Midwest Trails the Rest of the U.S. Economy
Interview conducted by Rachel Duran
Editor’s Note: This interview was conducted February 24, 2014. For the latest information in regard to the U.S. economic forecast, visit www.conference-board.org.
Rachel Duran: The Conference Board’s Leading Economic Index for the United States, released last week, finds the national economy is expanding moderately. Tell us about this.
Ken Goldstein: We think the year 2014 is the year the economy turns the corner. Through much of 2012 and 2013, we were running at a 2 percent rate of economic growth, which is better than 1 percent or 1.5 percent. For a lot of folks it has felt like we are stuck in the slow lane.
The fact that we may be making a turn to a 2.5 percent, possibly 3 percent rate of growth nationally, it will feel like the economy is moving for most folks.
Part of all of this is derived from and feeds into better consumption as consumer confidence becomes more optimistic that we are finally making this turn; if job growth is maintained, and especially if we get a bit of a pickup in terms of wage growth. That may or may not be a piece of the package this year.
But even without a pickup in wage growth, better sentiment and continued job growth will make folks think this is the time to not just go out and replace the old car in the garage, but the old furniture and old appliances.
If that is the case and demand picks up, then business investment which has been even weaker than consumption, it too will pick up as business realizes they have to invest in their production in order to meet the increase in consumer demand.
As the leading economic indicators show, not just for the United States but for the dozen or so countries we monitor around the globe, we may be looking at a modest pickup in the global economy, which will be good for trade.
And finally, if you get consumption and investments and exports going, business will naturally need more folks to meet demand.
Duran: Last year you stated businesses will begin to invest in plants, equipment and so forth this year, but the main question was: how much more? What do you see so far?
Goldstein: If the above scenario happens, we will also see inflation, which is low, begin to move back to the Federal Reserve’s target of 2 percent rate of growth. We are running right now, according to the Consumer Price Index numbers from last week, at a 1.6 percent rate of growth.
So we are not talking about big moves. Over the course of the year we might see energy prices slightly higher. We might see food prices move up a little bit, driven more by the drought in California than anything else.
And non-food and non-energy prices will move slightly higher as the pace of the economic activity improves. If we do get the activity and increases in prices, modest as they are, we will see a modest pickup in terms of interest rates, perhaps an increase of a half percent, in terms of long-term bond yields, and mortgage rates might move up by a quarter point.
In other activity, we have been looking at a strong demand for vehicles because people waited so long to replace cars, or in many cases, the cars wouldn’t run any longer. This will go on for a while but it will not increase, and in fact, may lose steam this year and next.
And the housing market is improving. It won’t improve as much as last year, both in terms of construction, lending of home mortgages, and certainly in terms of home prices.
At the moment, you can’t see this because we have been buried under a mountain of snow, both in terms of how much and how widespread. Not just in the Midwest and the Northeast but also in the Southeast. We have had not just an excess in the amount of precipitation, but the wrong kind of precipitation. And on the West Coast, and California in particular, it is the opposite. They have not had nearly enough precipitation to raise the crops, and therefore, feed the cattle. This feeds into the food piece of the inflation equation.
Now that the weather is starting to break, if you will, in the Midwest, East and South, we are not likely to see the economy turn the corner in first quarter because people were snowbound and stuck at home and couldn’t get to stores and/or work. Now they can get out, and for that reason, we will see things move up in the second quarter. Weather was not the only factor at play in the first quarter, but it was a factor.
Duran: Let’s look at the regional level to describe how the Midwest United States is faring thus far.
Goldstein: The Midwest economy is not doing as well as the national economy and it will not do as well, for some very specific reasons, such as the makeup of the Midwest economy in general. It is based on two strong pillars, manufacturing and agriculture, as well as additional factors.
One of the large mainstays is that the Midwest remains the manufacturing center for the U.S. economy. The industry is more important to the Midwest than any other part of the country.
The problem in the Midwest is the industrial economy is improving, but not as much as the rest of the country.
Also in the Midwest, agriculture will be held back for three reasons, one of which is lower prices for crops. So even though we will get this shortfall because of the drought in California, it will not help the Midwestern corn producers, simply because not much corn is grown in California, it is a different mix [of crops] out there than what is grown in the Midwest.
And, secondly as interest rates move up, because farming is very much a credit dependent industry and those farmers are not going to get that much of a pickup in terms of prices for their crops, but it will cost them more to finance all of their activities.
And finally, the third factor is that the Midwest is where all the agricultural equipment is manufactured.
It is as if it gets hurt twice in terms of the agriculture and manufacturing sectors.
These are the reasons the Midwest may be a half step behind the rest of the country in turning the economic corner.
In regard to other factors, the housing market in the Midwest will not have as much of an improvement that we see in other parts of the country. This is the part of the country where the uptick in mortgage rates is going to bite deeper than in other parts of the country.
The good news for the Midwest is that home prices didn’t move down as much as it did in other parts of the country, and therefore, it isn’t moving up as much. The ability to monetize the equity in the homes hasn’t been and won’t be as good as in other parts of the country.
Another factor in the Midwest is that the U.S. economy is doing better than Canadian economy. The Canadian economy is not in a recession but it is not doing as well, which will hold back the Midwest economy. There is a lot of trade that crosses a bridge between Detroit and Windsor, Ont. So trade with Canada is not a small factor in terms of impacting the manufacturing core of the Midwest economy. Both bringing in material through Canada and/or shipping finished products up to Canada.
Duran: Where are the regions of strength in the Midwest?
Goldstein: Some areas around the suburbs of Chicago in terms of Internet services. This is not a small piece of business; however, it doesn’t rival automobile manufacturing.
A second area, to the extent that there is a manufacturing renaissance in the United States, again this is the manufacturing base of the overall economy. So they are utilizing the latest technologies to build electric car batteries, designing and producing solar panels, and manufacturing parts that go into the wind turbines, for example.
Also, energy production, such as wind farm developments in places like Iowa, and natural gas development in the Bakken Shale play in North Dakota.
There are pockets of the Midwest economy that have strength, and in time, will result in pillars for the economy, but they are not enough to offset the drag from old line manufacturing, and certainly from the cycle that we are in terms of the agriculture sector, or to offset the drag in the cross border activity with Canada.
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.