GVSU economists chair weighs in on West Michigan's economy

Date: October 30, 2009

GVSU economics chair weighs in on West Michigan's economy

WEST MICHIGAN - Economists can be nervous about sitting down to interviews with reporters because the scribes have an interesting habit of writing down what the economists say and putting it in print.

In other words, their predictions get put on display for readers to see — and their words can be held against them if they're wrong.

But Paul Isely, associate professor and chair of economics at Grand Valley State University, was game for a broad-ranging interview with MiBiz. Given all the signs and indicators, Isely predicts:

•Unemployment will bottom out in the third and fourth quarters this year, with a slight, slow improvement in those numbers in the first and second quarter of 2010.

•Housing values will see some appreciation, although not faster than inflation, but the effect of the end of the first-time homebuyer tax credit is yet to be determined.

•Inflation will remain in check as much of the money the Fed made available is already getting paid back.

•Federal interest rates will likely increase next year, although the Federal Reserve remains very cautious.

•As China and India see more growth, they will increase their usage of oil, but oil will most likely stay below $80 per barrel, keeping gasoline prices relatively stabile.

Uncertain impact of housing stimulus phase out

Isely's computer was still grunting and groaning from just having computed a model for the housing market as he sat down for the interview. He said he's following the housing market in particular, because it, along with the credit industry, led the nation into the current recession and will help lead us out.

Home values in Grand Rapids are back to February levels and have begun to stabilize, and that's good news for the credit market as well. Banks are "skittish" when home values are "dropping like a rock, and they'll not lend unless they're certain what the prices are," he said.

He said housing would be among the leading indicators of a recovery because so much of people's credit is tied to their homes. Another consideration is the number of homes being put on the market because of foreclosure and the number of people leaving the state.

"The good news is that I can say that even with everything we've seen in the last year, it's not driving the prices down more," Isely said.

However, there are a couple of big ifs yet to be accounted for. Foremost in Isely's mind is the effect the $8,000 federal first-time homebuyer tax credit has had on home sales.

"It's definitely adding houses to the purchases right now. The question is how much —no one knows," he said. "What happens when that $8,000 goes away?"

One unreported fact of the federal housing stimulus is that it has been far more costly than cash for clunkers, which cost $2.877 billion dollars compared to an estimated $14-15 billion for the first-time homebuyer tax credit.

"It's substantially larger than cash for clunkers, but it's brought new people into the market…to buy a house," Isely said.

An analysis by finance and economics blogger Calculatedrisk.com, penned by former public company executive Bill McBride, found that the cost to taxpayers of the additional vehicles purchased under the cash for clunkers program —over and above what would have been sold without the incentives, the mark of it's stimulating effect — was $7,200.

The National Association of Realtors estimates that 1.9 million buyers will capitalize on the $8,000 first-time homebuyer credit, with 350,000 sales attributed directly to the credit. Using those numbers, that puts the cost per home sold — over and above what would have been sold without the credit —at $43,400.

Isely's also concerned about the impact a foreclosure law change has on the housing market. The law created a waiting period to allow homeowners time to renegotiate with their banks, but Isely said it didn't address the root issue that people with homes in foreclosure probably don't have jobs.

"We all know the things that started the problem were the credit market and housing. These are two places I'm always looking (at). We're starting to see some healing going on, but you can start to feel better while you're still damaged," Isely said.

One of Isely's favorite indicators for the credit industry is how much banks are borrowing from the Federal Reserve, which has dropped 47 percent since its peak in November 2008.

"It's saying that banks aren't needing to access that," he said. "And it spreads. The liquidity measures ease up and people get access to cash. Small business hasn't seen it loosen up. You can start to see some cracks in the long term, but we're not there yet."

Unemployed need retraining for future economy

Jobs are typically a lagging economic indicator, but what Isely's seeing is pointing to a slow recovery for employment numbers, largely because the economy has undergone "structural change."

"Structural change is unemployment caused because the job you used to do is no longer necessary," he said. These "technically unemployed" need to be retrained to work in the industries of the future, and that process takes time, hence the slow recovery of unemployment numbers.

But, other positive signs are lining up, he said. Businesses typically hold on to workers too long and are slow to rehire until they're sure that the recovery has started. That leads to spikes in productivity, which is exactly what Isely said the numbers are showing.

"When the workers get tired and their quality of life goes down —they're redlined, pushed to the max — businesses see that they need to get more people in there," he said. "We're just seeing the stories that we're reaching that point."

Auto industry holding state down

Michigan's seasonally adjusted unemployment rate hovered just over 15 percent in August. The key phrase there, Isely said, is "seasonally adjusted." He questions the accuracy of those formulas based on the traditional automotive cycles, which are becoming less and less normal, and with the drastic declines in that industry, perhaps less relevant.

A telling disparity is that the city of Detroit, in real numbers, saw unemployment increase by 22,000, but the state's seasonally adjusted increase, as a whole, was only 6,000, Isely said.

"Michigan is like two halves and a north," he said. The north is based on natural resources and tourism, while the east is heavily automotive dependent and the west is more diversified. Over the last five months, the southeastern portion of the state lost about 54,000 jobs, while West Michigan lost about 11,000. "They have twice the population, but that doesn't excuse five times the job loss," he said.

Statistically, the Grand Rapids, Ann Arbor and Kalamazoo areas are faring much better than the metro Detroit region, but Isely notes that the state as a whole, thanks to its ties to the auto industry, never left the last recession.

"We went up to 7 percent (unemployment) and stayed there. There's been a dichotomy occurring for the last seven years. The auto industry has shed close to half its jobs, and that's a huge problem for that side of the state. But every time I look at it, if you take automotive out, the rest of Michigan is doing well since 2001," Isely said.

It will be tough to quickly replace the thousands of jobs lost to the decline of the automotive industry, he said, but at least the state is trying to attract new jobs in the alternative energy and healthcare fields —even in the film industry.

"There certainly are potentials on the west side for alternative energy and healthcare," Isely said. "Unfortunately, we're not unique in that, so we have to be better at it than others. We have to find our piece of the pie and start gnawing at it."

He's encouraged that jobs in healthcare and social assistance were up 9,100 positions across the state —"a big bump." The trick will be for the industry to create wealth, which is driven by the intellectual property, patents and specialties developed in this region that attract people here, he said.

"There's ways to leverage medical knowledge and use it to bring in wealth, but it's not as easy as making widgets and selling them to someone on the other side of the state," he said. "It takes knowledge and human capital."

And unfortunately, as Isely pointed out, referencing a West Michigan Strategic Alliance report, the region is behind in higher education, although the gap is closing, starting with 20 year olds.

Cap and trade opportunity

With alternative energy, Isely said the region needs to pay attention to what happens with the cap and trade legislation currently before the U.S. Congress.

"Change brings about opportunity," he said. "If anything close to cap and trade comes through like we're seeing, there will be huge demand for alternative energy. And we already have a lot of alternative energy technology on the ground."

In essence, the state's manufacturers involved in alternative energy have a lot to gain.

The only way to reach the proposed carbon reductions is via technology, Isely posits. The American Clean Energy and Security Act would mandate that the country reduce its carbon emissions by 80 percent of 1995 levels by 2050.

"I'm not sure people understand the magnitude," Isely said. "We're talking about a big number and a big change."

Using government numbers, the U.S. would be limited to 1,200 teragrams of annual carbon emissions. Currently, electricity production emits just less than 2,500 teragrams, while industrial production is at about 1,000 teragrams, Isely said. To achieve the reduction goal, people would have to drastically change how they heat their homes and drive their cars —and that takes technology companies could develop and make in Michigan.

While many companies say the program is cost-prohibitive, the cost of cap and trade isn't that overwhelming, according to one model Isely ran. Using coal industry numbers on the cost of the program —and remember, the coal industry is not in favor of cap and trade —and dividing by total kilowatt hours, cap and trade would only amount to about a 1¢ increase per kilowatt hour, Isely said, an increase of about 10 percent.

Stimulus or bust?

Michigan still has about $4 billion to spend of the $7 billion the federal government made available to it via the American Recovery and Reinvestment Act, not including the funds that came into the state's economy via the Making Work Pay provision, Isely said.

Most of $3 billion already paid out came in unemployment and educational benefits. The state stands to leverage the remaining portion of the stimulus over the next 18 or so months.

In particular, when dividing the amount received by population, Southeast Michigan is getting less money compared to West Michigan, Isely said. But the real winner, per capita, in the stimulus funds race is the Upper Peninsula.

"Stimulus is an interesting animal —it's easy to prove it did and didn't work," Isely said. "The key is that it had to be a stimulus, that it has to turn off at some point, and the government spends it in a reasonable manner. They need to pull back when times are good.

"There's no doubt in my mind that unemployment didn't get as bad as it would have without the stimulus. If the Federal Reserve hadn't stepped in last year, we'd be close to seeing 1930s-style unemployment. We're seeing 1980s instead. In an aggregate, we're not far off the 1980s recession. I think that's a success story. It's pretty easy to have the '80s. And we are borrowing to do it, but you have to decide whether it was bad enough and drastic enough to do that."

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This article appeared in the Monday, October 12, 2009 issue of MiBiz, read by upper management executives in West and Southwest Michigan. Print subscriptions are free to qualified individuals who are employed in West and Southwest Michigan. For further information about MiBiz, visit www.mibiz.com.