Perspectives on the

Economy and Demographics

Part II

LAO's Economic Forecast

Based on recent developments in Asia and California's economy, the LAO's revised economic forecast assumes slightly greater near-term employment growth, but a slightly sharper economic slowing in 1999 and 2000, than does the administration.

National Forecast

Our economic forecast is summarized in Figure 9 (see next page). With regard to the U.S. economy, our forecast assumes that real GDP growth will slow from 3.7 percent last year to 2.3 percent in 1998 and 1.8 percent in 1999, before rebounding modestly to 2.4 percent in 2000. We project that U.S. corporate profit growth will slow sharply, reflecting the combined effects of tapering output growth and rising wage pressures over the next two years. Interest rates and inflation are projected to remain in the modest-to-moderate range, with the CPI increasing 2 percent this year, 2.4 percent next year, and 2.9 percent in 2000. The main reasons for the projected near-term slowdown are weakening exports and some slowing in U.S. capital spending.

Figure 9
Summary of LAO's Economic Outlook
Percent Changesa
Preliminary1997 Projected
1998 1999 2000
United States Forecast
Percent change in:
Real GDP 3.7% 2.3% 1.8% 2.4%
Personal income 5.8 5.1 4.2 4.5
Wage and salary jobs 2.3 2.0 1.1 1.5
Consumer Price Index 2.4 2.0 2.4 2.9
Unemployment rate (%) 4.9 4.8 5.2 5.5
Housing Starts (000) 1,476 1,446 1,435 1,414
California Forecast
Percent change in:
Personal income 6.8% 6.4% 5.7% 5.3%
Wage and salary jobs 3.5 3.4 2.5 1.9
Taxable sales 5.9 5.8 5.6 5.1
Consumer Price Index 2.2 2.7 3.1 3.2
Unemployment rate (%) 6.3 5.5 5.4 5.5
New housing permits (000) 107 138 150 155
aUnless otherwise indicated

California Forecast

With regard to California, our forecast assumes that wage and salary employment will increase 3.4 percent in 1998 (to 13.6 million jobs), before moderating to 2.5 percent growth in 1999 and 1.9 percent growth in 2000. Personal income is projected to grow by 6.4 percent this year, before moderating to gains of 5.7 percent during 1999 and 5.3 percent in 2000. While both the U.S. and California economies are projected to slow in 1999 and 2000, we project that California will maintain a significant growth margin over the nation during this period (see Figure 10). The state's higher projected growth partly reflects the positive near-term outlook for both California residential and nonresidential construction activity.

Services and Construction to Lead California's Economy. Figure 11 (see next page) shows our outlook for job growth in individual industry sectors in California. It indicates that in numeric terms, services employment is projected to be the fastest growing sector. As in past years, many of the new jobs will be in high-technology computer services, systems design, and software development occupations. The projected increases in residential and nonresidential building activity are expected to lead to major gains in construction employment.

Manufacturing employment is projected to increase by nearly 100,000 between 1997 and 2000. Most of these jobs are expected to be in the high-technology computer and electronic equipment subsectors. The slow increase in aerospace employment that began in 1997 (following several years of major declines) is expected to continue, with this subsector adding about 12,000 jobs between 1997 and 2000. Modest gains are forecast for utilities, trade, government, and finance-related industries during the next three years.

Home Construction to Continue Climbing in 1998. As indicated earlier, the long-awaited improvement in California home construction finally materialized in 1997. As shown in Figure 12, we assume that construction of both single-family and multi-family residential structures will continue to climb over the next three years.

The main factors behind the projected improvement in single-family construction are a rebound in population growth, as well as ongoing gains in jobs and income. The recent uptrend in housing prices, particularly in the inland regions of the state where there is room for new development, has also led to an improvement in confidence on the part of both prospective buyers and developers. And, this confidence is contributing to increased building activity.

Signs of improving conditions for new multi-family construction include a recent jump in average rents and declining vacancy rates in major metropolitan regions. Over the past twelve months, for example, the CPI for residential rents in the San Francisco Bay Area is up nearly 8 percent, which is the largest gain this decade.

Overall, we forecast that total permits for new residential construction will increase steadily from 112,000 in 1997 to 155,000 by the year 2000. While the projected levels are still well below those achieved in the 1980s,the level of building activity forecast for the end of the decade is nearly double that of the lowest levels experienced in the early 1990s.

Nonresidential Construction Also Strong. The high-technology economic boom in California has already led to major increases in the construction of office and industrial space in the San Francisco Bay Area during the past two years. More recently, however, gains in nonresidential building have spread to other regions of the state. Permits for nonresidential construction in late 1997 were up over 20 percent from the prior year. While the largest increases have been experienced in the Bay Area, where permit valuations are up by more than 35 percent, all regions of the state are experiencing increases in excess of 15 percent. We project that this sector will continue to grow over the forecast period, with the value of permits (in constant 1997 dollars) increasing from $11.9 billion in 1997 to $12.8 billion in 1998, $13.3 billion in 1999, and $13.5 billion in 2000.

Comparisons of Recent Economic Forecasts

Figure 13 (see next page) compares our current forecasts for the nation and California to our November 1997 forecasts (see California's Fiscal Outlook: The LAO's Economic and Budget Projections for 1997-98 Through 1999-2000), as well as the University of California, Los Angeles' (UCLA's) December 1997 economic forecast and the Governor's January 1998 budget forecast.

Figure 13
Comparison of Recent Economic Forecastsa
Percent Changes
Preliminary 1997 Projected
1998 1999 2000
United States Real GDP:
LAO November 3.7% 2.3% 2.2% 2.5%
UCLA December 3.8 2.6 1.9 2.3
DOF January 3.8 2.7 2.0 0.8
LAO February 3.7 2.3 1.8 2.4
California Wage and Salary Jobs:
LAO November 3.4% 3.1% 2.6% 2.3%
UCLA December 3.3 2.9 2.3 2.7
DOF January 3.1 2.8 2.3 1.9
LAO February 3.5 3.4 2.5 1.9
California Personal Income:
LAO November 6.7% 6.4% 5.8% 5.6%
UCLA December 6.5 6.0 5.6 6.0
DOF January 7.2 6.3 6.0 5.2
LAO February 6.8 6.4 5.7 5.3
Taxable Sales:
LAO November 5.6% 5.6% 5.5% 5.2%
UCLA December 5.9 5.6 5.5 5.8
DOF January 5.9 4.8 4.3 --
LAO February 5.9 5.8 5.6 5.1
aAcronyms used apply to Department of Finance (DOF); Legislative Analyst's Office (LAO); and University of California, Los Angeles (UCLA).

Taking into account the impacts of both a stronger economy in early 1998 as well as the negative consequences of Asia's problems on future California economic growth, our updated forecast has a sharper cyclical profile than our November 1997 projections. Specifically, we now project comparatively more growth in 1998 but less growth in 1999 and 2000. Our current forecast also contrasts with the budget forecast and UCLA in the same way (that is, more growth in 1998 but less growth in the out years).

In terms of their impacts on state revenues, the differences in the economic forecasts shown in Figure 13 for employment and personal income are minor. For example, as discussed later in Part III of this volume, the majority of our revenue difference with the administration with regard to projected personal income taxes is related to the translation of economic projections into revenues, and not to the economic projections themselves. From a revenue-forecasting perspective, our most significant difference with the administration in the economic area relates to our respective estimates of taxable sales. As shown in Figure 13, our projection of taxable sales growth is similar to UCLA's but significantly higher than the Governor's. We discuss in detail the state revenue implications of our differing economic assumptions in Part III.

California's Demographic Outlook

California's population is very dynamic--rapidly growing, highly mobile, and undergoing significant changes in terms of its ethnic and age mix. Population changes can have substantial impacts on the state's revenue receipts and expenditure demands. Thus, it is important that the Legislature be aware of the state's demographic trends and understand their budget-related implications, from both a near-term and longer-term perspective.

Population Growth Rate Increases

Figure 14 (see next page) shows California's total population and population growth rates for the 1980s and 1990s. We project that California's population growth will average 1.8 percent during the period 1997 through 2000, reaching nearly 35 million by the millennium. Numerically, we project that California will add 1.8 million residents during these three years--an amount greater than the current population of San Diego, the state's second largest city.

While the state's expected population growth rate over the next few years is not as robust as California's 2.3 percent average annual growth experienced during the 1980s, it nevertheless is a considerable increase over the 1.2 percent average annual rate experienced during the three-year period prior to 1997.

The Migration Turnaround Has Arrived

Population growth is due to two factors: natural increase (the excess of births over deaths) and net in-migration (the difference between the number of people who migrate to California and the number that leave).

Figure 15 shows the state's annual population changes since 1980, and depicts the contributions of both natural increase and net in-migration to the overall changes. It shows that a sharp decline in net in-migration (and an actual net outflow in three of the years) is primarily responsible for the reduced annual population change experienced during the early 1990s. Indeed, while natural increase only declined gradually (reflecting declining fertility rates) between 1990 and 1995, net migration to California fell sharply, as the state's severe recession discouraged those who otherwise would have migrated to California in search of economic opportunities. Now that economic conditions have improved in the state, net in-migration has resumed; and we expect net in-migration to add an average of 275,000 persons annually between 1997 and 2000.

Dramatic Reversal Involving Domestic Migration. Net-migration itself reflects two factors--domesticmigration (flows between California and the rest of the U.S.) and foreignmigration (flows between California and other nations).

Figure 16 shows that the recent recovery in net in-migration has largely been a "domestic" phenomenon. California was the destination of significant numbers of both domestic and foreign migrants in the 1980s. While steady foreign net in-migration continued into the 1990s, domestic net in-migration evaporated. In fact, the substantial number (averaging about 300,000 annually) of state residents leaving California for the other 49 states offset the net in-migration from other nations, resulting in the negative overall net in-migration identified in the figure (solid line).

The recent reversal in domestic net in-migration--from a negative to a positive--reflects primarily an upsurge of people coming into California from other states, as opposed to a lessening of people leaving California for other states. Even during the worst years of the early-1990s'recession, the number of domestic out-migrants remained relatively stable. In contrast, the number of people coming into California from other states dropped off. Now that better economic times have returned, domestic migrants are flowing into California once more, resulting in positive overall net in-migration.

California's Age Composition Continues to Change

Persistent, ongoing changes are taking place in the age distribution of California's population. Figure 17 shows our estimated age distribution of the state's population in 1997, and summarizes our projections of how various age groups will be changing over the next three years.

California's median age will be increasing, as the baby boomers enter their late 40s and 50s. The 25 to 44 year old group will stay relatively flat in numbers (and thus decline as a share of total population), as the baby boom cohort ages into the next-older age grouping. The K-12 school-age population will grow faster than the general population, while the college-age population's growth rate will be twice as fast. Conversely, the number of preschoolers is projected to decline, presaging a future slowdown in the K-12 population.

What Effect Will These Trends Have? Demographic trends occurring in the state are key determinants of both state revenues and expenditures. In the case of expenditures, for example, program demands are influenced by caseloads, which in turn are a function of such demographic factors as overall population growth and the age characteristics of the population. Likewise, revenues depend on such economic factors as income and job growth, which in turn are influenced by demographic variables such as the size of the labor force and the number of people using the various goods and services which businesses produce. The rapid changes in the size and composition of California's population will have many implications for California's economy, and for the volume and mix of public services in the budget year and beyond.

Return to 1998-99 Perspectives and Issues Table of Contents
Return to LAO Home Page