QUARTERLY OUTLOOK

IMAGE ILLUSTRATION 1

The U.S. and South Carolina economies appear to be heading into the springtime with a generally solid footing. Though there was a marked slowdown in national economic growth at the end of 2005, this

was likely a temporary dip in growth, and 2006 is still expected to be a strong year for the national economy. In South Carolina, there was some notable improvement in terms of total employment growth during the final months of 2005. This is always a dangerous time of the year to be discussing state-level economic trends because of the timing of annual revisions to employment and unemployment data. Concurrent with the release of January labor market data in March of each year, figures for the previous year are completely revised, sometimes with dramatic results in terms of both the level of employment and unemployment and the direction of recent trends. Yet, the preliminary data do indicate that South Carolina enjoyed a long-awaited pick up in job growth during the last half of 2005.

Against a backdrop of further interest rate increases, uncertain energy prices, ever-heightening global competition, and potentially tight household budgets, 2006 is expected to be a year of further economic growth both for the United States and South Carolina. However, growth at the national level should be a bit slower than in recent years, and the state's economy is likely to grow at a rate just below or near the long-term average.

The first estimate of U.S. gross domestic product (GDP) as of January 2006, indicates that real GDP grew at an annual rate of 1.1 percent during the fourth quarter of 2005. During the previous ten quarters, the national economy had not grown any slower than 3.3 percent. The 1.1 percent growth was the slowest since the fourth quarter of 2002. The slowdown in growth from 4.1 percent in the third quarter to 1.1 percent in the fourth quarter was largely due to slower growth of personal consumption spending and faster growth of imports.

Consumption grew by 1.1 percent during the quarter after growing 4.1 percent in the third quarter. This drop was due to a 17.5 percent drop in spending on durable goods, primarily motor vehicles and parts. Indeed, the decline in motor vehicle spending subtracted more than two percentage points from real GDP growth. That is, if not for the sharp drop in motor vehicle expenditures, real GDP would have grown roughly 3 percent for the quarter. Spending on motor vehicles is a volatile component of GDP, with changes in interest rates, gasoline prices, and incentive offers all contributing to sharp swings in spending from quarter to quarter. Meanwhile, imports increased 9.1 percent after rising 2.4 percent in the previous quarter. An increase in spending on imports subtracts from GDP because GDP is a measure of domestic production.

The slowdown in the fourth quarter likely reflects displacements and disruptions caused by the summer's hurricanes. These effects may well begin to reverse themselves in the coming year as conditions stabilize and investment returns to the Gulf Coast region. Overall, real GDP grew 3.5 percent for all of 2005, down from growth of 4.2 percent during 2004.

On the inflation front, the most recent consumer price index (CPI) data from January indicate that overall consumer prices are up 4.0 percent during the last 12 months. Energy prices specifically are up nearly 25 percent over the last year. The core CPI - prices of consumer goods and services excluding energy and food prices, is up 2.1 percent in the last year. The core inflation measure suggests a lack of significant inflation to date. However, higher energy prices clearly cannot be ignored especially as higher energy prices ripple throughout the economy and affect other prices. So, while inflation is not currently a significant problem, there remains the potential for increased price pressures in the future.

These inflationary concerns continue to prompt the Federal Reserve to tighten monetary policy. The Fed is widely expected to raise rates further at its meeting at the end of March, and the chances appear good for another rate hike at the following meeting in May. The new Federal Reserve Chairman Ben Bernanke delivered Congressional testimony in mid-February, and offered the following insight into the Fed's current view of national economic growth, inflation, and monetary policy stance: "...the risk exists that, with aggregate demand exhibiting considerable momentum, output could overshoot its sustainable path, leading ultimately-in the absence of countervailing monetary policy action-to further upward pressure on inflation." (Testimony of Chairman Ben S. Bernanke, available from www.federalreserve.gov) That is, the current Fed view is that the economy continues to grow quickly and is likely near a full employment level of output. Growth above the economy's potential may spark inflation, and the Fed appears willing to continue to moderate economic growth by tightening monetary policy (raising rates) as necessary.

The U.S. labor market has been performing well. Total employment is growing at an annual rate of roughly 1.5 percent with a total of more than 2 million net new jobs during all of 2005. Meanwhile, the U.S. unemployment rate dipped to 4.7 percent as of January 2006 after averaging about 5.1 percent during 2005.

The South Carolina economy generated mixed signals through all of 2005. Many indicators pointed to solid economic growth, including home sales and construction, retail sales, income and sales tax collections, and unemployment insurance claims. Yet, the labor market data revealed an economy struggling to generate enough new jobs to keep pace with a rapidly growing labor force, putting upward pressure on the state's jobless rate. The currently available data, however, show that the state saw much stronger job growth during the last half of 2005.

Between January and July 2005, total nonagricultural employment in South Carolina fell from 1,835,300 jobs to 1,827,900. By December, total employment had risen to 1,850,500 - the highest level since the end of 2000. December's employment level was 1 percent above the previous December. The preliminary data indicate that the average level of monthly employment in 2005 was 0.4 percent greater than the average for 2004. Again, though, it appears that there was an increase in growth towards the end of the year. 2005 marked the third year in a row of job gains for the state after losing jobs during 2001 and 2002.

On the downside, South Carolina's unemployment rate remained among the highest in the nation. In December, the jobless rate stood at 7.0 percent. After declining steadily during the first half of 2005, the jobless rate rose during the final months of the year. The rising jobless rate was accompanied by rapid growth in the state's labor force. Indeed, it appears that labor force growth is outstripping population growth, suggesting an increasing labor force participation rate. The problem of course is that it also appears that the state has not been generating enough new jobs to employ this growing labor force. However, if the most recent gains in total employment are maintained, then the state's jobless rate should decline during 2006.

Again, it is important to mention that all of these labor market statistics, and therefore any inference on the state's economic performance based on them, are subject to revision shortly. In recent years, these revisions have led to swings of tens of thousands of jobs one way or the other. The new numbers will perhaps shed more light on the true direction of the state's labor markets over the last year or so.

Among the many positive signals from the state's economy recently has been the strength of state tax collections. The state's Board of Economic Advisors recently raised the revenue projection for the current year and for the coming fiscal year. These actions have translated into roughly $1 billion in new revenue available for the coming fiscal year. How well the state can weather the next economic downturn will depend in part on how this new tax revenue is allocated in the coming year. Previous experience has shown that when new money is fully allocated towards new and ongoing programs, sometimes drastic budget cuts become necessary when revenues fall during a recession. Now, the next recession is not expected to occur in the immediate future, but it is precisely during the relatively strong times that we need to remember that there will be another downturn at some point.

Turning to the current economic forecast, the national and state economies do appear to be in good shape for further economic growth. Nationally, consumer and business spending remains largely intact despite the dip at the end of 2005. Of course there are potential obstacles, including another surge in energy prices, rising health care costs, higher inflation and interest rates, and possible declines in select real estate markets around the country. Yet, despite these possible negative factors, the U.S. economy has proven itself to be resilient. Overall, real GDP is currently expected to grow in a range of between 3 and 3.5 percent during 2006. This would put economic growth near or just shy of its pace from 2005. Unemployment should remain around 4.7 to 5.0 percent, and inflation is likely to creep up slightly, though rising interest rates and moderating economic growth should work to stave off substantially higher prices.

In South Carolina, many areas remain strong. Construction, retail sales, tax collections, unemployment insurance claims, and other indicators point to ongoing strength. The major issues to watch, then, will be the course of job growth, unemployment, and income growth. The current forecast does call for a strengthening of job growth in 2006, gains in personal income, and a declining unemployment rate throughout 2006.

AUTHOR_AFFILIATION

Dr. Donald L. Schunk is Research Economist for the Division of Research and Assistant Professor of Economies in the Moore School of Business at the University of South Carolina. He is responsible for the South Carolina Economic Forecasting Service, which provides quarterly and annual projections of the South Carolina economy, and teaches graduate and undergraduate courses in economics and forecasting.