Mid-year Economic Forecast: The road to recovery is not a straight path

Soaring oil prices, rising commodity costs, a cold spring, chaos in the Middle East and the uncertainty about the national debt ceiling conspired to dampen the U.S. economic recovery in the second quarter.

So, will all of these factors lead to a double-dip recession? Or did the economy merely catch its breath as it continues to rebound?

Most of the sources in this special report point to the latter.

Take comfort in knowing that 70 percent of the business executives surveyed by the Metropolitan Association of Commerce (MMAC) are forecasting growth in sales for their companies in the third quarter, while only 10 percent expect declining sales.

The majority of members of the Wisconsin Manufacturers and Commerce (WMC) expect to hire more employees in the second half of the year, and 88 percent of them believe the Wisconsin economy is going in the right direction.

For the Mid-year Economic Outlook overview, we turn to Professor Abdur Chowdhury, chair of the Marquette University Department of Economics. Chowdhury was the chief economist at the United Nations Economic Commission in Europe and was appointed to the Federal Reserve Bank of Chicago’s Academic Advisory Council.

BizTimes: So, let’s start with the big picture. All of these factors made things icy in the second quarter. Is it just a blip in the radar, or are we at risk of a double-dip recession?

Chowdhury: “I don’t think we will have a double-dip recession. What we are going to see is a very slow growth in GDP. The second quarter GDP growth rate was about 1.9 percent, so the third and fourth quarter will be slightly higher, but GDP will grow at a very slow rate. I don’t see a double-dip recession happening.

“Gas prices – I was afraid to see them increasing to $4.50 to $5.00. At this point, we have seen a downward trend, so that is good for the consumers and the economy. Releasing the (national petroleum) reserves was one thing that caused the drop over the past couple of days.”

What about the national debt ceiling debate between President Obama and the Republicans in Congress?

Chowdhury: “That’s an issue I think is a short-term challenge. At the end of July, we will see some sort of understanding between the two sides. What we are seeing right now is political posturing on both sides. Both sides know the stakes are very high if they don’t agree to raise the ceiling.”

BizTimes: What would happen if they didn’t agree?

Chowdhury: “Interest rates would go up, inflation would increase, the dollar would drop. (Those are) immediate effects. The federal government will have trouble meeting its bills because of the interest rates. It would have a significant negative impact on the recovery. My personal belief is that they will come to an understanding by the end of July.”

BizTimes: OK, then let’s presume eventually they’ll get it done. What do you see for the second half of the year in terms of interest rates? Are they likely to climb upward at all?

Chowdhury: “No. Interest rates, if you look at the Federal Reserve Bank, they said they will keep interest rates at the current level between 0 and .25 percent, so I don’t expect the Fed to raise interest rates in the second half of the year.”

So, if interest rates remain low, it would seem that inflation would not be much of a threat. Because to get inflation, you also would you need to see a rise in demand, and there doesn’t seem to be much of that going on, either.

Chowdhury: “I don’t see inflation to be a problem. I don’t see rising prices in the next few months. Commodity prices have gone up. That’s why we see differences between headline and core inflation. But I don’t believe inflation will be a major problem. It’s the high unemployment rate which I think is a bigger problem.”

BizTimes: The American automotive industry seems to be rebounding nicely. Are there any sectors in the economy that are poised to grow at a faster rate than others?

Chowdhury: “Yes. Interestingly, that is manufacturing. Historically, look at manufacturing. If you look at the last two years, the post-recession period – manufacturing’s contribution was about 30 percent. That’s unique. One of the reasons that is happening is the weak dollar and the demand we are seeing from the emerging markets. Exports have basically pushed the recovery for the past couple of quarters, and I see that continuing, because I expect the dollar to stay weak. So, the dollar will stay weak, and emerging markets will (increase) demand. Obviously, there’s a question of inflation in China or India.”

BizTimes: It seems like overnight we have gone from the headline being that all of America’s manufacturing was being shipped overseas to it being that there’s a revival of American manufacturing. The manufacturing sector has been leading this recovery. How did that situation reverse itself so quickly? Did the recession wean out the weak American manufacturers who could not compete?

Chowdhury: “That is one reason. Productivity at remaining (companies) has been high. Another reason, I think, is that outsourcing is not as profitable as it used to be. Costs and labors costs in other countries are increasing. Many American firms are coming back from China. It is not as profitable as it used to be, because of higher costs. One of the things we notice when you look at those countries, production is now moving from high-cost emerging markets to low-cost emerging markets. For example, a lot of production is moving from China to Vietnam because it is less expensive. The benefit of that has been U.S. manufacturing and the domestic economy.”

BizTimes: Do you see a growing middle class in some of those emerging countries?

Chowdhury: “Yes, especially in India and China. There’s a big market there.”

BizTimes: And yet there’s a sense that the American middle class is contracting.

Chowdhury: “Exactly. “

BizTimes: What can be done to give spark to the American middle class?

Chowdhury: “Some of the manufacturing has to come back for the American middle class to grow. There has been some increase in (service sector employment), but that is non-skilled employment. There has to be some sort of revival of the manufacturing industry.”

BizTimes: As a practical matter in the economy, looking back, did the Obama stimulus help the economy from becoming worse, or was it a waste?

Chowdhury: “That was the right call at that point. I would say that the stimulus was required because we needed to put money in the economy. I have some question to how the money was allocated. The reason is, if we look at the stimulus, where did the money go? A significant portion went to state and local government, basically to cover their budget shortfalls. Some people can argue if that didn’t happen we would’ve seen more unemployment of public employees, and that is true. But the money that was supposed to go to infrastructure development didn’t go. It went to state and local governments to pay their employees. You didn’t get that multiplier effect you expected from the stimulus. But was it necessary? I would say yes.”

BizTimes: Do you see the national deficit as an immediate priority or are you inclined to take a longer view on that?

Chowdhury: “I’m in the second group. I take a longer view. The reason is this: the deficit is a problem, and I believe the deficit we have at this point is not sustainable. We cannot continue to have a deficit at this level. The question is, do you do it now or do you let the economy recover and then do it? Given the state the economy is in now, if you significantly cut spending to reduce the deficit, that will have an adverse effect on the recovery by stifling whatever recovery we are seeing. At this point, I don’t want to kill the demand. We need to reduce the deficit at a slower pace. We need to give the economy some room to recover.”

BizTimes: What do you expect to the U.S. stock market to do in the second half of year?

Chowdhury: “The stock market has been doing pretty well, if you look at the post-recession performance. Compared with previous recessions, our stock market has been doing quite well. Our earnings per share for corporations have been quite high. Corporations have a lot of cash, so I expect the stock market to do well in the second half.”

BizTimes: When I talk our readers at BizTimes and ask them about how their companies are doing, they generally say things are going better, they’re moving in the right direction. But when I ask them about the big picture of the economy, they still don’t seem to have that confidence. Why is that, and what can we do to infuse some confidence back in them?

Chowdhury: “You’re right. If you look at the individual performance, they’re doing quite well, they have a lot of cash. But when you look at the overall picture, look at the confidence index, it has been dropping. I would say there are two things keeping consumer confidence low. One is the housing market – we’re not seeing any turnaround or recovery. And two, is the labor market. Those are the two immediate challenges.

“In the housing market, the problems are foreclosures. If you look at the total sales of existing homes, about one third of that is foreclosures. Now, that is depressing housing prices. Unless foreclosures stop, we won’t see a sustained recovery in the housing market, and that’s a problem.

“The labor market, unemployment will stay high – it’s 9.1 percent now. By next year, I don’t see it dropping below 8 percent, really. Unemployment will remain high for a couple for reasons. About 8.5 million people are out of jobs. To lower the unemployment rate, you have to create at least 150,000 to 200,000 jobs per month if you want to make a dent in the unemployment rate. For that to happen, the public sector has to start hiring. Now, we don’t see that happening, not in Wisconsin or nationally. Last month, only 900 jobs were created in Wisconsin. Also, there is a problem of long-term unemployment. Thirty million people have been unemployed for a year or more. That is scary. What happens is they are so discouraged, they don’t come back to the labor market and start losing the skills. And that is dangerous for the economy. The other reason I don’t see a significant improvement in the labor market is the number of temporary employment. That number has increased significantly. Business firms, because of uncertainty, are not hiring on a permanent basis. As a result, not much improvement in the labor market.”

BizTimes: You mentioned that manufacturing has been rebounding. Does that mean Wisconsin’s economy is well-positioned to rebound, given its prolific manufacturing sector?

Chowdhury: “It can. At least now on paper, There’s a feeling among companies that Wisconsin may be a better place (to business) than it was before (Gov. Scott Walker was elected). So, we have that. How far that will be effective needs to be seen. Things are moving in the right direction, but not as quickly as we would like to see. Going forward, the next two or three quarters, I’d expect a very low growth in GDP, a very slow recovery, but I don’t expect to see a double-dip recession.”

Is there anything that can be done to jumpstart the whole system?

Chowdhury: “The government tried a couple of things. They didn’t help as much as expected. At this point it is hard to say what else the government can do. I think now it’s the private sector’s turn to come forward. They can make a difference. They have the cash, so once they start investing, things can turn around. Unless the private sector moves now, I don’t see much change.”

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