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

The Arizona economy continues to expand at a slow pace. For instance, employment increased 2.0% in the third quarter, over the year. That was better than the dismal second quarter result and was just above the national rate, but it was not very good. Keep in mind that the state’s average job growth rate during the 30 years before the Great Recession was 4.1% per year. We’re seeing similarly slow gains across all the major indicators.

The missing link in the state’s recovery has been construction, which continues to battle headwinds. Without a serious rebound in this sector, it is unlikely that state growth will accelerate appreciably. Such a rebound in the next year seems unlikely at this point, which means that Arizona is headed for another year of modest growth.

Arizona Recent Developments

Arizona job growth rebounded in the third quarter of 2014, after a dismal showing during the previous three months. The state added 51,600 jobs in the third quarter on a year-over-year basis, which translated into a growth rate of 2.0%. That was slightly faster than the national job growth rate of 1.9%.

As Exhibit 1 shows, most of the job growth was concentrated in leisure and hospitality (especially jobs in food services and drinking places); education and health services; professional and business services; and trade, transportation, and utilities (especially retail trade). These sectors together accounted for 81.2% of job growth over the year. Government jobs rose modestly during the period, reflecting gains in state and local education, as well as slower job losses in the federal sector. Manufacturing jobs were up over the year, driven by gains in other manufacturing and non-durable goods. Aerospace and computer and electronic products both posted job losses.

Construction employment continued its string of disappointing results, dropping 5,700 jobs over the year in the second quarter. This primarily reflects sluggish activity in the construction of buildings, both residential and nonresidential.

Natural resources and mining also posted job losses over the year, but these seem to be related to an administrative reallocation of jobs across sectors by the U.S. Bureau of Labor Statistics.

Exhibit 1: Arizona’s Job Growth (and Wages) by Industry
Over-the-Year Job Growth in the Third Quarter of 2014
Job growth in the Phoenix MSA has outpaced gains statewide and growth in the Tucson MSA. Indeed, the Phoenix MSA added 38,400 jobs over the year in the third quarter, which translated into a growth rate of 2.1%. Phoenix job growth also accounted for 74.4% of state growth. The Tucson MSA added 4,200 jobs over the year, for a 1.2% growth rate, and accounted for 8.1% of state job growth.

As Exhibit 1 also shows, average (pre-tax) wages per worker in Arizona were $45,921 in 2013. That was just 0.7% above the 2012 level, before accounting for the impact of inflation. Adjusting for inflation, average wages were actually down in 2013. The job growth mix during the past year does not seem weighted toward particularly strong wage growth this year.

Arizona’s nominal personal income rose by 4.2% in the second quarter of 2014, over the year. That was slightly faster than the national rate of 4.1% and similar to the state rate in the first quarter. Personal income is composed of net earnings from work, asset income (dividends, interest, and rent), and transfer payments, like Social Security, Medicaid, Medicare, among other components. All three components contributed to income growth in the second quarter, with the largest contribution coming from net earnings from work.

After adjusting for inflation, Arizona’s personal income rose by 2.1% over the year in the second quarter.  However, 2.1% annual growth is roughly one-half of the state’s average annual growth rate during the 30 years before the Great Recession (4.8% per year). Overall, state income growth is on track to outpace results for 2013, but that is a low threshold.  Keep in mind that income growth last year was depressed due to the lingering effects of the 2012 federal fiscal cliff.

One reason that Arizona’s recovery has been tepid is the slow rebound of the housing sector. Exhibit 2 shows smoothed housing permit activity for Arizona, the Phoenix MSA, and the Tucson MSA. After bottoming out in late 2010, permits increased at a rapid rate during 2012 and the first half of 2013. However, by late 2013 growth slowed significantly, driven by both declines in multi-family permits and slower gains in single-family permits. Activity in Phoenix (and thus the state) jumped up in early 2014, driven entirely by a surge in multi-family permits. Single family activity remains sluggish for the state and the Phoenix MSA. The Tucson MSA did not experience the surge in multi-family permits early in 2014 and so growth has weakened a bit so far in 2014.

This basic pattern is consistent with the U.S. Census Bureau (ACS one-year estimate) data on household growth, which depicted a statistically significant (but not very large) year-to-year increase in 2012, but not in 2013.

Exhibit 2: Arizona Housing Permits Struggle Upward
Total Housing Permits, 12-Month Moving Average

House prices have followed a somewhat similar pattern, with strong increases beginning in 2011, which have gradually decelerated during 2013 and into 2014. According to data from Case-Shiller, house price appreciation in the Phoenix MSA peaked at 23.2% (year over year) in January 2013. The latest data, for August 2014, show year-over-year growth of just 4.3%. That general pattern holds for Tucson as well, with strong gains in 2012, followed by slower growth.

Overall, Arizona residential activity remains stuck in a low gear, held back by slow population and household growth, still-tight mortgage credit conditions, and modest supply constraints related the availability of affordably priced lots in desirable areas.

Arizona Outlook

Arizona is in good position to continue expanding in the future, assuming the national economy avoids recession. However, that growth is likely to remain slow in the near term. Exhibit 3 provides a summary of the forecast through 2016. Overall, gains in jobs, income, sales, and population are forecast to be steady and unspectacular through 2016.

Exhibit 3: Arizona Forecast Summary

Arizona employment is forecast to increase by 2.1% in 2015, up slightly from 1.9% in 2014. Growth accelerates modestly in 2016 and more strongly in 2017, as residential construction picks up a little more speed.

Most of the job gains expected during the next three years will be in the service-providing sectors, particularly trade, transportation, and utilities; professional and business services; leisure and hospitality; and education and health services. Together, these four industries account for 71.4% of net job growth through 2016.

Personal income is expected to rise at a faster pace in 2014 than in 2013. Keep in mind, however, that gains in 2013 were depressed by the federal fiscal cliff. Personal income growth of 3.4% in 2014 and 3.5% in 2015 is not rapid. Slow increases in personal income during the next two years reflect modest improvement in earnings from work, which are likely to be restrained as the state takes time to absorb slack in the labor market.

The Phoenix and Tucson MSAs are both expected to add jobs, residents, and income in the near term, although growth remains slow. As Exhibit 4 shows, employment is forecast to rise at a faster pace in Phoenix than Tucson. Tucson continues to battle the headwinds created tight federal spending (including the sequester), since federal government activities (both civilian and military) are a large part of the local economy.

Exhibit 4: Continued Moderate Job Growth Ahead for Both Phoenix and Tucson
Annual Job Growth Rates

Risks to the Outlook

The baseline forecast calls for continued slow growth in the near term for the state, Phoenix, and Tucson. However, this baseline scenario may turn out to be too optimistic, particularly if the U.S. economy underperforms and/or generates disappointing increases residential mobility and household growth. In that case, Arizona’s population growth and residential construction activity would be further depressed, dragging down overall state gains.  An optimistic scenario is possible is well, with stronger national growth contributing to increased residential mobility and household formation. This would boost state construction activity and contribute to faster overall growth.

Photo of flying super hero businessman in headwinds courtesy Shutterstock.

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