Michigan has been a principal beneficiary of the improved U.S. economy, thanks to a traditional driver: auto sales. The past three and one-half years have witnessed a revival in state jobs, entrepreneurship, confidence, fiscal footing, and business climate rankings.
These and other elements of expansion have lifted nearly all regions of the state, despite setbacks related to some of the most serious auto recalls in the industry’s history, along with nearly permanent headwinds from painfully high levels of gasoline prices.
Yet Michigan has only partially recovered the population, employment, housing, and income levels lost during and since the Great Recession. The reason: The national expansion has been sub-par, exhibiting only half the normal pace averaged during 11 recoveries over the past 68 years.
Fortunately for Michigan, vigorous gains in U.S. vehicle sales since 2011 have boosted auto-industry profits, job formation, and budget solvency. Consequently, the state’s economic standing has risen sharply, especially with regard to business climate and tax-climate rankings. Strong auto sales and a prolonged period of low auto and home financing rates have favored Michigan, particularly in light of the turmoil that enveloped Detroit and the Big Three automakers over the course of recovery and reform.
Clearly, the state economy at large will require continued national economic strength to maintain the positive momentum exhibited in so many of Michigan’s business sectors over the past two years. Also, to succeed, the state will require far more enlightenment in the realm of financial and regulatory policy.
Objective forecasting involves three steps: Gauging existing economic momentum; identifying the probable direction and strength of key economic vectors (shown by the most reliable leading economic indicators); and assessing shifts in pivotal policies (e.g., monetary, fiscal, and regulatory) that are likely to occur in 2015. Once the steps are listed and quantified, the economic and financial outlook becomes clearer, more accurate, and easier to project.
Current economic momentum is healthy in the Detroit area and in Michigan, and is generally better than it has been over most of the past eight years. The major reason for the continuity of recovery since 2009 has been the comeback sales of autos and trucks. After bottoming out during 2009 at less than 10 million units, vehicle sales in the U.S. have risen to rates approaching 16.5 million units in 2014.
Michigan’s automakers capitalized on the volume increases by recording improved profit margins. So robust are new management practices and technological improvements that Ford Motor Co., General Motors Co., and Chrysler Group can financially remain in the black, even when the level of U.S. vehicle sales dips below 13 million units. This stands in stark contrast to the early years of the 21st century, when Michigan’s automakers and their supplier industries had difficulty staying profitable despite U.S. vehicle sales consistently in excess of 16 million units. Michigan’s auto comeback has spurred noteworthy expansions in other automotive and nonautomotive facets of the local and regional economies. Parts suppliers, steel fabricators, dealerships, construction, warehousing, and rail and truck transport have grown in tandem with the post-recession boom. The manufacturing comeback, with its job-restoring impacts, reflects deferred (or pent-up) demand in the automotive arena. Housing prices, rentals, retailing, and tourism — not to mention banking and commercial lending activity (typically a laggard during business cycle upturns) — have also made resurgences.
Is there residual steam in these basic economic sectors? Oddly, the expansion phase for U.S. recoveries typically lasts between three and four years. The nation passed that magical average last January. And, indeed, the U.S. economy actually took a steep plunge in the first quarter of 2014, as if to acknowledge this “average” cyclical benchmark. In all likelihood, the stumble was more a reflection of the uncommonly cold and inclement winter season. If it had been an indictment of economic momentum, then second-quarter U.S. real GDP would have failed to snap back. But it did.
What forces might propel this current momentum forward, or perhaps break and reverse the economic motion? Variables with the finest record of predicting the strength and direction of real income, output, and employment are summarized in two especially reliable indexes: the Yield Curve and the Conference Board’s Composite index of 10 leading indicators. And what were they telling us as of midsummer?
The Yield Curve is simply the difference between an investment instrument that matures over many years in the future (e.g., the 10-year U.S. Treasury bond) and a very short maturing investment (e.g., a three-month U.S. Treasury bill). By Labor Day, the 10-year bond yielded a 2.3 percent return and the bill yielded essentially nothing. Thus, the difference — +2.3 percent — signals positive U.S. economic activity over the subsequent 11 months. Any reading of the Yield Curve in the range of two to three foreshadows continuation of real GDP growth for Michigan and the nation.
The second leading indicator, the Conference Board’s Composite Index, has accelerated in the past year. The prior six months (March-August) have shown monthly increases. Better yet, the latest six months have accelerated in comparison with the preceding six months, beginning in September 2013.
Essentially, the two most reliable leading indicators reinforce one another in predicting any further improvement in this business cycle, at least through mid-2015.
Key Policy Shifts
The three most critical policy categories affecting the economic and financial outlook for the states and the nation are monetary, fiscal, and regulatory.
Monetary policy is now focused on the Federal Reserve Bank’s decision to run a very loose monetary policy. For the past six years, the Fed has pursued a policy of stimulation that is unprecedented in length and strength. In concrete terms, this means the Fed has been printing money and adding new reserves to the financial system in quantities far in excess of the actual volume of real goods and services that our economy provides each year. The policy, better known as “quantitative easing,” explains why interest rates have been pushed to and held at historically rock-bottom levels, despite half a decade of consecutive yearly advances in real GDP.
On the one hand, low borrowing costs make it less expensive to finance new homes, cars, and business startups, or to expand existing businesses, propel stock market investments, and invest in state-of-the-art technology. On the other hand, a prolonged and persistent monetary policy that obstructs (and even prohibits) a very modest increase in interest rates in the midst of a five-year recovery is a policy that creates greater economic distortions and uncertainty. For instance, what happens to the cost of servicing the nearly $18 trillion national debt when interest rates rise?
Today, for example, the investment public is increasingly nervous over the outlook for their stock portfolios and scant returns on their fixed-income securities. Will the Fed, after hinting for years that they’d end the policy of quantitative easing and allow interest rates to rise, actually tighten monetary policy? Is such a policy shift in the cards over the forecast period? Yes, a modest shift toward tightening in late 2014 or early 2015 is probable, especially following the midterm elections.
Even a small upward movement of interest rates will cause retrenchment in the stock market. Many professional equity market-watchers believe that such a policy shift has been anticipated and is already incorporated into stock market evaluations. Nonetheless, it would be naïve to think that tightening would fail to generate the customary retreats in spending, wealth, and confidence. Shifting to a tighter money policy also will decelerate the growth vector by the end of 2015.
Fiscal policy — defined by federal spending, taxation, annual budget deficits, accumulating debt, and unfunded liabilities accumulating on the backs of future generations — is largely played out and is frozen for the balance of 2014 and 2015. Most tax hikes and new spending programs (e.g., TARP, the $1 trillion emergency stimuli, and Obamacare) have been implemented — or, as in the case of Obamacare, may have been delayed but is still evolving.
Massive amounts of new Washington spending and borrowing were the hallmark of fiscal stimulation during the 2008-10 portions of the Great Recession. Still, the $18 trillion in national debt is unprecedented, and it could get worse if interest rates were to rise more than expected, causing annual debt-servicing to spiral catastrophically. In short, the U.S. debt, like aging, increases and never seems to come down.
In assessing the impact of any fiscal policy shift, it is safe to assume that it performs a destabilizing role over the forecast period but has only weak marginal value in altering the economic direction already under way. Intergenerationally, of course, such profligacy and carelessness in fiscal matters is an endgame for any nation and its economic pre-eminence.
Regulatory policy is the arm of policymaking that predominates when monetary and fiscal policies have petered out in terms of economic effectiveness or visible political acceptability. Specifically, the costs associated with a plethora of new regulations are tantamount to imposing ever-higher taxation rates on firms and households. The proliferating rules and regulations stand apart from and well beyond the existing U.S. tax code.
Just a few notable examples include the recent regulatory leap in threshold levels and limits on CAFE standards affecting vehicles, environmental credits (coal, nuclear, farming industries), lending and capital penalties (Dodd-Frank statutes affecting banking, finance, and investment industries), and mandates in health care (medical, hospital, pharmaceutical, and insurance services industries). Every regulation affects profitability, hiring decisions, incentives, and confidence levels. They appear to be weakening the economy’s capacity to perform along its traditionally upbeat and dynamic trajectory.
For the 2015 outlook, the cost of the new federal legislative and bureaucratic rules and regulations in the U.S. and Michigan marketplaces will be heavier, less avoidable, and occur when the expansion phase of this business cycle — especially after mid-2015 — decelerates from increasingly anemic rates. In other words, the economy will have less recovery potential from future shocks, expected or unexpected.
Economic expansion will continue over the balance of this year and throughout much of 2015. Leading indicators confirm the probability that the five-year recovery will become a six-year phenomenon as of mid-year 2015. Freezes on (and postponement of) major policy initiatives until after the midterm elections are also key considerations in predicting continuity to this expansion.
Average real GDP growth during this expansion, dated mid-2009 to mid-2014, has been 2 percent. This is skimpy in comparison with most recovery periods. Scant improvement is particularly apparent in household purchasing power and the incomplete comeback of full-time employment, housing prices, and housing starts. Michigan continues to outperform the U.S. for two reasons: Our economy fell harder and the auto recovery is continuing. In the year ahead, Michigan will continue its recovery pattern, helped along by low borrowing costs and further gains in manufacturing employment.
Nevertheless, it would be folly to expect that the state and national economies can accelerate in the second half of 2015. Already, many forecasters have lowered their real GDP predictions. In fact, many economists, at the Federal Reserve and in private sector firms, recently lowered their growth expectations for calendar year 2014 significantly — to a meager 1.5 percent from their more robust prior predictions of 2.5 percent to 3 percent.
Both Michigan and U.S. growth rates will slow further in the year ahead. This is a natural course for business cycles, as productivity gains subside with the advent of fuller employment and firms reaching capacity constraints in the face of rising costs of labor, land, and financial capital. The forces of deceleration after the mid-2015 point are mounting. After all, stricter regulations already on the books (Obamacare, EPA, Consumer Financial Protection Bureau, Dodd-Frank, just to cite a few of the culprits) will impede business investment and hiring. Rising taxes will again create uncertainties, exacerbating offshore cash hoarding, trade restrictions, headquartering by U.S. firms abroad, and emigration by wealthy individuals. Rising interest rates and inflation, though modest, will depress growth potential. Uncharacteristically, the economic and financial outlook entering the national election year 2016 does not look at all promising.
Curse of Complaisance
As time passes, the pain from an injury, as well as the missteps that may have contributed to it, recede from one’s memory. And so it is true with economic pain. Borrowing, spending, and investment excesses, along with existing regulatory misdeeds, were revealed in the depths of 2009’s trauma. But careless behaviors that instigated the Great Recession were largely forgotten by 2012, as the passage of time, a partial recovery, and trillions of dollars of federal deficit spending helped expunge our collective memory of what should have become seminal, teachable lessons to old and new generations.
What does this mean for Michigan and Detroit today? For starters, it might be humbling, but ultimately helpful and realistic, to recognize how much economic turf must be retaken before prosperity and the state’s fiscal condition can be restored to levels that once claimed national pre-eminence.
Let’s take specifics covering population, Gross State Product, personal income, employment, and housing:
• MICHIGAN’S POPULATION, as of the 2000 census, was 9,938,444, and reached an estimated peak of 10,055,315 in 2004. In 2011, Michigan’s low point, state population was 9,874,589 — a peak-to-trough contraction of nearly 172,000, or 1.7 percent. But the latest annual estimate (2013) shows 9,895,622 citizens — a recapture of nearly 12,000, or +0.12 percent, of the peak-to-trough decline. Hard-hit Wayne County suffered a population loss of more than 240,000 people between the 2000 and 2010 censuses, and endured secondary attrition of 45,000 people from 2011 to 2013.
• GROSS STATE PRODUCT is a metric for Michigan, similar to GDP for the U.S. Michigan hit its stride in 2005 with an inflation-adjusted peak GSP of $433 billion. This constituted 3.04 percent of the gross national product of the nation. At the Great Recession’s nadir in 2009, Michigan churned out $366 billion in GSP, a staggering GSP loss of 15.5 percent.
Consequently, by 2009, Michigan’s share of U.S. GDP had plummeted to 2.54 percent, the lowest share since the Great Depression. As of 2013, the U.S. Commerce Department estimated that Michigan’s GSP had reached $408
billion, a claw-back of $42 billion worth of output, bringing our share of U.S. economic activity to 2.60.
• PERSONAL INCOME growth is the key to spending, saving, and expanding the tax base. It is important to remove the inflation component of income and to adjust for other elements related to cost-of-living among states and regions in order to compare real purchasing power among households. Michigan households, for example, experienced a 5.6 percent lower cost of living than average American households.
In 2007, Michigan’s income averaged $34,854 per person. This ranked the state 37th in the U.S. At the recession’s trough in 2009, the level had fallen to $34,168 and Michigan’s rank was 38, with the national average at $39,357. The four-year comeback, as of 2013, brought Michigan back to $39,215 — still 12 percent below the national average, but its ranking rose to 35th place.
• EMPLOYMENT in Michigan peaked in 2006 at an annual average of 4.7 million. The bottom occurred in 2010 at 4.2 million, a loss of 572,000 jobs. The gain from that trough to mid-year 2014 is 232,500 jobs. The growth still leaves Michigan 7 percent below the pre-recession level.
Michigan’s unemployment rate hovers some 1.5 percentage points above the U.S. average (7.4% in August), but is much improved from the 4.6 percentage-point disparity that existed between Michigan and the U.S. jobless rates in July 2009, our nadir (i.e., 14.1 versus 9.5 percent).
In metro Detroit, comparable data provided by the Southeast Michigan Council of Governments in the seven-county region showed a peak-to-trough decline of 273,000 jobs. Recovery through 2013 reveals a pickup of 84,000 jobs. Metro Detroit unemployment rates swung from 7 percent (2006) to 14.4 percent (2009), and back to 9.1 percent (2013).
• CONSTRUCTION AND HOUSING customarily accentuate swings in the business cycle. According to SEMCOG, new construction put in place or under way in the pre-recession boom year totaled 19 million square feet, involving 280 projects.
In contrast, the 2009 recession year saw only 8 million square feet of space developed. The recovery brought the total to 11 million in 2013, with prospects of another 5 percent to 10 percent gain expected in 2014.
The 232 communities comprising southeast Michigan issued a total of 7,766 building permits for new housing in 2013. This compares with a paltry 1,759 permits in 2009, one of three consecutive years (2008-10) in which the region experienced so many demolitions that the net southeast Michigan housing stock actually shrank. At its recent peak in 2004, total new permits issued stood at 25,122.
The three most promising prospects for Michigan during the second half of this decade include:
(1) Results of the Tax Foundation’s 2014 State Business Tax Climate Index. The index ranked Michigan’s tax climate as improving, which moved it into 14th place for 2013. Less than a decade earlier, we had been consistently ranked in the lower half with reference to our five major sources of state taxation.
(2) Results of the 2014 Economic Outlook Rankings by the American Legislative Exchange Council. Michigan was ranked 12th among the 50 states in its index, which is defined as a forward-looking measure of how each state can expect to perform economically based on 15 policy areas that correlate well with economic growth and prosperity over many decades.
(3) In 2013, Michigan elected to join the ranks of 23 states in becoming a right-to-work state, where workers can elect for themselves to join a union and pay dues, or not, without fear of losing employment.
Right-to-work economies consistently outperform states lacking this key workplace liberty, especially job and income growth and expansion of manufacturing and automotive sector activity.
In the end, Michigan is now better positioned for steady growth than it has been for many decades.
In years to come, we need firm allies in public service sectors who will favor competitive marketplace incentives to drive policymaking rather than cronyism, special political interests, taxpayer-funded subsidies, and other debilitating distractions.
Moreover, with a better focus on improving Michigan’s general economic climate, we assuredly will advance the timetable for Detroit’s long overdue financial recovery, as well. db