Dr. Paulo Guimarães is Research Professor in the Division of Research at the Moore School of Business, University of South Carolina. He teaches a course on forecasting and is responsible for the South Carolina Economic Outlook, which provides quarterly and annual projections of the South Carolina economy.
It is now clear that the U.S. economy entered a recession in mid-2008. There is a growing consensus among economic forecasters that this will be one of the most severe downturns since World War II. The main problems have emanated from the financial sector. The financial turmoil that originated in the subprime mortgage market more than a year ago continues to create a climate of fundamental uncertainty. \
To date, housing has been the sector most affected by the crisis. Falling housing prices and poor underwriting standards have led to a rapid increase in the number of mortgage delinquencies. The increase in the rate of foreclosures exposed a financial system that was highly leveraged and lacking adequate capital and liquidity cushions. As a result, the housing crisis became a more general financial crisis. Financial institutions had to deleverage and tighten lending terms and conditions, while lenders needed more collateral and net worth to back their own liabilities. The result has been a general freeze in the credit market that has seriously impacted the real economy—that is, employment, sales, and overall economic activity.
The financial crisis is just beginning to be felt in the real economy. In fact, the advance estimates for Gross Domestic Product (GDP), released by the Bureau of Economic Analysis, show a decrease in GDP of 0.3 percent in the third quarter of 2008. This number is likely to be revised downward because key monthly data released since then show that the real economy has deteriorated in the past quarter at a much faster rate than anticipated.
For the first time in years, Personal Consumption Expenditures, the main driver of GDP, had a negative contribution, subtracting 2.3 percentage points from real GDP growth. This drop in consumption was particularly large for big-ticket items. In real terms, consumption of durable goods dropped at an annualized rate of 14 percent in the third quarter of 2008. Retail sales figures for October of 2008 suggest that the drop in the fourth quarter will be even larger.
In nominal terms, overall retail sales had a yearly drop of 4.1 percent, with sales of motor vehicles and parts dealers dropping 23.4 percent. According to the U.S. Commerce Department, this was the largest decline since record-keeping began in 1992.
After almost three years of steady decline, residential fixed investment still contributes negatively to GDP growth. The extent of the decline in the housing market has surprised most analysts. In September 2008, for example, permits for privately-owned housing units were running at 786,000; that is 38.4 percent below the revised numbers for September 2007. In short, after almost three years of declines, the housing market is still not showing signs of improvement.
The bright spot in the economy has been exports, which managed to contribute 1.13 percentage points to GDP growth. However, in recent months, the dollar gained ground against major currencies, which tends to reduce exports. At the same time, the rest of the world is seeing a deceleration in economic activity and thus demand for exports. This should translate into lower demand for U.S.-made products. Both Japan and the Euro zone are now technically in a recession, following two consecutive quarters of negative growth. The Organization for Economic Cooperation and Development (OECD) forecasts that developed countries have already tipped into a recession that will last at least through the first half of 2009.
South Carolina is also experiencing a significant downturn in economic activity. Conditions in the labor market have deteriorated rapidly, leading to a sharp increase in the unemployment rate. Between February and October 2008, the South Carolina unemployment rate went from a relatively low 5.5 percent to 8 percent, a 25-year high. During the past year, the South Carolina economy lost 12,700 jobs.
So far, the main culprit for the state’s net job loss is the construction sector, which shed 17,700 jobs during the past year. Unfortunately, the employment cutbacks in the construction sector are likely to continue. Single-family housing permits are still trending downward, suggesting that even more contraction is yet to come. Fortunately, nonresidential construction has held up well and softened some of the declines experienced in the residential construction sector.
It remains to be seen how the crisis in the financial sector will impact private investment overall; but it can be expected that tightening restrictions on credit will translate into reduced business investment in plant and equipment. This would have a negative impact on nonresidential construction. Other important sectors, such as manufacturing; trade, transportation, and utilities; retail trade; and professional and business services are also shedding jobs, putting further downward pressure on the labor market.
In sum, the Palmetto State’s economy is in recession. Many of the economic problems in the state are linked to the nationwide stresses in the financial markets that are now affecting the real economy. Until financial markets stabilize, there will not be another expansion–either for the nation or for South Carolina.