Interview With Andres Carbacho-Burgos: Pre-Downturn Jobs Level By Late 2014, Early 2015

by: Harlan Levy

Andres Carbacho-Burgos is a senior economist at Moody's He currently analyzes the U.S. housing markets and the state of Connecticut. Previously he was an economics professor at Texas State University.

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Harlan Levy: Is the economy going in any particular direction?

Andres Carbacho-Burgos: The U.S. economy is still on course for a slow recovery. It'll be slow through the first half of 2013 at least because we will hit a small part of the fiscal cliff, namely the Social Security payroll tax cut, and also the extended unemployment insurance benefits will expire in the early part of next year.

We predict that the Bush tax cuts will only expire for income earners earning over $250,000. The Social Security payroll tax holiday expiration will be much more important. Thanks to that negative push and uncertainty over Europe, the U.S. recovery is not going to start accelerating until the end of 2013.

We marked down Gross Domestic Product growth for 2012 to between 2.1% to 2.2% and around the same in 2013. That's enough to maintain slow job growth and to keep up with the increase in the labor force, but it's not enough to get the economy back to potential. But we're only going to get better growth in 2014, when we predict 4% growth. That's based on the effects of the fiscal cliff fading out and some sort of recovery in Europe.

H.L.: What do you think will actually happen with the fiscal cliff?

A.C.-B.: Beside the Bush tax cut expiration for earners with incomes above $250,000, the payroll tax will return to its normal rate in early 2013 and extended unemployment insurance benefits will expire. We believe that approximately one third to one half of the scheduled defense cuts will actually happen. That's our baseline.

There are additional downside risks that depend on who wins the election. The first one is that all of the defense cuts of August 2011 that are scheduled to occur after the end of this year actually take place if Obama wins the election and the Republicans maintain control of the House of Representatives, possibly tightening their control of Congress. Then you'd have a situation that might lead to all of the Bush tax cuts expiring, not just the tax cuts on incomes above $250,000.

If Obama wins and the Democrats were to take back the House, I don't believe there would be any sort of downside risk occurring. The Bush tax cuts would be extended for those earning under $250,000, and the reductions to defense spending would be offset. Approximately $100 billion in defense cuts are now scheduled to occur over the next two to three years. If the Democrats take the House and Obama wins, it's conceivable that job creation would be the first priority, and they would move to repeal the August 2011 legislation to reduce the defense cuts. If Republicans maintain control of the House, they would hope to do the same thing, but then they would have to come to an agreement with Obama over the Bush tax cuts.

Our baseline forecast is that whatever happens in the elections, they do come to an agreement on the Bush tax cuts and on the August 2011 spending cuts, and they allow the Social Security payroll tax holiday to expire.

H.L.: Where is the stock market headed this year and next year?

A.C.-B.: The U.S. stock market has grown slowly over the past year, though it has been flat in the last two months. Uncertainty over the fiscal cliff and Europe's situation might cause another temporary downturn in the next two months.

Uncertainty will continue until the legislative hurdles are cleared, including raising the debt ceiling, which must be done by April. A bigger downside risk is another debt ceiling impasse like the one in August a year ago, which would trigger another ratings agency downgrade on U.S. credit. That's the last hurdle the U.S. must clear to eliminate uncertainty over its policy.

With Europe it's much more complicated.

H.L.: Do you see eurozone leaders fixing the zone's toxic sovereign debt problems and keeping the eurozone alive?

A.C.-B.: The only thing that we think is more likely than not is that before the year is out, Spain will need a bail out from the European Financial Stability Fund. Everything there depends on whether or not the German government maintains its current position. The downside risk is that the European leaders, especially the European Central Bank, and the Stability Fund say, "We'll lend you the money, but you need more tax increases and more austerity by the government.

Now there's pressure for them to change their position. The real potential for a crisis comes from protests in Spain which have been growing. If they get large enough, it could be the case that the government in Spain says we'd like to carry out these austerity conditions, but we can't. The rejection of austerity measures would be the start of a financial crisis. That's the main downside risk in Europe.

What we think is going to happen is that Spain does get bailed out, and due to the Spanish government's perseverance and some leniency by the European leaders, mainly Germany and France, Spain would continue to muddle through. That would mean prolonged unemployment, but Spain would continue to service its debts, and the European situation would calm down, and there would be less uncertainty, which would lead to more bank lending and the start of a recovery, which would occur by early 2014.

H.L.: What's ahead for the U.S. housing market?

A.C.-B.: Right now housing has passed bottom, prices have started to increase, and residential construction has started to edge up. There are some hot regional markets in the U.S., especially in the Mountain states, Phoenix and Salt Lake City in particular. The Mountain states and recovery in the rest of the U.S. has helped pull up housing prices in general.

Of course, there are exceptions to the recovery. You're still going to see some slight house price declines in some areas of the U.S., areas that have very high foreclosure inventory, like Florida, or states that don't have that large a foreclosure inventory but have a very slow foreclosure process, like Connecticut, which requires court approval before a lender can foreclose.

Prices in Connecticut have only just now reached bottom, and it won't be before the start of next year before they start rising.

The fact that housing is starting to recover is a very good sign for the U.S. economy, because a large share of job losses and income losses were caused by the collapse of construction activity during the recession.

H.L.: What do you think of the jobs trend?

A.C.-B: Right now the U.S. jobs tend is starting to improve, but at the current rate, it will be a long time before the U.S. regains either its pre-downturn employment peak or the pre-downturn income level. At the current rate of job growth, it would be 2017 or 2018, but thanks to the recovery in housing, better financial balance sheets for consumers, and an eventual recovery in Europe, we believe that the U.S. economy and GDP growth will accelerate at the end of 2013 and early 2014. So we don't believe the U.S. will resemble Japan in the sense of having almost perpetual slow growth.

So by late 2014 and early 2015, the U.S. should return to its pre-downturn level of jobs. And in the second half of 2013 income growth should return back to its pre-recession rate.

H.L.: What areas of the U.S. economy do you like?

A.C.-B.: The recession was caused by the collapse of housing, and there will be a rebirth of housing construction in 2014, but we think that while a recovery in housing is essential to a U.S. economic recovery, it will not be a predominant driver of subsequent U.S. growth.

So we're looking more at technology industries, mainly biotechnology, including things like electronic medical equipment, and satellite connectivity and computer systems design. In other words, technologies related to the internet and also to healthcare and also technical research services which are clustered around universities, those will be the main regional growth areas in the U.S over the coming years. Those will have the fastest growth.

Also, the automobile industry, aerospace, and financial systems will continue to generate very high income and profit margins, but they won't be growing as rapidly as the first group of industries.

H.L.: What's happening in Connecticut?

A.C.-B.: Connecticut has lost momentum. Its job growth has stopped, and there have been job losses over the last five months, indicating that Connecticut is at risk of another recession. Most of the drag is coming from central Connecticut. So far, Fairfield County is doing somewhat better.

There are two main drags: The first is financial firms. They're still doing flat at best and badly at worst, mainly because bond yields are low, and second, because of financial market uncertainty which is reducing asset price growth and capital gains incomes. Those are slowing growth in Fairfield County and actually sending it into reverse in Hartford County.

The other major drag is the public sector, as state and local governments are laying off workers left and right.

Having said that, we think that because tax revenues for the state are improving, we think that the hemorrhaging of public sector losses will stabilize by the end of the year. So we think Connecticut will not go into a recession because of that -- that the public sector will stop dragging by the end of this year. And state revenues are helped by the U.S. recovery and by the state's income tax increase two years ago.

Local governments are still in a very bad position, because there's not enough aid coming from the state, and local property values are still way down. But we think that by the end of 2012, state aid will start to increase, and property values will start going up again.

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