Legislative Analyst's Office, November 19, 1998

California's Fiscal Outlook
The LAO's
Economic and Budget Projections

Chapter 2:Economics and Demographic Projections

California's economy and demographics are key factors in assessing the state's future fiscal picture. These factors significantly affect both state revenues and expenditures, due to their impacts on state tax receipts, as well as caseloads and other cost-related factors affecting state programs. This chapter presents our economic and demographic projections for 1998 through 2004, which will help to determine California's fiscal condition over the period 1998-99 through 2003-04.

The Economic Outlook

We forecast that the U.S. and California economies will slow somewhat in late 1998 and early 1999. This slowing will reflect the combined impacts of Asia's economic crisis and stock market volatility on exports, household wealth, and consumer and business confidence levels. Over the full forecast period, our projections assume moderate economic growth and slowly rising inflation. Figure 1 summarizes our U.S. and California economic outlooks.

Recent Developments

National Economy Still Expanding. The unfolding of Asia's economic and financial problems and turmoil in the U.S. stock market had prompted mid-year concerns that the U.S. economy was headed toward a serious slowdownor perhaps even a recessionlate in 1998. Recent evidence suggests, however, that the national economy remained on an upward track through the summer months. For example, real Gross Domestic Product (GDP) expanded at a stronger-than-expected 3.3 percent annual rate during the July-through-September period, led by healthy gains in consumer spending.

However, Slower Growth Lies Ahead. Despite the economy's continued expansion and growth in aggregate output, there are a number of key indicators pointing toward some economic softening in the months ahead. One of these indicators is a continued deterioration in the U.S. foreign trade balance, caused primarily by falling exports to Asia. Another is a slowdown in business investment, partly reflecting weakening sales and profits in key manufacturing sectors of the economy. In addition, recent surveys have indicated a marked decline in consumer confidence levels. These and related factors suggest that, while the U.S. economy continues to expand, the near-term outlook is for more subdued growth than in the recent past (see Figure 2). The same holds true for California.

California Feeling Impacts of Asia. The factors affecting the national economic picture are also having an impact on this state. For example, employment growth in key sectors is slowing in the second half of 1998, primarily reflecting the negative effects of the ongoing weakness in Asia on high-tech and related manufacturing businesses in California. As shown in Figure 3, sales of California-produced goods to South Korea, Japan, and other Asian destinations fell sharply between the first half of 1997 and the first half of 1998, leading to a small decline in overall exports during the period.

The slowdown in exports has had a particularly significant impact on California's computer and electronics manufacturing industries. These industries account for over 50 percent of California's shipments abroad, much of which goes to Asia. After several years of strong growth, these industries are experiencing major slowdowns in sales, corporate earnings, initial public offerings, employee bonuses, stock-option earnings, and jobs. As indicated in Figure 4, employment in the computer and electronic manufacturing industries has subsided in recent quarters, and fell during the summer.

Other Factors Are Keeping State's Economy On Upward Track. The slowdown in the state's high-tech manufacturing sectors has been mitigated by positive developments in certain other areas of California's economy. For example, services employment continues to expand at a healthy pace, reflecting strength in such sectors as software development, management consulting, and engineering. Also, building activity continues to climb in California, with permits for both residential and nonresidential construction increasing to their highest levels in eight years.

Despite these positive factors, however, the overall pace of economic growth is slowing in the latter half of 1998.

The National Outlook

Near-Term Forecast (1998 Through 2000). We expect that the U.S. economy will slow but remain on a positive growth path through 2000. As indicated previously in Figure 1, real GDP is projected to grow by 1.9 percent next year and 2.4 percent in 2000, compared to 3.5 percent in 1998. Slower growth in spending by consumers and businesses is the main factor responsible for the overall slowdown. We expect inflation to rise modestly, as lower import and commodity prices only partly offset increases in labor costs. The U.S. CPI is projected to increase by 2.3 percent in 1999 and 2.9 percent in 2000, compared to 1.6 percent in the current year.

Longer-Term Forecast (2001 Through 2004). We project that the U.S. economy will experience moderate growth and slowly rising inflation over the longer-term forecast period. This projection reflects the fact that the U.S. economy is currently operating at near full capacity, characterized by low levels of unemployment and high factory operating levels. Given this, the longer-term outlook is tied to increases in the U.S. labor force (estimated to grow by slightly less than 1 percent per year) and the growth in productivity of the workforce (estimated to be about 1.4 percent per year). Our forecast implies moderate real output gains averaging about 2.4 percent per year. It also assumes that inflation will slowly accelerate, with the CPI increasing at annual rates of slightly over 3 percent by the end of the forecast period.

California's Outlook

Near-Term Forecast (1998 Through 2000). We project that employment and income growth will slow in California during late 1998 and early 1999reflecting the impacts of a slowing national economy and Asia's economic problems on our high-tech industries. Specifically, we forecast that California personal income growth will slow from 6.8 percent in 1998 to 5.2 percent in 1999, and then recover a bit to 5.6 percent in 2000. After declining for several years, the state's unemployment rate is expected to stabilize in the range of 6 percent in late 1998 and 1999, before resuming a modest downward trend in 2000.

Longer-Term Forecast (2001 Through 2004) As with the nation, the long-term outlook for California is for moderate growth and slowly rising inflation. As indicated in Figure 1 and Figure 2 earlier, we expect that employment growth in the state will outpace the nation over the next several years. This will reflect such factors as above-average population increases, and a positive long-term outlook for California's mix of high-tech manufacturing and services industries.

Our economic forecast also assumes that residential construction activity, which has lagged in the 1990s, will continue to climb over the forecast period. This will occur as builders step up production to meet housing demands created by increases in population, jobs, and incomes. As shown in Figure 5, we project that permits in California for new residential construction will rise from 130,000 units in 1998 to 200,000 units by 2004.

The Demographic Outlook

We project that California's population will increase from 33.5 million in 1998 to 37.1 million by 2004, an average annual increase of 1.7 percent. Our year-to-year demographic projections are shown in Figure 6, which depicts both total annual population and yearly percent changes. The projected pace of population growth is faster than that which occurred in the first half of the 1990s, but is slower than the 2.5 plus percent pace of the late 1980s.

Population Growth Components. California's population growth can most effectively be discussed in terms of its two main componentsnatural increase (births minus deaths) and net in-migration (persons moving into California from other states and countries, minus people leaving the state for destinations outside of California). Figure 7 depicts the contributions of these two key demographic components to California's overall population growth from the start of the 1990s through the forecast period.

We project that the natural increase component will account for a bit over half of the state's population growth during the forecast period, averaging slightly over 310,000 per year. While this amount is similar to recent levels, it is significantly less than the nearly 400,000 occurring annually in the early 1990s. This reflects in large part the aging of the baby boomers beyond their years of highest fertility rates, as well as recent declines in birth rates within younger age groups.

Regarding the net in-migration component, we project that it will average about 280,000 per year during the forecast period, or slightly less than half of total population growth. Figure 7 shows that this is similar to the current in-migration level, but is significantly higher than for the first half of the 1990s, when net in-migration actually turned negative for three years.

The recent sharp swing in net in-migration from negative to positive primarily reflects domestic population flows that is, the flows of workers and their families between California and other states. In the early part of the decade, California's deep recession resulted in a large outflow of people from California seeking better job prospects in other states, along with a diminished number of workers from other states coming to California to seek work here. The combined effect was to cause net domestic out-migration from California to occur. In more recent years, however, due to the resurgence of California's economy, net domestic in-migration has returned to more "normal" patterns, with fewer people leaving for jobs elsewhere and more workers from other states seeking opportunities here. As a result, net inflows of workers and families from the rest of the country are again occurring.

Our forecast assumes a slight dip in the level of net in-migration in 1999, due to our projected slowing in California's economy. However, we expect that the state will continue to experience positive net in-migration from other states throughout the forecast period.

Growth to Vary by Age Group. Figure 8 shows our population growth projections over the forecast period by broad age categories, in both numerical and percentage terms. In numerical terms, the 45-to-64 age group (baby-boomers) easily dominates, followed by the 5-to-17 age group (their children). In percentage terms, the 45-64 age group again leads the way, followed by 18-to-24 year-olds.

These various age-group demographic projections have significant implications for the state expenditure outlook in many different program areas, including education, health, and social services. For example, population growth in the
5-to-17 and 18-to-24 age groups are the single most important determinants of K-12 and higher education enrollments.


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