By George W.Hammond, Ph.D. EBR Associate Director and Eller Research Professor

  The Arizona economy is still generating solid economic growth, with job gains above the national rate but well below the long-run state average. The housing market is improving, although the level of building activity remains low. Overall, the state is on pace to generate job, income, population, and retail sales gains in 2013, with faster growth expected during the next two years. The national economy is also growing at a modest pace that is expected to accelerate beginning in the second half of the year. By 2015, the U.S. is expected to reach trend growth, as the housing market gets back to normal, the impact of the sequester cuts fade, and as world growth accelerates. The long-run outlook calls for the state to outpace national growth for many indicators. However, it also calls for slower growth during the next 30 years than during the past 30 years. That reflects in large part the aging of the baby boom generation, which slows labor force growth and ultimately gains in potential output. Nonetheless, the economy expands during the 30 year period due to continued innovation and capital investment.

U.S. Recent Developments

U.S. real GDP increased by 1.7% in the second quarter of the year, according to the advance estimate, which was faster than the 1.1% growth rate in the first quarter. The second quarter increase was driven by fairly broad-based gains in consumption and investment spending, including inventory investment. Net exports and federal government spending were a drag on growth in the second quarter. The second quarter GDP release reflected a comprehensive revision of the National Income and Product Accounts that included both definitional and statistical changes. One of the most important changes was a shift in the way that research and development expenditures are treated. This spending is now considered to be fixed investment and this allows data users to better measure the effects of innovation and intangible assets. In addition, GDP now includes expenditures for the creation of entertainment, literary and artistic originals as fixed investment. These changes increase the level of GDP but do not change general trends or business-cycle patterns. Annual real GDP growth from 1929 to 2012 has been revised up slightly, from 3.2% per year to 3.3% per year in the revised data. As a result of the revision, the U.S. Bureau of Economic Analysis (BEA) has created a line item tracking fixed investment spending on “intellectual property products”, which includes research and development; entertainment, literary, and artistic originals; and software. In addition, BEA has updated the base year for real GDP to 2009. U.S. jobs also continue to expand at a modest pace. Seasonally adjusted nonfarm payroll jobs rose by 162,000 in July, which translated into a year over year growth rate of 1.7%. Further, job growth in May and June were revised down a combined 26,000 jobs. Year-over-year job growth in May and June are now estimated to be 1.6% and 1.7%, respectively. Retail trade; professional and business services; and leisure and hospitality accounted for nearly two-thirds of job growth from June to July. Construction jobs were down, while manufacturing jobs increased.

U.S. Outlook: Short-Run Rebound

The U.S. forecast calls for real GDP growth to accelerate during the second half of 2013 and into 2014. However, after a sluggish start to the year, that leaves real GDP growth at just 1.6% in 2013. The forecast calls for stronger growth in 2014 (at 2.7%) and 2015 (3.5%). The acceleration next year arises from stronger growth in consumption spending (especially nondurables and services), nonresidential fixed investment (both structures and equipment), residential investment, rebounding export growth, and less fiscal drag (at both the federal and state and local level). Residential construction is expected to contribute to faster growth next year, as the housing recovery continues to gain momentum. Continued growth in U.S. households gives rise to another increase in housing starts, which increase by 27.0% in 2014. Rebounding demand also contributes to rising house prices in 2014.

U.S. Outlook: Long-Run Growth

The long-term outlook extends the projections through 2043. It assumes that the economy encounters no major mishaps during the forecast period. Further, actual growth is expected to closely follow potential growth, once the economy gets back on track. The forecast calls for U.S. real GDP to average 2.5% per year from 2012-2043. That is 0.4% percent per year slower than average growth during the previous 30 years. U.S. real GDP growth decelerates during the 2012-2043 period as baby boomers retire, which slows labor force growth. Even so, output continues to expand due to increased business fixed investment.  In addition, productivity growth averages 1.9% per year during the forecast period, compared with 2.0% during the past 50 years. Assumptions about productivity growth are crucial and always somewhat controversial. Some researchers, particularly Professor Robert Gordon of Northwestern University , take a more pessimistic view of future productivity growth, arguing that innovations in the future will be “evolutionary” compared to the “revolutionary” innovations of the past 100 years. U.S. population growth is assumed to decelerate from the 1.0% per year range to 0.7% per year during the forecast. Population growth in the older age groups accelerates as the baby boomers age. Indeed, the share of the population age 65-and-older is forecast to rise from 13.8% in 2012 to hit 20.8% by 2043. This pushes up outlays for Social Security, Medicare, and Medicaid.

Arizona Recent Developments

Arizona continues to add jobs at a faster pace than the U.S., as Exhibit 1 shows. Indeed, from the second quarter of 2012 to the same quarter in 2013, Arizona added 49,900 jobs, which translated into a growth rate of 2.0%. That was faster than the national rate of 1.6% during the same period. During the past year, leisure and hospitality and construction added the most jobs, with each increasing by just over 10,000 jobs. Professional and business services; financial activities; and education and health services rounded out the top five.  These five sectors accounted for nearly 85% of job gains during the past year. Job gains were small in government (with a decline in federal government); natural resources and mining; manufacturing (with a decline in computer and electronic products); and information. Other services (repair, religious, grantmaking, and personal services, like laundry and dating services) was the only super-sector to produce year over year job losses. The Phoenix MSA also continues to add jobs, with growth during the past year (at 2.6%) exceeding both the state and national rates. Preliminary data suggests that job growth in the Tucson MSA is coming at a slower pace (0.8% during the past year) and is decelerating.

Arizona growth currently outpacing U.S.

Exhibit 1: Arizona is Currently Outpacing U.S. Job Growth: Arizona and U.S. Nonfarm Payroll Job Growth, Year-to-Year Growth Rate, Seasonally Adjusted.

Construction job gains reflect in part increasing housing activity in Arizona.  Seasonally adjusted housing permits were up by 35.7% in the second quarter, compared to the year-ago level. That reflected gains in both single and multi-family permits.  In addition, both Phoenix and Tucson contributed to the statewide gains. However, it is important to keep in mind that housing permits are still running at relatively low levels. House prices continue to rise, with Phoenix MSA prices (Case-Shiller measure) up 20.6% in May 2013, compared to the same month in 2012. Strong house price increases reflect reviving demand and tight inventories. In addition, according to Census data, both homeowner and rental vacancy rates declined in the second quarter, compared to year-ago levels. Overall, the housing sector in the state continues to gradually recover, but there remains room for improvement.

The Arizona seasonally adjusted unemployment rate was steady in the second quarter of 2013 at 7.9%, 0.4 percentage points above the national average of 7.5%. The state rate in the second quarter was 0.5 percentage points below its year-ago level and 1.6 percentage points below the second quarter of 2011. Job growth is contributing to lower unemployment rates. Unfortunately, the state has also posted labor force declines during the period. This suggests that the falling unemployment rate reflects in part unemployed residents dropping out of the labor force. U.S. and Arizona personal income declined rapidly in the first quarter of 2013, after a large surge in the final quarter of 2012. The decline in the first quarter reflected a decline in dividends, interest, and rental income, which fell off after a surge in the fourth quarter related to accelerated payments in anticipation of end-of-year tax changes. First quarter income growth was also restrained due to the expiry of the temporary payroll tax holiday. We expect income growth to rebound to more normal levels in the second quarter.

Arizona Outlook in the Short Run

The forecast calls for the state to grow modestly in 2013, then accelerate in 2014 and 2015. Arizona job growth is expected to accelerate from 2.1% in 2013 to 2.8% in 2014 and again to 3.5% in 2015, with state job growth also beating the national average. The forecast calls for continued recovery in the housing sector for the state, Phoenix, and Tucson, with growth in housing permits driven by rising net migration. Statewide housing permits are forecast to hit 47,200 in 2015, compared to 21,700 in 2012. Population growth drives the recovery in housing activity, with net population change hitting 116,500 in 2015, compared to 60,000 in 2012. Job gains drive income growth up in Arizona, with personal income growth rising by 3.9% in 2013, then accelerating to 5.5% in 2014 and 5.7% in 2015. Rising income growth supports retail sales, broadly defined, which is forecast to increase by 4.1% in 2014 and 4.9% in 2015.

Arizona Outlook in the Long Run

Exhibit 2 summarizes the state long-run forecast, which we update annually. Population is expected to hit 10.4 million by 2043, which translates into an average annualized growth rate of 1.5%. That is slower than average growth during the previous 30 years (2.7%) but above the national average (0.7%). Nonfarm payroll jobs reach 4.3 million by 2043, an annual growth rate of 1.8%, below the previous 30 year average (2.9%) but above the national rate (0.8%).

Arizona lon run forecast

Exhibit 2: Arizona Projections to 2043.

Job growth in the state is forecast to be concentrated in the service-providing sectors, which account for 91.0% of jobs in 2043, compared to 88.3% in 2013. The manufacturing employment share declines during the forecast, falling from 6.2% in 2013 to 4.2% in 2043. Employment shares also fall in mining and logging; construction; leisure and hospitality; other services; and government, which declines from 16.4% in 2013 to 13.7% by 2043. Education and health services and professional and business services post the largest increases in employment shares. By 2043, education and health services accounts for 18.1% of state jobs, up from 14.9% in 2013. Most of that increase comes from gains in health care and social assistance. Professional and business services jobs account for 16.9% of employment in 2043, up from 14.5%. Arizona’s growth slows in the long-run as the baby boomer’s age and retire. This will affect the state’s jobs-to-population ratio (measured using nonfarm payroll jobs), which never regains its pre-recession peak. Instead, the ratio plateaus in the 42.0% range, which is well above its post-recession low of 37.3% in 2010, but well below its high of 43.3% in 2000 and well below the national rate (44-46%). Job growth during the forecast will drive gains in per capita personal income, even after adjusting for inflation.

The forecast calls for state per capita income growth to average 3.7% during the next 30 years, equal to the national rate. State gains are expected to exceed the national average initially, but then fall behind as the forecast progresses. Overall, the state makes no progress in closing the income gap with the U.S. Continued income growth contributes to gains in retail sales, but the ratio of retail sales to income continues to fall during the forecast. This likely reflects in part an aging population that spends more on services, especially health care, and less on taxable goods. Both the Phoenix and Tucson MSAs expand during the forecast, but growth is faster in Phoenix. By 2043, Phoenix accounts for 75.4% of state jobs, up from 71.7% in 2013, and 70.2% of state residents, up from 65.9% in 2013. The Tucson MSA is forecast to account for 12.9% of state jobs in 2043, down from 14.5% in 2013, and 14.0% of state residents, down from 15.2% in 2013.

If you need more detailed economic forecast data for Arizona and its communities, learn about the advantages to your organization of membership in EBR’s Forecasting Project.

Man on ladder with binoculars image courtesy Shutterstock.

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