for goods produced in the U.S. The result has been a ballooning trade deficit accompanied by a loss of U.S. jobs, as well as diminishing corporate profits. It is a testament to the tremendous strength of the national economy that the rate of unemployment continues to remain at or near a thirty-year low.
Although the causes of the current crisis are as varied as the countries themselves, we find some common threads. These include heavily indebted banking systems, overvalued currencies, and an over-reliance on foreign loans. Countries heavily dependent upon commodity exports have been hurt by steep declines in the prices of crude oil, grains, copper, and other metals. Some countries are hurting simply because of their close trading ties with another country in distress. Some countries are still reeling from the almost overnight flight of capital which followed the Russian government’s default in its international debts, as investors began to worry about the safety of any developing country, healthy or not.
Despite the remarkable resiliency of the U.S. economy, global turmoil remains a threat. Japan, the second largest economy in the world, remains mired in its worst recession since World War II. Japanese industrial production fell 6.7 percent in 1998 compared with the previous year. Although there are signs that the worst may be over for Korea and Thailand, their economies, along with those of Indonesia, Malaysia, and Singapore are still in serious difficulty. In addition to Southeast Asia and Central Europe, smaller economies such as New Zealand's also have been affected. Some oil-producing nations, such as Saudi Arabia, Venezuela, and Nigeria, have been hurt as well.
For the moment, international concern appears most focused on Brazil, Latin America’s largest economy and the ninth largest in the world. The devaluation of Brazil’s currency in mid-January has left Latin America facing its worst recession since the debt crisis of the 1980’s. A slide of more than 40 percent in the Brazilian real since it was allowed to float freely against international currencies has triggered concern that Brazil too may be forced to default on its debts. Many fear a return to the days of hyperinflation and economic mismanagement that led to Latin America’s "lost decade" of stagnation in the 1980’s. There are some 2,000 American businesses operating in Brazil. Fully 405 of the Fortune 500 firms, including Ford and General Motors, have large operations there. Moreover, U.S. banks have a $27 billion stake in the Brazilian economy.
The spreading global malaise has had a sizeable negative impact on U.S. corporate profits. Until recently, U.S. firms had benefited substantially from both the declining value of the dollar and the rise in foreign incomes, both of which have increased world demand for U.S. exports. However, since the collapse of Southeast Asian currencies in the fall of 1997, the demand for those exports has been on the decline. Consequently, U.S. corporate profits actually declined 1.7 percent during the first three quarters of 1998, compared with the same period of the previous year.
The impact of the decline in global growth has been seen most dramatically in the deterioration of the nation’s trade deficit. Weak foreign currencies and slower income growth abroad caused U.S. exports to slow down significantly. For 1998, the exports only grew 1.6 percent, which is the slowest growth since 1983. Indeed, it is the first time since 1986 that the annual average growth rate of exports is lower than that of real GDP. Comparing the first eleven months of 1998 to the same period in 1997, U.S. exports to all of the ten largest East Asian economies except for China were down. Total exports to East Asia declined $28.3 billion, or 15.1 percent. In contrast, U.S. imports increased 10.6 percent in 1998. Imports from the East Asian countries in particular have risen as the devaluation of their currencies makes their goods suddenly cheaper, while at the same time making U.S. goods more expensive. Consequently, the U.S. trade deficit has been widening. In 1998, the trade deficit reached $168.6 billion, 53 percent higher than 1997’s deficit of $110 billion.
The U.S. dollar has appreciated substantially since the Asian crisis began. Table 1 indicates the extent to which the value of the U.S. dollar has risen relative to almost all of the East Asian currencies in 1998. The weakness in the foreign currency market has put tremendous pressure on U.S. manufacturing. Not only is the demand for U.S. exports down, but competition with foreign imports discourages domestic producers from raising prices, even in the face of rising costs.
Prior to the current crisis, U.S. export industries had been booming. The real value of U.S. exports increased from $402 billion in 1987 to $985 billion in 1998, representing average annual growth of 8.5 percent. In contrast, real U.S. GDP grew an average of 2.2 percent per year during the same period.
There are three factors which can induce an explosion in export growth. First, a rise in U.S. productivity increases the efficiency of the production process, thereby allowing producers to sell their goods at lower prices both at home and abroad. Second, a depreciation of the U.S. dollar, i.e., a decline in the value of the dollar relative to other currencies, reduces the price of U.S. exports from the point of view of the foreign buyer. Finally, rising foreign incomes increase the demand for all goods, including those of the U.S.
Studies indicate that the growth in U.S. exports after 1987 is mainly due to the latter two factors. If true, the implications for the current period are not reassuring, since both are now moving in the opposite direction. The authors of one study used comprehensive plant-level data to investigate the source of both the rapid growth in exports, as well as their increased intensity, defined as export shipments as a share of total shipments.(2) They find that the depreciating dollar and growth in foreign incomes are strongly associated with increases in the quantities of exports and, particularly, an increase in export intensity (see Figure 2 and Figure 3). While productivity growth was indeed associated with a higher level of exports at the plant level, it was not systematically related to increased export intensity. In quantifying the relative importance of the three factors, the authors found that productivity gains over the period from 1987 to 1992 accounted for less than 10 percent of overall export growth. Foreign income growth and exchange rate fluctuations were found to be the dominant sources of export gains.
However, only a moderate improvement is expected in global growth for 1999. At 3.1 percent, U.S. export growth for 1999 is expected to exceed last year’s extremely poor performance, but not by enough to improve the nation’s international trade balance. Hence, the foreign sector will continue to be a drag on U.S. economic growth for 1999.
The devaluation of foreign currencies and decline in foreign incomes are not only affecting U.S. goods markets, but financial markets as well. The notion that the U.S. financial markets may have put the crisis behind them early in the year was firmly laid to rest by midsummer. The rapid flight of capital from markets that were once considered safe was perhaps an unexpected result of the extent to which global financial markets have become integrated. Over the last 20 years, the total value of U.S. corporate stock purchases by Asian investors from U.S. residents has increased at an average annual rate of 26.1 percent (see Figure 4). Similarly, the total value of U.S. stock sales by Asian investors to U.S. residents rose at an average annual growth rate of 28.3 percent for the same period. Investors in this region of the world also engage prolifically in U.S. government bond and corporate bond transactions.
The extent to which Latin America has also become integrated into global financial markets is equally impressive. The total value of U.S. corporate stock purchases by investors from this region are estimated to have reached $550.2 billion in 1998, growing at an average annual rate of 31.8 percent over the last 20 years. The value of U.S. corporate stock sales by investors from this region to U.S. residents increased, on average, 32.3 percent per year. The bond market tells a similar story. The total value of U.S. government and corporate bond purchases by Latin American investors in 1998 reached $684 billion.
Most analysts would agree that, overall, global economic integration has raised the rate of world economic growth. By allowing capital to flow more freely, integrated capital markets facilitate economic development. Those regions which are most in need generally offer the highest returns, as they tend to combine great potential with great risk. However, global integration also makes it impossible for the economies of one region to completely insulate themselves from the problems of another. Freely moving capital can create and destroy fortunes almost overnight. It is estimated that between July and the beginning of October of 1998, $1.5 trillion in consumer and business wealth was erased in U.S. stock markets. U.S. Corporate profits, and consequently bonus incomes, both declined in 1998. The financial wealth lost during the last half of 1998 has since been fully recovered, and as stated above, the wealth effect is expected to continue to have a positive impact on consumption growth in 1999.
As of December 1998, the current expansion went on record as the second longest expansion of the postwar era, with no end in sight. By all accounts, the fundamentals of the U.S. economy are sound. U.S. firms continue to invest in productive capacity at a healthy pace, particularly in computer equipment and related products.(3) Federal fiscal policy can no longer be deemed contractionary, and recent actions by the Federal Reserve Board lean toward an expansionary monetary stance as well. However, is the internal momentum of the U.S. economy so solid that it can absorb shocks from abroad without significantly breaking its stride?
Consumption: The Nation’s Growth Engine
Given the weak state of the nation’s export sector, the answer to the above question rests in large part with the future path of consumer spending. Consumption is the largest component of U.S. GDP, representing 69 percent of total in 1998. More than half of consumption spending goes to the purchase of services, which account for 38 percent of GDP (see Figure 5). The purchase of non-durable goods accounts for 21 percent, while durable goods spending accounts for 10 percent.
There is no indication of a slowdown in consumers’ recent behavior. Real consumption growth tends to decelerate prior to a recession, with consumption sometimes falling while the economy is in recession. Figure 6 compares the most recent four quarters of consumption growth with the last four quarters of the average postwar expansion just prior to a recession. After six-percent growth during the first half of 1998, consumption continued to grow at a robust rate of 4.9 percent for the entire year. Durable goods spending grew more than 10 percent in 1998. Consumption of non-durable goods grew 3.8 percent, while the consumption of services grew 4.3 percent.
The Committee staff is projecting consumption growth of 3.5 percent for 1999. Although this is below its very strong 1998 performance, it is still high by historical standards. What factors might cause consumption spending to slow further or even decline? Consumers tend to spend more when they are feeling generally confident about economic conditions and the security of their jobs (see Figure 7). As stated above, consumer confidence tends to run high when employment growth is strong and is expected to remain strong. However, when workers begin to hear news of layoffs, they may begin to feel less secure about their own jobs and begin to spend more frugally. Of course, if overall employment falls, as it does during a recession, then the consequent decline in earnings may cause consumption spending to fall. Interest rates also play an important role. As interest rates rise, consumers may delay the purchase of automobiles and other such expensive consumer durables. Falling rates would have the opposite effect.
Finally, the value of wealth can also play a role in the rate of consumption growth. Individuals want to be able to consume goods and services over the entire course of their lifetimes. This is why we are willing to set aside some of today’s income, thus sacrificing some immediate consumption, in order to be able to spend later on in life, particularly after retirement. As the rate of return on our saving rises, we may feel the impulse to save more to take advantage of the higher rate, but the dominant impulse may be to save less simply because we think we can afford to. Higher rates of return mean we can put away less and still have the same amount or more during some later period. In other words, we can consume more today. Economists often refer to this latter impulse as the "wealth effect."
How long can the current robust pace of consumption growth last? Although the unemployment rate remains low, there are indications that the Asian crisis has produced layoffs in some export industries. These announced layoffs might explain four consecutive monthly declines in the Consumer Confidence Index since hitting its all-time high in June. However, with the stock market rebounding and the Asian crisis subsiding, the index bounced back in November and December and is now only 8.3 percent below the all-time high reached in June, indicating a substantial improvement in consumers’ confidence in the economy.
But what of the wealth effect? Analysts agree that Wall Street’s extraordinary performance in recent years has had a positive impact on consumption growth through the wealth effect. Does this mean that in the event of a large stock market correction, we will experience a large decline in consumption? In fact, the impact of the 1987 crash on consumer spending was barely perceptible (see Figure 7). However, much has changed since the late 1980’s with consumers now holding a much larger share of their assets in stocks and mutual funds. In 1998, corporate equities and mutual fund holdings constituted over 30 percent of households’ total financial asset holdings. This share is almost double what it was in the mid-1980’s (see Figure 8).
A statistical analysis performed by the Committee staff indicates that the stock market and consumption do indeed move together. Therefore, a decline in the market can be expected to have a negative impact on growth in consumption. Our analysis incorporates Standard and Poor’s Index of 500 common stock prices (S&P 500), adjusted for inflation, as a proxy for the real value of corporate equities.(4) Controlling for those factors mentioned above which also affect consumption, we found that a one percent decline in the S&P 500 is associated with a 0.03 percent decline in consumption. This implies that even a 20 percent decline in the value of the stock market will produce a decline in consumption of 0.6 percent, or $320 billion in 1999.
Are Americans Saving?
In 1998, consumption grew faster than at any other time during the current expansion (see Figure 7). However, the "flip side" of consumption is saving. Whatever percentage of disposable income consumers decide not to spend is saved, with that percentage defined as the saving rate. In 1998, the saving rate fell to 0.6 percent (see Table 2). Without saving, there is no pool of funds available for firms to borrow in order to finance capital investment. Capital investment is the economy’s engine for long-run growth. Of course, even if domestic saving is low, funds may still be made available by foreign savers. However, an important lesson learned late last summer is that foreign financial capital can be quite "flighty," depending on the collective mood of foreign investors. An additional concern is that the baby-boom generation save a sufficient amount to finance their retirement.
Does a low saving rate necessarily imply that people are not saving? The U.S. Department of Commerce Bureau of Economic Analysis (BEA) measures disposable income by subtracting from total income all taxes paid. National saving is defined as what is left after subtracting total consumption. However, there is one source of income which the U.S. Department of Commerce Bureau of Economic Analysis (BEA) does not include in their definition of personal income—capital gains realizations, that is, the income secured when an asset is sold for more than it was originally bought. Although capital gains realizations are not included in the calculation of personal income, they are taxable and, therefore, measurable. Total capital gains realizations are estimated to have been over $370 billion in 1997, about 6.4 percent of total disposable income.(5) If one were to expand the BEA definition of income to include capital gains realizations would bring the saving rate reported in Table 2 for 1997 up from 2.1 percent to 8.0 percent.(6)
The remarkable magnitude of capital gains realizations in 1997 is a reflection of the change which has taken place in the typical household’s financial asset portfolio over the last five decades (see Figure 8). Moreover, thanks to the extraordinary performance of Wall Street, net asset holdings of individuals have increased remarkably since 1994 (see Table 2). Households’ corporate equity holdings went up 90 percent, while mutual funds increased a substantial 110 percent over the period. In summary, a completely different picture emerges when we include the change in the value of net household asset holdings in our measurement of saving.
Given the recent evolution of the household’s financial asset portfolio, the BEA’s definition of saving may be becoming obsolete. As Table 2 shows, the ratio of the change in net assets to disposable income has been increasing. Observing these substantial gains in the value of their asset holdings, households may see less of a need to save out of their disposable incomes (as measured by the BEA). Is this an indication of irresponsible behavior on the part of consumers? Household asset holdings have been growing much faster than liabilities during the 1990’s. One close watched consumer liability—consumer credit—has been declining over the last two years. It would seem that the stock market’s strong performance over the last three years has permitted households to increase both their saving and consumption at the same time. It is therefore reasonable to expect another solid year for both consumption and saving growth for 1999, although not quite matching 1998.
For four years, the nation has been enjoying the unusual combination of strong economic growth and low inflation. For 1998, the unemployment rate averaged an historically low 4.5 percent, while consumer prices rose a mere 1.6 percent. For 1999, the Committee staff is projecting the unemployment rate to fall to 4.4 percent, while the inflation rate is expected to rise only slightly to 2.1 percent. If this were a typical postwar business cycle, inflation might be rising even faster, given the low rate of unemployment. But in this regard, the current expansion has been far from typical. Why?
Historically, the rates of inflation and unemployment have tended to be inversely related to one another; as unemployment goes down, inflation goes up. As the economy expands, the demand for labor and other production inputs rises. Forced to compete for workers, firms offer higher wages and salaries and will in turn try to pass their higher costs onto consumers. Consequently, inflationary pressures will tend to build. Hence, the rate of unemployment has generally been recognized as a key indicator of whether inflation can be expected to accelerate in the near future.
Because of its stated commitment to maintaining price stability, the Federal Reserve Board watches the employment indicators, including the unemployment rate, very carefully. It is therefore important to be able to accurately assess at what rate of unemployment price growth can be expected to rise. That critical rate is known as the "non-accelerating inflation rate of unemployment," or NAIRU. The general consensus is that as long as the rate of unemployment remains above the NAIRU, the monetary authority need not feel compelled to raise interest rates in order to forestall price growth. Below the NAIRU, the Federal Reserve may feel the need to raise interest rates. Since monetary tightening can result in a loss of jobs, it is vital that economists know what the economy’s underlying NAIRU is.
The inverse relationship, which has historically existed between the unemployment rate and change in inflation, is depicted in Figure 9. This relationship is often referred to as the Phillips’ curve.(7) Note that the sloping line intersects the horizontal axis at a value of approximately 6.0. Since this is the rate of unemployment at which the change in inflation is zero, it can be identified as the value of the NAIRU. This finding is consistent with other studies. In 1996, the President’s Council of Economic Advisors estimated the value of NAIRU to be 5.7 percent, while the Congressional Budget Office estimated the NAIRU at 5.8 percent for the same year.(8)
Interestingly, the relationship between inflation and unemployment has changed recently. Since 1995, inflation and unemployment have moved together, rather than inversely. In other words, low inflation rates have been associated with low rates of unemployment. Such an observation has stirred up much discussion on the relevance of the historical relationship between inflation and unemployment.
Understanding the current relationship between inflation and unemployment is vital to the effective conduct of monetary policy. For example, despite the nation’s low rate of unemployment, the Federal Reserve was able to cut short-term interest rates on September 29th and October 15th of 1998 to prevent world financial turmoil from spreading to U.S. financial markets, without worrying unduly about inflation. Consequently, the stock market strongly rebounded, which in turn fueled economic growth. Had inflationary pressures been a concern, it is unlikely that the Federal Reserve would have taken such action.
A variety of factors have been suggested as explanations for the low inflation-low employment phenomenon we now observe. These include increases in worker productivity, demographic changes in the labor force, improvement in levels of worker education, as well as exogenous shocks such as foreign currency devaluations and falling energy prices. Some have even related it to the exuberance of the stock market.(9)
While it is true that demographic, educational, and productivity factors are all contributing to the current environment, it is also true that these factors have been changing over a long period of time. Why then has this positive inflation-unemployment relationship been evident only over the last four years? We think that the more likely causes are exogenous shocks. For example, oil prices have declined about 66 percent from their peak in 1981. Moreover, with the Asian financial crisis and devaluation of foreign currencies, imports from these countries have become cheaper for Americans. This has fostered competition in the domestic market, depressing prices at home. Health care cost containment efforts might be another contributing factor. We discuss each of the above three factors in turn.
A significant change in the world price of crude oil can have a substantial impact on the U.S. economy. Following the first oil shock in the early 1970’s, the price of a barrel of crude oil rose from an average of $1.95 in 1972 to $34.76 in 1981. Over the 11-year period, inflation as measured by increases in the GDP price index, a more general measure of inflation, averaged 7.3 percent. Similarly, growth in the Consumer Price Index averaged 8.1 percent per year. However, since 1981 price growth has slowed down, with the inflation rate averaging only about 3.9 percent per year. The average since 1992 has been even lower.
As Table 3 shows, the world price of crude oil declined significantly over the last two years. Indeed, the price declined about 44 percent following a 20 percent increase in 1996. In 1998, the average price of crude oil was $11.91 per barrel, the lowest since 1976. These low oil prices coincide with an annual average rate of inflation of less than 1.8 percent since 1995. However, historical experience tells us that the oil market can be very volatile and that current conditions will not last forever. Although we do not expect any large oil price increases in the near future due to the currently depressed state of the world economy, neither do we expect further price declines.
The recent devaluation of many foreign currencies has also played a role in keeping U.S. inflation at bay. As Table 3 illustrates, since 1990 the rate of import price growth as measured by the import component of the GDP price deflator has been lower than the rate of inflation as measured by the overall GDP price deflator. Since 1996, import prices have actually been falling. For 1998, the decline was a record 5.2 percent, related in large part to the Asian financial crisis. A decline of comparable magnitude is unlikely to recur in 1999.
Finally, recent developments in the health care industry have also played an important role in restraining U.S. inflation. In general, the medical CPI grew faster than the GDP deflator did (see Table 3). In the late 1980’s and early 1990’s, the rate of growth of medical care prices was double the rate of overall inflation. However, this trend clearly began to change around 1993, when the gap between the two inflation rates began to narrow. In 1997, the medical CPI only grew 2.8 percent, the lowest since 1965. Health care reform efforts taken up by the Clinton administration, which led to a national movement toward managed care and a recognition by the industry that cost growth had to be contained, contributed to this dramatic decline in price growth. However, it is now widely believed that the industry’s options for further cost reductions have become exhausted and that higher rates of price growth may be forthcoming.
In summary, it has been largely the impact of three factors, two of which originated abroad, that has helped to keep U.S. inflation in check. However, it is expected that the effectiveness of all three of these factors will diminish in time, and that the historically inverse relationship between inflation and unemployment is likely to re-emerge. At that point, economic forecasters can expect the Federal Reserve to be much more likely to adopt a contractionary stance when the rate of unemployment falls as low as it is today.
The U.S. economy has exhibited remarkable vigor despite the weakness off our shores. In addition to solid consumption growth, investment growth for 1999 is expected to remain strong at 8.1 percent. What is the source of the domestic economy’s tremendous momentum? As discussed above, the stock market’s strong performance over the last four years has been an engine for consumption growth. However, the economy’s strongest growth engine may currently be the computer industry. One phenomenon which has helped to propel sales of both computer hardware and software is a computer glitch known as the "Year 2000 problem," or Y2K.(10)
The source of the Y2K problem dates back to the 1950’s and 1960’s when computer memory was relatively scarce. In an effort to be frugal, programmers comfortably adopted our cultural habit of representing a year by its last two digits. At that time, the end of the century seemed too far off to worry about, and the term "legacy code" had yet to be invented. Hence, computer code so written would fail to recognize the year "00," or 2000, as a date which follows "99," or 1999. Hence, any system which depends on chronology¾ including both the national and international payments systems, and vital infrastructure systems, such as energy, transportation, and medical systems¾ could fail to function without some form of intervention. The habit of representing years by their last two digits has been so pervasive that almost every large firm, institution, and government agency either has had or will have to make an investment of some magnitude in dealing with Y2K.
The Year 2000 problem can potentially affect the national economy in three ways. The first relates to the short-term costs of fixing the problem. The second relates to the possibility of system failures.(11) Finally, the third relates to the long-term consequences, particularly in relation to productivity, of having diverted resources to Y2K rather than to other uses. The extent of any of the potential economic impacts is uncertain at this time.
There exist many estimates of how much it will cost both governments and the private sector to fix the millenium bug. Solving the Y2K problem has significantly increased the demand for programmers, particularly those who know the COBOL language used by older mainframes, bidding up wages as a result. Companies will, of course, try to pass these costs onto consumers, in the form of higher prices. But those most subject to competitive price pressures will see their profits drop as a result. Hence, the largest short-term threat is the squeeze on profits associated with spending for fixes.
The public’s confidence in electronic payments systems may begin to erode toward the end of this year. In anticipation of this development, the Federal Reserve plans to increase the amount of available currency by about one-third toward the end of 1999. Although financial market systems will be among the most prepared for the new millenium, the public might be induced to hold extra cash out of fear that alternative types of transactions will become difficult or unreliable. The volume of transactions of any kind may diminish as the day approaches as the fear of not getting paid increases.
However, Y2K may also be having a positive short-run economic impact, with investment in information technologies proceeding at an accelerated pace. Real U.S. GDP grew 3.9 percent during 1998, but without the computer-related investments of businesses, GDP would have grown only 1.0 percent (see Figure 10). Growing employment among computer programmers may to some extent be counter-balancing employment declines in the export sector. In 1998, computer services employment grew 11.2 percent, compared with overall employment growth of 2.6 percent. It is also believed that firms may accumulate inventories in anticipation of supply problems during early 2000. Uncertainty as to whether the financial payments system will work or whether certain goods may be in under-supply may induce households to accelerate consumer spending from the first quarter of 2000 into the fourth quarter of 1999. Such activity on the part of both firms and households may put upward pressure on prices toward late 1999. Hence, the net short-run impact on economic growth for both 1998 and 1999 may be positive.
The long-term impact of the millenium bug will depend on the extent to which resources are currently being diverted from productivity-enhancing uses to the mere quick-fixing of legacy computer code. Many firms have chosen to upgrade their information systems creating a boom for companies which sell integrated business software systems. However, such improvements often require long lead times. Firms only now beginning to address the problem may have little choice but to patch their existing systems. If most of what has been spent to fix the problem has been for new productivity enhancing software, then the long-term cost to productivity growth will be diminished. However, as the deadline approaches, there may only be time for a quick-fix approach, in which case, the long-term cost may be substantial.
Global Risk and Wall Street
The global economic crisis, which started in East Asia, has affected the New York State economy largely through two channels. One channel has been through State exports to foreign countries. State export of manufactured goods declined 3.5 percent in 1998.(12) However, as the home of the financial capital of the world, it is not surprising that the primary channel through which New York has been affected has been the financial sector. Below we examine how the financial markets have been affected by the crisis and how that impact is likely to affect State personal income growth. With Latin America now increasingly at risk, it is as important as ever to understand how the State is affected by international shocks.
At the beginning of last year, some thought that the Asian crisis looked like just the medicine the U.S. economy needed to reduce its feverish pace of growth. The resulting optimism helped to fuel what was shaping up to be another year of record-breaking profits on Wall Street. During the first half of 1998, total underwriting of corporate securities seemed to be approaching an annualized pace of just above $2 trillion.(13) An overwhelming proportion consisted of bond underwriting, mergers and acquisitions, the rest was stocks. However, that changed during the third quarter. Bond underwriting during the second half of the year fell to an annualized rate just under $1.5 trillion (see Figure 11), while stock underwriting fell to $114 billion. Additionally, there was a slowdown in merger and acquisition activity during September of 1998.
It is evident that during the third quarter, and during September in particular, investors were becoming weary of even the smallest amount of risk. The flight from corporate stocks and bonds into U.S. Treasury securities produced an unprecedented "decoupling" of corporate and Treasury yields. As seen in Figure 12, after the Russian government defaulted on its debt in mid-August, the spread between even the highest quality corporate securities and those of the U.S. government began to widen. On August 14, two days before Russia’s default, the average yield on Aaa corporate bonds was 6.52 percent, while the yield on the 10-year U.S. treasury bond was 5.40 percent, a spread of 112 basis points. By October 9, just before the Federal Reserve Board’s second interest rate cut, the spread had increased to 178 basis points. As of February 5 of this year, the spread was still as high as 148 basis points.
Crises such as the one instigated by the Russian default induce extreme volatility within the financial markets. Foreign investors exhibited particularly risk-averse behavior during 1998, reducing their net purchases of corporate securities by half during the second quarter and almost shunning them during the third, in favor of U.S. Treasuries. The S&P 500 stock index had declined almost 20 percent by the end of August 1998 from its July 17th peak.
Such extremes of market volatility often bode negatively for Wall Street firm profits. Securities industry profits topped $12 billion in 1997, and were on their way to breaking yet another industry record in 1998 until the crisis hit in the third quarter. Although data on third and fourth quarter profits are not yet available, the anecdotal evidence is not promising despite a pick-up of financial market activity during the fourth quarter. Several firms, such as Citicorp and Merrill Lynch announced layoffs following a disastrous third quarter.
The threat to industry profits is also likely to have implications for bonus income earned by industry employees, and hence for New York State income growth. As indicated in Figure 13, securities industry bonus payments are the driving force behind State bonus income overall. Because bonus income tends to be taxed at the highest marginal tax rates, a decline in bonus payments can be expected to have a particularly significant impact on State revenues. The Committee staff is projecting a decline in bonus income of 4.8 percent for the 1998-99 bonus season now underway, to be followed by an 11.3 percent increase for 1999-2000.
Although bonus earnings for 1999 are not expected to keep up with the record-breaking pace of the recent past, they are still expected to be large by historical standards. Throughout the 1990’s, mergers and acquisitions have been a significant source of revenue for both Wall Street firms and those legal enterprises which primarily do business with these firms. Despite the volatility of the stock and bond markets, the merger and acquisition activity has remained quite strong. The introduction of the euro, the European unified currency, and the continued integration of the European market is expected to be a strong catalyst for mergers and acquisitions activity for some time to come as firms seek ways to improve their competitive advantage in this potentially huge market. As shown in Figure 14, the value of completed mergers and acquisitions attained a record $357.9 billion during the third quarter. It is the first quarter to have verifiably topped $300 billion in history and brought the dollar value for the first nine months ahead of the total for all of 1997. The merger and acquisition market may have had its first trillion-dollar year of completions in 1998.
The continuing national expansion, combined with four years of spectacular performances by Wall Street has improved New York job growth and rejuvenated a flagging State economy. After a prolonged period of sluggishness, employment in the State has picked up during the last two years.
Amidst this positive picture for the State, however, exists wide disparities in the distribution of gains from the State’s now stronger job performance. Three essential types of disparities are revealed in employment and wage growth patterns for New York State. First, the State continues to lag the nation in job growth. Second, there have been inter-regional as well as intra-regional differences in the distribution of these new job benefits. Third, several of the industries that have been creating a significant portion of jobs are low-wage industries.
State Employment Growth Fails to Keep Pace with the Nation
New York employment growth is estimated at 2.0 percent for 1998. Although this represents the State economy’s best performance since the 1980’s, it is still significantly below the national rate of 2.6 percent. New York’s relatively low rate of job creation puts the State well behind other large states, such as California, Florida and Texas.
Above we examine a host of industries which stand out as key to the State’s economic future. Some represent important emerging or "high-tech" industries, such as telecommunications and computer services. Others have special regional significance because they are either among the region’s fastest growing or account for a significant share of regional employment.(14) Among the industries we examined, the State’s computer industry was one of the few that outperformed the nation in terms of job growth. Between 1992 and 1997, it grew 2.0 percentage points faster than the nation as a whole, with further improvement in 1998.(15)
However, many of the State’s industries that we looked at, failed to keep pace with the national averages during the 1992-97 period. The securities industry grew 3.5 percent annually for New York State compared with 6.3 percent for the nation. Employment in the electronics, automotive and telecommunications industries declined for the State (see Table 4). For the nation as a whole, however, employment in these industries grew at rates of 2.7 percent, 3.9 percent, and 2.2 percent, respectively. The aircraft industry lost jobs in both the State and the nation, but the rate of decline was much higher for the State. Employment in New York State’s aircraft industry declined at a rate of 15.7 percent, much higher than the nation’s corresponding annual decline of 3.9 percent. Similarly, the banking industry’s rate of job loss was much higher than the nation’s 0.7 percent rate of decline.
Regional Disparity in New York State
At the end of the early 1990’s recession for New York State, the upstate regions began to recover earlier than the downstate regions. A combination of factors, including corporate restructuring, defense downsizing, and the stock market crash, led to the downstate regions’ continued job losses during the early expansion period. With employment growing very slowly in both New York City and the Mid-Hudson region, downstate overall lagged the upstate regions in job growth over the period from 1992 to 1995. The tide turned for the downstate regions in 1996, with the start of Wall Street’s impressive performances combined with a strengthening of the national expansion. Since 1996, it is the upstate regions that have lagged the State in employment growth.
Between 1992 and 1995, New York’s three downstate regions experienced annual average employment growth of only 0.4 percent (see Table 5). In contrast, the upstate regions combined experienced corresponding job growth of 0.6 percent, 0.2 percentage points above downstate. However, the situation reversed during the 1995-97 period, with the upstate regions now lagging well behind downstate. Between 1995 and 1997, the State witnessed average annual employment growth of 1.1 percent. Downstate job growth was 1.3 percent during this period, while the upstate regions lagged downstate by one full percentage point (see Table 5).
More recently, the job growth performance of the upstate regions has improved (see Table 5). However, they still continue to lag the State and the downstate regions by one full percentage point. Additionally, the Western New York region’s divergence from the statewide average has actually widened during 1998. Western New York accounts for about eight percent of the upstate workforce.
Moreover, there exists disparity in average wages across regions as well. For instance, the average wage for New York City is $53,363, while Mohawk Valley’s average wage is only $24,295 (see Table 5). While some of this difference is related to variation in the cost of living, much of it due to the extraordinarily high wages earned by a relative few on Wall Street.
There is also considerable variation within regions, again with New York City standing out as a glaring example. Much of the job gains for New York City were concentrated in Manhattan in 1998. This was especially true for certain high-tech, high-wage industries.
Regional Employment and Wage Trends
Below we examine employment and wage trends for each of the State’s ten regions over the life of the current expansion, which began in late 1992. We look at trends in each major industrial sector as well as trends for some specific industries. We place particular emphasis on certain industries that we believe have the potential to become regional growth engines in the future.
All regions, except Western New York, saw considerable improvement in employment growth during the 1997-98 period as compared to the period from 1992 to 1997. Mid-Hudson and North Country regions in particular experienced marked progress. Within New York City, however, the Bronx and Staten Island both saw a decline in job growth during the first half of 1998, with the Bronx actually losing jobs.
New York City
New York City experienced average annual job growth of only 0.7 percent over the entire 1992 to 1997 period. However, the City’s growth rate accelerated over the period. Of the job growth that occurred, the largest gains occurred in the services sector. Trade and construction were other big job producers adding 28,574 and 6,747 jobs, respectively, during the same period.
Looking at specific industries makes one wonder whether the computer industry is this region’s future engine of growth. Over the 1992-97 period, this industry added 14,988 jobs to the local economy. This represents an average annual growth of 14.4 percent. Its performance further improved in 1998.
The securities industry of course, performed well. Adding 26,678 jobs between 1992 and 1997, this industry grew at a healthy annual average rate of 3.4 percent. Other industries that did well in terms of job growth were the temporary services, home care, and the media industries. The media industry in the City has been a major beneficiary of the dramatic growth in motion picture, television, and commercial production that the State as a whole has witnessed over the last three to four years. Between 1994 and 1997, the number of films shot in New York State reportedly grew over 50 percent. It is likely that the City would be a prime beneficiary of this growth.
Not all industries did as well, however. As a result of mergers and restructuring, the banking industry was a major employment loser. It eliminated a net total of 27,535 jobs, an annual average decline of 4.2 percent (see Table 6).
Additionally, the City’s strong employment growth was not evenly spread across the five boroughs. Between 1992 and 1997, over half of the net total jobs created by the New York City economy accrued to Manhattan. However, Manhattan’s rate of job growth was still 0.2 percentage points below the citywide average (see Table 7). All other boroughs grew at an average annual rate equal to or above that of New York City as a whole. This situation changed during 1998, however, with Manhattan employment growing 2.2 percent, 0.3 percentage points above the citywide average.
Of the total 14,988 computer jobs added by the City, the lion’s share went to Manhattan, home to "Silicon Alley," where a host of new, high-tech firms are involved primarily in computer services, telecommunications, and media activities. This borough added 13,386 computer jobs, while the remaining four boroughs together added a combined total of only 1,600 computer jobs during the same period. The securities industry is concentrated in Manhattan as well. Of the 26,678 net securities jobs created by New York City between 1992 and 1997, 25,473 were in Manhattan.
Further, there exists tremendous disparity in wages among the various boroughs that constitute the New York City region. Manhattan tops the five boroughs in terms of wages, earning an average wage of $65,752 in 1998, while Brooklyn is at the bottom of the list with a corresponding wage of $27,915 (see Table 7).
The disparity in economic performance also shows up in the City’s unemployment rates. In 1998, the City witnessed its lowest unemployment rate since 1990, at 8.7 percent. However, not all boroughs within the City fared equally well. Brooklyn and the Bronx both continue to suffer double-digit unemployment rates. At 11.1 percent, Bronx had the highest unemployment rate among all the boroughs in 1998, followed by Brooklyn with 10.3 percent.
Long Island’s economic performance over the last several years surpasses that of the State as a whole. With over a fifth of New York’s net job creation between 1992 and 1997 accruing to Long Island, this region grew the fastest among all the ten regions (see Table 5).
The largest share of the job gains went to the services sector with a net addition of 43,819 jobs between 1992 and 1997. The trade sector contributed 15,555 jobs and the construction sector accounted for 8,941 new jobs, exhibiting the fastest growth at an annual average rate of 4.3 percent, well above a corresponding 1.6 percent for the State. This trend continued into 1998.
A look at specific industries for the 1992-97 period shows the securities industry growing strong, well above the 3.5 percent growth for the State overall (see Table 8). The home care services industry, which added 3,225 jobs, grew annually at a rate of 4.0 percent, though this growth has recently tapered off. The temporary services industry produced another 1,809 jobs, for a growth rate of 3.5 percent. Although slower than the statewide average, the computer industry in Long Island, which is home to the software giant, Computer Associates International, grew at a respectable average annual rate of 3.7 percent during the 1992-97 period. There was considerable improvement in 1998 (see Table 8).
Not all sectors benefited from job growth, however. The manufacturing sector was a big job loser, eliminating a net total of 14,301 jobs, while the FIRE sector shed 1,352 jobs, representing declines of 2.4 percent and 0.3 percent annually, during the 1992-97 period. The manufacturing sector picked up in 1998, however, adding 856 jobs, growth of 0.8 percent compared with a decline of 0.1 percent experienced by the State as a whole. The FIRE sector continued on its downward trend in 1998, due to downsizing in the commercial banking industry.
The aircraft industry was a major job loser in the Long Island region. This was largely due to downsizing by large firms such as the Grumman Corp., causing this industry to shed 8,205 jobs between 1992 and 1997. Aircraft industry job losses continued into 1998 as well. Additionally, after adding a significant number of jobs between 1992 and 1997, employment in the securities industry declined in 1998 (see Table 8). The banking industry also suffered heavy job losses, eliminating 5,173 jobs between 1992 and 1997.
While the job gains made by the temporary services, home care and computer industries more than offset the job losses of the aircraft industry, it is important to note the wide wage disparity among these industries (see Table 8). The aircraft industry paid an average wage of $66,067 in 1998. On the other hand, the two large job gainers, the temporary services and home care services industries paid only $23,217 and $17,204, respectively. This was only partially redeemed by the computer industry, which is a high wage industry with an average salary in 1998 of $76,911. With the securities industry joining the job losers in 1998, this trend has only intensified (see Table 8).
Additionally, the benefits from Long Island’s relatively strong employment growth was not evenly spread across the two counties, Nassau and Suffolk, that comprise the region. Of the 62,847 new jobs added by Long Island between 1992 and 1997, 24,292 accrued to Nassau County; and 38,555 jobs were created by Suffolk County. This represents average annual employment growth of 0.9 percent for Nassau between 1992 and 1997 as compared to 1.5 percent for Suffolk, and 1.2 percent for the region as a whole. This trend only intensified in 1998.
The Mid-Hudson region experienced more rapid growth in employment in 1998 than did any other region of New York State (see Table 5). The largest employment gains were in the services sector with a net addition of 28,409 jobs between 1992 and 1997, an average annual gain of 2.4 percent. The construction sector also grew at 2.4 percent annually, 0.8 percentage points faster than the State as a whole.
Additionally, Mid-Hudson region has shown a marked improvement in its job growth performance over the past year. During 1998, the region outperformed the rest of the State. All major sectors showed positive job growth in 1998, with the construction sector and the services sector growing at rates of 11.7 and 4.2 percent, respectively.
Aided by a remarkable upsurge of several hundreds of small computer software firms in Mid-Hudson region over the last few years, the computer industry experienced rapid growth between 1992 and 1997; its performance improved further in 1998 (see Table 9). Producing 1,956 jobs, the temporary services industry showed strong growth of 6.6 percent as well, though 1.0 percentage point slower than the State. The trend continued for the most recent year. The home care services industry grew at an average annual rate of 2.3 percent, creating a net total of 1,469 jobs between 1992 and 1997.
However, as the result of corporate downsizing by large firms such as IBM, much damage was suffered by the manufacturing sector, which discarded over a fifth of its jobs between 1992 and 1997, a loss of 26,135 jobs. Specifically, the electronics industry lost jobs in a big way. Additionally, the telecommunications industry has been losing jobs in this region (see Table 9).
The FIRE sector was another large job loser in the Mid-Hudson region, shedding 2,580 jobs, an average annual decline of 1.1 percent. Much of the damage here occurred in the banking industry, which lost 2,785 jobs, an annual decrease of 4.2 percent. This trend continued in 1998 for the banking industry, although the FIRE sector as a whole picked up significantly in 1998.
Finally, much of the region’s job gains during the 1992-97 period occurred in relatively low wage industries (see Table 9). The temporary services and the home care industries paid an average wage in 1998 of only $23,365 and $16,283, respectively, while the electronics industry’s corresponding salary was $60,856. Another high paying industry, telecommunications, was a heavy job loser as well.
The Capital Region added a net total of 12,499 jobs between 1992 and 1997. The services sector led the way both in terms of the number of jobs added and the average annual rate of employment creation. A net total of 12,226 service sector jobs were created, an average annual growth of 1.9 percent. The retail and wholesale trade sector grew at an average annual rate of 1.4 percent, adding another 6,954 jobs.
In the Capital Region, the tourism and the home care industries were big job producers between 1992 and 1997 (see Table 10). More recently, the temporary services industry added another 1,390 jobs to this region in 1998. Although employment growth in the Capital Region’s computer industry was lackluster in comparison with other regions during the 1992-97 period, there has been a reversal in more recent years. This industry added 795 jobs to the regional economy during the first half of 1998 as compared with the same period the previous year, representing a growth of 14.4 percent. The hub of high-tech activity in the Capital Region is the Rensselaer Technology Park, home to about 50 high-tech companies including Metlife Information Center, NYNEX Information Center, MapInfo Corporation, among others.
The overall lackadaisical job growth performance of the Capital Region was driven by the enormous job losses suffered by the manufacturing sector. Affected by corporate downsizing by important area firms such as General Electric Power Systems, it lost 6,584 jobs during the 1992-97 time period, an annual decline of 2.6 percent. Specifically, the well-paying electronics industry, with an average annual wage of $74,956 lost 210 jobs.
Also, the government sector in the Capital Region lost 1,798 jobs, an average annual decline of 0.3 percent. Much of the loss occurred at the state and federal government levels.
Further, much of the job gain in the Capital Region occurred in low wage industries. The tourism and home care industries each pay an average annual salary of only $17,136 and $17,270, respectively. In comparison, the electronics industry, which lost jobs in the Capital Region, paid an average wage of $74,956 (see Table 10).
Mohawk Valley added 5,761 jobs between 1992 and 1997. The largest gain was in the services sector, which expanded employment at an annual average rate of 4.1 percent, with an addition of 8,175 jobs between 1992 and 1997. The trade sector was responsible for another 1,672 jobs, an annual average growth rate of 0.9 percent, though more recently, this sector lost 532 jobs in 1998.
A look at specific industries shows that tourism is flourishing in Mohawk Valley. This industry created employment at a faster pace than the State overall. Adding 2,148 jobs between 1992 and 1997, it grew at an annual average rate of 14.3 compared with 0.9 percent for the State. The tourism industry in this region has been bolstered by the thriving Turning Stone Casino Resort in Oneida County. Temporary services was another big job producer, growing 16.2 percentage points faster than the State as a whole did. Home care services produced a few jobs as well (see Table 11). More recently, the computer industry grew 65.9 percent in 1998.
The manufacturing, government, FIRE, and construction sectors all saw a decline in employment between 1992 and 1997 in the Mohawk Region. The manufacturing sector suffered the most, casting off a net total of 2,298 jobs, a loss of 1.5 percent annually. All the four sectors, however, have seen a reversal more recently, with each gaining jobs in 1998.
The banking and metal industries both lost a few jobs during the 1992-97 period. This trend changed in 1998, however. During 1998, the telecommunications industry and home care services both suffered job declines.
A notable feature of the top employment creators in Mohawk Valley over the last several years is that many of them are low-wage industries. Temporary services, the fastest job producer paid an average wage of only $11,566 in 1998 compared to the region’s overall average wage of $24,295 (see Table 11). Both tourism and home care services are low paying industries as well, with an average wage of $17,574 and $14,221, respectively. Finally, even the relatively high-wage computer industry pays less in the Mohawk Valley than in other regions.
North Country fared the most poorly among all the regions of New York State in terms of employment growth between 1992 and 1997. Adding only a net 691 jobs, this region created jobs slowly at a rate of 0.1 percent annually (see Table 12).
Services and public utilities have been the top job creators in this region. The services sector added 2,814 jobs between 1992 and 1997, an annual gain of 1.8 percent. Public utilities was farther behind, adding 290 jobs, an annual average growth of 1.0 percent. The employment situation in North Country improved somewhat in 1998. Services and public utilities continued to add jobs, while employment growth in the construction, FIRE, and government sectors all picked up in 1998.
The trade sector has continued on a downward trend, however. Losing 655 jobs between 1992 and 1997, an annual decline of 0.4 percent, there was a further fall in employment of 2.4 percent in 1998 as 796 jobs were lost.
Several industries that have flourished elsewhere have grown exceedingly slowly in North Country. The computer industry is one such example. It added only 72 jobs between 1992 and 1997 (see Table 12). The tourism industry added a relatively significant number of jobs. Growing at an annual average rate of 3.0 percent, the tourism industry added 490 jobs during this period.
Central New York
Central New York added a net total of 2,392 jobs during the 1992-97 period. At an aggregate level, the services sector was by far the largest job creator, adding 7,623 jobs to the economy between 1992 and 1997, an annual average growth rate of 1.7 percent, a full 1.0 percentage point below the statewide average. Another sector to gain a significant number of jobs during this period was the trade sector, which grew at an annual rate of 0.2 percent, adding 937 jobs between 1992 and 1997.
More recently, the job growth situation has improved considerably in this region. More jobs were added to the Central New York economy between the first half of 1997 and 1998 than over the entire 1992-97 period. Between the first half of 1997 and 1998, several sectors besides services added jobs to the economy. A significant number of construction, manufacturing and government jobs were created in 1998.
A look at specific industries shows that a few industries experienced positive job growth between 1992 and 1997. The auto and metals industries were each significant employment creators. Some of the job creation in the automobile industry may have been aided by companies such as New Venture Gear Inc. which operates an automobile parts manufacturing division in this region. Also, in contrast to the State as a whole, which suffered telecommunications job losses at an average annual rate of 0.1 percent, this industry added 655 jobs to the Central New York economy during the 1992-97 period. This trend changed during 1998 (see Table 13).
were several major job losers in this region between 1992 and 1997. The manufacturing
sector shed 3,087 jobs, an annual loss of 1.1 percent. Others to suffer job
cutbacks were the FIRE and the construction sectors, with a loss of 2,263 and
1,449 jobs, respectively.
The computer industry, which has shown vigor in most other regions, growing at an annual statewide average rate of 9.8 percent between 1992 and 1997, added a mere 117 jobs to the Central New York economy during the same period (see Table 13). More recently, this industry actually lost 8.4 percent of its jobs between the first two quarters of 1997 and 1998, in contrast to the State’s growth in computer jobs of 19.7 percent.
The banking industry also suffered employment cutbacks. Between 1992 and 1997, a net 1,132 banking jobs were eliminated, an annual decline of 4.8 percent, higher than the statewide average rate of decline.
The Southern Tier region has experienced slow job growth over the last several years. It added a net total of 2,630 jobs between 1992 and 1997. During the period from 1992 to 1997, the largest job gains occurred in the services sector with 6,598 jobs being added, an annual growth rate of 1.7 percent.
A look at specific industries shows that the computer industry was the largest job producer, employing an additional 2,159 workers between 1992 and 1997. This corresponds to an annual average growth of 22.7 percent, higher than the statewide average by 12.9 percentage points. Temporary employment services, tourism, and automotive industries also performed well (see Table 14). The electronics industry added another 666 jobs during the same period, a growth rate of 1.6 percent, in contrast to a statewide average annual decline of 2.3 percent.
Although the manufacturing sector in Southern Tier witnessed a considerable loss of 5,310 jobs during the period from 1992 to 1997, there was a rebound in 1998, with 1,175 new jobs being added. A large job shedder in this region in the early 1990’s, IBM Corp. recently made a comeback and has been adding jobs to the local economy.
However, the construction and FIRE sectors both suffered rapid job losses. Between 1992 and 1997, each declined at respective rates of 6.9 percent and 4.4 percent respectively. Within the FIRE sector, the banking industry lost a significant number of jobs during the same period; more recently, however, this industry picked up a few jobs. Temporary services and home care services, on the other hand, lost jobs during the first half of 1998.
A notable feature of Southern Tier’s relatively fast growing industries is that many of them have low average wages. For instance, the tourism industry, which added jobs between 1992 and 1997, pays an average wage of only $14,883. Similarly, the temporary services industry’s average wage in 1998 was only $16,610, compared with a regional average of $27,719.
Western New York
Western New York added 17,354 jobs to the economy between 1992 and 1997. The services sector was the largest employment producer, creating a net total of 16,984 jobs between 1992 and 1997, an annual increase of 2.0 percent, with the trend continuing in 1998. The construction and utilities sectors were other significant job creators, adding 1,054 and 1,471 jobs, a gain of 1.0 and 1.1 percent annually.
Looking at specific industries shows that in common with several other regions of the State, the temporary employment services and computer industries grew at a rapid pace in Western New York. The temporary services industry was a large gainer adding 3,768 jobs between 1992 and 1997, an impressive average annual gain of 10.6 percent. The computer industry gained 736 jobs between 1992 and 1997, an average annual growth of 4.1 percent. Both industries continued to do well in 1998 (see Table 15).
The manufacturing and the trade sectors both saw a fall in employment, losing 2,814 and 451 jobs respectively, an average annual decline of 0.5 percent and 0.1 percent over the 1992-97 period.
Moderate job losses occurred in banking, media and tourism industries as well between 1992 and 1997 though job creation in these three industries picked up in 1998 (see Table 15). Employment losses in the auto industry between 1992 and 1997 intensified in 1998.
The Finger Lakes region added 18,963 jobs to the economy between 1992 and 1997, the largest gain among all the upstate regions (see Table 5). At an aggregate level, the services sector was the largest job creator between 1992 and 1997 adding a net total of 16,470 jobs, an average annual growth of 2.4 percent. The trade and construction sectors were also significant employment creators, with respective job additions of 4,268 and 900, which correspond to annual growth rates of 0.8 and 1.0 percent respectively. This trend continued in 1998.
Looking at specific industries, we see that the computer, home care services, and metals industries grew rapidly in this region during the 1992-97 period. Adding 3,559 jobs to the economy, the computer industry grew at an impressive annual rate of 14.9 percent between 1992 and 1997, further accelerating in 1998 (see Table 16). Home care services and the metals industry added 1,882 jobs and 1,032 jobs over the same period, at average annual growth rates of 4.9 percent and 2.8 percent, respectively.
Downsizing by some of this region’s biggest and best paying employers, Eastman Kodak, Xerox, and Baush and Lomb has cost Finger Lakes dearly in terms of manufacturing jobs. The manufacturing sector shed 5,099 jobs between 1992 and 1997, an annual rate of decline of 0.7 percent. Additionally, the FIRE sector lost 1,736 jobs, a decline of 1.5 percent annually.
The electronics industry, which dominates this region as a large employer has seen a steady decline in employment over the last several years. Losing 5,726 jobs between 1992 and 1997, it declined at an average annual rate of 2.1 percent. Additionally, the banking industry also lost 2,770 workers between 1992 and 1997, a decline of 6.6 percent. The job loss rate intensified for both industries in 1998 (see Table 16).
A notable feature of the employment growth pattern in Finger Lakes is the significant contribution in job gains of low-wage rather than high wage industries. With the exception of the computer industry, much of the job losses was suffered by high-wage industries such as electronics and banking, while a major proportion in the number of jobs added came from low-wage industries, such as home care and temporary services (see Table 16).
Most regions of the State experienced sluggish employment growth during the period from 1992 to 1997, with an improvement occurring more recently. The downstate regions collectively fared much better than upstate. The slowdown in upstate job creation occurred during the 1995-97 period, with an improvement during the first half of 1998. However, upstate still considerably lags downstate in job creation.
In addition to the disparity between the upstate and the downstate regions, there also exists differences within regions in the distribution of job gains. For instance, the benefits reaped by the rest of the City, from Wall Street’s extraordinary performances over the last four years, seem to have bypassed the Bronx and Brooklyn boroughs altogether. Similarly, Suffolk County in Long Island experienced much stronger employment growth than did Nassau Country.
All regions, except Western New York, improved in their rate of job creation during the 1997-98 period as compared to the period from 1992 to 1997. Employment growth in the Western New York region has been sluggish over the entire period from 1992 to 1998, with the situation only exacerbating over time.
The computer and temporary services industries have been the most dynamic of all industries we examined during the 1992-97 period. For most regions, the computer industry further accelerated in job creation during 1998. Central New York and the Southern Tier regions were the exceptions; the computer industry actually shed jobs here.
The banking industry suffered significant job losses in all regions between 1992 and 1997. A few banking jobs were recovered in five of the ten New York State regions during the 1997-98 period. Additionally, the electronics industry lost a significant number of jobs between 1992 and 1997, with the trend continuing in 1998.
A notable feature of the job growth trends in New York State is that low-paying industries such as temporary services expanded rapidly, offsetting the expansion of the high-paying computer industry. Additionally, there has been a decline in jobs in other high-wage industries such as the electronics and the banking industries. Such a trend is particularly visible in some regions, such as Mohawk Valley and North Country.
U.S. ECONOMIC FORECAST
The persistent strength of the national economy has continued to surprise economic forecasters for the last several years. The same may be true for 1999. The particular strength of the last quarter of 1998 has already led forecasters to significantly revise upward their predictions for the current year. Whether this is just the first of many future revisions remains to be seen. The Ways and Means Committee staff predicts that national economic growth, as measured by growth in real U.S. Gross Domestic Product (GDP), will be 3.3 percent during 1999. Although this forecast is below the 3.9 percent growth experienced in both 1997 and 1998, it is above both the 2.6 percent average over the life of the expansion and the 2.8 percent average over the last 20 years (see Table 17). Although the current expansion is already in its ninth year, its strength is more characteristic of expansion in its early stages.
Consumer spending is projected to grow a robust 3.5 percent in 1999, following 4.9 percent growth for 1998 (see Table 17). Much of this slowdown is related to the sluggish world economy, with the nation’s foreign sector continuing to be a drag on national economic growth. Consequently, growth in both employment and wages and salaries is expected to fall in 1999 relative to 1998, putting downward pressure on consumption growth as well. The continued uncertainty surrounding the world economy will also have a dampening effect on stock market growth, producing a modest wealth effect which could also have a negative impact on consumption.
The projected decline in the rate of consumption growth is reflected variably in each of the components of the total. Durable goods consumption is expected to grow 5.9 percent during 1999, compared with 10.1 percent growth for 1998 (see Figure 15). The historical data show that durable goods consumption is the component of consumer spending which is most sensitive to changes in economic conditions. The purchase of a car or large appliance can often be put off until times are better, whereas the purchase of food and clothing cannot be. In contrast, services consumption has exhibited a consistent pattern of growth since 1965. Services consumption is the biggest component of total consumption, accounting for 55.8 percent in 1998. The consumption of services is projected to grow by 3.3 percent for 1999, following 4.3 percent growth in 1998. Growth in the non-durable component of consumption is much more stable than that of durable goods but not quite as stable as that of services. Non-durable consumption is predicted to grow 2.9 percent for 1999, following growth of 3.8 percent in 1998.
The Committee staff is predicting investment growth of 8.1 percent for 1999, following stronger growth of 10.5 percent in 1998. Investment has cooled off since rising 28.6 percent during the first quarter of 1998. Following a decline of 4.0 percent in the second quarter, investment grew 7.7 percent during the third quarter and a much stronger 12 percent in the fourth quarter. The slowdown in investment growth anticipated for 1999 is attributable to a decline in both fixed capital and residential investment.
The Committee staff predicts export growth of 3.1 percent for 1999, following almost no growth during 1998 (see Figure 16). Import growth is expected to slow down in 1999. Imports are expected to grow 8.4 percent in 1999, following 10.6 percent growth in 1998. Hence, this forecast implies further deterioration in the U.S. trade balance. The deficit in goods and services for 1998 is $168.6 billion, 53 percent above last year’s deficit of $110 billion. After discounting for inflation, it is expected that the deficit will have reduced overall GDP growth by 2.1 percent. In 1998, the U.S. trade deficit with East Asia was up 30.6 percent. The strength of the U.S. dollar, combined with the collapse of many Southeast Asian currencies, has seriously weakened exports to Asia. However, there is hope that the worst may be over in Thailand and Korea, improving the outlook for export production for 1999. Meanwhile, the deteriorating situation in Latin America is a reminder that there is still reason to remain concerned about the state of the world economy.
Real government spending grew 1.0 percent in 1998, with an increase in spending by state and local governments of 2.1 percent having been partially offset by a 1.0 percent decline in federal government spending. For 1999, the Committee staff anticipates that overall government spending will increase 2.0 percent, with both federal and state and local governments spending more. Most government entities appear to be in good fiscal condition thanks to the bull market. The tremendous realization of capital gains spawned surpluses at all levels of government in 1998.
National employment growth has been quite strong. For the five years from the 1994 to 1998, job growth averaged about 2.6 percent a year, which is above the last 20 years’ average of 1.9 percent. National employment growth for 1998 is 2.6 percent. The Committee staff predicts slower growth of 2.0 percent for 1999, consistent with the overall slowdown of the U.S. economy next year. The services sector is expected to once again lead the other sectors in job creation in 1999 with growth of 3.8 percent, following 4.1 percent growth for 1998 (see Table 18). Retail trade employment is expected to grow 2.0 percent in 1999, following 2.1 percent growth for 1998. The transportation, communication, and utilities sector is forecast to grow 2.4 percent in 1999 as it did in 1998. Construction industry job growth is expected to slow to 3.9 percent in 1999, following robust growth of 5.0 percent for 1998. As a direct consequence of the global malaise, manufacturing employment is predicted to decline 0.6 percent in 1999, following growth of 0.2 percent for 1998. Government sector employment is expected to grow 0.5 percent for 1999, following 1.5 percent growth for 1998.
Personal income is estimated to have grown at a rate of 5.0 percent in 1998, with its largest component, wages and salaries, growing 6.7 percent. The Committee staff anticipates that growth in these two income measures will slow somewhat to 4.7 percent and 6.2 percent, respectively, for 1999. The historical data series for U.S. personal income has recently undergone substantial revision due to a change in methodology by the U.S. Bureau of Economic Analysis. For this reason, the current Committee staff estimate for 1998 and the forecast for 1999 are not comparable with those of the past (see Box 1). Thus far during the current expansion, personal income and wages and salaries have grown only modestly by historical standards. Wages and salaries have grown at an average annual rate of 5.3 percent during the current expansion, far below the 7.1 percent average for the period since 1978 (see Table 17).
Inflation and Unemployment
The Ways and Means Committee staff projects that inflation, as measured by growth in the U.S. Consumer Price Index (CPI), will accelerate slightly to 2.1 percent in 1999, following a remarkably low 1.6 percent in 1998. Inflationary pressures have continued to remain in check during the last several years. Increasing international and domestic competition, the slowdown in global growth, a restructuring of the health care industry, as well as rising productivity have helped keep both inflationary pressure and inflationary expectations at bay. However, increases are expected within the services components of the CPI, as producers in that sector are more able to pass wage increases on to consumers due to its relative insulation from international competition. In particular, medical care services price inflation is expected to rise as the savings which the industry has enjoyed as a result of the shift toward managed care approaches its limit. Productivity is expected to grow 1.6 percent in 1999, following 2.0 percent growth in 1998. This relatively strong productivity growth contributed to the low inflation environment. The national unemployment rate is expected to average 4.4 percent in 1999, following an average of 4.5 percent in 1998.
The average short-term interest rate, as measured by the yield on three-month Treasury bills, stood at an average of 4.8 percent for 1998. The average long-term rate, as measured by the yield on ten-year government notes, stood at 5.3 percent. Actions by the Federal Reserve are expected to keep interest rates for 1999 somewhat below their 1998 levels—4.4 percent for short-term rates and 5.2 percent for long-term rates. In contrast, the yield on Aaa corporate bonds is expected to average 6.4 percent for 1999, almost the same as for 1998.
Corporate Profits and the Stock Market
The global economic crisis has taken its toll on U.S. corporate profits. Profits are estimated to have declined 1.5 percent in 1998, but are projected to grow 4.3 percent in 1999. Corporate profits, which have been strong since the beginning of the national recovery, slowed down significantly during 1998, mainly due to the global financial turmoil and declining demand for U.S. exports. However, we expect that whatever losses were incurred in 1998 were fully written off by the end of the year. Hence, a more positive outlook is warranted for 1999, as world financial markets recover their stability, and the condition of the international economy improves.
Stock prices, as measured by Standard and Poor's Index of 500 common stock prices, is projected to grow 15.4 percent on an annual average basis for 1999, following 24.2 percent growth for 1998 (see Table 17).(16)
The Ways and Means Committee staff forecast of 3.3 percent for overall economic growth in 1999 is above the Blue Chip Economic Consensus forecast of 2.9 percent. The Blue Chip Economic Consensus is a compendium of the forecasts of 50 private sector groups. Some of these forecasters may not have incorporated the latest data released in late January. As of February 1999, Standard and Poor’s DRI was predicting real GDP growth of 3.4 percent for 1999. As of February 1999, the WEFA Group was predicting real GDP to grow by 3.2 percent for 1999. The New York State Division of the Budget predicts growth of 3.2 percent for 1999 (see Table 19).
Risks to the National Forecast
The most substantial risk to this forecast remains the global economic crisis which originated in East Asia. The Ways and Means Committee staff forecast is based on the assumption that export production will begin to recover before the end of 1999. However, if neither Japan nor Korea can bring about an improvement in the current situation, the U.S. trade balance could deteriorate even more than we expect, reducing real GDP growth below the forecast. Moreover, if Brazil falls into an even more severe recession, U.S. economic growth could turn out to be less than predicted.
A more severe global recession than anticipated could also affect the Committee staff’s baseline forecast for U.S. corporate profit growth. There are two possible ways that global recession can affect corporate profits. The first is through the demand for U.S. exports; the second is through demand for the products produced by the subsidiaries of U.S. firms located in those countries which are at risk. The latter is often referred to as direct foreign investment and accounted for 13 percent of the profits earned by U.S. corporations in 1996, but only 11.5 percent in 1998.(17) Lower profits could ultimately reduce domestic business investment and result in worker layoffs.
Greater layoffs than anticipated could result in lower employment growth and a higher unemployment rate than predicted. This employment effect could translate into lower consumption growth than anticipated. Of course, the possibility that the global economy will begin to rebound sooner than expected—producing stronger than anticipated exports, profits, employment, and consumption—poses an upside potential to our forecast.
Of course, the uncertainty related to the stock market poses a significant risk to the forecast. If the exuberance which investors have exhibited for most of the last four years should produce even greater market growth than projected, then we may see a positive impact on consumption growth via the wealth effect. Similarly, if global uncertainty, particularly as related to Latin America should drive markets down, consumption growth could fall below expectations.
Finally, the millenium bug presents a risk to our forecast. If firms spend more in 1999 than we anticipate to fix the problem, then GDP, employment, and wage growth will all be stronger than we predict. If consumers and firms feel even less confident about the readiness of major electronic systems, such as transportation, utilities, and the electronic payments system, than we anticipate, then growth will be lower than projected. However, if consumers and firms feel even more confident about these systems, growth may be even higher.
NEW YORK STATE ECONOMIC FORECAST
Short-term prospects for economic growth in New York continue to be tied to the success of both the national economy and Wall Street in overcoming the impact of the global recession.
The Committee staff projects that the New York economy will generate 130,700 jobs in 1999, for growth of 1.6 percent (see Table 20). This is below the expected rate of national employment growth of 2.0 percent. New York is estimated to have added 160,000 jobs in 1998, for growth of 2.0 percent.
By far, the biggest employment gains have occurred in the services sector, a trend which is expected to continue (see Table 20). Services sector employment is predicted to grow by 3.2 percent in 1999, following 3.7 percent growth in 1998. The Committee staff is also forecasting net job gains in the trade sector for 1999 with expected growth of 1.0 percent, following 1.3 percent growth in 1998. The construction sector is predicted to grow by 4.9 percent in 1999, following an estimated increase of 6.8 percent for 1998. The utilities sector is expected to increase by 0.5 percent in 1999, following a 1.1 percent increase in 1998.
The long-term decline in the State's manufacturing sector is expected to continue. The Committee staff predicts a 0.4 percent decline in manufacturing employment for 1999, following a decline of equal magnitude for 1998. Since 1978, manufacturing employment has been falling at an average rate of 2.3 percent per year. This trend deteriorated further with the onset of the last recession when the average annual rate of decline rose to 2.7 percent. Total manufacturing employment now stands at about 921,600 workers in 1998, compared to over 1.6 million in the mid-1970's.
The forecast for government employment calls for an increase of 0.7 percent in 1999 following 0.6 percent growth in 1998. The number of federal government employees in New York State has been falling since 1990 due to the downsizing of the federal government, particularly the defense department. On the other hand, local governments have slightly increased their employment levels.
As we have explained in previous Committee publications, the unique composition of the New York economy can support strong income growth, even in the absence of strong growth in employment. Over the past twenty years, personal income has grown at a substantially higher average annual rate than employment. Since 1978, employment growth has averaged 0.8 percent per year while personal income grew at an average of 6.7 percent. Even after adjusting for inflation, real personal income grew at 1.9 percent per year, more than doubled the rate of job growth.
Personal income grew by 5.3 percent in 1998, and is predicted to grow 4.6 percent in 1999 (see Table 21). The historical data series for State personal income has recently undergone substantial revision due to a change in methodology by the Bureau of Economic Analysis of the U.S. Department of Commerce. For this reason, the current Committee staff estimate for 1998 and the forecast for 1999 are not comparable with those of the past (see Box 1). The largest component of New York personal income, wages and salaries, grew 7.5 percent for 1998 and is expected to grow by 5.9 percent for 1999.(18) Much of the decline in income growth forecast for 1999 is due to a decline in the growth of finance industry bonus earnings. That decline is largely related to the hit which Wall Street firms took during the third quarter as a result of the global financial crisis.
Comparison with Other Forecasting Groups(19)
As of December 1998, the WEFA Group was predicting New York State personal income growth of 4.3 percent for 1998, followed by 5.0 percent growth for 1999. They also predict wage and salary growth of 7.1 percent for 1998 and 6.2 percent for 1999. For nonagricultural employment, WEFA is predicting growth of 1.5 percent for 1998 and 1.2 percent for 1999.
According to Standard
and Poor’s DRI’s February 1999 forecast, State personal income is expected to
grow 5.1 percent for 1998, followed by 4.3 percent growth for 1999.
DRI is forecasting wage and salary growth of 6.5 percent for 1998, and
4.3 percent for 1999. DRI expects non-farm employment to grow 1.5 percent
in 1998 and 0.7 percent in 1999. As of February 1999, the Executive was
forecasting personal income growth of 4.7 percent for 1998 and 4.5 percent
for 1999. The Executive predicts employment will grow by 1.9 percent in
1998 and 1.4 percent for 1999 (see Table 22).
The uncertainty that surrounds the global economy is expected to be the primary source of risk to the State as well as the national forecast. If either global or national economic growth slows down by more than we are predicting for 1999, then our forecast for the State will have been overly optimistic. Not only would State exports to both its international and domestic trading partners be affected, but Wall Street as well. The volume of bond and equity underwritings did begin to rebound during the fourth quarter from their third quarter woes, benefiting substantially from an expansionary federal monetary policy. Should the markets be hit by another shock, we might see a more lasting downturn in corporate underwritings. This would result in lower Wall Street profits and, hence, lower bonus income than predicted.
On the other hand, should there be more merger and acquisition activity than expected, the opposite might come to pass. Moreover, stronger corporate profits than expected could result in higher bonus income as well as stronger stock market growth than predicted, producing in turn, higher profits on Wall Street, and, again, higher bonus income.
Statistical and Narrative Summary of the Executive Budget
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New York State Revenue Report
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New York State Expenditure Report
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