Quarterly   outlook

Despite a slight detour during the late spring and early summer, the U.S. economy continues to forge ahead.

Total economic growth during the second quarter was slower than expected, and the summer months brought a few weaker-than-expected employment and retail sales reports. Yet, many forecasters expect this softness to be temporary and for the economy to continue to grow. Clearly the Federal Reserve considers this to be the case, for it recently enacted two interest rate hikes for the purpose of heading off unsustainably rapid growth and inflationary pressures.

Overall, the U.S. and South Carolina economies are expanding. Output is growing, employment is growing, and the unemployment rate is generally holding steady or falling slightly. Now, much of the economic growth is being supported by increases in productivity. As such, we still are not seeing employment growth at the national level that is consistent with other periods of economic recovery or expansion. Yet, the economy is creating jobs. For example, South Carolina has seen employment increase by about 1.7 percent between July 2003 and July 2004, and the state’s unemployment has fallen from 7.2 percent in July 2003 to 6.0 percent as of July 2004. Overall, the economic expansion is still on track.

The release of national GDP data for the second quarter also involved some interesting revisions to the earlier data. These most recent revisions suggest that the recession of 2001 was even shallower than was previously thought. Further, the recession itself was literally revised away—if we follow the standard textbook definition of a recession: two consecutive quarters of a decline in real GDP. The newly revised data show that U.S. real GDP fell by 0.5 percent in the third quarter of 2000, increased by 2.1 percent in the fourth quarter of 2000, fell by 0.5 percent in the first quarter of 2001, rose 1.2 percent in the second quarter of 2001, fell by 1.4 percent in the third quarter of 2001, and has been growing consistently since the fourth quarter of 2001.

Now, I am not suggesting that we did not have a recession; we did. But our view of the timing and depth of the recession keeps changing as the data are revised. Actually, I point all of this out more for the purpose of a useful bit of economic education: all of the numbers we use so often in tracking the economy are ultimately estimates of what is really going on “out there.” And, these estimates are almost always subject to revisions as more complete data sources are made available.

Most recently, real GDP for the United States grew at an annual rate of 3.0 percent during the second quarter of 2004 after four consecutive quarters of growth in excess of 4 percent. While growth did slow, it was almost right at the historical average for real GDP growth. Since 1980, real GDP has grown an average of just under 3.1 percent each quarter.

The largest contributor to the slowdown in real GDP growth was a slowdown in personal consumption expenditures. Consumption grew at an annual rate of 1.0 percent in the second quarter compared with growth of 4.1 percent in the first quarter. At the same time, however, the pace of business investment quickened. Business spending increased 8.9 percent in the second quarter compared with 4.2 percent in the first quarter, with gains coming from businesses spending more on structures, equipment, and software. Meanwhile, the growth in national defense spending slowed sharply from the previous two quarters.

Overall, the recent GDP statistics are consistent with an economy that is growing solidly. The ongoing concern, then, is the fate of labor markets. After adding jobs at a torrid pace during the spring, job growth slowed considerably during June and July. In part, there probably remains some underestimation of employment from the payroll survey, as the household survey of employment showed a substantial surge in employment during July. Aside from these survey accuracy issues, however, it appears to continue to be the case that the current economic growth is largely being driven by productivity gains. Again, a more productive workforce can contribute to labor market weakness in the short term, but is vitally important to provide for long-term economic growth.

A common question concerns the ability of households to continue spending in an environment of higher energy prices and below-average job growth. To date, consumer spending has held up well for several reasons. First, tax cuts enacted during recent years have clearly boosted disposable incomes. Second, we’ve not seen any significant inflationary pressure outside of energy prices. Of course, the cost of certain goods and services – health care, for example – continues to rise. Still, by and large, inflation is not a severe problem. Because of this, real incomes (income adjusted for inflation) have also received a boost. Finally, even with interest rate increases, the cost of borrowing remains near an all-time low, again providing a boost to the ability of households to continue spending.

Turning to the recent performance of the South Carolina economy, again the economic expansion appears to remain on track. The most recent labor market data for the state show that South Carolina’s unemployment rate fell to 6.0 percent in July. During July 2003, the state’s jobless rate stood at 7.2 percent. Meanwhile, total employment in the state in July was 1.7 percent greater than it was during July 2003. In my previous column, I stated that we are still on track to see jobs growing at an annual rate of almost 2.0 percent by the end of 2004. During the first months of 2004, the 12- month rate of job growth stood at just under 1 percent. This has increased to 1.7 percent in just a few months, so I will again stick with the forecast of several previous quarters and maintain that the state’s economy remains in line with expectations.

Beyond the labor market measures, the state’s economy continues to appear strong when looking at construction, retail sales, and tax collections. In terms of residential construction, the total number of single-unit building permits issued in South Carolina between January and July 2004 was 20,881. During the same period in 2003, the total was 18,828. For the year to date, building permits are 10.9 percent ahead of last year’s pace – and 2003 was a record year for new construction in South Carolina. Similarly, business construction is also ahead of last year’s rate by more than 8 percent. Because of this building activity, construction sector employment during recent months has been about 2 percent greater than last year.

The first six months of 2004 have seen retail sales in South Carolina surge 10.8 percent ahead of the same period in 2003. The only large county in South Carolina to post a lower level of retail spending during 2004 has been Greenville County. Similarly, the Greenville-Spartanburg-Anderson metropolitan area is the only major metro area that has posted an overall decline in employment so far in 2004, though this drop has been small. The Greenville area has a much larger manufacturing base than the other metro areas of the state and has felt the brunt of the pressures facing the manufacturing sector in recent years. The loss of manufacturing jobs in the Upstate is having an impact on non-manufacturing business in the area as the lost income is reducing household spending, evidenced by retail sales figures. However, the area should stand to benefit as the U.S. manufacturing sector is currently in the midst of a rebound. Factory production has been increasing steadily since the summer of 2003, and manufacturing employment has been holding steady or posting gains nationwide and also for South Carolina overall during 2004.

Finally, South Carolina’s improved economy contributed to the state’s $243 million fiscal surplus for the recently ended fiscal year – the first surplus since 2000. Sales tax collections, individual income taxes, and corporate income taxes all grew sharply for the year. Across the nation, the general state tax revenue picture has also improved dramatically over the last year. The improved state budget situation will likely provide a modest boost to the Columbia area’s economy and its larger-than-average share of state government employment.

The current forecast for the United States shows continued economic growth, with real GDP growth coming in at, or slightly above, average. Earlier in 2004, real GDP growth was expected to be in the 4 to 4.5 percent range for the last half of 2004. This forecast has been lowered slightly, with growth now expected to be near 3.5 percent during the last half of the year. Along with this growth in output, the United States is expected to continue to post positive job growth. The forecast of new employment growth is strong enough to slowly bring the unemployment rate down from the 5.5 percent rate of July.

In terms of interest rates, the Federal Reserve will likely continue to raise the federal funds rate slowly, probably in additional one-quarter point increments. By the very end of 2004, the Fed funds rate—at 1.5 percent in August—should be near 2 percent. Longer-term interest rates, such as mortgage rates, should also increase, but more slowly than the short-term rates.

The last few months have provided a great example of the fact that the Fed does not directly control all interest rates. The Fed has relatively precise and predictable influence over short-term interest rates, such as the Fed funds rate and the 3-month Treasury rate. However, longer-term rates like mortgage rates and 10-year Treasury rates respond to many different factors. After the Fed enacted its first rate hike in June of 2004, these longer-term rates actually declined. For example, the average 30-year conventional mortgage rate was near 6.3 percent during the late spring. As of late August, it had fallen back below 6 percent.

For South Carolina, the forecast also shows continued economic growth. Compared to 2003, almost every economic indicator has shown improvement. Most recently, the state has been adding jobs at an annual rate of just under 2 percent. These gains are expected to continue, with job growth picking up steam during the rest of the year.

Of course, risks to this forecast remain. The largest risks, on the downside, include the uncertain future of energy prices and the ever-present concerns about potential terrorism. Even on the downside, however, it is unlikely that the current economic expansion would truly become derailed.  o