Tuesday, May 17, 2011

Scrutinizing Economic Forecasts: RI Employment Growth

In the most recent Revenue Estimating Conference, a rather interesting projection of future payroll employment for Rhode Island was made. According to this forecast, not only would Rhode Island's payroll employment rise in the next four years, this projection saw it actually returning to its pre-recession peak by the end of that period. To say that this forecast is optimistic is truly an understatement. Let me explain why this is the case.

First, and foremost, we need to consider how far we are from our pre-recession employment peak. Second, we must take historical growth rates into account to get an idea of what is possible or likely. Finally, as with any forecast, it is necessary to incorporate current and likely future conditions in arriving at a final forecast.

As for the first point, Rhode Island is now slightly more than a year into its current recovery. That recovery is from "The Great Recession." It takes a truly severe recession to merit a name, which is what we had nationally and in Rhode Island. As of March 2011, here's the data for payroll employment in Rhode Island needed to determine this (all data are seasonally adjusted, in thousands):

Pre-Recession Peak:            496.5
March 2011 Employment:     460.2
             Required Increase:                 36.3 (= 7.9%)

So, this forecast requires a four-year employment increase of 7.9 percent. Because growth compounds, that does not mean annual growth is just this figure divided by four. Taking compounding into account, assuming a constant rate of growth over this period, gives a required annual rate of growth of 1.92 percent.

Moving to the second point, what is the historical behavior of growth in Rhode Island? A graph will allow me to convey this information fairly effectively. Below is a chart of annual rates of change in payroll employment for Rhode Island since the end of World War II, starting in 1947 (click to enlarge). I have separated the period when Rhode Island was a manufacturing-based economy (through 1987) and its post-manufacturing period (since 1987).

How likely has it been for Rhode Island to experience job growth just below 2 percent for four consecutive years? In the post-manufacturing era, this occurred only once -- during the tech boom of the late 1990s. Look closely at growth rates for all the other years, especially since 2000. Not very impressive, to say the least. So, this could happen, but it requires that we replicate an extraordinary set of circumstances during a tech boom, the likes of which we haven't seen since. Note also, how Rhode Island's job growth failed to sprung back very sharply from the severe job losses in 1990 and 1991. So much for V-shaped recoveries here!

This brings me to the final point, taking current circumstances into account. At the risk of being redundant, Rhode Island has a string of large budget deficits ahead. Add to this unfunded pension liabilities, financial crises in cities, most notably Providence, which may well run out of money by early fall, a slowing national economy, and our state's labor force which has major  skill deficiencies, and it is apparent that there is a large and growing number of factors that will continue to mitigate the pace of cyclical momentum here. This has been confirmed by the recent performance of my Current Conditions Index, which shows that Rhode Island's economic growth has slowed since the third quarter of 2010. There are several positives as well. Rhode Island is in a recovery that, as of the March data, has extended thirteen months since its beginning in February of 2010. Also, the recent labor market data revisions show that our state's employment picture is better than we were led to believe based on the prior data. Lastly, Rhode Island did institute some structural changes to the cost of doing business here, notably lowering income tax rates. We therefore have some margin for error.

In light of all this information, I can't conceive of any realistic scenario under which this forecast ultimately proves to be accurate. For someone who has been analyzing Rhode Island's economy for longer than I care to say, I generally consider a one percent growth rate for employment here as a "norm," unless other factors intervene. And, if the problems in Providence are anywhere near as severe as I believe them to be, their resolution, either with or without the help of the state, will inevitably slow Rhode Island's rate of growth for several years.


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