Midwest Suffers from Weak Manufacturing and Service Sectors
Interview conducted by Rachel Duran
Editor’s Note: This interview was conducted May 6, 2013, with Ken Goldstein, an economist with The Conference Board. For the latest economic news and the results of the Leading Economic Index, visit www.conference-board.org.
The U.S. economy is on a strong and relatively robust growth path. In the Midwest, which features a large base of manufacturers, a surge in economic activity is expected as consumers begin spending, no longer willing to put off purchases such as cars, appliances and furniture. The challenge is that some companies may not be able to make it that far.
The Conference Board projects by the fourth quarter the economy will leave the headwinds behind, achieving 3 percent growth in GDP through 2014. Of course there are bumps in the road, such as with gas prices, the badly designed sequester at the federal level, and the increase in withholding taxes, however; they should not distract from the sustained growth that is on the way.
Global Corporate Xpansion: The numbers show the economy is on its way to robust and continued growth. What can we expect to see in the coming months?
Ken Goldstein: The economy, at best, is going through turbulence. Some numbers are coming in good. The last Leading Economic Index was not quite so good. This is to be expected when the economy is picking up steam. And indeed if it was only the economic story, what we would have is an economy that is finally gathering steam, and will likely deliver sustained strength through the end of this year and perhaps even the next year or two.
The sequestration is throwing a speed bump into this growth path. And it is very likely to result in a dip in GDP growth perhaps down to 1 percent in the second quarter.
For review, let’s go back to the third quarter of last year when we had a strong GDP number, largely because we had a big inventory run up. And what businesses had to do was wind that back down in the fourth quarter, which is exactly what happened.
In the first quarter of this year they did it again. So the second quarter is going to come in weaker as we wind down the inventory. This up and down represents the timing of the inventory cycle.
Underneath is the strength of the overall economy, but it is running into the sequestration. So the two things that will impact the second quarter this year is the sequestration and the wind down of the inventory. So with the 1 percent growth rate, if that is what it comes in at for the second quarter overall GDP; the economy is not nearly that weak.
We have an underlying strength in the overall economy that keeps building momentum. By the third quarter of this year, certainly by the fourth quarter, we will go from a headwind to a tailwind.
That combination will likely tell consumers it is time to release that pent up demand on more than just buying new cars. These factors, along with an overall better global economic picture, not in Europe but certainly other countries, will drive us up to a 3 percent rate of growth, certainly by the first quarter of 2014, continuing through 2015.
GCX: What do businesses do in the interim?
Goldstein: Businesses and consumers have essentially tuned out the gridlock taking place in Washington, D.C., which is allowing the politicians to continue going down this road.
Business would love immigration reform, especially for the more technically oriented companies. They are actively lobbying for immigration reform.
There is strong backing from business. One of the pieces to immigration reform is to keep international students here after they graduate, if we can; as well as fast track them or give them their green cards outright once they graduate and make a commitment to stay here and help American businesses.
For any business making their strategic plan for the next three years to five years; when you arrive at the questions about what to do about taxes and regulations — just assume Congress is deadlocked and won’t change anything.
For example, there is a bill before Congress right now to collect sales taxes on Internet sales. It may just go into a hopper, where anything that helps the administration, Congress is against. And anything that Congress is for, the Administration is against.
We are absolutely stuck. There isn’t a sense that this will break up before the November 2014 elections — with no guarantee it will break up then.
GCX:How does the Midwest United States fit into this state of affairs?
Goldstein: We have discussed how the south Atlantic, the west south central and the Pacific Northwest are the three strongest regions of the country. That hasn’t really changed. Part of this is because these areas were hard hit by the housing debacle. Phoenix and Las Vegas were two of the cities hardest hit.
Home prices in Phoenix are 20 percent higher than a year ago. The point is none of this is in evidence in the Midwest.
The improvements in the housing market have created growth in the construction sector. It is also feeding into the overall service sector in terms of finances and retail trade, and other pieces of the sector.
We don’t see this much in the Midwest, which was evident in March when we had a bit of improvement in auto assembly but nothing else in the manufacturing sector.
A large base of manufacturing is located in the Midwest. With the improvement in car sales, you would think it would benefit states such as Ohio, Michigan and Indiana. That is not the case. Even in these states, the service sector still dominates.
The Midwest also has areas with high rates of unemployment. On May 3 we learned the unemployment rate for the country is 7.5 percent.
Illinois, Michigan, Ohio and Indiana are the big states in the east-north central region. In the region as a whole, the unemployment rate is 8.3 percent.
Before the Great Recession, of those four states, Illinois was doing better than the rest. Now Ohio is doing the best of those four, and Illinois is doing the worst. The unemployment rate in Illinois is 9.5 percent, which is 2 percent higher than the nation. Michigan’s unemployment rate is 8.5. And Indiana’s unemployment rate is 8.7 percent.
Part of the reason these states have higher unemployment rates is not just because these states have a larger base of manufacturing — the so-called manufacturing renaissance is more rhetoric than reality, unfortunately — but also the service sectors are not growing. If we look at services, without health and education, in Illinois during the last 12 months, it is up 0.2 percent. In Michigan it is up 1.1 percent. And in Indiana it is up 1.7 percent.
What is not happening is retail trade and manufacturing, which is helping in the Southeast, the Southwest and the Pacific Northwest, is not helping in the Midwest.
In addition, these states are not only considered Midwest states but they are also Great Lakes states, which means they are influenced in some sense by what is going on in Canada. Canada has gone from a hot economy to one that has really cooled off.
Another factor, in manufacturing, outside of auto assembly, is the fact that the sector is stuck. We as consumers are still not replacing old furniture and appliances. We are not ready to spend money, and absolutely not ready to borrow money to buy consumer goods unless we absolutely have to.
That keeps the Midwest factories on a slow burn. And this is slowing down growth in retail in the region.
It is a bad-news, good-news scenario in the sense that the demand is not there for the goods produced in the Midwest or the services that come out of the Midwest.
However, there is light at the end of the tunnel. Once the economy is clearly back on its feet, with strong job growth month after month, consumers will release that pent up demand. There is a burst of economic energy down the road for the Midwest, specifically in manufacturing, and for the Midwest in general. We are talking fourth quarter this year, first quarter of next year. The big story is that some companies won’t be able to hold on that long.
Ken Goldstein is an economist with The Conference Board, and can be reached by emailing email@example.com. The Conference Board is a global, independent business membership and research association working in the public interest. The board’s unique mission is to provide the world’s leading organizations with the practical knowledge they need to improve their performance and better serve society. The Conference Board is a non-advocacy, not-for-profit entity holding 501(c)(3) tax-exempt status in the United States. Among its services, the organization publishes information and analysis, makes economics-based forecasts and assesses trends. To learn more, visit www.conference-board.org.
Illustration by dream designs at Free Digital Photos.net