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Regional Update
Eleventh District Economy Catching Up
July 2004

Pia M. Orrenius reviews recent economic conditions in Texas.

First the Good News ...
After a prolonged recession, the regional economy is finally catching up to the nation. This is the good news. The Texas economy is in broad-based recovery. The leading index is trending up, signaling further acceleration in growth ahead. The health, energy and export sectors are particularly strong. We also continue to see record contract values and sales in single-family homes, even as the rate of increase has slowed.

As seen from the bars in Chart 1, Texas’ gross state product caught up to national GDP in fourth quarter 2003. Texas and the nation also grew at the same rate in the first quarter of this year. The prolonged Texas recession, meanwhile, is evident from the four quarters of negative growth in 2002 and early 2003. At this time, Texas was contracting while the national economy was already in recovery.

Chart 1

Despite lagging output growth, the Texas labor market has held its own (Chart 2). The resumption of job growth in Texas was coincident with the nation in the fall of 2003. Since then, Texas has had consistent monthly job gains, although at a slower pace than the nation since March. We expect some of the recently weak job numbers to be revised up in the coming months, so we are not making much of this discrepancy for now.

Chart 2

The Texas Leading Index is also on an upward trend, as shown in Chart 3. This suggests tat job growth should accelerate in the coming months. Currently, the index is forecasting between 1.5 and 2 percent job growth for the year. So far in 2004, Texas employment has grown at only a 1.3 percent annual rate.

Chart 3

The improvement in the Texas economy in 2004 is broad-based. Table 1 illustrates the sectors that have turned around, going from losing jobs in 2003 to gaining jobs in 2004. Total employment, for example, contracted by 0.3 percent last year. Other sectors that are now growing include trade, transportation and utilities, government, construction and information.

Table 1
Broad-based improvement in '04

Sectors that grew last year and are still growing include education and health, leisure and hospitality, financial activities, professional and business services, and energy. The only sector still losing jobs, although at a much slower rate than before, is manufacturing. One important point about manufacturing, though: If we were to break out high-tech manufacturing, it would fall into the turned-around category. High-tech manufacturing employment has risen slightly this year.

The energy sector has been a strong contributor to the region's recovery (Chart 4). Although we have seen oil and natural gas prices recede from their recent highs, futures prices suggest they will remain high going forward. Natural gas prices are expected to reach close to $7 this winter and West Texas Intermediate crude to be around $37 per barrel.

Chart 4

Many factors are driving energy prices higher, but one important long-term factor is data suggesting that OPEC output is nearing capacity for the first time in 30 years (Chart 5).

Chart 5

Given growing demand in developing countries such as China and few signs of OPEC expanding capacity, the outlook for oil and gas is for above-average prices to continue even as the risk premium recedes.

Another area of emerging regional strength is the export sector. First quarter 2004 posted the largest increase in exports in two years, due primarily to growth in Asia and Mexico. China and the rest of Asia now account for 25 percent of all Texas exports, compared with 41 percent for Mexico (Chart 6). As a result of the rising importance of Asia, a hard landing in China—while it would not have a widespread impact—would be felt here.

Chart 6

Now the Bad News ...
There is some bad news to balance the outlook. Catching up to the nation is just fine, but Texas typically averages about a 1 percentage-point higher job growth than the United States. In other words, our current rate of growth is below long-run trend. Also, we are catching up to the nation not only in terms of economic growth but also with respect to inflation.

Chart 7 illustrates the first point. Since November 2001, the Dallas District has turned in an average performance with regard to employment growth, falling between St. Louis and New York. The Atlanta and San Francisco districts have realized the strongest growth, Cleveland the weakest. Before the recession and 9/11, Dallas was consistently among the top three districts (with the exact order depending on the index year).

Chart 7

In the other bit of bad news, regional price pressures have quickly caught up to the nation, as core CPI indicates in Chart 8. In the past six months, Texas core CPI increased 1.9 percent.

Chart 6

Conclusions
Regional economic growth is catching up to the nation. Output growth is already on par with the United States, and recent weak job numbers are likely to be revised up. Nevertheless, the region is not back up to its trend growth rate.

Getting back to trend growth will require several elements. Net job creation has to reach the two remaining sectors that are still struggling—manufacturing and information. The recovery in the U.S. and Mexican economies must continue. It would also help for China to realize a soft landing and any terrorist acts this year to be thwarted or their economic impact minimized.

And last but not least, trend growth exceeds national growth because Texas has a low cost of living and institutions that favor businesses and the churn. State tax reforms that raise the burden on businesses will speed institutional convergence to the nation and likely eliminate some of the Texas growth advantage.

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