2010 was a year in which the economy largely treaded water, leaving many to wonder whether we will ever return to a world with 4-5 percent GDP growth and 3-4 percent unemployment. The answer appears to be: not in 2011.
This article reviews the performance of the U.S. and Kentucky economies in the past year as well as the three major metropolitan areas in the state:
Cincinnati/Northern Kentucky, Lexington and Louisville. It also examines the housing market and the manufacturing sector, parts of the economy we expect to play a significant role in determining whether we will see significantly higher growth this year. Finally, we discuss what we think will occur in 2011. This review is based on our article, “The U.S. and Kentucky Economies in 2010: When Will the Recovery ‘Really Start?’ ” from the 2011 “Kentucky Annual Economic Report.”
Gross domestic product (GDP)
Starting in Q3 2008, the economy contracted for four straight quarters; from Q3 2007 through Q2 2009 the economy contracted in five of eight quarters. Since 2007, the economy shrank by an amount that matches the recessions of the mid-1970s and the early 1980s. But beginning in Q3 2009, the economy has grown the past five quarters. Because some of this growth appears at least partially due to a temporary increase in federal government spending, there is continued concern about the future growth of the economy.
Despite the increase in GDP that started in Q3 2009, the unemployment rate for both the United States and Kentucky has declined only slightly from the highest levels seen in the last 30 years. In October 2010, the U.S. unemployment rate stood at 9.6 percent, which was well above the 4.7 percent rate in November 2007 and the 6.8 percent rate in November 2008. The 10 percent unemployment rate in Kentucky last October is also substantially higher than the rate just one year earlier. Unemployment rates also had risen substantially in all three metropolitan areas in the state, with the highest rates found in Louisville and Cincinnati and the lowest rates in Lexington.
One particularly troubling aspect of the recent unemployment increase is that many individuals are unemployed for long durations. Nationally, the median duration of unemployment is over 21 weeks; since the government started reporting this statistic in 1967, the previous high was approximately 12 weeks in 1983. Though Kentucky has higher rates of unemployment, the duration of employment is lower. In 2009 (the most recent state-level data on duration), the median unemployment duration was 13.9 weeks in Kentucky compared with 15.8 weeks nationally. Previously, the difference between Kentucky and the rest of the nation has been smaller.
The housing market
Efforts by the federal government and the private sector to increase the number of people who own homes succeeded in pushing homeownership rates up to 69 percent – the highest level in history. It is now clear, however, that many of those new owners could not afford their home, leading to a significant increase in foreclosures. Between Q1 2006 and Q1 2010, the percentage of mortgages in foreclosure in the nation increased from 1 percent to over 4.5 percent. Although foreclosure rates stabilized in 2010, they are still well above 4 percent.
The foreclosure rate is up in Kentucky also, but rose much more slowly than the foreclosure rate for the entire country. Kentucky’s foreclosure rate historically has been higher than the U.S. average, but Kentucky’s foreclosure rate dropped below the U.S. average in 2008. In 2010, the foreclosure rate in Kentucky was one-fourth lower than the rate for the nation as a whole. This is one indication that the housing problems plaguing many places in the country are less severe in Kentucky.
Rising foreclosure rates, earlier efforts to increase homeownership and the 2009-10 housing tax credit program led to an increase in the supply of housing in the county. Because this increase in the supply of houses was not met by an increase in demand, we have seen a significant fall in housing prices in recent periods. Figure 1 plots the Federal Housing Finance Agency’s housing price index for the U.S. and Kentucky. As this figure shows, housing prices in the country have been falling since Q2 2007. Overall, U.S. housing prices in the country have fallen approximately 9 percent since their peak. Although housing prices rose slightly during Q3 2010, they declined the fourth quarter.
In contrast, Kentucky housing prices have remained fairly steady over this period, although down slightly in 2010 compared to 2009. Housing prices remained steady in both the Lexington and Louisville markets. In contrast, the Cincinnati/Northern Kentucky market has seen a fairly steady fall in housing prices the past two years. Like the national market, the local markets should be closely watched to see if the recent price decline will continue.
Housing prices will only begin to stabilize once the excess supply of housing is eliminated through an increase in housing demand. One measure of the excess number of houses is the homeownership vacancy rate, defined as the percentage of single-family homes currently empty. Starting in 2005, the vacancy rate shot up and now stands at around 2.6 percent. Until the homeownership vacancy returns to around 1.6 percent, its rate from the mid-1980s through the early 2000s, vacancies will put downward pressure on housing prices, and economic growth will be limited by homeowners’ reluctance to spend money.
Unfortunately, recent events appear likely to only prolong the problems in the housing market. In the end the housing market will need to fix itself, through individuals moving into more economically appropriate housing situations and through an increase in the number of people demanding a home. Until this occurs, the housing market will continue to limit the growth of the economy.
The manufacturing sector
The manufacturing sector traditionally has employed a large percentage of workers, particularly in Kentucky. As shown in Figure 2, manufacturing employment fell from January 2002 to January 2010; reductions in employment were particularly large starting in mid-2008. In 2010, manufacturing employment rose slightly, although it is nowhere close to pre-recession levels. In Kentucky, manufacturing employment has fallen by 37,000 jobs since January 2008, which represents a 15 percent decline.
Figure 3 shows the dramatic fall in manufacturing employment occurred in all three metropolitan areas in the state. Louisville experienced by far the largest decline in employment. Lexington’s manufacturing employment remained relatively constant throughout 2010, whereas Northern Kentucky/Cincinnati has been growing since late 2009.
Outlook for 2011
For the U.S. economy as a whole, persistent problems in the housing market will continue to limit growth. Although we expect the U.S. economy will grow throughout the year, our forecast of 2.9 percent growth is well below the growth needed to significantly reduce unemployment. We expect unemployment to remain at historically high levels much of the year. Finally, we expect inflation in the next year to remain fairly low, although we believe that in the next three to five years we have an increasing chance for much higher rates of inflation.
We believe the Kentucky economy will continue to outperform the U.S. economy, although the state will not grow fast enough to significantly reduce the unemployment rate in the state. On the bright side, we think the housing market in the state will continue to be relatively stable, with below-average foreclosure rates and above-average growth in prices. Unfortunately, continuing housing problems in other parts of the country will continue to have a negative effect on Kentucky’s manufacturing sector as well as the rest of the state’s economy.
In summary, we remain somewhat pessimistic about the performance of the economy in 2011. The economy will grow at about the same rate as it did this past year, but the growth will remain below the level necessary to put a serious dent in the unemployment rate. Hopefully by 2012 the housing market will begin to show signs of a recovery, which will bring faster growth and falling unemployment.