eading into 2007, economic activity in Michiana and throughout the nation is marked by a salient trend at each end of the economic indicator spectrum, with manufacturing and corporate productivity residing at the top among robust, healthy indicators while the household savings rate wallows far, far below amid dire signals.
"When productivity goes up, your costs go down," said Phillip Powell, associate clinical professor of economics at Indiana University's Kelley School of Business. "So every-
body's happy with more productivity. And productivity growth is healthy right now," he added Nov. 9, 2006, during the IU Kelley School of Business 2006 Business Outlook Panel, sponsored by TCU Investment Services in conjunction with Crowe Chizek, WorkOne of Northern Indiana, the Economics Club of Michiana, WNIT Public TV, Workforce Development Group, Inc., IU South Bend Alumni Association, Notre Dame's Mendoza College of Business, the St. Joseph County Chamber of Commerce, and the Plymouth Chamber of Commerce.
However, an immense and unhealthy trend has dampened the 2007 outlook. "The weakest part of the economy right now is households. That's the part that worries me," noted Powell, adding that in any given year, household spending and house-
hold economic activity account for about two-thirds of the U.S. economy. "While we have not seen a dramatic fall in spending by households, households are definitely under stress more than they have been in the past. And it's a bit worrisome."
The savings rate nationally for U.S. households jumps out most prominently among the unhealthy indicators; it is making lots of noise with economists because the savings rate is below zero, standing at negative 1.7-percent. This means that for every $100 earned by working adults within a household, they're spending nearly $102. "It's a negative savings rate. We blast the American government for a deficit; we should be blasting American households for a deficit," Powell said. "We're living way above our means, folks." The event, which drew about 270 attendees, was held at the College Football Hall of Fame in South Bend.
The negative savings rate means that households are open to severe financial risks, especially for those holding adjustable rate mortgages. As interest rates have risen 17 different times over recent months, the rate of foreclosures has elevated, as well.
'A Widening Prosperity Gap in the U.S.'
"It really comes down to this," Powell said, "there is a widening prosperity gap in the United States. And it comes down to education; the folks that are enjoying the benefits of the current growth are those that have a bachelor's degree. Those are the folks who are seeing the real value of wages go up because they're tooled and prepared to handle the global economy."
Individuals who "don't have the education, don't have the skills to compete with China and Mexico for jobs that used to be secure in the United States," he added. "We continue to see their real wages fall. And so at the bottom of the income spectrum we have households with higher debt, higher interest rates, and lower real value of income; it's a worrisome issue."
The IU Kelley School of Business outlook team reached a "guardedly optimistic" forecast for 2007. The team expects the U.S. economy to grow at about 3 percent next year, a bit lower than the 3.5-percent boost in '06. Inflation will fall from a current level of 3 percent to about 2.9 percent in 2007, and energy prices should be a bit more stable, Powell said. The national economy should create 1.7 million jobs next year, and the federal defict should be flat at $250 billion, down from $400 billion. Nonetheless, the housing market will remain weak, but "you won't see a collapse in real estate, especially in Indiana, like we saw with the stock market in 2000," Powell said.
Regarding foreclosures, however, the numbers for Indiana don't look good, said John Boquist, the Edward E. Edwards professor of finance at IU's Kelley school. The national foreclosure rate in the third quarter of 2006 was one foreclosure in every 363 households, which was up 43 percent from the third quarter of 2005. For its part, Indiana ranks 10th worst among the states in the foreclosure rate, with one forclosure out of every 233 Hoosier households, Boquist said. There will be a problem emerging from the overall economic drag-down effects from the real estate situation.
"Investors never seem to learn the lesson, always chasing the next hot thing, and, unfortunately, if you don't get out in time, you can get burned," Boquist added. Economist Kim Hunter once observed, he said, "The best way to double your money is to fold it over once and put it in your pocket."
The Federal Reserve Board appears to be done raising interest rates after 17 consecutive core point increases to a level of 5.25 percent in August 2006, Boquist explained. However, several interest-rate indicators have been thrown out of kilter.
"One of the scary parts of the interest rate scenario that we now see is the yield curve is downward sloping," Boquist said. "What this means is that short-term interest rates are actually higher than long-term rates." The Fed has increased short-term rates to 5.25 percent, while the rate for a 10-year Treasury bond is about 4.7 percent.
"A downward sloping yield curve generally scares economists because it's a sign that the economy's not going to do well in the future," he noted. "I don't see it that way and neither does our panel. There are some odd things going on in the interest rate market that we don't think necessarily means that the typical reaction of a downward sloping yield curve will occur," Boquist remarked. "Most importantly," he added, "are foreigners, who seem to be willing to finance our deficits."
Foreigners Own More Than Half of U.S. Bonds
In 1984, 13.5 percent of all Treasury bonds were held by foreigners. In 2000, foreign ownership of bonds more than doubled to 35 percent of the total value of bonds issued by the U.S. Treasury Department. By 2005, the last full year for which data are available, foreign ownership rose to 51.7 percent of all Treasury bonds. "Basically, what's going on is it's the foreigners who are fueling our deficit, and this is primarily China and Japan," Boquist said. "Why are they doing this: Because they don't want their currency to appreciate so they can continue to have a positive trade balance with the U.S."
Referring to the downward sloping yield curve, he said, "This is why the long-term interest rates are lower—because there's almost this insatiable desire by foreigners to hold our debt. Should that spigot be turned off, of course, then the negative savings rate is going to come into play, and we're going to have to finance our own future, and people are going to have to change their habits and they'll have to save." To add perspective to the negative savings rate, Boquist noted that in the early 1980s the savings rate was 12 percent of personal income—on the positive side of ledger.
Turning to the corporate sector, Boquist provided a bright forecast for 2007. "Cor-
porate profits: This is the good sector. The S&P [Standard & Poors] profits are at double-digit gains for seventeen quarters in a row. [This growth trend is] unparalleled in the history of corporate perfor-
mance, and it shows excep-
tional profit performance."
A couple of supremely positive macro-economic factors have driven this growth, he added. First, corporations have cut expenses "to the bone" and are very reluctant to hire people, and, "as it turns out, I'd have to say that outsourcing has lowered costs and added to the bottom line," Boquist explained. Secondly, moreover, "productivity—that holy grail as Phil mentioned—has come back to really benefit corporate profits." Productivity in 2007 might grow as much as 2 percent, which would be slower than 2006 "but still positive, which is good."
However, the upward trend of productivity gains achieved in many sectors of the economy has shunned the domestic automobile sector. Nonetheless, productivity issues have played second fiddle to the gargantuan health-care and benefits expenses being absorbed by General Motors, Ford, and DaimlerChrysler as they proceed through restructuring efforts. For instance, GM faced total labor costs, including benefits, of $81 an hour at a now-closed SUV plant in Arlington, Texas, while Toyota has spent 57-percent less ($35 an hour in total labor costs, including benefits) at its newly opened facility next door in San Antonio. This scenario contradicts a traditional economic theory, "Economies of Scale," holding that a big enterprise can generate large operating profits via lower unit costs, higher productivity, stronger buying power to lower materials costs, and better use of a manufacturing plant.
The GM-Toyota competition "can't be explained by economies of scale because the Toyota plant is 40-percent smaller," Boquist said, noting "it is very difficult to compete with that labor-price differential."
Jerry Conover, director of Kelley's Indiana Business Research Center, focused on Indiana's economy heading into 2007. Hoosier companies involved in trade, transportation and utilities added jobs during '06 and are expected to grow next year as well. In addition, professional and business services firms, as well as construction companies, likewise have increased jobs over the past year and are viewed as strong sectors for 2007, he said.
Indiana's Historical Rollercoaster
However, Indiana's manufacturing industries, which have propelled the state into the top position nationwide for the highest concentration of employment in manufacturing, increased jobs by only 350 over the past year. "But at least we're not still shrinking at the rather plummeting rate that was the case for the last several years, up until this past year," Conover said. The manufacturing sector still is more concentrated in Indiana than in other states, with 19.1 percent of all Hoosier payroll employment within manufacturing. But it's no longer the largest sector in light of retail services surpassing manufacturing in Indiana.
"Overall, the pattern across our state's economy for employment is one of slow growth. Some sectors are relatively flat, others are growing modestly. And there has been a little bit of acceleration in the last couple of months in one sector, financial services, which bears further watching," added Conover.
The state's overall output of goods and services, called the Gross State Product (GSP), rose during 2006 compared to 2005, but the gains fell short of the growth experienced by the nation as a whole. During 2006, Indiana grew only 1.3 percent in economic output, compared to a national figure of more than 3.5 percent.
"We're growing at about only a third of the pace of the rest of the nation," Conover explained, "as a matter of fact, only five states had slower growth in output than Indiana ... and we've fallen from fifteenth largest economy among the states to sixteenth, with Maryland surpassing us now."
The per capita personal income of workers in Indiana, including income souces such as earnings, dividends, interest, rent payments, and Social Security, lost precious ground during 2006, dropping one percentage point to 90.3 percent of the national personal income figure. "That is discouraging," he said, noting that 34 other states have higher per capita income figures. In light of these indicators and others, what's the outlook then?
"For 2007, we're predicting that the Indiana economy should once again grow slowly; we've heard about the auto industry struggling in this country, the Big Three especially, we don't really see much change in that dimension. As a result, Indiana's manufacturing sector, which feeds into the auto industry, is going to have a challenging time," Conover said. However, many Indiana companies that supply automakers wisely "are looking to broaden their [customer] base" with a new Honda plant committed to Greensburg, Ind., and a Toyota expansion in Lafayette.
In the Michiana region, manufacturing was a big contributor to growth over the past year, with 1,300 additional manufacturing jobs, all but 100 of them in Elkhart County, Ind., said Grant Black, assistant professor of economics at Indiana University South Bend. The leisure and hospitality industry added nearly 800 new jobs, and the trade, transportation and utilities sector rose by 350 new jobs.
The other side of the Michiana coin, however, was not pretty: Federal, state and local government offices cut more than 700 jobs regionwide, with 530 of those reductions occurring in South Bend. And the con-
struction industry lost nearly 480 jobs, with South Bend taking a hit for 350 eliminated jobs, Black said. The education sector lost 235 jobs while information services shrunk by nearly 170 jobs.
"So, we've seen a bit of shaky ground, but there are some positive signs," he remarked.
Among pluses in the local economy, wages grew 6.3 percent in South Bend and a hefty 10.5 percent in the Elkhart metro area. Wages in the manufacturing sectors in South Bend increased 6.0 percent and in Elkhart rose 14.0 percent, Black said. And wages in health care elevated in South Bend by 2.6 percent and in Elkhart by 1.7 percent. In South Bend, average weekly earnings are $675.
"Wages are starting to rise a bit to respond to higher prices and inflationary pressures," he noted, "and we've seen productivity contributing to those gains being passed on to workers." For 2007, Black sees modest job growth in Michiana. "We'll see increases in construction, and education will likely start to expand. Manufac-
turing will likely hold its own and do pretty well. I think wage growth will start to slow down." Robert Ducoffe, dean of the Indiana University South Bend School of Business and Economics, served as moderator for the panel.
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