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San Francisco Regional Outlook - Third Quarter 1997
Strong Growth in Services, Aerospace, and High-Tech Boosts the San Francisco Region's Performance
Strong Growth Continues in the San Francisco RegionOver the past year the San Francisco Region has grown at a much faster pace than the nation as a whole, both in terms of personal income and employment. In addition, high-tech and commercial aerospace manufacturing, construction, and business and tourist services all have exhibited noteworthy strength over the past year. Most analysts continue to give the Region favorable marks and anticipate continued expansion in 1997, although perhaps at more moderate rates. The robust performance of the Region is clearly a factor in the strong earnings and generally improving asset quality of the Region's banking industry.
The Region continues to lead the nation in generating employment, as it has over the past two years. Over 724,000 jobs were added in the Region in the 12-month period ending April 1997. The 3.3 percent increase in nonfarm payroll employment was the fastest over a comparable one-year period since the national recovery began in 1991. Job growth in 6 of the Region's 11 states (Arizona, California, Nevada, Oregon, Utah, and Washington) was 3 percent or better, well above the 2 percent increase in employment elsewhere in the nation. Idaho, which had been showing signs of slowing over the past year, slipped to a 2.5 percent growth rate over the past 12 months, down from 3.3 percent a year ago. Over the past year, employment growth rates for the Region's slowest growing states--Alaska, Hawaii, Montana, and Wyoming--ranged from 1.1 percent in Montana to zero in Hawaii.
The manufacturing sector is presently a key source of strength for the Region. Over the 12 months ending April 1997, the Region's manufacturing employment grew 3 percent. In contrast, elsewhere in the nation manufacturing employment actually contracted. The bulk of the nearly 88,000 new manufacturing jobs created in the Region over the past year were in the production of durable goods.
The strength in two manufacturing industries, high-tech and aerospace, was especially noteworthy. Chart 1 shows that several states, and the Region as a whole, are much more dependent on the health of these two industries than is the nation as a whole. Nationally, high-tech and aerospace employment combined made up only a little more than 10 percent of total manufacturing employment, according to the 1995 Census Bureau survey on manufacturing employment. In contrast, over one-quarter of all manufacturing jobs in both Washington and California were in either aerospace or high-tech. Arizona and Idaho also have a relatively high concentration of their manufacturing jobs in these two industries.
High-Tech Should Improve with the Chip MarketHigh-tech employment is defined here to include jobs in manufacturing computers, electronic components, communications, and measurement and control equipment. The Region accounted for over 34 percent of the nation's employment in high-tech electronics in 1995, according to the Census Bureau survey on manufacturing employment. The importance of California to the nation's high-tech industry is illustrated in Chart 2. California accounts for less than 11 percent of the nation's employment, yet 25 percent of the nation's high-tech manufacturing jobs are located in the state.
The soft demand for chips and computer products that surprised the industry in 1996 is expected to give way to a moderate increase in production in 1997. Recent forecasts by industry analysts suggest that the chip market should grow between 5 and 12 percent in 1997. That rate of expansion would benefit both California and the growing number of states, including Arizona, Idaho, Oregon, Utah, and Washington, that have developed sizeable high-tech manufacturing industries.
Within California, high-tech is most dominant in the booming Silicon Valley. A low unemployment rate, a scarcity of skilled workers, housing shortages, and extremely low commercial real estate vacancy rates all attest to the impact of the industry on business conditions in the Silicon Valley. Moreover, the boom is extending to other parts of the Bay Area and the Sacramento region, as well as to out-of-state manufacturing centers.
Expansion, however, continues to present challenges for the Silicon Valley. Technological changes, competition, and the lure of lower-cost production facilities continue to lead firms to relocate their manufacturing facilities outside the Silicon Valley. Several manufacturers have recently announced that it is more cost-effective to build new facilities in other locations than to refurbish an obsolete plant in the Valley. According to Strategic Marketing Associates, an industry market-research firm, of the 14 large semiconductor fabrication facilities planned to open around the world by the year 2000, only three will be built in the United States, and none will be located in California.
Movement from the Silicon Valley has benefited many emerging manufacturing centers located in other areas. While other states in the Region have much smaller high-tech industries than California does, their growth rates have outpaced California's. Computer-manufacturing employment grew at rates in excess of 20 percent in Oregon and Washington last year, compared with a 7.7 percent increase for California.
Aerospace Is Booming in Washington StateThe Region's share of the nation's aerospace jobs is even greater than its share of high-tech employment. Aerospace employment is defined here to include jobs in manufacturing aircraft, missiles and spacecraft, and search and navigation equipment. As shown in Chart 3, the Region accounts for 40 percent of aerospace employment nationally. For comparison purposes, the Region accounts for under 19 percent of the nation's employment. The bulk of the aerospace employment in the Region is in Washington and California.
Commercial aerospace manufacturing, especially in Washington, is reaping the benefits of a favorable economy, growth in airline passenger traffic, and the need to replace aging or noisy jet fleets. The surge in demand has built a huge backlog of orders, more than half of which are from foreign air carriers whose fortunes are less closely tied to U.S. economic conditions. Boeing, headquartered in Seattle, and its many subcontractors have responded to the aerospace boom by increasing production to meet the demand. Boeing alone is slated to add another 10,000 employees over the course of 1997 following the addition of more than 20,000 employees in 1996.
In 1996 Washington's aerospace employment surpassed that of California, and by April 1997 it again exceeded the 100,000 level. Despite the current boom, Washington aerospace employment still is well below the peak of 118,000 it hit in 1989 before the full impact of defense cutbacks hit the industry. However, Washington's turnaround still compares favorably with California, which because of its dependence on defense contracts has yet to experience an upturn in aerospace.
Technology and Aerospace Stand Out Because of Their History of Wide Business Cycle SwingsBoth the high-tech and aerospace manufacturing industries have a history of experiencing more severe business cycle swings than do most other sectors of the economy. High-tech and aerospace investments are sensitive to interest rates movements. Weak industry or economic conditions also may warrant postponing high-tech investments or costly aircraft purchases until conditions improve. In addition, demand for aircraft tends to move in cycles that depend on air traffic volume and the performance of the world's airlines, factors that are strongly influenced by economic conditions.
These highly cyclical industries usually are procyclical; they tend to boost the Region's growth during good times and weaken it during recessions. Chart 4 shows the exaggerated business cycle swings since the mid-1970s for California's high-tech industry compared with total employment (excluding high-tech). Chart 5 shows the similar patterns for Washington's aerospace industry. Aerospace also has been subject to wide swings related to increases, and more recently decreases, in defense spending. At the state and local levels, where these industries may account for a large portion of local economic activity, their boom and bust cycles can be especially important.
Implications: High-tech and aerospace tend to exhibit wide swings in growth over the course of the business cycle that can affect business conditions at the local, state, and regional levels. The San Francisco Region's exposure to these swings is even greater than the nation's because the Region is much more dependent on these industries. Thus, while the growth phase of the business cycle for these industries may stimulate expansion in other industries and increase the demand for loans, the contraction phase traditionally has weakened economies that are dependent on these industries and caused deterioration in asset quality. Because of the highly cyclical nature of these industries, it is important to understand both their current contribution to the Region's economic health and their future prospects.
Construction Employment Climbs as Real Estate Markets Heat UpA third highly cyclical industry is construction. The San Francisco Region is slightly more dependent on construction employment than is the nation. Current conditions in the Region's construction sector are generally robust, with the key exceptions of Hawaii and some areas of Southern California. Over the 12 months ending in April 1997, the sector added more than 80,000 jobs. This increase of 7.7 percent is nearly twice the rate of growth nationally. Despite a sharp decline in housing permits, residential construction activity remained strong in Nevada during the first quarter. Building activity also has picked up in California in the aftermath of the devastating flooding earlier in the year and the mild winter that followed.
Relatively low commercial vacancy rates in most office and industrial markets in the Region, along with increased activity in the commercial real estate industry, also are contributing to the pickup in construction employment. As noted in Retail Shakeout: Causes and Implications for Lenders, most analysts believe that vacancy rates and market fundamentals for retail-based real estate in most metropolitan areas of the Region remain positive.
Strength in Services and TourismThe service sector tends to experience relatively small variations in annual growth rates over the business cycle, a sharp contrast with the behavior of high-tech, aerospace, and construction. Not only has the service sector been more stable in recent decades, it also has been the fastest growing sector. Its current performance is consistent with that trend.
The Region's service sector added 309,000 jobs over the past year, a robust 4.7 percent growth rate. Business services, which encompasses an array of rapidly growing activities including programming and software services, equipment leasing, and temporary employment agencies, added more than 129,000 jobs over the past 12 months, an increase of 9.3 percent.
Tourism and travel services also scored gains in much of the Region and helped boost service sector activity. The healthy economy has stimulated both business and tourist travel. Five states reported noteworthy strength in tourism: Arizona, California, Nevada, Oregon, and Utah. The San Francisco and Los Angeles areas recorded increased tourism in 1996, and analysts expect similar favorable conditions for 1997. Arizona reported nearly a 4 percent increase in domestic visitors last year, and Utah reported rapid growth in lodging employment. High occupancy rates have improved conditions for hotels in Las Vegas, Portland, and San Diego. Finally, both the travel and amusement industries are reporting rising employment levels.
Implications: The simultaneous robust performance of three cyclical industries over the past year is a key factor in the current health of the Region's economy. Still, the boom in all three highly cyclical industries bears monitoring. While all three are presently doing well, and most analysts anticipate continued favorable conditions, this Region is much more dependent on the health of these industries than is the nation as a whole. Furthermore, the strong economy is an important reason for the robust performance of the Region's banking institutions. However, in the past, downturns in these sectors, like aerospace in Washington in the early 1980s or California in the 1990s, high-tech in the Silicon Valley in the mid-1980s, or real estate in California in the first half of the 1990s, all have adversely affected both the Region and some of its banks.
Gary C. Zimmerman, Regional Economist
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