EconSouth (Fourth Quarter 2003)


Cover Story

During 2003, the U.S. economy went through a significant transition as it continued its recovery from the recession of 2001. During the third quarter of 2003, gross domestic product growth surged, but employment continued to lag. The 2004 outlook appears stronger for the nation and the Southeast as business investment builds and consumer spending holds steady. Both of these developments should contribute to improved job prospects.

The national economic outlook for 2004 is bright, promising a more upbeat scenario than in the past two years. Since the beginning of 2002, the economy, as measured by real gross domestic product (GDP), has grown at an average annual rate of around 3 percent, substantially below the nearly 5 percent growth rate of the late 1990s. But GDP was especially strong in the third quarter of 2003, and this strength signals that the economy is gaining a firmer footing.

The robust economic growth in the second half of 2003 was predicted, but the long delay in achieving it shook confidence in economic forecasting. The modest growth during the first half of 2003 was the result of unsettling and hard-to-measure conditions — including the Iraq war and the subsequent occupation — that hindered decision making for businesses and consumers. On average, firms postponed large spending decisions such as purchasing capital equipment and hiring.

Stronger and broader-based growth in the second half of 2003 sets up continued improvement in economic activity in 2004. This resurgence reflects a number of positive adjustments by businesses and consumers to a variety of negative shocks.

Reacting to shocks
The recession of 2001 was driven mainly by a contraction in business investment. Dwindling business profits and the stock market’s decline from its March 2000 peak sent a message that a substantial amount of businesses’ capital investment was not paying off as expected. The steep decline in business capital and inventory expenditures was followed by an extended period of weakness in investment spending. Businesses became less willing to commit large portions of their cash flow to uncertain investment projects. Instead, they committed funds to low-risk, cost-reducing projects, many of which involved computer equipment and software. Even those expenditures, though, were restrained by historical standards.

Businesses have had to make some difficult decisions. Declining profits and a sequence of shocks — Sept. 11, Enron, WorldCom and other corporate confidence breakers — put the burden on firms to retain or regain profits. Generally, the first line of defense on profits is to reduce costs. Cost-cutting efforts during the past two years positioned firms for a rebound when economic activity picked up. In retrospect, efficiency-enhancing investments and labor-saving technologies that were already in place must have been paying off because real output increased at the same time that labor input decreased.

At last, a revival
The revival of business expenditures was a key element of virtually all forecasts of a turnaround in the second half of 2003. With profits replenished, businesses are increasingly able to shift attention away from the concerns of their near-term budgets and toward longer-term growth and expansion opportunities. Capital investment expenditures rose sharply in the second half of 2003 as businesses put resources toward raising output as well as productivity. This shift indicates that businesses believe economic activity is hitting a higher gear, so further robust growth in business investment spending is likely during 2004.

The disappointing growth in payroll employment in 2003 is related to high productivity growth. Some of this productivity growth is likely to prove long-lasting. For instance, certain industries have introduced new technologies that generate more output with less labor input, hence increasing returns. Short-lived productivity increases reflecting unsustainable demands on employees, such as extensive overtime work, will eventually give way to permanent additions to payrolls as output continues to expand.

Consumer spending sustained recovery
Consumer spending continued to grow in 2003 despite the sluggish employment situation. Low interest rates sustained growth in new housing construction and sales. At the same time, low interest rates and modest alternative investment opportunities gave consumers incentives to buy durable goods and undertake housing improvements such as renovations and expansions. Rising after-tax personal incomes, driven largely by tax reductions, supported the surge in consumer spending in the second half of 2003. Though unsustainable, this rapid consumption growth provided a welcome boost to economic activity.

Undoubtedly, sustainable growth in consumer spending will depend on a resurgence in the labor market. Recent signs indicate this resurgence has already begun. Further employment gains should accompany continued increases in business investment spending in 2004 as firms add workers to use additional productive capacity.

Southeastern Employment Momentum by
State, Third Quarter 2003
Note: Figures for the Southeast include results for the six states in their entirety. An employment decline from the previous quarter indicates a loss of momentum even if employment is higher than a year earlier (slipping). On the other hand, employment growth over the previous quarter’s level shows a gain in momentum even if employment is lower than a year earlier (improving). If employment starts to decline on both a quarterly and year-over-year basis, then employment is lagging.
Source: Calculated by the Federal Reserve Bank of Atlanta using Bureau of Labor Statistics data provided by Haver Analytics
Southeastern Employment Momentum by
Industry, Third Quarter 2003
Note: An employment decline from the previous quarter indicates a loss of momentum even if employment is higher than a year earlier (slipping). On the other hand, employment growth over the previous quarter’s level shows a gain in momentum even if employment is lower than a year earlier (improving). If employment starts to decline on both a quarterly and year-over-year basis, then employment is lagging.
Source: Calculated by the Federal Reserve Bank of Atlanta using Bureau of Labor Statistics data provided by Haver Analytics

Right now, the U.S. economy is humming like a V-8 engine in high gear. The level of activity nearly matches the growth rates of the late 1990s. However, all the imbalances that led to the recession have not been worked out, and some sectors continue to suffer. These issues require more time and resources to settle out completely. Still, the near-term momentum for output growth looks promising, and the growth in activity should bring renewed economic opportunities and spur employment gains.

Employment provides
momentum in Southeast

Conditions in the employment market are often central to assessing the economy’s health. How healthy is the Southeastern employment market in late 2003? Florida’s and Georgia’s economies are leading the national recovery in job growth (see chart 1). In contrast, Louisiana and Alabama continue to lag the nation. Apart from a brief period in late 2001, Florida’s employment did not contract during the national recession. But the pace of employment growth in Florida has slowed markedly from that of the late 1990s. Georgia, on the other hand, experienced a significant contraction at the same time as the national economy. Unlike the national economy, though, Georgia began adding jobs on net in early 2003, and this trend continued at a brisk pace through the third quarter. While Georgia has not yet recovered all the jobs lost during the downturn, the employment trend is positive.

Industry-level employment momentum indicates where jobs were created and destroyed during 2003. The Southeast as a whole has seen encouraging signals (see chart 2). Only the information services sector, which includes the embattled telecommunications industry, and the manufacturing sector continue to contract. All other major sectors have added jobs on net over the year and from the second to third quarters of 2003.

Retailers see midyear turnaround
The retail sector faced intense competition and a disappointing holiday season in 2002. Several retailers shuttered unprofitable stores early in 2003 and put expansion plans on hold. Positive signs began to emerge around midyear. Back-to-school sales exceeded many retailers’ expectations. As of early October, retailers were cautiously optimistic about the 2003 holiday season although inventories remained lean. Healthy holiday sales should set retailers up for a good 2004 as consumers gain confidence about the economy.

Auto sales are mixed
Auto dealers in the Southeast reported a mixed performance in 2003 compared to 2002. Generally, dealers noted weaker sales volume in 2003 than in 2002 for most cars and slightly better sales for light trucks and SUVs. For example, sales were up sharply for the Honda Odyssey, assembled in Lincoln, Ala., the Saturn Vue SUV, made in Spring Hill, Tenn., and the Chevrolet Venture minivan, assembled in Doraville, Ga. Meanwhile, sales of sedans such as Ford Taurus, Mercury Sable and Saturn were off from 2002 levels but showed signs of recovering later in 2003. Overall, demand for foreign autos continued to drive much of the growth in regional vehicle sales in 2003. An improved economy and the introduction of several redesigned vehicle models should encourage vehicle sales in 2004.

Tourism looks up after slow start
In early 2003, the tourism and hospitality industry continued to struggle. Below-par attendance at trade shows and conventions resulted in anemic occupancies at hotels in convention-dependent cities such as Atlanta. Attendance at major vacation destinations also fell below expectations, and international travel into the region declined.

As the year progressed, however, promotions and discounting helped stimulate attendance at theme parks, and the cruise industry continued to post strong bookings. Drive-to destinations remain popular, and gaming revenues along the Mississippi Gulf Coast in late 2003 outpaced those of a year earlier.

The outlook for the tourism and hospitality industry in 2004 is positive. As European and South American economies improve, more international tourists are expected to visit Southeastern destinations. Drive-to markets, primarily along the Mississippi Gulf Coast, should remain strong, and the cruise industry is likely to continue to thrive. The expanding domestic economy will generate more business travel, and this development could boost attendance at conventions and trade shows around the region.

Single-family housing markets sustain strength
Low mortgage rates were a significant driver in the Southeast’s housing markets in 2003. Housing markets were also fueled by strong migration into south Florida. Housing activity in the Southeast was strong overall and surpassed national levels for both new and existing home sales as well as new home construction. Starter and midpriced homes sold well around the region although Florida markets accounted for nearly half of the region’s home sales in 2003. The outlook for 2004 is for modest growth in the housing market as in-migration and employment growth continue.

During 2003, the demand for apartments was weak, so multifamily construction activity declined. Rents were flat, and concessions were widespread. Newer properties tended to fare better than older ones. Apartment vacancy rates were particularly high in Atlanta. On the other hand, condominiums were strong sellers. Properties along the Florida and Gulf coasts were in particularly strong demand, as were in-town condominiums in Atlanta. In 2004, the apartment industry should benefit from employment growth and the limited new supply on tap.

Nonresidential construction remains soft
Nonresidential real estate markets in the Southeast continued to suffer from weak demand during 2003. Nonresidential construction in the region through the third quarter was down slightly from a year earlier. Vacancy rates remained at high levels across much of the Southeast, especially in the office segment. Very affordable sublease space continued to place downward pressure on rental rates, and concessions were widespread. In the retail sector, much of the vacated space had been filled by late in 2003, and retailers were beginning to move forward with expansion plans. On net, the outlook for 2004 is generally positive in the nonresidential segment, but vacancy rates in the office market will need to subside before significant new construction will emerge.

Drilling in the doldrums
Despite strong prices, drilling activity in Louisiana stayed at relatively low levels in 2003. Domestic activity appears to have given way to energy companies’ increasing investments in the Middle East, Russia, Africa and other areas with accessible oil reserves. Louisiana’s rig count averaged around 155 for much of the year. Growth for the oil and gas industry in Louisiana in 2004 will depend on a pickup in drilling activity, which could be generated by increased industrial demand for energy.

Manufacturing declines but expects upturn
The Southeast’s factory sector continued to decline in 2003 but at a slower pace than in 2002. Employment has been shrinking in labor-intensive industries such as apparel and textiles but expanding in durable goods industries such as automobiles and shipbuilding. New investment in the region’s vehicle assembly plants and vehicle parts industry resulted in new jobs. Shipbuilders expanded because of new military contracts.

Over the year, producers of machinery, electrical equipment and other manufactured goods associated with capital investment pared back payrolls. However, by the third quarter new orders for industrial equipment and hours worked were on the rise. Employment in the nondurable goods sector, especially outside the food processing industry, continued to slide throughout 2003.

The factory outlook should improve modestly in line with the national economy although the gains will be dispersed. Defense-related industries are likely to continue to stimulate the region’s economy. The auto industry should also continue to bolster the region’s economy, with expansions and new facilities planned for 2004. Manufacturers of high-tech equipment and machinery may see increasing business activity as firms begin to replace worn-out and obsolete equipment.

The outlook for manufacturers of lumber, building supplies, furniture and carpets will depend on the pace of residential markets in 2004 and the speed of the recovery in nonresidential construction. Further layoffs are on tap for the apparel industry in 2004 as additional firms shut down or move operations offshore.

Services see solid growth
Temporary staffing demand was strong in the Southeast during the second half of 2003 as businesses sought to remain flexible on staffing in the face of uncertain conditions. As the economy expands, some temporary and contract jobs will likely be made permanent. The demand for business and professional services such as accounting, engineering and consulting will pick up as activity increases in the corporate sector.

Health services, especially nursing and residential care, continued to be a source of solid job growth in the Southeast in 2003. The region’s aging population should provide for moderate growth in the health care industry in 2004.

Employment Stuck in Neutral in 2003

After a dismal 2002, the employment situation was stuck in neutral through most of 2003. Job losses continued during early 2003, slowed by midyear and finally turned toward growth in the second half. Still, the stagnant employment conditions contrasted with measurable, and now buoyant, growth in real output during the past two years.

Real economic growth often precedes an employment recovery, but the patterns in the two most recent business cycles differ from those in prior post–World War II business cycles. Even comparisons of the 1991–93 cycle with the 2002–03 cycle show a contrast because current employment weakness is so notably prolonged.

The chart displays the percentage change from the peak of employment in the 1990–91 and the 2001 recessions, respectively. Notably, 21 months after the employment peak in June 1990, the employment situation began a vigorous turnaround. But during and following the 2001 recession, job losses continued, and the percent change from the employment peak of February 2001 did not reach a low point until 29 months later, emphasizing the extended delay in the recovery of the employment market.

Payroll employment data for 2002 and 2003 point to two key sources for the current employment market weakness. First, manufacturing job losses continue, although at a diminished rate, as U.S. manufacturers respond to lower-cost, competitive producers. Second, service job growth has been muted relative to the substantial growth observed in the 1992–93 period.

The key difference between employment market conditions in 1990–93 and 2001–03 hinges on two areas: ongoing job destruction in the manufacturing sector and weaker job creation in the service sector. Over the 2001–03 period, nearly 2.5 million manufacturing jobs were lost, and 800,000 service industry jobs were created on net. For the 1991–93 period, about 950,000 manufacturing jobs were lost, and 1.9 million service industry jobs were created.

The strong growth in GDP anticipated for 2004 portends invigorated growth in payroll employment. Although it is unclear which sectors will experience employment growth, most analysts suggest that some component of service employment will likely be a key contributor.

Nonfarm Payroll Employment:
Percent Change From Peak
Note: Data are seasonally adjusted.
Source: Calculated by the Federal Reserve Bank of Atlanta using Bureau of Labor Statistics data provided by Haver Analytics

Editor’s note: Throughout this issue, Southeast refers to the six states that, in whole or in part, make up the Sixth Federal Reserve District: Alabama, Florida, Georgia, Louisiana, Mississippi and Tennessee. John Robertson, Ellis Tallman, David Avery, Nick Haltom, Whitney Mancuso, Navnita Sarma and Gustavo Uceda of the Atlanta Fed research department contributed to this article.

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