Sunday, January 29, 2012

One More Thing To Worry About

I was struck a few weeks ago when the third quarter personal income for Rhode Island was released and it indicated that our state's personal income fell. I quickly went to the Bureau of Economic Analysis' web site ( and looked over the various components of Rhode Island's personal income change. In a very short time my general presumption was confirmed: a fairly substantial decline in transfer payments did Rhode Island in. This can be further summarized with just two words: unemployment insurance. This might seem like good or neutral news, but it is not. A little background on this should help to explain why.

The way that our state's economy is "built," which is true of all other states and the nation as a whole, is that when economic conditions deteriorate, be it from a slowing of economic growth or a full-blown recession, the resulting decline in income is "cushioned" by changes in transfer payments. If you are not familiar with what transfer payments are, these are transfers of income from taxpayers to persons based on their qualifying for programs such as unemployment insurance, food stamps, welfare, etc. You might know these by another name: entitlement spending. They get this name from the fact that government does not (contrary to its wildest dreams) set the total amount that is ultimately spent on these programs. Instead, government merely sets the criteria for entitlement along with various parameters that pertain to amounts paid and the maximum duration of benefits.

What, then, determines the amount that is ultimately spent on entitlements? This is based on how well or how badly the economy performs. So, as noted earlier, during times of economic weakness, as income declines, more people satisfy the criteria for entitlement to various programs, and they are allowed to receive the benefits they have qualified for. As this occurs, transfer payments or entitlement spending automatically rises, helping to offset weakness in income. It is important to be clear that the resulting increases in transfer payments are never large enough to totally offset income declines. The offset is only partial.

At this point, a few points need to be stated. First, there are two types of entitlement programs: those that are cyclical, and hence related to the overall level of economic activity, and secular-based entitlements like Social Security and Medicare. In this post I am only referring to the cyclically based entitlements. Second, cyclically based transfer payments and entitlements are countercyclical -- spending on these programs moves in the opposite direction of the overall economy by design. Finally, because spending on these rises during weak economic times, these add an element of stability to  the overall economy. Economists often refer to this as "automatic stabilization." 

Equipped with this background, a chart of quarterly wage and salary income for Rhode Island along with transfer payments (both expressed as percentages of personal income) should illustrate the basis for my concerns about the income report. In this graph, it should be apparent that when Rhode Island's employment weakened, then began falling after 2006, wages and salaries fell from about 22 percent of personal income to a low of about 16 percent. As everyone knows, because Rhode Island's employment peaked so early (December of 2006, a full year before the US), this produced the very high unemployment rates we have been burdened with for years now. The "bright" side of this, if you want to think of it this way, is that this high unemployment ushered in substantial increases in transfer payments (also for food stamps and welfare), moving transfer income from about 17 percent of personal income in late 2006 to about 21 percent in 2009 and beyond.

The result was some offset to the lost wage and salary income which made the recession here less deep and severe than it might otherwise have been. My concern, however, is what has begun to occur during the most recent quarters: employment has remained very week here, causing wage and salary income to remain at a reduced percentage of personal income at the same time that increasing numbers of Rhode Islanders are exhausting their unemployment insurance benefits (many after 99 weeks of benefits), which is causing entitlements to fall relative to income. In other words, these two are no longer offsetting. Weakness in each is reinforcing declines in the other. This bodes very badly for income growth in future quarters, especially our ability to sustain the strength in retail sales we observed in the last part of 2011.

Looking forward to the remainder of 2012, this becomes yet another question mark for Rhode Island's economic future. As employment here remains about 7 percent below our late-2006 employment peak and our state's unemployment rate stays in the "top five" nationally, things here continue to look very weak overall, in spite of occasional improvements in our cyclical performance. But is the existing labor market date that lies at the heart of all of this accurate?

Historically, in the year following upward date revisions, which we saw last year, the data are revised lower. I refuse to believe that when the next round of labor market rebenchmarking occurs in late February these atrocious numbers will remain or be made worse. IF that occurs, and I truly hope it doesn't, I will have a great deal more to say about what Rhode Island needs to be concerned with and the pace at which our leaders will need to start dealing with our structural problems.  Stay tuned!

Tuesday, January 17, 2012

Current Conditions Index Report: November 2011

This is an abbreviated version of the November Current Conditions Index report. For the complete version, which includes a table with individual indicator performance for this month along with historical reports in PDF format, please visit my web site: . This report was covered by the local media. The Providence Business News did a very nice job with its story, as did GoLocalProv. Today, I also appeared on Channel 10. Here is a video of my appearance.

Rhode Island’s economy finally showed a spark of life in November, as it was able to break out of the neutral range it had been stuck in since May. The Current Conditions Index rose to 67 in November, its highest value since February, as eight of twelve indicators improved.

While this month’s reading may be a signal that Rhode Island’s economy has finally moved to a sustainable higher level of economic activity, I believe it is still too early to make that call. Why? As I have stated numerous times over the years, in tracking the overall performance of Rhode Island’s economy, there are always groups of positive and negative forces interacting. Whichever of these dominates ultimately determines the overall direction our state’s economy takes. Suffice it to say that there was a great deal of such interaction in November.

Even though the November CCI showed a substantial improvement, it still lagged behind its value of 75 last November. The Current Conditions Index has now failed to match or exceed its year-earlier value for nine consecutive months. Perhaps more importantly, a critical indicator of Rhode Island’s performance, Retail Sales, did manage to improve again on a yearly basis (+1.8%) while declining for a third consecutive time in terms of monthly change. This raises the obvious question of the sustainability of late-2011 levels of Retail Sales as we move into 2012. Yet Retail Sales was able to register these recent annual gains in spite of declining US Consumer Sentiment. Furthermore, on a monthly basis, US Consumer Sentiment has now improved for three consecutive months. It will be interesting to see how this interaction plays out, especially since personal income for Rhode Island actually declined in Q3.

One other indicator, the Labor Force, has continued to perform very badly on a yearly basis, as it has now failed to improve every month since February. But it too has begun to improve on a monthly basis, and along with this monthly improvement has come higher levels of resident employment, a very positive sign, and a falling Unemployment Rate.

Two indicators that failed to improve in October showed improvement in November. The first of these is Single-Unit Permits, which reflects new home construction, and is perhaps the most volatile of the CCI indicators. Based on the volatility of this indicator, this month’s improvement cannot be viewed a signal that new home construction has bottomed. The other is Total Manufacturing Hours, a mainstay of this recovery, which barely increased (0.6%), but did reverse last month’s decline.

Of the remaining indicators, Employment Service Jobs, a leading labor market indicator that includes “temps,” rose by 0.3 percent, only its second improvement since February. This indicator may well have bottomed. Private Service-Producing Employment continued to grow, albeit slowly (+0.2%). Not surprisingly, Government Employment fell once again in November (-2.3%), while New Claims, a leading labor market indicator that indicates layoffs, rose by 0.2 percent, its fifth consecutive failure to improve. Are layoffs trending higher?

The Manufacturing Wage surged by 17 percent in November to $17.38, if anyone actually believes this, following several double-digit increases in prior months. Finally, Benefit Exhaustions continued its trend of improvements, falling by 27.3 percent.

Tuesday, January 3, 2012

The Long View of New Home Construction in Rhode Island

New home construction has always been a critical part of Rhode Island's economy. It's not hard to see why that is the case. The economic effects of housing are very substantial, as there are the both the direct effects of the actual building, not the least of which concern job gains, along with secondary and tertiary effects dealing with further additions to employment along with the retail sales of appliances, furniture, carpets, etc. Anyone who examines the behavior of retail sales must consider the relative strength of housing, as these are strongly and positively correlated. Furthermore, new home construction is highly cyclical, meaning that it fluctuates more than does the overall economy.

Once upon a time, new home construction in Rhode Island was very strong, as it provided our economy with major boosts, both when recessions ended and as recoveries progressed. Of course, there was always a downside as well: during recessions, new home construction would fall substantially, exacerbating economic woes as economic activity deteriorated based on the direct and indirect effects involved.

How good were "the good old days?" How do those days of old compare to what we have seen the last few years? A picture is worth a thousand words here. The graph below shows Single-Unit Permits (i.e., new one-family homes) in Rhode Island since the 1980s (click to enlarge). Think of this as new home construction in Rhode Island.

Note the rapid and large rise in new home construction during the first part of the 1980s, moving from around 1,600 annual units in 1980 through a peak period of about 5,000 annual units during the 1985-1987 period. Look at that as long as you want -- we will never see the likes of that again here! In order to have such strong housing momentum, it is necessary to have two key ingredients that have been conspicuously absent here of late -- a rising population and substantial job creation.

You can see that the long-term decline in new home construction in Rhode Island began around 1987, the year of a major stock market crash and the last year during which Rhode Island was a manufacturing-based economy (a link to my web site on this). New home construction then began a precipitous fall from around 5,000 annual units all the way down to 2,000 annual units. As bad as that was, at least Rhode Island stabilized at that now-lower level for many years, through the very end of the last millennium.

What I find very striking about this history is how it is accurate to gauge Rhode Island's new home construction as "stepping down" since 1990. Note the trendlines in the chart above. Not only are these all downward sloping, their steepness continues to increase through time. Should that be surprising, given that Rhode Island is the only state for which population has been continually declining since July of 2004, the effects of which are clearly reflected in this chart?

During the depths of "The Great Recession," Single-Unit Permits here fell to as low as 33 units on a monthly basis, or 396 annual units. As I write this, the November 2011 value was 53 monthly permits, which translates to 636 annual units. So, it's not difficult to imagine that things can't get worse than what they are now.

What can we expect to happen when the US housing market at long last begins to improve? While you might think this should propel new home construction here back toward the 2,000 annual unit level, I don't see how this can actually occur. What would be our engines for such growth? I don't see our population ending its disturbingly long decline. And, given the lack of skills of our state's labor force, where would the jobs that would be suitable for all those persons with inadequate skills come from?

To repeat a quote from the Addams Family movies applied to Rhode Island: "Be scared, be very scared." Why? Because when the national housing market improves, it will be much easier for skilled Rhode Islanders to sell their homes here and move to states and regions that have far more favorable employment (and earnings) prospects. That, of course, will further exacerbate the skills deficiencies of Rhode Island's labor force. Even worse, Rhode Island will find itself losing persons who pay substantial taxes and who tend to not rely much on government services. That, of course, holds the potential to prolong and very possibly exacerbate Rhode Island's fiscal woes in coming years. Three guesses what the implications of those changes are for Rhode Island's housing market in coming years?