THE TOUGH TIMES ARE STILL HERE 3 Md. economists foresee a year of slower growth and higher interest rates MARYLAND'S ECONOMY 1995

THE BALTIMORE SUN

For a look at 1995 prospects for the nation and the state, three Maryland economists participated in The Sun's annual round-table discussion. Participants were Michael A. Conte, director of regional economic studies at the University of Baltimore; Ann O'Brien Franklin, chief economist for the state Board of Revenue Estimates; and Douglas Kinney, chief economist for Baltimore Gas and Electric Co. They were interviewed by economics writer John E. Woodruff.

Q: Will the U.S. economy continue to grow through 1995?

Douglas Kinney: Yes, I believe it will. By all preliminary reports, consumers spent quite liberally for this Christmas, although that raises concerns as to whether there will be some retrenchment after the holidays.

Michael A. Conte: Autos will probably be impacted, and housing starts have already seen a hit. That's the beginning of the traditional part of the slowing, and I think we will see that carrying into next year. So there will be a slowdown, but not a recession.

Ann O'Brien Franklin: I agree. But growth will be supported by stronger growth in exports and continued strong growth in capital investment.

Q: Can Maryland hope to catch up with national growth rates in 1995?

Mr. Conte: I really don't think so. We have a problem in terms of engines of growth that needs to be resolved before we can expect to grow with the balance of the nation.

Ms. Franklin: I think employment growth in Maryland will be about 1 percent in '95, which will be the best performance we have had since the late '80s. There are definite sectors that will show stronger growth and may even approach national growth, but overall I think that we will still lag.

Mr. Kinney: It is true that the Maryland economy hasn't claimed its full share of the national recovery. If you look at real personal income for the second quarter of 1994 with, say, the first quarter of 1990, for the U.S., it is up 6 or 7 percent over that 4-year period. For Maryland it is up about 3.7 percent, and the Baltimore area appears to be lagging both the U.S. and Maryland.

Q: The Federal Reserve has raised interest rates six times since February 1994. Will interest rates go still higher in 1995?

Ms. Franklin: Yes. We are looking for the federal funds rate to go up about another half-point.

Mr. Kinney: We don't expect long-term rates to go higher in 1995. The Federal Reserve may see fit to raise short-term rates another notch. But we believe that that increase in the short-term rates perhaps will be favorably viewed by the bond markets as forestalling inflation. On the long term end we don't see much room for increase in 1995.

Mr. Conte: In terms of long-term rates, it depends upon whether we have a significant deficit associated with the new "Contract with America," which involves increased defense spending and decreased taxes. I think that we may very well see as much as a point on long-term rates as a result of the potential lack of fiscal discipline.

Q: How will interest rates affect the national economy?

Mr. Kinney: We are going to see a dampening effect begin to take place. Housing construction has dropped off slightly, and I would expect that as adjustable mortgages get adjusted upwards in the coming years, that's going to take purchasing power out of consumers' hands.

Mr. Conte: As we increase interest rates, money tends to flow to the U.S. from abroad. That places upward pressure on the price of our currency, which interestingly enough has a reinforcing effect on inflation.

Ms. Franklin: There seems to be some reduced responsiveness to higher interest rates this time

around, because adjustable rate mortgages are taking an ever-increasing share of the total. I think that the slowing in '95 will be modest in the housing sector and the consumer sector, and I think the corporate sector is largely shrugging off higher rates.

Q: How will interest rates affect the Maryland economy in 1995?

Mr. Conte: A fairly high percentage of Maryland's growth over the last year has been in areas that are highly interest-rate sensitive, consumer durables and real estate follow-on-type purchases. Therefore the dampening affect will be more severe.

Ms. Franklin: I think that there is still a fair amount of pent-up demand among Maryland consumers, because the recession was so severe and because the employment prospect has just " started to brighten. That will keep consumer spending pretty solid through early '95. While housing construction will slow because of interest rates, the commercial construction sector is on potentially a whole different cycle. Also, the multifamily housing market is being supported by tax benefits, so that might also be somewhat stronger.

Mr. Kinney: We do not expect housing activity to continue at the rate it has for the last 12 months.

Q: Which sectors do you see driving Maryland's growth in 1995?

Ms. Franklin: I think that we have seen improvement in the traditional sectors, to some extent in services, in research and in health care as well, although not in the traditional health care areas. Transportation will be a strong growth sector -- both trucking and activity at the port and at BWI as well, and wholesale trade, reflecting some of the increases in distribution facilities in the region.

Mr. Kinney: Congress is talking about cutting their congressional staff by something on the order of 30 percent, which in the great scheme of things may not seem like a huge number, but I suspect a lot of those people, even though they work in the District, probably live in Maryland.

Mr. Conte: If you take a look at 1993, of the some 340 sectors in Maryland, out of the top five, two are tourism-related. Research and testing services continued to be a growth area in 1993, but the preliminary data for '94 showed that research testing services were trending down. We are very concerned about that.

Q: Which sectors do you see retarding the state's growth?

Mr. Kinney: I don't expect to see any expansion and indeed some contraction in manufacturing. There still appears to be a fair amount of consolidation going on in the commercial banking sector. I don't expect that one can see much growth in the public sector employment.

Mr. Conte: The services sector is going to continue to grow, but not as rapidly as before. Utilities are under tremendous pressure to become more efficient. We continue to lose jobs in defense electronics. We still have a relatively high fraction of our work force in defense electronics, so that is still an area of excellence for Maryland and maybe as a result of the "Contract with America" that will be an area of reprieve.

Ms. Franklin: The leading sectors that will continue to decline will continue to be defense, manufacturing and banking, and all of these reflect structural changes.

Q: We have mentioned here that manufacturing jobs, especially in defense industries, and white-collar jobs, especially in the financial sector, have been generally in decline in Maryland, as in the nation, for some years. Has that process played out?

Mr. Conte: I think that is really the question of the year. There are regions of the United States that are pretty much going gangbusters in manufacturing. Maryland has not been getting our share, and I think that if we could somehow figure out why that is and do something about it, then we could make a dent in the cycle.

Ms. Franklin: We may be reaching the end. But, for example, the shake-out in white-collar jobs I think reflects the economic environment -- the environment of low inflation. In service industries, virtually all of your costs are your employees. And if you can't raise prices, you have to restrain costs to make a profit. So as long as the environment stays as it has been with low inflation, cut-throat competition, there will remain pressure to down-size, consolidate, keep operations as lean as possible.

Mr. Kinney: I suspect that the process has not played itself out entirely. What we are seeing both locally and nationally is a fundamental change in the way businesses organize their operations. When your starting point for reorganizing is in many cases a very large bureaucratic-type organization, you could make some rather large cuts without impeding your efficiency and your effectiveness.

Q: Which geographic areas of Maryland will do best in 1995?

Ms. Franklin: I think that the central part of the state will continue to do very well -- transportation, distribution centers. The Washington suburbs, where the high-tech services are located, will continue to show some growth as well. Baltimore, because it is home to the organizations that are still in the process of down-sizing -- banking, for example, and some of the large insurers and utilities -- will probably show the slowest growth.

Mr. Kinney: The area around the airport, the Maryland suburbs around Washington, the I-270 corridor will be strongest. I also think that the Cecil and Harford County areas of the state will be fairly strong performers.

Mr. Conte: If you take a look at the golden triangle area, Howard, Frederick and Harford, I think that is the area that has the strongest employment growth recently. Worcester County has really done quite well. Here is sort of a second tier on the Eastern Shore. Queen Anne's and Talbot have done well because of the expansion across the bridge, and I think that is going to continue to happen. Montgomery County has lost a lot of jobs in the past few years, and there are some big question marks in my mind about that. But Anne Arundel is going to do quite well. I would say that the single fastest-growing county for Maryland for the next two years is going to be Frederick.

Q: What thoughts do you have about what the new political situation in Washington will mean to the national and/or Maryland economies?

Mr. Kinney: We know from the "Contract with America," which the Republicans set out prior to the election, they have set out a road map of sorts. I would say that there are some contradictory elements to it. For example, one major component of it is the commitment to a constitutional balanced budget amendment; another element of it is a middle-class tax cut. If that increases the federal budget deficit, that could exert some upward pressure on interest rates and could be at least for the short term a negative for the economy.

Mr. Conte: I think to the extent that we do pump more money back into the defense area that would help Maryland lTC disproportionately. This congress will probably not be able to carry out an effective health care reform, and I predict that we will see a resuscitation of double-digit inflation or close to double-digit inflation in health care pricing. I think that is one of the single most retarding influences on our competitiveness, because a lot of businesses bear a very high, rapidly escalating cost in that area.

Ms. Franklin: If the Congress passes significant tax cuts without equivalent spending cuts, then pressure on long-term interest rates could be the prime problem.

Q: With a new administration taking office in Annapolis, how should the new governor structure Maryland's economic development efforts?

Mr. Conte: We have to link up the business and labor groups, the various counties, etc., and, while we protect the interests of various parties, not have groups that are effectively preventing growth.

Mr. Kinney: The Chamber of Commerce study that was just published a short time ago laid out a very detailed list of recommendations, and that will be certainly one of the things that will be explored as part of a task force investigation into the organization of the state's economic development activities.

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