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March 2008 — Vol. 86, No. 2

COVER STORY

How well will Connecticut weather the U.S. downturn?

 

Punxsutawny Phil wasn’t the only one making predictions in February. While the groundhog foretold more weeks of winter, economists offered somewhat more-optimistic outlooks for Connecticut’s economic weather-to-be.

In late January and early February, CBIA News asked five economists: If the U.S. goes into recession, how might Connecticut expect to fare? “Fairly well, unless ...,” was their unanimous response.

Although past recessions hit Connecticut hard, this downturn should pose less of a problem. Connecticut now has more factors buoying it up than dragging it down.

“We’re in an excellent position to weather the downturn,” said Todd Martin, principal of Todd P. Martin Economic Services.

Recession or just a slowdown?

For one thing, it’s not certain that a U.S. recession is imminent, the economists noted. Instead, “We might see an extended period of sluggish growth,” said Ed Deak, a professor of economics at Fairfield University.

“We think that if there is a recession, it will be mild,” said James Diffley, managing director of regional services for Global Insight, an economic forecasting firm based in Waltham, Mass.

How well Connecticut fares in the next few months, said Martin, will depend on what’s causing the downturn. “If a U.S. recession is just due to housing, Connecticut will do better than the country as a whole. Right now, what’s causing problems [nationally] is the housing market. The housing sector is in severe recession already.

“If, however, the subprime mortgage crisis affects the financial and capital markets — which we’re starting to see — Connecticut will be more vulnerable. [The] finance, insurance and real estate [sector] accounts for about 8.5% of our labor force. In Fairfield County, it’s about 9.5%. The U.S. is probably 6 or 7%,” he said.

Connecticut mostly well-situated

Whichever scenario — slowdown or recession — turns out to be right, Connecticut should outperform the U.S., according to the economists, who gave the following reasons:

  1. Connecticut is not overbuilt with new housing — “unlike other areas of the country, such as California, Arizona and Florida, where they had huge numbers of new homes, largely fueled by speculators trying to take advantage of low interest rates,” said Martin.

  2. Connecticut consumers, for the most part, are doing OK. “The consumer is under stress throughout the U.S., but that’s mostly true for consumers below median income. Connecticut is a wealthy state and has proportionately fewer consumers below the median income than other states,” said CBIA Vice President and Economist Peter Gioia.

  3. Connecticut has strong exports. “The weak dollar makes U.S. goods attractive to overseas buyers, so exports will be the best-performing part of the economy. That’s especially true for aerospace, medical and energy-generating equipment,” said Gioia. “In addition, defense will outperform other sectors. Connecticut is very strong in all of these areas.”

    Professor Deak agreed, noting that Connecticut “defense firms, exporters and small businesses all have been saying they’re doing pretty well. In fact, defense companies and exporters are having trouble filling orders because they can’t find enough people.”

    One cause for concern, however, is that a slowdown in the U.S. economy will be felt overseas, he said. An economic slowdown in other countries could dampen their demand for U.S. goods and services. “So exports in the U.S. and Connecticut could cool,” Deak said.

    On the other hand, slower economies in some countries — most notably, China — could have a silver lining, said Gioia. “Commodities prices, including for oil, building products and manufacturing commodities, have been run up by Chinese demand. As China slows, we’ll see lower commodities prices, which will help U.S. businesses and consumers. That would help lead to a recovery in 2009.”

  4. Connecticut has job creation. “Even though we lagged the U.S. in job growth during the expansion of the past six years, we’ve actually held our own pretty well in the past year or so,” said Martin. “Jobs grew about one percentage point last year.”

    “We added over 16,000 net new jobs,” said Gioia.

    CBIA’s surveys show that “many more businesses are hiring than are letting people go,” he said. In addition, he noted, “the relocation of Pfizer workers from Michigan will help southeastern Connecticut. The RBS [Royal Bank of Scotland] expansion in Stamford will help stabilize financial services, housing and other employment. And the casinos have announced major hires.”

  5. Credit is available to most small and midsize Connecticut businesses, according to the most recent CBIA/TD Banknorth Credit Availability Survey.

  6. “We have a much more diversified workforce” than we did in the severe recession of the early 1990s, Martin said. “In the ’80s, we were highly dependent on defense, but after the Cold War ... defense jobs basically got cut in half. Since then, we have a much healthier diversification, including jobs in FIRE [finance, insurance and real estate], education, health care and casinos.”

    Deak added, “The insurance industry has always been a rock of stability [in Connecticut]. It’s true that we have fewer insurance jobs than in the past, but there are still a lot of national and global insurance businesses in Connecticut.”

    In addition, “Connecticut banks are much more stable than in previous downturns,” Deak said.

Financial industry vulnerable

As a result of these advantages, “Connecticut so far has not been as affected by the national slowdown as other states, with the exception of financial services,” said Diffley.

That industry has suffered of late. “The ramifications of the subprime mortgage crisis surprised Wall Street,” which didn’t realize how exposed large financial institutions were to the mortgage problem, Diffley said. “Although financial firms did well on the whole in 2007, all the big financial companies announced huge losses in the last quarter.”

That has begun to hurt Connecticut — especially Fairfield County, which has a large number of hedge funds and private equity firms and many residents who work in or derive income from the financial markets.

“There are going to be problems in financial services, particularly in lower Fairfield County,” agreed Deak. “I expect to see layoffs in large commercial banks, investment banks and Wall Street, which all have been losing money.”

“There have been some job losses lately in financial services in Fairfield County,” said Andres Carbacho-Burgos, an economist at Moody’s Economy.com who tracks the Connecticut economy. Fortunately, he believes “that is a temporary effect. I think financial activity will resume in late 2008.”

In the meantime, however, the large bonuses that financial industry employees have become accustomed to could evaporate.

“We’ll have to watch what happens to bonuses,” said Diffley. “So far, the bonuses that were recently announced are pretty close to what they were last year, which was a record.” It seems that those bonuses were given in recognition of the whole year’s performance, not the last quarter’s, he said.

What will consumers do?

Job or bonus cutbacks in the financial services sector could “hurt the high level of consumer spending Connecticut saw in ’05, ’06 and ’07,” said Deak.

The cost of energy will hurt, too. “Higher energy prices work against us. They’re like a tax on consumers,” noted Martin. “The question is, how will consumers react? The [U.S.] personal spending figure for December is relatively weak. ... Right now, it looks like the consumer is pulling back a bit.”

Consumer spending accounts for approximately 70% of economic activity, according to Gioia.

Government finances a concern

Companies losing money, people losing jobs and income, consumers not spending — all of these factors would hurt state and local government finances.

“The state surplus that everyone seems so eager to spend will evaporate — or at least, it won’t grow,” said Deak. “That’s because [there probably will be] a decline in tax revenues and increased demand for help from the large cities — Bridgeport, Hartford, Waterbury, New Haven and New London.” Those cities will see “greater demand for social services from people who have lost their jobs or have increasing costs for energy or mortgages.”

At the same time, municipalities will also receive lower property tax revenues. Although Connecticut in general doesn’t have a lot of subprime mortgages, Gioia said, “the cities do have subprime mortgages. People who default on their mortgages won’t pay property taxes. The cities will be looking to the state for help.”

At the state level, “capital gains taxes will be somewhat affected [by the financial market downturn] for the 2007 tax year and possibly more affected for the 2008 tax year. Sales taxes will be hit by slower consumer spending. And the real estate conveyance tax will reflect the slowdown in housing sales,” Gioia noted.

According to Carbacho-Burgos, of Moody’s Economy.com, “Housing sales in Connecticut averaged around 15,000 units per metro area in early 2005; at the end of 2007, they were around 9,000 to 10,000 units. In some areas, that has led to a decline in house prices — for example, in New Haven, where the median house price has slowly dropped. In Hartford, it has stopped growing. And in Bridgeport and Fairfield County, [price growth] has substantially slowed.”

Policymakers taking action

These concerns are not going unnoticed by political leaders in Washington and Hartford.

To stimulate the U.S. economy, “the Federal Reserve has been aggressively loosening monetary policy ... They cut the targeted funds rate 1.25% in the last eight days [on Jan. 22 and 30]. That’s extraordinary — we’ve never seen that before,” said Martin. “Since last year, they’ve lowered the rate by 225 basis points. That will help get the economy moving again.”

In addition, President Bush and Congress have been working on a stimulus package that includes tax rebates and other measures.

“I think by June 1, plus or minus a few days, that money should be in people’s hands,” said Deak.

Here in Connecticut, the governor as well as Republican and moderate Democratic legislators have proposed eliminating the business entity tax on small businesses and said they will be fiscally prudent in making needed adjustments to the state budget for fiscal year 2008/09.

CBIA is pleased that state policymakers recognize the need for fiscal prudence, said Gioia. “Now, they need to follow through. First, they should do no harm — do not increase business costs. Then, they should adopt the recommendations in CBIA’s government affairs program,” he said.

That program urges the state to address three overarching priorities: more-competitive business costs and lower taxes, a top-notch education system that will produce a skilled workforce, and an efficient transportation infrastructure. (To learn more about these issues, including specific legislative recommendations, see CBIA’s
government affairs program, “2008 Blueprint for a Competitive Economy”)

Getting through the tough time

“The challenge for Connecticut businesses will be getting through the rough patch and being ready for recovery in 2009,” said Gioia. “That will require having the needed workforce. So businesses that are struggling should be cautious about any layoffs — only do it if it’s necessary for survival.”

So far, the state’s unemployment and job creation outlook isn’t bad.

According to Carbacho-Burgos, “It’s estimated that Connecticut’s unemployment rate for 2008 will be 4.7% to 4.8%, the same as the U.S. average. Connecti-cut was doing slightly better than the U.S. until late 2007, when Connecticut’s unemployment rate was slightly above the U.S. rate.”

CBIA’s Gioia said, “Connecticut should get through this downturn with 6,000 to 8,000 net new jobs for 2008, which is certainly lower than for 2007, but it is better than what we saw in the past several downturns.”

Ultimately, how well the state’s economy performs in the next few months will partially depend on the severity and length of the U.S. downturn. As Global Insight’s Diffley noted, “All states have economies that rely on general demand from the U.S. as a whole. So no state is not affected if the U.S. goes into recession.”

If the state’s political leaders keep that in mind and take the appropriate actions, the predictions the economists made in early February should ultimately prove to be right: Connecticut will indeed weather the downturn.

 

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