The Beacon Outlook: California
Welcome to The Beacon Outlook
This succinct, quarterly outlook delivers up-to-date analysis of leading indicators driving the national and state economies, including GDP growth, employment, housing and commercial real estate markets, taxable sales, international trade, and more.
OUTPUT REACHES PRE-COVID LEVELS
Many parts of California’s economy have recovered to their pre-pandemic levels and, in some cases, have returned to their pre-pandemic trend. By the first quarter of 2021 (the most recent data available) economic output in the state had recovered to within 1% of pre-pandemic levels. It’s safe to assume that California’s economy is now producing as much output as it did prior to the pandemic.
SUPPLY SIDE DRIVING LABOR MARKET LAG
There are still 1.2 million fewer people employed in California compared to pre-pandemic levels or around 8% fewer jobs. With approximately a half million fewer workers in the state’s labor force today than prior to the crisis, supply-side factors are an important factor behind the labor market’s slower recovery.
HOUSING INVENTORY FAMINE
Housing inventory in California has fallen to unprecedented levels. Currently, there is a mere 1.8 months’ worth of home supply available on the market (a balanced market has about 6 months). This historically tight supply, coupled with high demand fueled by low interest rates, increased savings, as well as little pandemic-related financial fallout among high-income earners, has caused prices to surge. Statewide, home prices have swelled by 18%, on average, over the past year.
Per Worker Real output
Despite having more than a million fewer jobs, the state’s economy is producing pre-pandemic levels of output. Output per worker has grown from $162,000 in Q4 2019 to $176,000 in Q1 2021. While short-term, productivity gains can replace jobs, productivity growth is the lifeblood of economic expansion.
California Popultion Vaccinated
Vaccination rates in the state have surpassed national levels, and while the trajectory of California’s economy could be influenced by the coronavirus in the very short-term, it would amount to a slight slowing of growth rather than an economic contraction.
Wage Growth in California
Wages in the state have increased 18% on a year-over-year basis. While such wage growth is intriguing, and welcome, pandemic effects are clearly at play, as the labor market fallout disproportionately affected low-income earners.
CALIFORNIA REAL GDP
CALIFORNIA HOME SALES
CALIFORNIA HOME PRICES
CALIFORNIA FORECAST – KEY INDICATORS
California’s Recovery: Output Up, Workforce Down
As with the national economy, many aspects of California’s economy have recovered to their pre-pandemic levels and, in some cases, have returned to their pre-pandemic trend. After falling by about 10% from the fourth quarter of 2019 to the second quarter of 2020, by the first quarter of 2021 (the most recent period for which data are available) economic output in the state had recovered to within 1% of pre-pandemic levels. Given the growth that occurred in second quarter 2021 output nationally, where the economy grew by 6.5%, it’s safe to assume that California’s economy is now producing as much output as it did prior to the pandemic. Second quarter data won’t be released for California until later in the summer.
One of the most intriguing features of the pandemic economy, as noted in the national outlook, is the extent to which the recovery of the labor market has lagged the recovery in output. There are still 1.2 million fewer people employed in the state compared to pre-pandemic levels or around 8% fewer jobs. Supply-side factors have been a major feature of the labor market’s slower recovery. There are around half million fewer workers in the state’s labor force today than there were prior to the pandemic. School closures, leading some parents to drop out of the labor force, fears of contracting COVID-19, and enhanced unemployment benefits have taken a toll on labor force participation in the state.
It is also worth underscoring that California is now producing pre-pandemic levels of output with 1.2 million fewer workers. In other words, the state’s economy is producing the same level of output with many fewer workers. In addition to supply-side dynamics, productivity gains have clearly replaced many thousands of jobs in the state. In the fourth quarter of 2019, each worker in the state produced $162,000 of real output, compared to $176,000 in the first quarter of 2021. While in the short-term, productivity gains can replace jobs, productivity growth is the lifeblood of economic expansion over time.
As of June 2021, Transportation, Warehousing and Utilities is the only sector in California that has seen employment growth since February 2020, the last pre-pandemic data point. Two-thirds of all job losses sustained during the pandemic have occurred in just three sectors: Leisure and Hospitality, Government, and Other Services, which includes hair and nail salons. Leisure and Hospitality and Other Services are largely made up of relatively low paying jobs and the core functions of these businesses rely almost exclusively on person-to-person contact. The continued losses in these two sectors are likely due to a combination of reduced demand for their services because of fears surrounding COVID-19, as well as supply-side constraints driven by labor shortages.
With respect to labor supply in these industries, the unemployment rate in California stands at 7.7%, still double pre-pandemic levels. Since the unemployed count as those who are officially looking for employment but are not working, under normal circumstances the high number of unemployed workers in the state would equate to slack in the labor market for these industries – this is not true today. Since February 2020, the number of unemployed workers in the state has increased by 600,000. Some of these 600,000 unemployed workers may be holding out for a different type of job than they held prior to the pandemic (e.g., a better paying job). It is also possible that enhanced unemployment benefits pay better than pre-pandemic wages for these workers, meaning they are slower in returning to employment. Notably, there is some evidence that a hiring boom has not yet occurred in states that cut enhanced unemployment benefits early, suggesting that labor shortages have not been driven by these benefits.
Uneven Regional Recovery
Geographically, in relative terms, the largest job losses have occurred in Santa Cruz and San Luis Obispo. Local universities play an important role in the economies of both regions, and online instruction has led to fewer students spending money locally. The communities of the Central Valley, as well as the Inland Empire, have been the most resilient with respect to labor market performance. The Inland Empire has been boosted by the performance of the Transportation and Warehousing sector, which has a strong presence in the region. For Central Valley communities, the importance of the Agriculture sector has likely sheltered the region’s local economies from significant job losses. After all, the state has continued to grow crops over the past 18 months!
Wage Strength Amid Worker Shortage
By the fourth quarter of 2020, at the heart of the second wave of the virus, wages in the state had increased by 18% on a year-over-year basis. While such wage growth is intriguing in many ways, pandemic effects are clearly at play. For example, the largest wage growth of any sector was seen in Leisure and Hospitality, the sector most affected by job losses during the pandemic. Wages for Leisure and hospitality workers grew by 34% on a year-over-year basis, growth that was likely driven by compositional effects: part-time workers were laid off, while managers, the better paying workers in the sector, were least likely to have been laid off. In other words, the mix of workers who retained employment in the sector were found in higher paying occupations.
That said, there should be sustained upward pressure on wages, at least in the short-term, given the aforementioned labor market shortages. These shortages, while amplified, have certainly not been caused solely by the pandemic. Since 2016, population growth in California has been slower than the national average, and population growth turned negative in the state in 2020. There are a variety of reasons for California’s slow population growth rate, including housing supply and costs, as well as stringent immigration policies under the Trump administration, which disproportionately affected California. The immediate effect of these trends is a labor shortage that will place upward pressure on wages.
Housing Market: Inventory, Inventory, Inventory
The performance of the housing market has been by far the most impressive aspect of the state’s economy over the past 18 months. After home sales collapsed in the second quarter of 2020 due to the fallout from the pandemic, the rebound since that time has returned home sales to their pre-pandemic trend. At the same time, home prices have surged over the past year, growing by more than 18% in the state, on average. Although this level of price growth is not sustainable and should subside, house price growth in some parts of the state has been truly staggering, with prices growing by nearly 25% in Monterey and Santa Barbara.
The strength in the demand for housing is well understood. Low interest rates, increased savings for the wealthy, and a labor market fallout from which high-wage earners were largely sheltered, are key drivers of the strong demand. On the supply-side of the market, housing inventory has fallen to unprecedented levels. Currently in California, there is only 1.8 months of housing inventory available. Housing inventory refers to the number of months it would take for the current inventory of homes on the market to sell given the current pace of sales. A balanced housing market is usually one in which there is about six months of inventory. Moreover, there is little evidence of relief anytime soon, as the number of building permits issued for multi-family housing units over the past three years has declined, while the number of single-family permits issued has remained constant. In other words, there are no indications that supply constraints in the short-term will be resolved by the construction of new housing.
While many aspects of California’s economy are back on track, there are concerns surrounding the resurgence of COVID-19 cases, which currently number more than 100,000 new cases a day nationally. In California, there are now more than 10,000 new cases a day.
The spread of the virus will not have the same impact on the economy as it did in 2020, primarily due to vaccinations. In the state, 53% of the population has been fully vaccinated compared to 50% nationally. Rather than business closures, which seem unlikely given high rates of vaccination and a better understanding of how to manage the spread of the virus, the biggest impact of continued spread could be on labor supply. If school closures are extended, as they have been in some places across the country, or if parents are reticent to send children to school, this will again place a constraint on labor supply. Additionally, some workers in industries that have a high degree of person-to-person contact could withdraw from (or remain out of) the labor market in the short-term, further exacerbating labor supply issues.
All said, the trajectory of California’s economy in the third quarter could be influenced by the coronavirus but would amount to a slight slowing of growth rather than an economic contraction.
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