Legislative Analyst's Office, November 20, 1997

California's Fiscal Forecast
The LAO's Economic and Revenue Projections 1997-98 Through 1999-00

Chapter 2: Economic and Demographic Projections

The economic and demographic outlooks play important roles in determining the state's fiscal condition, through their effects on revenues as well as on caseloads and various other factors affecting the costs of state programs. This chapter presents our economic and demographic projections for 1997 through 2000, which will influence the state's fiscal condition in 1997-98, 1998-99, and 1999-00.

THE ECONOMIC OUTLOOK

We forecast that California's economic expansion will continue near its current healthy pace through 1998, before moderating in 1999 and 2000. We expect virtually all major industries and geographic regions to participate in California's expansion during this period. Figure 1 summarizes our U.S. and California economic outlooks.

Figure 1
LAO Economic Forecast
Percent Change (Unless Otherwise Indicated)
1997 1998 1999 2000
United States
Real GDP 3.7 2.3 2.2 2.5
Wage and salary jobs 2.2 2.0 1.4 1.2
Consumer Price Index 2.4 2.3 2.8 3.1
Unemployment rate (%) 5.0 4.9 5.2 5.3
Housing starts (millions) 1.45 1.42 1.41 1.38
California
Personal income 6.7 6.4 5.8 5.6
Wage and salary jobs 3.4 3.1 2.6 2.3
Consumer Price Index 2.2 2.5 2.7 3.1
Population 1.4 1.7 1.8 1.8
Unemployment rate (%) 6.4 5.7 5.5 5.4
Housing permits (thousands) 107 132 144 148
 

Recent Developments

Economic Gains Surpass Expectations. Both the U.S. and California economies grew faster than expected during the past year. California added approximately 400,000 jobs between the fourth quarter of 1996 and the fourth quarter of 1997, reflecting major gains in high-technology manufacturing and service industries, as well as improvements in two industries that had lagged so far in the current expansion--aerospace and finance. A key positive development for late 1997 has been the improvement in the state's real estate markets. Home sales, prices, and new construction are now increasing in most regions of the state.

Unemployment and Inflation Rates Are Down. As a result of ongoing economic growth, both the national and California unemployment rates continued to fall in 1997. As of September 1997, the California rate stood at 6.3 percent, down from 7.1 percent 12 months earlier. The U.S. rate is now down to 4.7 percent, which is near its lowest level in three decades. Despite the tightness in national labor markets and other signs that the U.S. economy is operating at near full capacity, wage and price pressures have not yet emerged. In fact, most measures of inflation fell in 1997 relative to 1996. For example, the U.S. Consumer Price Index (CPI) rose just 2.2 percent between September 1996 and September 1997, down from the prior-year increase of 2.6 percent.

The National Outlook

Slowing But Sustained Growth. We project that the U.S. economy will experience moderate growth with continued low inflation over the next three years. As shown in Figure 1 and Figure 2, we forecast that U.S. Gross Domestic Product (GDP) growth will slow from 3.7 percent in 1997 to between 2 percent and 2.5 percent per year through the end of the decade. The projected slowdown is consistent with the consensus of economic forecasters, which believe that with the economy operating at near full capacity, 2 percent to 2.5 percent growth is the maximum that can be sustained without a significant acceleration in inflation.



Consumer expenditures and business spending on capital equipment are expected to be the main forces behind the continued expansion, reflecting high confidence levels as well as the continued emphasis on investments in new technologies.

Inflation to Remain Low. Figure 1 also shows that we forecast that inflation will remain low. After dipping to just 2.3 percent in 1998, the U.S. CPI is projected to rise slowly to 3.1 percent by the year 2000. This outlook assumes some acceleration in wages, but it also assumes that strong foreign competition will limit the ability of domestic businesses to significantly raise product prices over the next several years.

Stock Market Turmoil Poses Risk. The recent volatility in the stock market is not expected to have a major impact on the national economy. Even with the declines experienced in late October and early November, the market remains significantly above its level at the beginning of 1997. However, further declines of a sufficient magnitude could depress consumer and business wealth, confidence, and ultimately, spending in the U.S. economy. As of mid-November, a wide diversity of opinion existed as to the market's likely future course, especially in the near term, ranging from continued expansion to significant downward corrections.

California Outlook

Healthy Growth to Continue. In contrast to the nation, we expect economic growth in this state to continue near its current pace in 1998 (see Figure 3). For example, wage and salary employment is projected to increase by 3.1 percent next year, down only slightly from 3.4 percent in the current year. The continued healthy growth is partly due to the upturn in residential construction, which will give an added boost to California's economy in 1998.



Our forecast assumes that employment and income growth will moderate a bit more in 1999 and 2000, as the state's economic expansion matures and the impact of a slowing U.S. economy takes effect. However, we project that California will continue to grow faster than the nation as a whole, reflecting the ongoing beneficial effects of the upturn in home construction and the continued growth in the state's high-technology manufacturing and services sectors.

State's Expansion Broadening. The California economic expansion continues to broaden, both in terms of industries and geographic regions that are contributing to the overall growth in the state.

In terms of industries, Figure 4 shows that employment in the state's high-technology manufacturing and services sectors is expected to continue growing at a healthy pace over the next three years, moderating only slightly from the recent past. Growth in these sectors will be joined in 1998 and beyond by significant increases in two industries that have lagged in the current economic expansion--aerospace and residential construction activity.



Aerospace Stabilizing. After declining dramatically for several years in the early 1990s, aerospace employment has finally turned the corner, and is now growing modestly again. The growth in this sector partly reflects expanding production of commercial aircraft and parts in this state, as well as a stabilization of defense-related contract spending. While this sector is expected to recoup only a fraction of the jobs lost in the previous decade, the gains will give an added boost to California in the late 1990s.

Home Construction Picking Up. A key positive factor for California's economy in 1998 is the outlook for growing home construction activity. Based on improving home sales and an upturn in home prices, we forecast permits for new construction to increase 14 percent this year, to 107,000 units, before growing further to 132,000 units in 1998 and 144,000 units in 1999. Although these totals are still well below those of the 1980s, when permits for new construction averaged more than 200,000 per year, the gains have positive implications for both the economy and revenues. For example, increased home construction will boost state sales tax receipts related to the sales of building materials, home furnishings, appliances, and other home-related goods.

Regional Economic Growth

Figure 5 compares the relative performance of the northern and southern California regionsduring the recent recession and subsequent recovery. The recession hit southern California much harder than the northern part of the state. This was due partly to the greater impact of the declines in housing construction and aerospace in that region. In addition, the figure shows that the north also emerged from the recession earlier, reflecting the rapid growth in commercial elec-tronics in the San Francisco Bay Area. However, the southern California economy has gained some momentum over the past year, reflecting balanced growth in many industry sectors. As shown in Figure 5, the southern California economy, although still less robust than the north, has finally recouped the jobs lost in the 1990s' downturn.


We expect that economic growth in the two regions will converge over the next two years, with the north moderating some from its recent pace, and the south continuing to accelerate.

THE DEMOGRAPHIC OUTLOOK

We project that California's population will expand over the next three years at an annual average rate of almost 1.8 percent. This is shown in Figure 6, which presents our forecasts for population growth in both percentage and numerical terms. While our projected growth is well above the pace of the recession-plagued first half of the 1990s, it is well below the 2.5-plus percent average of the rapid-growth years during the latter half of the 1980s. Numerically, we are projecting that California will add an average of close to 590,000 persons annually during the three-year period, with total population reaching more than 34.6 million in 2000.



Population Growth Components. A state's population growth can be broken down into two main components--natural increase (births minus deaths) and net migration (persons moving intoCalifornia from other states and countries, minus people leaving the state for other destinations). We project that natural increase will average close to 300,000 annually, while net migration will average somewhat over 290,000 annually.

Net Migration Rebounding. Figure 7 shows our forecast for net migration and its two major components--net domestic migration (population flows between California and other states) and net foreign migration (population flows between California and other nations). It indicates that total net migration (right panel) is projected to rebound to close to its prerecession level by the end of the forecast period. The primary reason involves a sharp turnaround in net domestic migration (left panel). Specifically, we forecast that net domestic migration will turn positive after 1998, compared to net population outflows to other states in excess of 300,000 at the depth of the recession.



Growth to Vary by Age Group. Figure 8 shows our population growth projections by age category, in terms of both percentage and numerical change. The most rapidly growing groups are the 45-to-64 age group and K-12 school-age children (aging baby boomers and their children). These various age-group projections have significant implications for state expenditures in many different program areas, including education, health, and welfare. For example, population growth in the 5-to-17 and 18-to-24 age groups influence K-12 and higher education enrollments.

Continue to Chapter 3: Revenue Projections

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