Bay Area Economic Pulse

Clues to the Bay Area Recovery Lie in National Trends

By Michael Dardia

As several economists have noted in the past year, this recession is the first since World War II that has been driven by a plunge in business investment rather than consumer spending. Consumer spending has remained robust thanks to tax cuts, tax rebates, and a dramatic decline in interest rates. Falling interest rates not only lowered borrowing costs but also allowed homeowners to reduce their mortgage payments and, thanks to the strong housing market, take out cash during refinancings. Strong household spending has supported economic output despite declines in business investment and employment that have been twice as severe as was typical in previous postwar recessions. The race remains between the anticipated slowdown in consumer spending and a sustained increase in business investment and hiring.

The 1990s surge in business investment saddled the business sector with a large amount of excess capacity. Yet productivity gains from many of those investments continue to accrue, and there are some signs that the long-awaited and oft-predicted recovery may actually take place in late 2003 or early 2004. Gross Domestic Product growth has accelerated, business investment in equipment has increased from very low levels, the stock market has advanced, and new unemployment claims have declined. National venture capital investments have also increased, if only slightly, for the first time in three years.

Local evidence also suggests some hopeful signs. Although Bay Area newspaper help-wanted ads remain depressed, the major online employment sites have seen job listings increase significantly in the second quarter. Anecdotal evidence from local employers, as well as job seekers, also suggests an increase in hiring activity. But even if this anecdotal evidence represents a real trend, it may take many months to translate into measurable increases.

The Bay Area labor force shrank slightly in the second quarter and employment was flat while unemployment fell, so the unemployment rate declined to 6.3%. Interpreting labor force figures can be difficult at turning points in the economy. As noted last Spring in this column, there have been signs of the out-migration that historically has followed sharp employment losses. As Figure A shows, however, both labor force and employment totals have stabilized since the end of 2002, and unemployment has fallen slightly. Should the decline in the labor force resume, it could suggest an acceleration in out-migration in search of better employment prospects (these data will be released in late 2003).

The deepest job cuts continued to be in the manufacturing sector, and once again high-tech industries accounted for most of the losses. Upper-end professional and business services saw larger losses, as did construction (Figure B). Cuts also continued in transportation and wholesale and retail trade. In what may be an early response to the state budget crisis, government employment fell at an annualized rate of almost 4%, even though spending cuts in the 2002–03 fiscal year were quite small.

Within the Bay Area, employment declines were relatively similar in the three largest metro areas (San Francisco, San Jose, Oakland), but employment in the Vallejo-Fairfield-Napa metro area fell at an annualized rate of 6%. This is in sharp contrast to its relatively strong performance since 2000 and bears watching. Job losses were minimal in Sonoma County.

Commercial vacancies and rents remained at their severely depressed levels with a slight worsening in Oakland. The residential housing market continued to benefit from the sharp fall in mortgage rates, with all counties showing an increase in median prices in the second quarter even though price appreciation in the rest of the state handily outpaced prices in the Bay Area. Compared to the same quarter last year, increases averaged 3% in the Bay Area compared to 17% in California. Only Santa Clara County posted an annual decline in median prices (just over 2%). The failure of regional home prices to fall despite large job losses is likely due to a combination of pent-up demand and historically low mortgage rates. How this important segment of consumer demand will hold up now that rates have risen rapidly will be an important factor in Bay Area economic performance later this year.

The regional economy still faces additional risks going forward. While there are at least some signs of national recovery, rising interest rates and political developments within the state pose new risks. The gubernatorial recall election introduces major uncertainty, and the new state budget once again avoids resolution of fiscal imbalances by pushing the problem off until next year. Higher state and local taxes appear likely, and increased business taxes— in workers compensation and unemployment insurance, the loss of the manufacturer investment tax credit, and possibly substantial property tax increases—will weigh on the business community in the coming year, just as a recovery may appear on the horizon.

The opinions expressed in this article are those of the author and do not necessarily reflect the viewpoint of the SFAA or the San Francisco Apartment Magazine. Michael Dardia is Vice President of the SPHERE Institute, a nonprofit organization that provides analysis and advice for policy makers on a variety of issues, including welfare, health, education and labor programs on national, state and local levels (sphereinstitute.org).