Laura L. Anglin
First Deputy Fiscal Director

Another "Soft Landing" for the U.S. Economy

• The current economic expansion in the United States is the longest on record.
• Economists are now watching carefully to see if the Federal Reserve can maintain a second "soft landing" for the economy-a moderate economic slowdown with no recession-following their most aggressive easing of interest rates since 1982.

• It remains unclear whether the "new economy" of low inflation and low unemployment is a temporary phenomenon. However, several key ongoing factors-the shift of employment away from manufacturing and toward services; careful monitoring by the Federal Reserve; intense competition engendered by global economic integration; and a resurgence in productivity growth-make it likely that, when compared to the period prior to 1982 (the beginning of our previous expansion), national business cycle expansions will be longer and recessions will be shorter.

• The NYS Assembly Ways and Means Committee staff predicts that the national economy (real Gross Domestic Product, or GDP) will grow 2.4 percent during 2001. Although this forecast is less than the 5.0 percent growth for 2000, the strongest annual figure since 1984, it nevertheless represents sound economic expansion that is sustainable without an increase in the current rate of inflation (see Figure 1).

• The NYS Assembly Ways and Means Committee staff expects productivity growth for the nonfarm business sector to be 2.9 percent this year, which is consistent with the reduction in the rate of GDP growth expected.

• The new economy appears to be having a favorable impact on New York State.
• Although consumer confidence has dropped to the lowest level since 1996-with unemployment remaining low and the ratio of household net worth to disposable income still high, despite a much tamer stock market-there is little reason to believe that consumption growth will fall enough to threaten the viability of the expansion.

Employment

• A shift toward a service economy has occurred in New York, and the State's business services industry has shown the most consistent strength of any industry since the end of the last recession in the early 1990's.
• Overall, New York State employment grew 2.7 percent in 1999-the highest rate of growth since the mid-1980's-increased 2.0 percent in 2000, and is forecast to grow by 1.4 percent in 2001. The Federal Reserve's success thus far in maintaining relative price stability has been a boon to the financial markets, which play an important role in employment growth in New York City.
• The NYS Assembly Ways and Means Committee staff projects that New York State employment will grow 1.4 percent in 2001, generating about 123,500 new jobs. For the year 2001, the Committee staff forecasts that employment growth rates for New York State will exceed those of the United States.
• New York State employment grew faster than the United States in 1999. However, since the current U.S. expansion started in 1991, employment in the New York has grown at about one-half the rate of the nation (see Figure 2).

• Economic growth in New York State continues to be strongly tied to the national economy as well as Wall Street.
• New York's unique economy can support income growth, even without strong growth in employment. In fact, since 1979, annual real personal income has grown at roughly double the rate of job growth.
• The NYS Assembly Ways and Means Committee staff projects that wages and salaries will grow by 5.7 percent in 2001, following growth of 9.2 percent in 2000. The high rate of growth in 2000 was driven largely by Wall Street, and especially by bonus earnings in the financial sector and stock options exercised.

• Benefits of a more integrated global economy have proven to be quite variable across the regions of New York State. Upstate manufacturing employment began to fall in July 1998, following a short period of growth immediately prior. The Western New York region saw virtually no growth in 1998, and has seen very little improvement since then.
• In contrast to upstate's slow employment growth, many downstate areas have seen significant growth due to more integrated global markets. International demand for financial market services, such as those related to merger and acquisition activity, has increased. Global integration has produced a strong wave of merger and acquisition activity.

The current economic expansion in the United States is the longest on record. A crucial debate among economists has centered now around the question of whether the Federal Reserve will be able to once again successfully maintain a soft landing-a moderate economic slowdown with no recession. How many more interest rate cuts will it take to maintain the momentum of this economy? How much of an impact will unpredictable energy prices have on domestic prices and consumer demand?

Prior to the problems in the Middle East and the resulting jump in oil prices at the end of last year, many felt that another quarter-percentage point increase in the Federal Reserve Bank's federal funds target rate might have been all that would have been required to keep the economy on a steady growth path for the foreseeable future. Few would argue that the economy's growth rate through early last year could be sustained without sacrificing price stability. However, based on the experience of the last four years, the Federal Reserve appears to believe that the economy can sustain growth rates of close to four percent without igniting a lasting surge in general inflation.

The above conclusion rests on the key assumption that today's low-inflation, low-unemployment environment, the so-called "new economy," is not merely a temporary phenomenon. As stated in the NYS Assembly Ways and Means Committee staff's February 2000 economic report, national business cycle expansions can be expected to be longer and recessions shorter than the period prior to 1982. We attributed this phenomenon largely to four factors: the shift of employment away from manufacturing towards service production; the careful monitoring by the Federal Reserve; the intensely competitive forces engendered by global economic integration; and the resurgence in productivity growth.

National Economic Outlook

For the year 2001, the Ways and Means Committee staff projects continued growth of 2.4 percent in real U.S. Gross Domestic Product (GDP), following growth of 5.0 percent in 2000-the strongest annual figure since 1984. While we expect to see a moderation in the rate of general inflation, an increase in the near-term would be attributed almost exclusively to the diffusion of higher energy prices.

Three key factors will prevent increases in the cost of energy from generating the wage-price spiral experienced three decades ago. First, the U.S. economy is more service-oriented and requires fewer BTUs of energy to produce a given dollar of GDP. Second, the forces of global competition, which are far more relevant to our daily economic life today than in the 1970's, will inhibit the ability of firms to raise the prices of their products. Third, accelerating technology-related investment has fueled productivity growth, allowing firms to earn solid profits despite higher energy costs. Implicit in this scenario is the absence of a global energy crisis caused by further deterioration in the Middle East.

Slower Growth for 2001

Amid rising concerns over an economy that was perceived as growing too quickly, the Federal Reserve began raising interest rates in June 1999. The higher interest rates were expected to slow the vigorous growth in consumption, but not before the end of 2000, particularly in durable goods. As the Federal Reserve increased short-term interest rates six times over the twelve-month period between June 1999 through May 2000, the impacts on the economy began to be felt.

However, as the economy began to slow, it soon became clear that the high growth to low growth transition had developed into a no-growth situation. Faced with strong signals that the economy may have stalled, the Federal Reserve reversed policy and began to reduce interest rates in an attempt to prevent the slow down-or "soft landing"-from developing into on economic downturn-or recession. Because determining the exact path of the economy at a specific point in the present is a complex process, analysts are faced with determining "after the fact" whether or not the economy in fact slowed to nearly no-growth, or if it fell into a recession. A so-called "turning point" is when the aggregate economy transitions from positive growth to negative growth, or vise-versa.

The Committee staff feels that the economy has not gone from positive growth to negative growth. Rather, we feel the economy is at an inflection point. After a period of growth, we have now slowed to nearly no-growth but will resume positive economic growth in the second half of this year. Because there is a time lag before the effects of changes in monetary policy are fully felt, the Federal Reserve's aggressive rate reductions in January of this year were clearly seen as a commitment to ensure the economy did not slip into a recession (a.k.a. hard landing).

While a federal tax cut seems likely to be implemented some time this year, it is not yet clear when a tax cut would take effect or precisely what effects it will have. However, the Committee staff believes that any federal tax cut would further ensure a return to moderate growth in late 2001 and into 2002.

So although economic growth may be slow in the first half of 2001, the outlook for the latter half of the year and for 2002 is brighter. In fact, the February 2000 Blue Chip Consensus is predicting growth for the real GDP of 3.5 percent in 2002.

State Economic Outlook

The new economy appears to be having a positive impact on New York State. A shift toward a service economy has occurred in New York, where the State's business services industry has exhibited the most consistent strength of any industry since the end of the last recession. The Federal Reserve's success in maintaining relative price stability has been a boon to the financial markets, which play an important role in employment growth in New York City. Overall State employment grew by 2.7 percent in 1999-the highest rate of growth since the mid-1980's-then increased 2.0 percent in 2000, and is expected to grow by 1.4 percent in 2001. For the years 1999 and 2001, the Committee Staff estimates that employment growth rates for New York State will exceed those of the U.S., thus reversing a trend throughout the current expansion during which national employment growth exceeded State employment growth.

Wage growth has accelerated in each year since 1993, reaching a rate of growth of 9.2 percent in 2000. However, due to a slower growth in the economy, stock options exercised, and bonuses-wages are expected to grow by 5.7 percent this year.

Regional Variations

However, the benefits of a more integrated global economy have proven to be quite variable across the regions of New York State. Upstate manufacturing employment began to fall in July 1998, following a short period of growth immediately prior. The Western New York region saw virtually no growth in 1998, and has seen very little improvement since then.

In contrast, many downstate areas have seen significant growth due to more integrated global markets. International demand for financial market services, such as those related to merger and acquisition activity, has increased. Global integration has produced a strong wave of merger and acquisition activity. While it is true that global integration makes every economy vulnerable to the crises of another, Wall Street recovered fairly quickly from the deepening of the Asian financial crisis in the Fall of 1998, and went on to earn a record level of profits in both 1999 and then again in 2000. Wall Street profits in 2001 are expected to be at the same level as in 2000.

Real Gross Domestic Product

The NYS Assembly Ways and Means Committee staff predicts that the national economy, as measured by real U.S. Gross Domestic Product (GDP), will grow 2.4 percent during 2001 (see Table 1). Although this forecast is below the 5.0 percent growth experienced in 2000, which is the strongest annual figure since 1984, it still represents continued economic expansion. The Committee staff believes this rate of growth is sustainable without an increase in the current rate of inflation (see Figure 3).

Consumer spending is projected to grow 2.8 percent in 2001, following 5.4 percent growth for 2000 (see Table 1). Much of this slowdown is related to the realization of the full impact of the Federal Reserve's six interest rate increases since June 1999 and the recent spike in energy prices. Employment growth will decline in 2001, putting downward pressure on consumption growth.

Consumption is comprised of three major types, all of which have remained strong over the last several years (see Figure 4). Services consumption is the largest component of real consumption-representing about 55 percent of the total-as well as the least volatile. This component includes housing, household energy, and other household operation services; as well as transportation and medical services. Services consumption growth is decelerating from a rate of 5.2 percent in the first quarter of 2000 to 4.6 percent in the second quarter and 3.8 percent in the third quarter, although it rose by 5.3 percent in the fourth quarter. On an annual basis, services consumption is expected to increase by 3.4 percent in 2001, following an increase of 4.5 percent in 2000.

The second largest component of overall consumption is nondurable goods, including such items as food, apparel, and gasoline. Comprising roughly 30 percent of real consumption, growth in consumption of nondurables slowed from 6.0 percent in the first quarter of 2000 to 3.6 percent in the second quarter of 2000, with a rebound to 4.7 percent in the third quarter, and a drop to a 0.8 percent rate in the fourth quarter. On an annual basis, nondurable goods consumption is expected to increase by 2.2 percent in 2001, following a gain of 5.0 percent in 2000.

Consumption of durable goods is the smallest and most volatile component of consumer spending, comprising roughly 15 percent of the total. Growth in consumption of durable goods slowed dramatically from 23.6 percent in the first quarter of 2000 to a drop of 5.0 percent in the second quarter of 2000, followed by a gain of 7.7 percent in the third quarter and a decline of 3.4 percent in the fourth quarter. While motor vehicles have shown great strength in the past few years, computers (which figure prominently in both consumer spending and investment spending) are by far the fastest growing components of both real and nominal consumer spending. On an annual basis, durable goods consumption is expected to increase by 1.7 percent in 2001, following a gain of 9.6 percent in 2000.

The Ways and Means Committee staff is predicting investment growth of 4.3 percent for 2001, following growth of 10.3 percent for 2000. Although the overall rate of investment growth will be less in 2001, its composition will look much different. Higher interest rates reduced residential investment in 2000, with a slight rebound expected in 2001 to a level still below that attained in 1999. The growth in residential investment slowed from 3.2 percent in the first quarter of 2000 and 1.3 percent in the second quarter of 2000 to a decline of 10.6 percent in the third quarter and 2.5 percent in the fourth quarter of 2000. On an annual basis, residential investment is expected to advance 2.0 percent in 2001, following a decline of 0.5 percent in 2000.

However, non-residential fixed investment, which includes computers and software, is expected to post further gains in 2001 as firms continue to perform technological upgrades and move into the 21st century. We expect business fixed-investment to advance 7.2 percent in 2001, following a gain of 12.5 percent in 2000. It is important to note that the non-computer piece of investment spending is slowing, i.e., the non-technology segment of producers durable equipment has been experiencing weakness in the last couple of quarters.

Net Exports

The Committee staff predicts export growth of 6.0 percent for 2001, down from the 9.2 percent growth experienced in 2000. This projection is consistent with continued expansion of the international economy. Import growth is expected to slow from 13.7 percent in 2000 to 8.7 percent in 2001.

Government Spending

Real government spending grew 2.8 percent in 2000, with spending rising 1.5 percent at the federal government level and 3.5 percent at the State and local levels. For 2001, the Committee staff anticipates that government spending will slow-increasing 1.2 percent at the federal level and 2.7 percent at the State and local levels, for combined growth of 2.2 percent.

Employment

Consistent with a slowdown of the U.S. economy, the Committee staff predicts national employment growth to slow to 1.2 percent in 2001 from 2.1 growth during the previous year (see Table 2). The national unemployment rate is expected to average 4.4 percent in 2001, slightly higher than the 4.0 percent for 2000.

The services sector is expected to lead the economy in job creation in 2001 with growth of 2.6 percent, following 3.5 percent growth for 2000. Retail trade employment is expected to grow 0.9 percent in 2001, following 1.5 percent growth for 2000. The transportation, communication, and utilities sector is projected to grow 2.4 percent in 2001, just below the 2.5 percent rate for 2000. Construction industry job growth is expected to slow down to 2.6 percent in 2001, following growth of 4.5 percent for 2000. Manufacturing employment fell 0.5 percent in 2000. The downward trend will worsen in 2001 with an expected drop of 1.4 percent in 2001. Government sector employment is expected to grow 0.1 percent for 2001, following 2.0 percent growth for 2000.

Personal Income and Wages

Personal income increased 6.3 percent in 2000, with its largest component, wages and salaries, growing 6.7 percent. The Committee staff anticipates that growth in personal income will continue at a 4.5 percent pace in 2001, with wages growing 5.2 percent.

Thus far during the current expansion, personal income and wages and salaries have grown only modestly by historical standards, primarily due to the fact that employment growth was relatively slow during the first four full years of the expansion. However, employment growth has picked up during the past five years, and record breaking profit levels on Wall Street have produced phenomenal growth in bonus income within the securities industry. In addition, there has been a significant rise in the granting and exercising of stock options. Consequently, average annual wages and salaries growth has increased.

Executive Compensation

The share of employee compensation coming from wages has declined over time. The variable components of wages such as bonuses, stock options exercised, and restricted stock have increased.

For example, in 1995, salaries for executive's accounted for 30 percent of total compensation and only 16 percent in 1999, while compensation from stock options exercised from stock options granted nearly doubled from 27 percent to 51 percent (see Figure 5).

Another way to look at this phenomenon is focusing on the growth of salaries compared to the growth of stock options exercised. Salary grew by 25.1 percent from 1995 to 1999, while stock options exercised grew by 353.4 percent-or almost 14 times faster.

The Ways and Means Committee staff projects that inflation, as measured by growth in the U.S. Consumer Price Index (CPI), will be 2.7 percent in 2001, following 3.4 percent growth in consumer prices for 2000. Inflationary pressures continue to remain in check due to rising international and domestic competition, as well as higher productivity growth. However, the risk of higher-than-expected inflation for 2001 exists due primarily to the potential rise in energy prices (both independent of and related to the turmoil in the Middle East) and an upward pressure on world commodity prices fueled by better-than-expected economic recovery overseas. Moreover, medical care services price inflation is expected to rise as the cost reduction, which the industry has recently enjoyed as a result of the shift toward managed care, continues to approach its limit.

Interest Rates

The average short-term interest rate, as measured by the yield on three-month Treasury bills, was 5.8 percent for 2000, incorporating three increases in the Federal Reserve's federal funds rate target in February, March, and May of 2000. The Committee staff forecast for 2001 of 4.9 percent presumes additional interest rate cuts, subsequent to the January 31 Fed rate reduction, totaling 50 basis points. The average long-term rate, as measured by the yield on ten-year government notes, averaged 6.0 percent for 2000, and is forecast to fall to 5.0 percent for 2001.

Corporate Profits and the Stock Market

U.S. corporate profits grew a strong 12.8 percent in 2000, after having increased at an 8.5 percent rate in 1999. The Ways and Means Committee staff projects growth to slow to 1.4 percent in 2001, owing to the slowing of the economy and the inability of firms to pass much of their cost increases on to buyers due to competitive pressures.

Stock prices, as measured by Standard and Poor's Index of 500 common stock prices, are projected to grow 0.6 percent on an annual average basis for 2001, following 7.6 percent growth in 2000 (see Table 1). The Committee staff forecast presumes that the market should return to a steady growth path, following a couple quarters of decline, much as it did in 1995. The Committee staff's annual average forecast for the year 2001 is 1,435.0, virtually unchanged from 1,426.7 for 2000.

Comparison with Other Forecasting Groups

The Ways and Means Committee staff forecast of 2.4 percent for overall economic growth in 2001 is above the Blue Chip Economic Consensus forecast of 2.1 percent, Standard and Poor's DRI forecast of 2.1 percent, and the WEFA Group forecast of 2.0 percent. The Blue Chip Economic Consensus is a compendium of the forecasts of 50 private sector forecasters. The NYS Division of the Budget is predicting growth of 2.7 percent for 2001 (see Table 3). Note: On February 13, the Executive revised their forecast downward. Their new 2001 forecast for real GDP growth is 2.2 percent.

Short-term prospects for economic growth in New York continue to be tied to the success of both the national economy and Wall Street.

Employment

The New York State Assembly Ways and Means Committee staff projects that the New York economy will generate about 123,500 jobs in 2001, for growth of 1.4 percent (see Table 4). This is slightly above the expected rate of national employment growth of 1.2 percent. New York State added about 167,900 jobs in 2000 for growth of 2.0 percent, 0.1 of a percentage point below the national rate. By far, the biggest employment gains have occurred in the services sector, a trend that is expected to continue (see Table 4).

The long-term decline in the State's manufacturing sector is expected to continue in 2001. Manufacturing employment losses were 2.1 percent in 1999. Total manufacturing employment stands at about 883,000 workers in 2000, compared to over 1.6 million in the mid-1970's.

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. Between 1990 and 1999, federal government employment in New York State decreased 16.5 percent. State government employment also fell during the 1990-1999 period, posting a 10.3 percent drop. On the other hand, local governments have slightly increased their employment levels, rising by 2.5 percent.

Personal Income and Wages

The composition of the New York economy (i.e., Wall Street and the financial services sector) can support strong income growth, even in the absence of strong growth in employment. Over the past two decades, personal income has grown at a substantially higher average annual rate than employment. Since 1979, employment growth has averaged about 0.8 percent per year while personal income grew roughly 6.5 percent on average. Even after adjusting for inflation, real personal income grew at roughly 1.9 percent per year, about double the rate of job growth.

Personal income is estimated to have grown by 7.8 percent in 2000, and is predicted to grow by 5.3 percent in 2001 (see Table 5). The largest component of New York personal income, wages and salaries, is estimated to have increased 9.2 percent for 2000 and is expected to rise 5.7 percent for 2001.

Comparison with Other Forecasting Groups

For 2000, the Executive and the Ways and Means Committee staff expect somewhat stronger growth in personal income and wages and salaries than do WEFA and DRI. This is due to the fact that both the Executive and the Committee staff estimates are based on NYS Department of Labor's ES 202 data, rather than U.S. Bureau of Economic Analysis (BEA) data. Due to substantial revisions often experienced by BEA data (for a complete explanation, see footnote 11, page 14), the ES 202 usually provides a more accurate picture of the current economic measures. The Committee staff expects that BEA data revisions will result in an upward revision to the BEA series, resulting in estimated growth rates more similar to those estimated by the Executive and the Committee staff.

For 2001, the wages and salary forecasts all call for slower rates of growth, consistent with a slowdown in the aggregate national economy. Similarly, personal income and employment growth rates also call for slowing growth.

Risks to the National Forecast

Downside Risk

The NYS Assembly Ways and Means Committee staff forecast presumes continuing conditions of low inflation, declining interest rates, and a successful soft landing. An unanticipated increase in raw material prices due to, for example, a shock to the highly volatile oil market, could increase inflationary pressures. Such a shock would likely alter the Federal Reserve's monetary policy stance. A stronger-than-expected stock market correction could have a negative impact on consumption, producing slower than expected growth in GDP. Similarly, a continuation of the current drop in consumer confidence would alter the expected rebound in the recovery during the second half of this year. A further deterioration in the current electricity and natural gas markets (higher prices coupled with supply shortages and resultant blackouts) would also affect national employment, output, and the price level.

Upside Potential

Corporate profits may be higher than anticipated, on the other hand, as firms reap the benefits of increased productivity that, in turn, could produce both larger corporate bonuses, as well as higher stock market growth. If productivity were to increase faster-than-expected, due to greater-than-expected diffusion of technology (or capital-deepening), there would be additional upside potential to the forecast. An earlier-than-expected tax cut and a substantial reduction in federal wage withholding would also have a positive impact on the outlook for 2001. Higher stock market growth could, in turn, produce higher profits on Wall Street resulting in larger finance sector bonuses and, therefore, greater income growth. The reinvigoration of the economies of the nation's primary trading partners, particularly the European Union, Canada, and Japan, could result in stronger than expected export growth, and, hence, stronger GDP growth. The possibility of a weaker world economy, conversely, creates downside risk for our forecast.

Risks to the New York Forecast

Downside Risk

The uncertainty that surrounds the national economy is expected to be the primary source of risk to the New York State forecast. If the national economy slows down more than we have predicted for 2001, then our forecast for the State will have been overly optimistic. Should unanticipated inflationary pressure emerge, the Federal Reserve is likely to adopt a more restrictive monetary policy resulting in higher interest rates (i.e., the failure to continue the interest rate cuts initiated with the January 3 policy stance change and the accompanying interest rate reductions on January 4 and 31). This policy change would restrain State income growth due to the pivotal role of the FIRE sector to the State economy. A stronger than expected stock market correction could have a similar impact.

Upside Potential

Stronger corporate profits than expected, on the other hand, will 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. The possibility of a stronger world economy also creates upside potential for our forecast.

The nation's longest economic expansion on record is now in its 119th month (February 2001, starting from April 1991). For this, the Federal Reserve can claim some credit. Moreover, the character of the slowdown appears quite favorable to continued growth over the long-term, barring an unforeseeable economic shock. Moderating growth in consumption coupled with growth in business investment can be expected to produce sustainable growth in an environment characterized by low unemployment, low inflation, and solid productivity growth. This fortuitous combination supports the Committee staff's outlook for continued but slower growth of 2.4 percent for 2001.

A Portrait of a Slowdown

The high flying national economy has decelerated from growth of 7.0 percent in the second half of 1999 to growth of 5.0 percent in 2000. The slowdown is occurring approximately one year after the Federal Reserve's first interest rate hike in June 1999, although a few signs appeared earlier. With private sector borrowing costs at their highest levels in a decade at the end of 2000, the economy's slowdown is most visible in such interest rate-sensitive sectors as construction and durable goods manufacturing. While the unemployment rate remains low, jobs have actually been lost in the nation's manufacturing sector. Other signs of slower growth include declines in hours worked, inventory build-ups, and reductions in some prices at the wholesale level.

The slowdown is being led by consumers, who pulled back from spending growth of 7.9 percent in the first quarter of 2000 to growth of 2.9 percent for the second quarter, 4.6 percent for the third quarter, and 2.7 percent in the fourth quarter. While it appears consumers are indeed responding to the Federal Reserve's six interest rate increases (prior to the shift in policy on January 3 of this year), it is not clear precisely through what channels. The second quarter saw a significant financial market correction. Are consumers responding directly to an increase in borrowing costs, or are they responding to the impact of higher rates on the value of their stock market wealth?

Trends in Business Investment

In contrast to the moderation in consumption growth, private business investment appears to remain relatively solid, as firms continue to invest in information technologies expected to increase efficiency and, hence, profits. These layouts have resulted in increased purchases of computers and other durable goods orders, particularly those related to business-to-business infrastructure building. Growth in private fixed-investment spending for equipment and software accelerated during the first half of 2000 to 19.2 percent from 14.7 percent for the first half of 1999. This combination of lower consumption and continued strong investment may represent the best of all possible worlds for the Federal Reserve. With spending growth strongest in areas that will ultimately increase productivity, we can expect continued growth without a dramatic acceleration in inflation over the long-run. Since it takes time for technological changes like those we are now witnessing to disseminate throughout the entire economy, we can expect this process to remain ongoing.

Need there be a concern that the Federal Reserve may have overshot its target and that the economy may slow too much? Although consumer confidence has dropped to the lowest level since 1996, with unemployment remaining low and the ratio of household net worth to disposable income still high, and despite a much tamer stock market, there is little reason to believe that consumption growth will fall enough to threaten the viability of the expansion.

The Committee staff expects consumption growth to continue to moderate into 2001. Growth of 2.8 percent for 2001 is expected to follow 5.4 percent growth for 2000. This moderation in consumption will be accompanied by continued growth in investment of 4.3 percent in 2001, following growth of 10.3 percent in 2000.

Soft Landing II

The debate among economists still centers around how successful the Federal Reserve will be in once again engineering a soft landing. Our persistent low-inflation, low-unemployment environment-the hallmark of the new economy-may indeed be here to stay for some time to come. Business cycle expansions can be expected, on average, to be longer, and recessions to be shorter and less painful than those before 1982. This phenomenon is largely due to four factors: the economy's shift away from manufacturing towards service production; the careful monitoring of the Federal Reserve; the forces of global integration; and the resurgence of productivity growth.

Historically, there has been a close relationship between attempts by the Federal Reserve to slow the economy and the onset of an economic downturn. Contractionary monetary policies, which raised the federal funds rate and, consequently, other short-term interest rates, have been associated with national recessions with only three exceptions. Only during 1966, 1984, and the current expansion (circa 1995) did the Federal Reserve successfully manage soft landings-or moderate slowdowns with no recession-enabling the U.S. economy to experience its two longest post-war expansions. For example, real GDP grew by 6.6 percent in 1966, but was reduced by the Federal Reserve's actions to a weaker but positive 2.5 percent in 1967. Similarly, real GDP grew by 7.3 percent in 1984, but slowed to 3.8 percent in the following year. Real GDP increased by 4.0 percent in 1994, but fell back to a 2.7 percent pace the following year. The first soft landing of the current expansion followed seven interest rate hikes over a 13-month period between February 1994 and February 1995; what is potentially our second soft landing of the current expansion followed six interest rate hikes over a 12-month period between June 1999 and May 2000.

Managing Economic Cycles

Research results published several years ago by Data Resources, Inc. (DRI) indicate that during the post-World War II period, the national economy exhibited a decisive response-either an official National Bureau of Economic Research cyclical peak or a soft landing-to the Federal Reserve's interest rate hikes with an average lag of 13 months. In December 2000, we were in the nineteenth month of monetary tightening. Although annual GDP growth remained relatively high, the growth rate on a quarterly basis has been somewhat reduced. For example, GDP grew by 4.4 percent in both 1997 and 1998, and increased by 4.2 percent in 1999 and 5.0 percent in 2000; however, the quarterly rate has come down from a meteoric 8.3 percent in the final quarter of 1999 to a 4.8 percent and a 5.6 percent rate in the first and second quarters of 2000, and only 2.2 percent in the third quarter, and just 1.4 percent in the fourth quarter-the weakest pace since 1995.

The question remains: Will the Federal Reserve be able to manage yet another soft landing as it did in 1966, 1984, and 1994-without producing a recession this year? Or are current economic conditions too different from those that existed in prior years? Did the Fed wait too long to change its policy stance and reduce interest rates on January 3 of this year? The Federal Reserve continues to scrutinize the economy's rate of expansion and price growth with vigilance, ready to act on any signs of inflationary pressure. The Fed successfully engineered a soft landing for the national economy by raising short-term interest rates seven times between February 1994 and February 1995. These actions effectively turned the clock back, giving the current expansion more of the characteristics of a young, rather than a mature, expansion.

Thus, by the middle of 1999, the Federal Reserve was faced with a situation similar to the one in early 1994-growth was so strong that it could potentially threaten price stability. In June 1999, the central bank shifted its policy stance yet again in order to slow the economy's momentum. The federal funds target rate was raised six times between June 1999 and May 2000. However, with consumer confidence down from record highs, along with consumption growth and the public's appetite for technology stocks slowing, the Federal Reserve, in its most aggressive easing move since 1982, cut interest rates twice in January 2001 in order to ensure the continuation of the current expansion. The Fed can be expected to further reduce interest rates this year in two moves (totaling 50 basis points) in order to keep the economy on track for a soft landing in 2001.

The Federal Reserve was sufficiently encouraged that economic growth was slowing enough to keep inflation in check that they decided to leave interest rates unchanged at their November 15, 2000 meeting. Given that decision, a key interest rate controlled by the Federal Reserve-the federal funds rates-stayed at 6.5 percent, the highest level in nine years. It marked their fourth meeting in a row in which the Federal Reserve passed up the chance to raise rates for a seventh time. The Fed left interest rates unchanged at its October 3, August 22, and June 28 meetings, citing signs of moderating economic growth. The prime rate stood at 9.5 percent, its highest level since January 1991 when the country was in its last recession.

As of early December 2000, one would have expected that over the ensuing six months, the recent interest rate hikes would further slow the growth in consumption, especially in the case of consumer durables. Then-current interest rates would also have been expected to reduce housing market activity. Nonresidential investment, however, was expected to remain healthy despite the higher interest rates, as firms continue technology-related spending. Export growth was expected to pick up momentum as the East Asian economies recover and revive their demand for U.S. goods.

As the month of December 2000 progressed, however, the economy appeared to slow beyond that which was anticipated by both the financial markets and the Fed. With manufacturing orders down, inventories up, consumer sentiment falling, and the stock market dropping, it appeared the economy was heading toward a hard landing. In an effort to forestall a "premature" end to our current expansion, the Fed cut interest rates on January 3 between the regularly scheduled meetings (i.e., without warning). This sent a strong signal: the Federal Reserve policy stance had indeed shifted and the objective was now to prevent the current softening of the economy from progressing into a contraction/recession/hard landing. The Fed followed-up with another rate cut at its regularly scheduled meeting at the end of January, thus producing the most aggressive easing move since 1982.

Some economists believe the U.S. economy is skirting a recession much more closely than expected if we were indeed experiencing a soft landing. In fact, the drop in household wealth and consumer confidence, in addition to the slowdown of the rate of growth in business investment, does threaten to turn the soft landing into a crash landing.

It may be useful to compare the state of the economy to an airliner that is preparing to land. As the plane enters the stage of flight when it is making the transition between a descending flight path and one which is parallel to the ground, it is in an extremely vulnerable position.

A delicate balance of factors is acting on the plane-the exchange of lift for weight on the ground, decreasing thrust, and increasing drag work to slow the aircraft. Even the slightest adjustment in throttle can transform a smooth landing into a bumpy one. Any change in external conditions-a sudden wind gust-requires a quick reaction from the pilot. If necessary, the pilot can adjust course or even abort the landing, but such action requires dependable information and immediate, decisive response. Depending upon the many factors acting upon the aircraft, the result can be a continued smooth landing, or a bumpy, hard-or crash-landing. Similarly, if the Federal Reserve does not carefully monitor the economy, or is slow to respond to any unforeseen changes, the economy could very quickly transition away from a soft landing.

Productivity and Profit Growth in the New Economy

The most significant force propelling the U.S. economy forward is the ongoing process of technologically transforming itself from an energy-based to an information-based economy. This transformation is evident in the profound growth of investment in computer and computer-related hardware and software. U.S. businesses spent more than $2 trillion on computers, software, and other technological products during the 1990's. In 1999 alone, corporate spending on technology grew 22 percent to $510 billion, accounting for more than 40 percent of all business investment. This high rate of growth defies predictions made in 1999 that computer-related spending would trail off as Y2K preparations wound down.

Three key components of nonresidential fixed investment spending which enable enhanced productivity growth are investment in computers, software, and communications. For the past three years, spending on software has far-exceeded spending on the other components, and is expected to continue to do so in the future. In 2001, for example, businesses are expected to spend roughly 50 percent more on software than on computers, and roughly 45 percent more on software than on communications equipment.

These substantial increases in U.S. capital investment, particularly when compared to the growth in the size of the labor force, explains a large part of the acceleration in productivity growth over the past five years. The U.S. Department of Labor, Bureau of Labor Statistics reports that productivity growth for the nonfarm business sector rose 4.3 percent in 2000, a significant acceleration from the 2.9 percent growth experienced for all of 1999, and the largest annual increase since 1983 (see Figure 6). The Committee staff expects productivity growth for the nonfarm business sector to be 2.9 percent this year, which is consistent with the reduction in the rate of GDP growth expected.

A study by the Federal Reserve confirms that much of the jump in productivity growth since the mid-1990's can be explained by investment in new information technologies. By now, much attention has been paid to the use of information technologies to better manage and reduce the need for large stocks of inventories. In addition, the companies that produce computers and the embedded semiconductors appear to have achieved major efficiencies in their own operations, boosting productivity growth for the economy as a whole. The study concludes that the use of information technology and the production of computers accounted for about two-thirds of the one percentage point rise in productivity growth between the first and second halves of the 1990's. The study's authors estimate that much of the remainder reflects the improved managerial practices that have resulted from innovation-driven technological change.

Productivity growth has allowed firms to experience increased earnings in the face of intense competitive pressures by reducing the growth in the cost of producing goods and services. Moreover, despite a huge increase in the supply of high-tech capital assets, there is little evidence of a noticeable reduction in prospective rates of return on the newer technologies. These high rates of return permit firms to earn solid rates of profit growth despite the absence of price flexibility. The Committee staff projects after-tax profit growth of 1.4 percent for 2001, following strong growth of 12.8 percent for 2000.

Inflation and the Internet Economy

Much of the technology investment we now witness is related to business firms further integrating the Internet into both their production and sales management systems. Businesses are using information-based systems more and more extensively to conduct and re-engineer production processes, streamline procurement processes, and manage internal operations. Firms are also utilizing Internet resources to reach new customers, with manufacturers and wholesalers who once only engaged in business-to-business transactions now developing a retail capacity as well.

Has the growth of the Internet economy had the promised downward impact on inflation? Easily accessible information about what competitors around the country are charging for the same goods, as well as easy access to those goods online, should enhance overall economic competitiveness with consumers reaping the benefits in the form of lower price growth (see Figure 7).

How Internet Sites Impact Conventional Retailers

Numerous studies show prices for many products are, indeed, lower when purchased via the Internet. For example, one study concluded that books and compact disks cost an average of 9 to 16 percent less on websites than at conventional retailers, based on 8,500 prices posted over a 15-month period ending in May of last year. Another researcher compiled an Internet price index of eight different types of products, ranging from pharmaceuticals to clothing. The total basket of goods was 13 percent cheaper online than offline, including shipping charges. Prescription drugs were 28 percent cheaper and apparel 38 percent cheaper.

In addition, although Internet retail sales still comprised about one percent of total U.S. retail sales, the Web can also force prices down at conventional stores. For example, although only three percent of all car buyers actually purchase their vehicles over the Internet, about half of all buyers now use the Internet for research. This impact may be visible in several components of the consumer price index, such as that for new cars, which has been flat or negative for the past three years.

However, the ease with which information on prices can be attained, in some cases, lead to higher prices. Retailers can get quick access to prices being charged by their competitors, making them better able to judge when the market will bear a higher price. As one economist has written, the structure of the market itself may ultimately determine whether the Internet will lead to higher or lower prices. In markets where there are many competing sellers, there will tend to be more downward pressure on prices. Where there are only a few sellers, low-cost information about what they are charging could, perversely, lead to higher prices. With price information widely available, it becomes easier for suppliers to "coordinate" their pricing, thus avoiding competition.

Market structure can be expected to have a similar impact in the booming online business-to-business market. In a market where there are few buyers and many sellers, easy access to price information is likely to work for the benefit of the buyers-pushing down prices. But where there are few sellers and many buyers, the availability of timely price information may well have the opposite effect-pushing prices up.

On balance, the Committee staff expects the growth of the Internet economy to act as a restraining force with respect to inflation. That, along with continued high rates of productivity growth, will help to move the economy to a rate of inflation of 2.7 percent for the current year, following consumer price growth of 3.4 percent for 2000. This is consistent with the gradual filtering of higher energy prices through the economy last year.

The Economy and Energy

The most significant source of uncertainty surrounding the forecast for consumption is the future price of energy. With stocks of heating fuel particularly low, it is expected that energy will take a large bite out of consumer budgets this winter, especially in the Northeast. In addition, natural gas prices have risen dramatically, causing a significant increase in both heating costs and the cost to produce electricity in the U.S.

The recent increase in the price of natural gas is best explained by demand-supply analysis. Following several years of warmer-than-average winters, which reduced the demand for natural gas and thus depressed the price, the Northeast returned this year to a more normal (colder) winter weather pattern. Supply has not kept up with demand.

This situation is exacerbated by the increased reliance of electric utility generators on natural gas. As new electric utility generating plants come online in the U.S. in order to meet increased demand for electricity (owing to both increased use of computers and other electricity-driven high-technology devices, and for other residential needs), additional demands are placed on the already-strained supply of natural gas. Unfortunately, some feel much of the promised generation capacity that is supposed to save electricity markets from crisis will never be built-largely due to insufficient gas supplies. The result may very well be an electricity market in short supply, with price spikes and electricity shortages during the peak demand periods.

According to a recent report by Salomon Smith Barney (SSB), the consensus view that power plant development now underway will reduce electric prices is mistaken. According to SSB's Power/Gas Team, the proposals for new plants that have been announced fails to keep pace with expected electric demand growth in the U.S. SSB calls the availability of natural gas "the critical factor" when discussing the ability of electric generators to meet the expected levels of future demand.

In the long-run, the price of crude oil is expected to settle somewhere between $25 and $30 per barrel, significantly below the $34 per barrel where it was at the end of 2000. However, in the short-run, we suspect that the energy crunch now facing the nation and the world may play a role in 2001 similar to the role which the Asian financial crisis played in 1998. High energy prices are expected to act as more of a brake on consumption growth than a harbinger of inflation. Therefore, the Federal Reserve is not expected to have to engage in any further monetary tightening. Indeed, if the global economic expansion is sufficiently derailed by an inadequate supply of energy, such as that currently being experienced by California, the Federal Reserve may have to be prepared to lower rates further.

Recent Producer Price Index data shows that the high prices of energy are starting to be felt in core producer prices, however, the effects remain small. If energy prices remain at or near their year-end 2000 level, we will see energy costs put pressure on core inflation. Indeed, there is good evidence that energy prices will not reverse course easily. Therefore, inflationary pressures will not likely subside quickly as it takes some time for the effects of high energy prices to show up in the core index, as businesses try to pass on higher costs.

The implications for the Federal Reserve's monetary policy are that there is no need for an immediate tightening. However, the Fed will watch for any sign that high energy prices translate into rising core inflation.

Effects of Increasing Energy Prices

How is the U.S. economy going to be impacted by this turn of events in the energy price arena? The altered structure of the U.S. economy, which is now centered in services rather than energy-intensive manufacturing, and our growing use of other forms of energy such as natural gas, electricity, and coal, has helped ease our dependence on oil. However, the Energy Information Administration estimates tell us that petroleum supplied 39 percent of our energy needs in 1998. Clearly, the U.S. is still quite dependent on crude oil. While it is unlikely that the current upsurge in oil prices will plunge the U.S. economy into a recession, a prolonged increase will undoubtedly have a significant impact on the U.S. economy as corporate profits decline, inflationary expectations rise, and consumer confidence erodes-slowing down the economy. Given these factors, the question of how long these high oil prices will persist remains an important one.

Since OPEC had agreed to increase oil production by only 800,000 barrels a day at the Vienna meeting in September 2000, we certainly could not have expected a sustained price decline in the short-term. Inventories of gasoline, distillates, and heating oil had been low at the end of 2000 compared to the year-ago period. Low gasoline inventories going into last summer precluded rebuilding distillate stocks, thus setting the stage for a potential shortfall in distillate supply entering the peak demand season in the winter months. Despite a return to below-average winter temperatures, oil prices have declined since early this year owing, in part, to a softening world economy and a resultant weaker-than-expected demand. At the most recent OPEC meeting on January 17, the decision was made to cut production by 1.5 million barrels a day (5 percent) effective on February 1 in order to prevent a sustained drop in crude oil prices, which had fallen to just over $25 a barrel. So, it appears unlikely that oil prices will average much below $30 per barrel in the near term.

The longer-term outlook, however, appears more optimistic. Some non-OPEC oil producers in Canada, Latin America, Mexico, the U.S., Southeast Asia, and West Africa have started drilling projects, and if the high price is sustained, others may follow suit. Moreover, while it is in the interest of OPEC to keep short-term prices high, member countries would not want their market share to be eroded, and oil prices to collapse, especially if the global economy were to slow down. Since there is a 12- to 18?month lag between expanding output from existing fields and getting oil in the tanker, and the non-OPEC producers had only just begun their drilling activities in mid-2000, we can expect an impact on price only by around mid-2001.

International Trade

The strength of the dollar is yet another factor contributing to the relatively low rate of inflation enjoyed by the U.S. economy in recent years. However, that very strength, combined with the sluggish rates of growth for the nation's major trading partners, has engendered a trade deficit that continues to break records month after month. The declining dollar value of the euro combined with higher energy prices does not bode well for demand for U.S. exports.

On the upside, the global economy is very likely to experience in the decade ahead the same technology-led boom which has been underway in the U.S. for some years. The rapid pace of technology spending is likely to result in increased productivity growth throughout the global economy in the years ahead, increasing the demand for U.S. exports and reducing the U.S. deficit over the long-run.

The outlook for the international economy improved significantly in the first three quarters of 2000. Merchandise exports to the nation's two largest trading partners, Canada and Mexico, rose 9.5 percent and 33.7 percent, respectively, during the first three quarters of 2000. Overall, U.S. exports fell by 4.3 percent in the fourth quarter of 2000, following growth of 13.9 percent in the third quarter and 14.4 percent in the second quarter. However, imports rose by 0.5 percent, 17.0 percent and 18.5 percent, respectively, during the same periods. Furthermore, the monthly trade deficit has widened to set new monthly records throughout most of last year.

Despite the U.S. record current account deficit relative to GDP, the foreign currency value of the dollar has been rising, on average, since the end of 1999. This means that the dollar exchange rate has moved in a direction which promotes the growth of imports relative to exports. The dollar's appreciation suggests that, all things being equal, the U.S. trade deficit will set new record highs.

The Dollar Remains Strong

The relatively robust U.S. economy, and its strong currency, should continue to buoy import volumes. United States exports have rebounded from their 1998 lows despite declines in shipments to sluggish Latin American economies, other than Mexico. Perhaps the biggest problem is with the Asian economies, which accounted for roughly half of the U.S. trade deficit for the first half of 2000; trade deficits with China and Japan accounted for about one-third of the deficit. The major deterioration, however, has been against the OPEC countries as a result of rising oil prices.

At the present, one of the biggest obstacles to closing the U.S. trade deficit is the weakness of the euro vis-a-vis the dollar. Why had the euro recently plummeted to its lowest value since its inception in January 1999? According to a study by the International Monetary Fund, such economic fundamentals as interest rate differentials and the relative strengths of the respective economies can explain only about half of the euro's plunge since early last year. The weak euro fuels inflation in European Union (E.U.) countries by making imports more expensive, but is beginning to create export jitters in the E.U.'s biggest trade partner, the United States. A wider trade deficit could undermine the U.S. economy and the value of the dollar, unless the E.U. can rival U.S. growth rates.

The strength of the U.S. dollar also reflects the unprecedented inflow of foreign capital into the U.S. economy. Large amounts of foreign direct investment have helped to sustain a robust pace of capital expenditures. Of the nearly $25 trillion of the U.S. outstanding debt obligations in 2000, 11.0 percent is owed to foreigners, compared to 5.7 percent in 1987. When improved investment opportunities arise elsewhere, the world's demand for the financial and real assets of the U.S. will ebb.

Despite a generally ambivalent outlook for the global economy for 2001, two forces will act to restrain U.S. export growth. One is the rise in oil prices, which appears to be having a more disruptive impact in Europe than in the U.S. The other is the slowdown in the U.S. economy in response to the Federal Reserve's six interest rate hikes, to the extent that foreign economies have come to depend on U.S. consumers. Concern over what happens to the world economy once U.S. consumer spending returns to more historic levels helps to explain equity market declines in Korea, Singapore, Hong Kong, Mexico, Brazil, and Japan.

On balance, the impact of higher energy prices on the global economy, as well as the weak euro, will produce weaker growth in U.S exports in 2001 than we saw in 2000. The Ways and Means Committee staff expects export growth to fall from 9.2 percent in 2000 to 6.0 percent in 2001. At the same time, imports are projected to grow 8.7 percent in 2001, down from the 2000 rate of 13.7 percent. With import growth in 2001 continuing to overwhelm growth in exports, we expect yet another record trade deficit.

Wall Street and Bonus Income Growth

In 1999, a number of records were broken on Wall Street. The securities industry saw their pre-tax profits surge to a record $16.3 billion in 1999, up 68 percent from 1998's $9.7 billion level, and far exceeding the prior record level of $12.2 billion reached in 1997. The industry also saw year-end bonuses rise by over 23 percent to nearly $12 billion. In addition, U.S. securities industry revenues set a new record at $183 billion in 1999, and initial public offering activity (IPO) set a new record at $69 billion. The robust financial markets also were responsible for strong gains in security and commodity brokerage jobs. Although New York City continues to hold the dominant share of the U.S. jobs in security and commodity brokerage, that share has dropped from 34 percent in 1990 to 26 percent in 2000.

Despite the recent slump in the U.S. equities markets, the record-setting pace of Wall Street activity continued in the 2000. Although pre-tax profits for the fourth quarter are expected to be 29 percent lower than the third quarter of 2000, the figure is expected to come in at $3.5 billion. This compares to $5.2 billion in the second quarter of 2000, and a quarterly record of $8.2 billion in the first quarter of 2000. And while lower, the fourth quarter 2000 profits are good enough to bring the full year 2000 domestic profit figure to $22.0 billion. This represents a new record level of profits, exceeding 1999's full-year record of $16.3 billion by 35.0 percent (see Figure 8).

The Federal Reserve interest rate hikes between June 1999 and May 2000 designed to slow the level of growth in both the aggregate economy and in asset prices had caused the market to falter and were a large factor in the third and fourth quarter 2000 declines (see Figure 9). Indeed, many segments of the securities business, including mergers and acquisitions, will be negatively affected as the impact of the interest rate hikes through mid-2000 filter through the economy. Fourth quarter 2000 profits came in extremely weak, and new records won't likely be set in 2001, as the current profit environment becomes tempered by layoffs from ongoing mergers and acquisitions, and anticipation of further consolidation in the financial services industry in the fourth quarter 2000 and the current year. This trend slowed growth in employment and compensation costs as 2000 drew to a close.

The slowing of industry profits growth is likely to have implications for bonus income earned by industry employees, and hence, for New York State income growth. Securities industry bonus payments are the driving force behind State bonus income overall. In addition, since bonus income tends to be taxed at the highest marginal tax rates, a decline in bonus payments can be expected to have a negative impact on State revenues.

Although bonus earnings growth for the fourth quarter of 2000 may not have kept up with the record-breaking pace of the recent past, it is still nevertheless expected to be large by historical standards. Wall Street's banks and brokerages are expected to have set a record high for employee bonuses in 2000, paying a total of $13.3 billion. New York City's world-leading financial sector thus improved upon the prior record of nearly $11.8 billion in bonuses paid in 1999.

Throughout the 1990's, mergers and acquisitions have been a significant source of revenue for both Wall Street firms and those legal enterprises that service these firms. Despite some volatility of the stock and bond markets, the merger and acquisition activity has remained quite strong.

The financial markets appear confident that the Federal Reserve is committed to maintaining a low inflation environment. This confidence is evident in the strong bond and stock market growth we have experienced for the last four years. As the world's financial capital, New York City's economy has benefited from the recent surge of financial market activity. For instance, the securities industry had relatively strong job gains in the second quarter of 2000, and the average salary for this industry is $180,000. In addition, the vacancy rate for the commercial real estate market declined significantly in the second quarter of 2000 compared to the same quarter last year, based on data published by Cushman and Wakefield.

In addition, the financial market firms derive their revenues from a broad variety of sources other than stock trading. One of the most lucrative of these activities is the management and underwriting of mergers and acquisitions.

Mergers and Acquisitions

Mergers and acquisitions should continue to be an important source of Wall Street profits for the foreseeable future. In 1999, the value of mergers and acquisitions completed was $1.3 trillion, which was only slightly lower than 1998's record level. In 2000, the value of mergers and acquisitions completed was $1.7 trillion, which was 30.8 percent higher than in 1999 and a new record-high level (see Figure 10).

Factors responsible for the sustained level of merger and acquisition activity include the following:

• Increasing globalization-which has encouraged firms to consider strategic cross-border mergers and acquisitions as companies seek to improve their positions in the global market.
• The rapid pace of technological change has caused large firms who have traditionally relied primarily on their own innovations and internal research and development (a slow and expensive process) to attempt to gain immediate access to a desired technology by acquiring another firm.
• Changes in the regulatory environment have also encouraged growth in the mergers and acquisitions market-as the U.S. Justice Department has tended to approve deals that it would have prevented a few years ago, preferring to add conditions to the deals rather than stop them.
• The recent deregulation of the electric power-generating industry.
• Repeal of the Glass-Steagall Act-provisions which were intended to prohibit banks from entering the securities trading and underwriting business.

As for the future of the stock market in 2001 and its impact on the economic health of Wall Street, recent developments may give one pause. In the first half of September 2000, stocks were losing value and market watchers began worrying about an ensuing bear market. The real quandary may be that just as economic fundamentals do not fully explain valuations that are still currently very high, a serious market sell-off may be equally unrelated to underlying economic trends.

Silicon Alley and Tourism

Although its dependence on Wall Street renders New York City vulnerable to an economic downturn, the diversification of the City's economic base continues to progress and to take on added significance. The proliferation of high technology/internet firms along Silicon Alley (notwithstanding recent layoffs), travel/tourism activity, and continued growth of the motion picture industry in New York City all work to help mitigate the City's heavy reliance on the securities industry.

There has been much talk about the financial troubles being experienced by internet firms recently. The so-called "new media" jobs had been cut by a total of about 5,000 during the year 2000; industry sources predict many more cuts in the early part of this year. According to the chief executive of Double Click, Inc., Silicon Alley's largest employer, one-third of all companies will disappear or consolidate, and the worst is yet to come.

In fact, New York's Silicon Alley dot-coms alone have laid off about 3,000 people in the late-summer to early-fall of 2000. The good news is that Silicon Alley is still not big enough to have a significant effect on the City's overall economic health. "As a share of income and employment, it's 2 or 3 percent (of the City total)… That's not bad, but Wall Street accounts for 20 percent of income in the City," according to a New York Federal Reserve Bank economist.

This is not meant to diminish the significance of recently-announced layoffs associated with high-technology firms, which have significant impacts on regions of the U.S. outside New York State. For example, on February 15, 2001, Dell Computer Corp. announced it was laying off 1,700 employees, or four percent of its staff, in its first job cuts ever. Nortel Networks Corp., a telecom-gear maker, also announced on February 15 of this year a plan to cut its staff by 10,000 from the level at the end of last year-in January of this year, Nortel had said it would cut 4,000 jobs in slow-growth areas this year.

According to recent reports, more than 200 dot-com firms nationally have either ceased to exist or filed for bankruptcy, including about two dozen from New York's Silicon Alley. In addition to the abovementioned layoffs in the New York metro area, a 28 percent drop in the amount of investment spent in the fourth quarter of 2000 over the third quarter and a 25 percent drop in the use of Silicon Alley office space is now evident. According to a board member of the New York New Media Association, one can expect that at least half of the 50 or so publicly traded dot-coms once based in New York either will have merged into other firms or disappeared by this time next year (February 2002).

Far more significant than Silicon Alley is the impact of travel/tourism activity on both the City and the State economy. Tourism is New York State's second largest private sector industry, and with attractions like the Adirondacks, Niagara Falls, and New York City, a certain number of people will travel here regardless of how much or how little is spent. There were a record 36.7 million visitors to New York City in 1999, who spent $15.6 billion, paying the salaries of roughly one-quarter million workers in tourism-related jobs. According to estimates from New York City & Company, last year saw a 4.7 percent increase in the number of visitors, setting a new record of 38.4 million total visitors to New York City, who spent $16.7 billion. Their forecast for 2001 calls for a new record-level of total visitors of 39.4 million, who are expected to spend $17.1 billion.

The hotel occupancy rate rose to 84.6 percent in 2000, up from 81.2 percent in 1999-it is forecast to be 83.0 percent in 2001. The New York City hotel room count is expected to have risen by 3,400 last year, and is forecast to rise by another 1,700 this year. In fact, New York City is now the number two tourist destination in the U.S. for domestic visitors (after Orlando, Florida), but is the number one tourist destination for overseas visitors.

Regional Diversity

The economy of New York State as a whole has shown significant improvement over the last few years. A comparison across the regions of New York, however, creates a picture of dramatic contrasts. Not all regions have benefited equally from the most recent economic expansion. In order to ascertain how the ten economic development regions of New York State, as well as their underlying counties, have fared relative to each other and the State as whole, this section will provide a summary of recent job growth rates for select time periods. In addition, a breakdown of the share of a region's jobs occurring in each of several major industrial groups will also be detailed. Finally, the shares of each region's total payroll being generated in each of these major industrial groups will also be compared. For illustrative purposes, the regions are mapped in Figure 11.

Regional Overview

The nation's last economic recession lasted from July 1990 to March 1991. As the country transitioned into the current period of economic expansion, New York State has lagged behind the nation. It wasn't until December 1992 that the State began its current period of economic growth, more than 20 months after the national recovery began.

There is wide variation in economic performance across the State. For example, the Bronx, Western New York, and the North Country have generally fared poor while other areas such as Long Island and Staten Island have generally been strong.

Since the start of the current State expansion at the beginning of 1993, the disparity in the economic recovery for upstate versus downstate, as well as among the regions and underlying counties comprising upstate and downstate, has been the source of considerable inquiry. In order to provide some basis of comparison, Table 7 details job growth rates for each of the 62 counties in New York over select time periods since 1993. Also provided is a ranking of the county-by-county job growth rates. The counties upstate and downstate can be aggregated into the State's ten regions which are also ranked against each other-where ranks range from one to ten, based on job growth.

Condensing the earliest years (1993-1997) of the State's economic recovery in Table 7, average annual employment growth for upstate was 0.5 percent while downstate grew by 0.7 percent. The upstate/downstate distinction, however, does not tell the whole story. During this time, the Long Island region skewed the downstate growth rate upward in the early years of the State's economic recovery, while New York City and the Mid-Hudson regions had significantly lower job growth rates. Considerable disparity also existed within the regions. In New York City, for example, Richmond County (Staten Island) had the third highest job growth in the State, while New York County (Manhattan) ranked much lower at 37th among the 62 counties.

More recently, both upstate and downstate saw improved employment growth in 1998 and 1999. As a whole, upstate underperformed the downstate region by slightly more than a percentage point in 1998 and by one percentage point in 1999. As previously discussed, there was considerable variation at the county level in job growth. In 1998, growth ranged from a high of 5.8 percent in Ulster County to a low of negative 2.0 percent in Hamilton County. Yet in 1999, Hamilton County ranked first in job growth while Cortland County took the lowest position among the 62 counties.

Employment data for 2000 suggests that the economy is slowing down for both upstate and downstate. Upstate, job growth decreased from 1.6 percent in 1999 to 1.2 percent in 2000. Downstate jobs grew by 2.2 percent in 2000-down from the 2.6 percent growth in 1999. Thus, upstate continues to lag behind downstate in employment growth, as has been the pattern since 1996.

Regional Variations

Employment Growth

Some regions have fared better than others in the slowing economy. Despite the decline in employment growth for downstate overall, New York City was the one region experiencing increased job growth in 2000. The City's growth in 2000 was the highest across the State's ten regions. However, New York City's improving job growth occurred entirely in New York County (Manhattan), home to Wall Street-including the stock and bond markets. In the other four boroughs job growth was not as strong.

The Mid-Hudson and Long Island regions each saw job growth slow in 2000. Despite this decreased job growth of 1.7 percent, Long Island ranked third highest among all ten regions in the State. By comparison, growth in the Mid-Hudson region for 2000 ranked last among downstate regions and exceeded growth in only three regions statewide-Central New York, Finger Lakes, and Western New York.

The Mohawk Valley, North Country, Western New York, and Finger Lakes regions all saw employment growth moderate by approximately one half of a percentage point in 2000. The Mohawk Valley and North Country regions fared much better, ranking second and sixth respectively, than the Western New York and Finger Lakes regions which ranked at the bottom of the ten regions for job growth in 2000. Specifically in the Western New York region, four of its five counties including Erie County, continue to languish near the bottom of the rankings for job growth in 2000. The same was true in 1998 and 1999. Monroe County in the Finger Lakes region also ranked poorly-fifty-fourth out of sixty-two counties for job growth in 2000.

Employment and Payroll

The shares of total employment in each industry in a geographic area and the shares of an area's payroll generated by jobs in a particular industry yield additional regional insight. Employment shares, in particular, shed some light on the reasons why one region or county may have fared better in job growth than other places. Some industries may be less affected by business cycles than others. The industrial mix in a region or county, then, has an impact on job growth as regional conditions change. Payroll shares, on the other hand, are related to the average wage paid to employees in a particular industry. The combination of good paying jobs in certain industries (high average wages) coupled with a sizeable number of those jobs (as determined by employment shares) will generate a larger share of a region's or county's total payroll. So a geographic area's economic prosperity is reflected in its payroll shares across industries.

A region-by-region analysis of employment and payroll shares within New York State indicates that the effects of a soft landing are experienced differently in various areas of the State (see Table 8 and Table 9). This is best illustrated by contrasting the financial and services industries with the manufacturing industry.

Wall Street and Services

New York City has a relatively large share of finance, insurance and real estate (FIRE) jobs, though primarily located in a single county, New York (Manhattan). The City and other downstate areas also have a higher percentage of workers in the services sector, all of which is somewhat less likely to feel the effects of a slowdown. In 2000, regions with larger shares in these two industries-services and FIRE-tended to have stronger job growth rates.

Looking at employment shares in conjunction with payroll shares (Table 8 and Table 9), a more complete story begins to emerge. The important FIRE sector in New York City has not only a sizeable share of regional employment in 2000, but FIRE generates an even greater share of New York City's wages. The finance sector alone has dominated wage growth. Thus the FIRE sector has a sizeable effect on the City's economic prosperity.

Manufacturing

Both the nation and New York State have been shifting over time into a service-oriented economy, rather than a manufacturing-oriented economy, as was true over much of the last century. The manufacturing sector is generally expected to continue downsizing in coming years.

Manufacturing jobs have traditionally paid better than many service-oriented jobs and so one would expect regions (or counties) with a larger employment share in manufacturing to have a larger share of their regional payroll, and thus, prosperity, linked to the status of the manufacturing sector.

The Finger Lakes, Southern Tier, Western New York, Mohawk Valley, and Central New York have a relatively high percentage of manufacturing jobs. In these communities, there has been a disproportionate negative impact due to the loss of manufacturing jobs.

An example of this can be found in the Finger Lakes region where the firms of Xerox and Kodak are facing significant employment pressures. Therefore it comes as no surprise that this region ranked near the bottom in job growth in 2000.