R.I. CONFRONTS BIG
by Leonard Lardaro
It has been hard to overlook all of the headlines on how well the national economy has been performing. After a weak first quarter, economic growth rebounded sharply to 3.8 percent in the second quarter and all the way to 4.9 percent in the third quarter. The airwaves are full of analysts who have concluded that with employment holding up fairly well and recent rapid rates of growth, the national economy should be able to overcome ongoing weakness in housing, manufacturing and retail sales. Whether one agrees or disagrees with this assessment, the important point is that slower growth in Q4 will occur with a margin for error based on rapid prior rates of growth. Even a one-percent rate of growth this quarter will give an average growth rate over the past two quarters of almost 3 percent!
There is, however, one critical flaw in the predictions of continued strong future growth: the analysis upon which it is based is entirely backward looking. The third quarter is behind us. We are in the final month of the fourth quarter. When potentially approaching turning points, analysis should instead focus on the behavior of leading indicators. The overriding message from two of the more important leading indicators, the stock and bond markets, is that slower growth does indeed lie ahead.
This raises an obvious question: will there be a national recession in 2008? Personally, I don’t foresee a national recession next year, but I won’t rule out the possibility. In fact, it is possible that the US is already in a recession. How could this be? What most people fail to consider is that recessions vary in terms of stages and severity. In the early stages of a recession, whether national or local, the data being released still reflect relative strength, as the economy has not yet veered far from its recovery peak. Obviously things eventually get worse as the economy moves closer to its low point.
At any rate, on the national level, weakness has begun following a period of substantial strength, giving us a margin for error as we move into next year. Is the same true or Rhode Island’s economy? Unfortunately the answer is a very definite “no.”
The most accurate ongoing gauge of the progress of Rhode Island’s overall economy is my Current Conditions Index (CCI), which is released each month (http://members.cox.net/lardaro/current.htm). This index consists of twelve indicators of economic activity for this state. When the CCI exceeds 50, economic expansion is occurring as the majority of the indicators are improving on a year-over-year basis. The neutral value is 50. Values below 50 are consistent with contracting economic activity.
As the national economy soared in Q3, the CCI showed that Rhode Island’s economy struggled, with an average value barely in the expanding range (56). That was the good news! The third quarter started off with its highpoint -- a neutral value in July. After that, the CCI fell into its contracting range from August through October, with values of 33 and 42. So, in the third quarter, Rhode Island had already entered a period of weakness, decoupling from a strong national economy. Unlike the situation for the national economy, this gives our state little or no margin for error as the national economic activity slows and we are forced to balance ongoing budget deficits.
What do the leading indicators that are part of the CCI indicate? Nothing that is very encouraging. New Claims for Unemployment Insurance, the most-timely measure of layoffs, has now failed to improve for eleven of the last twelve months even after adjusting for a change in eligibility by senior citizens. Total Manufacturing Hours has fallen for all but one month in the past year. For October, both manufacturing employment and the workweek fell. The number of Employment Service Jobs, a category that includes “temps,” has declined over the past three months, currently accelerating to double-digit rates of decline. Finally, Single-Unit Permits, which reflects new home construction, is in the midst of a downtrend, having fallen for eight of the last twelve months.
So, not only is the collective behavior of these leading indicators discouraging, there is no obvious reason to expect them to reverse their current negative trends. Future values of these indicators, and our state’s economy for that matter, have two strikes against them: a slowing national economy; and the need to balance large budget deficits. Both will only further exacerbate the existing weakness in our state’s economy.
A thorough examination of the CCI, its indicators, and a set of other state-level economic data has led me to a not very flattering conclusion: I can no longer rule out the possibility that Rhode Island is currently in the early stages of a recession. It is important to keep in mind that more data is required before this determination can ultimately be made, and that would not occur until February or March of 2008 at the earliest.
Even if Rhode Island is not in a recession, tracking our state’s economic performance promises to cause ongoing heated debate. What I have provided here is an honest and accurate assessment of the present state of our economy. I honestly can’t see any other basis upon which our leaders can make decisions that will strengthen our economy over the long term. There are those who reject such analysis outright, in spite of its analytical basis, insisting that we should always view “the glass” as being half full. Those persons tend to focus almost exclusively on the levels of different variables, many of which are actually of little relevance when analyzing our state’s economic performance. The difference in my perspective occurs because I focus on levels as well as rates of growth for key variables. Apparently lost on the “glass half full” crowd is the fact that today’s levels are the direct result of yesterday’s rates of growth.
As Rhode Island moves into 2008, it will have to deal with a slowing national economy and persistent state budget deficits. The ultimate size of those deficits is still not known, since slower growth makes these deficits larger. Budget balance will therefore be destabilizing, as slowing growth raises deficits, the elimination of which further reduces growth. This is a vicious circle. And, it’s not too healthy for “the glass.”
My fondest hope for 2008 is that the “glass half full” crowd will at long last come to realize the error of its ways, since the way we balance our current and future budget deficits will be fundamental in determining our state’s future well being. From this, hopefully we will arrive at what should be our state’s economic rally cry: It’s the size of the glass, stupid!