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Tuesday 11 December 2018
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2019 ECONOMIC FORECAST

The U.S. economy is a lot like Monopoly.

Spending. Saving. Do Not Pass Go.

Navigating the board game is part strategy and roll of the dice.

So, when it comes to the economic outlook for the year ahead, there is always room for chance.

Here, Penn State Behrend professors Ken Louie, Ph.D. and Val Vlad, Ph.D., economists at the Economic Research Institute of Erie (ERIE), examine the statistics and trends that may impact the economy in 2019 – which, as of now, is looking like more of the same, mixed with a hint of cautious optimism.

Ken Louie, Ph.D.

“The national economy is still doing well,” explains Louie, director of ERIE, “but we have to exercise care in navigating through some possible headwinds, such as rising interest rates, additional tariffs, changes in health-care policy, etc. Monopoly is a good way to capture the state of the economic environment since it signals the potential for rising prosperity, and the ‘Do Not Pass Go’ warning may be a good way to indicate that caution is, nevertheless, still needed.”

In fact, although Federal Reserve Chairman Jerome Powell recently described the U.S. economic outlook as “remarkably positive” and Chicago Fed chief executive Charles Evans said he expects the outlook to remain good for “quite some time,” local economists are reluctant to call the projected U.S. GDP (gross domestic product) growth rate of 2 percent to 3 percent as “remarkable.”

Val Vlad, Ph.D.

“The outlook is as good as a short-run snapshot: The economy experienced a few quarters of good economic performance,” Vlad explains. “But, for the U.S. economy to function ‘normally,’ a sustained growth rate of at least 3 percent is needed.”

And, although the United States recovered from the recent recession, economists say it still suffers from insufficient economic growth. According to Vlad, the period from 2006 to 2017 went on record as the longest period (12 years) with less than 3-percent growth. In 2010, the Bureau of Economic Analysis characterized a similar situation as without precedent in the last 85 years (see Graph 1).

“For the first half of 2018, the economy had grown at a normal rate,” Vlad continues, “but two quarters of normality is not enough to reverse a long-run trend of underperformance and justify using the expression ‘remarkably positive.’ ”

To put it in perspective, local economists say: Here in the United States, “We’ve been popping champagne all the way since 2013 by focusing on a few positives and neglecting the scary skeletons in the closet: lack of economic growth, the highest debt/GDP ratio since World War II, an aging population and our connection with a world economy,” just to name a few.

A cautious approach may seem rather dispiriting, given that the current labor market is quite strong with unemployment below 4 percent, its lowest level in 18 years. It’s a rate that, according to Vlad, will stay in the 4 percent to 5 percent range for the next five years, which is below the natural rate (5.5 percent). “But, that should be taken with a pinch of salt because there are some other aspects that must be considered when analyzing the labor market: labor force participation rate, underemployed people, discouraged workers,” he says. “Moreover, if unemployment is below the natural rate (5.5 percent), we should see strong pressure on real wages to go up. But, we don’t see that, which means that there might be some ‘leakages’ in the link between production and employment.”

Still, many employers remain upbeat. The National Federation of Independent Business’ small business optimism index hit the highest level in the survey’s 45-year history in August. Small businesses are planning to hire more workers, raise compensation for current employees, and spend more on capital investments according to the index — a trend local economists agree with.

“It is much better to be optimistic and start building things from the bottom up than waiting for some policy miracle or some government help,” explains Vlad. “The future belongs to local initiatives and strategic partnerships: building the economy from the bottom up; relying on the growing role of small communities in pursuing innovation-led growth.”

Local Outlook
For communities like Erie, Pennsylvania, however, economists say there is room for improvement in terms of economic growth. “Unfortunately,” states Louie, “Erie continues to lag behind the state and the nation in terms of aggregate measures of economic performance such as total output growth, unemployment, income and poverty.”

According to ERIE’s research, in 2017, the real value of goods and services (or gross domestic product) produced by Erie County stood at $9.7 billion, which represented a slight decline of 0.8 percent compared to the previous year. In contrast, real output grew during the same period by 1.8 percent in Pennsylvania and by 2.2 percent in the nation as a whole.

Erie’s unemployment rate continues to be higher than that in the state and the nation. As of August, the seasonally adjusted unemployment rate was 4.3 percent in Erie, 4.1 percent in Pennsylvania and 3.9 percent in the United States.

“The good news is that Erie did experience a modest 0.3-percent increase in employment year-over-year in August,” says Louie. “Although this was less than the 1.3-percent employment growth during the same period for the nation as a whole, it was higher than the 0.1-percent growth in Pennsylvania.”

On the income front, the latest one-year estimates by the U.S. Census Bureau indicate that real median household income in 2017 was lower in Erie ($50,614) compared to the state ($59,195) and nation ($60,336).

The latest one-year estimates from the Census Bureau reveal that the poverty rate in Erie County inched up slightly to 16 percent in 2017 from 15.9 percent in 2016. In contrast, during the same period, the poverty rate fell slightly to 12.5 percent from 12.9 percent in Pennsylvania, and to 12.3 percent from 12.7 percent in the United States as a whole.

Who are the real winners and losers in our region when it comes to tariffs and trade policies in 2019?

Louie: “Assuming the steel and aluminum tariffs remain in place, the winners in our region are likely to be companies in sectors such as primary metal manufacturing. The losers from the tariffs are likely to be companies that use steel or aluminum, including those in machinery manufacturing; electrical equipment, appliance and component manufacturing; and transportation equipment manufacturing. In addition, consumers, as well as firms that purchase machinery, equipment, or appliances and components, are also likely to be harmed due to the higher prices of these final products as a result of the tariffs.”

Vlad: “From a macroeconomic perspective, there are more losers than winners. The whole real economy is the biggest loser. There is a short-run illusion that tariffs will benefit the economy, but over the long-run, the direct costs will exceed the benefits.

We have to think also about the indirect costs (externalities) associated with increasing trade restrictions (retaliation, slow growth in a globalized economy, lack of policy and economic collaboration, policies that are not harmonized across
borders, etc.).”

According to ERIE, one sector of the local economy that may face challenges in 2019 is retail trade. “With relentless expansion of internet commerce, the local retail sector is likely to continue to face increased competition from online vendors,” adds Louie. “Local retail employment fell by 2 percent (300 jobs) year-overyear in August, although the upcoming holiday season may provide a brief boost.”

In addition, the local manufacturing sector has faced significant challenges in terms of job growth, and this is likely to continue in 2019. Employment in Erie’s manufacturing sector fell by 1.6 percent (300 jobs) year-over-year in August.

“While many factors have played a role,” states Louie, “perhaps two of the most important reasons behind the manufacturing sector’s difficulties have been rapid technological change and increased competitive pressure due to globalization.”

As ERIE reports, one potentially bright spot for local manufacturers is the continued strength of the national economy, which grew at an annual rate of 4.2 percent in the second quarter. Median household income at the national level also has increased for a third consecutive year, reaching a record $61,372 in 2017.

“The strength of the U.S. economy is likely to have a positive effect on local manufacturers that sell their products across the country,” Louie says.

The Tax Cuts and Jobs Act (TCJA), passed in December 2017, made several significant changes to the individual income tax. How much of an impact do you expect the TCJA will have on the economy in 2019?

Vlad: “According to a recent study by the Brookings Institution, the TCJA is expected to stimulate the economy in the near term but have a relatively small effect on U.S. gross domestic product (GDP) in the long term. Earlier this year, we did see some of the positive effects of the TCJA, which lowered corporate tax rates to 21 percent from 35 percent. For example, in the first quarter, after-tax corporate profits rose by 8.7 percent. And in the second quarter, real GDP rose by 4.2 percent. However, it’s unclear whether these positive trends can be sustained during the remainder of 2018 and into 2019.

One reason why the expansionary effects may gradually be diminished is the impact of the TCJA on the federal budget deficit. Since the TCJA will reduce federal revenue, this will increase federal borrowing and in all likelihood raise interest rates and, hence, the cost of capital. The higher interest rates may serve to offset some of the stimulating effects from the lower taxes. Consequently, the TCJA’s impact on the economy may be relatively small in 2019.”

Growing Sectors
Economists say another sector that is seeing an uptick is the local construction industry, which is likely to remain strong in 2019, especially with the large-scale building projects in the downtown area. Furthermore, employment in the mining, logging and construction
sector increased by 6.8 percent (300 jobs) in August compared to a year ago.

Are there are any other key economic trends that we should be mindful of for 2019?
Louie: “It will be important to watch other policy measures that may be taken in 2019. For example, the Fed’s monetary
policy stance and the resulting decisions regarding short-term interest rates can have significant effects on the economy. Likewise, it will be important to watch whether the trade war with some of our major trading partners will intensify in 2019. Finally, it will be important to watch for any major regulatory changes that may affect household and business decisions.”

Vlad: “Year 2019 will be in many economic aspects very similar to 2018.”

According to ERIE, the education and health services sector also continues to be robust, with employment growing by 2.5 percent (700 jobs) year-over-year in August. With 28,400 jobs, this continues to be the largest local sector in terms of employment. Continued investments by the Lake Erie College of Osteopathic Medicine (LECOM) and other local colleges and universities, as well as by the two major local medical centers, are likely to keep this sector strong.

With the ongoing development of the Erie Bayfront, the leisure and hospitality sector is expected to improve, as well. Experts say employment in this sector expanded by 6.4 percent (1,000 jobs) in August compared to a year ago.

“We are likely to see the local economy continue on a relatively stable trajectory in the near term, with slow overall growth and a fragile labor market,” states Louie. “However, the many initiatives that are underway to revitalize the local economy may begin to produce some noticeable results over a longer time horizon. With the completion of major investment projects by local companies, such as Erie Insurance and Velocity Network, the gradual expansion of the Erie Innovation District, and continued development of the Bayfront,
we are likely to see improved performance of the local economy beyond 2019.”

For the most current information from the Economic Research Institute of Erie (ERIE), visit http://eriedata.bd.psu.edu.