U.S. Regional Outlook: The Shape of Recovery

View the Moody's Economy.com U.S. Regional Forecast.

• Job losses are slowing and industrial production is improving, but housing has not stabilized and consumer confidence is tentative.
• High unemployment will weigh on wages and spending in the Southeast and industrial Midwest and on the West Coast.
• Florida could see a sluggish turnaround as population growth slows and investor demand remains weak.
• Financial services will play a smaller role in supporting regional growth than they did during the housing boom years.

The recession's intensity is easing across the U.S. This is clearest in the North Central region from the Mississippi to the northern Rockies, where employment has stabilized, industrial production is rising, and housing markets are improving moderately. The entire central region, extending from Texas to North and South Dakota, is benefiting from a relatively short and shallow recession, a moderate housing cycle, rising energy and commodity prices since early this year, and stable household balance sheets. Much of the rest of the country is still struggling to emerge from the recession. Job losses are slowing, and industrial production is improving nearly everywhere. But housing markets have not definitively stabilized, and consumer confidence remains tentative.

Shifts in unemployment rates indicate how quickly vitality can return to a region once it begins to recover. Where jobless rates have risen the most—on the West Coast and in the Southeast and industrial Midwest—a labor surplus may persist, weighing on wages, household income growth and spending, even as employment begins to rise.

The unemployment rate can be misleading, however, if discouraged workers leave the measured labor force. A deep decline in income during the first half of 2009 distinguishes areas that may lag in recovery, at least during 2010. As of the second quarter of this year, wage and salary income is down over the year by more than 5% in the New York City area, the entire Great Lakes region, California and its three bordering states, as well as in Florida, and North Carolina. At a time when labor markets are weak nearly everywhere, income trends indicate where it may take longer for recovery to revive the labor market.

Recent income trends illustrate the factors generating the most important differences across the regions—manufacturing, housing and finance.

Manufacturing to lift the Southeast

The sharp downturn in manufacturing was not limited to the industrial Midwest. Ultimately, cutbacks in consumer demand, investment spending and exports knocked the Southeast into recession as well. The turnaround in industrial production is one of the strongest indicators of economic recovery and will help lift the Southeast out of recession soon to meet export demand and domestic growth.

The Midwest's recovery will be lagged. While workers have been called back to auto production lines in recent weeks, further consolidation is needed for the industry to sustain profitability. Outside auto-intensive areas, however, export and investment demand will help stabilize the rest of the Midwest and Plains states.

Technology-producing areas also stand to gain in the near term. Business investment spending may remain tepid during the coming year, but it did turn positive in the third quarter of 2009 following six consecutive quarters of decline. The turnaround is enough to stimulate tech-producing industries, which will further gain from export demand and from some domestic consumer demand where technology change is evident. Electronics, telecom and software industries in areas such as Silicon Valley, Portland OR, Seattle, Austin TX, Dallas, Boston and Raleigh NC should feel this effect. The exception is likely to be pharmaceuticals, concentrated primarily in the Northeast, which is an industry also experiencing consolidation.

Housing uncertainty

House prices generate the most uncertainty for the regions. The importance of a stable housing market is clear from the recent performance of the central Plains economy. Risks are greatest in four regions: California, because of its sharp downturn in house prices and high rate of foreclosures; Florida, where investor buyers have disappeared; the Northeast, as a result of the sharp downturn in income and the fact that housing affordability remains below 1990s levels; and the Pacific Northwest, where affordability also has not adjusted, and risks to the region's aerospace industry are intensifying.

Upside potential for California's housing market derives from stable population growth with significant pent-up demand due to its long period of low affordability. Further, the California housing market depends to a high degree on endogenous demand, which could improve as the strengthening Asian economy supports the region through its trade and transport links.

At greater risk of a sluggish turnaround is Florida, as population growth slows to near zero, and investor demand remains weak. Further, the construction industry drives Florida's economy to a larger extent—by about 33%—than it does in California.

A diminished role for finance

The Northeast, particularly within the commuting shed of New York City, may be one of the last housing markets to stabilize. Its cycle began well after the rest of the nation's, and weak income growth will weigh on demand and prices in the region near term. Even if financial service bonuses rebound in early 2010, the propensity to spend such payouts may be much reduced. More broadly around the country, the finance industry will play a diminished role in supporting most of the regional economies than it did in recent years when it expanded as a result of demand for mortgage finance and of expanded retail and commercial business portfolios of many institutions.

First the Plains, then the Southeast

Economic recovery has begun in the upper Plains and will soon emerge throughout the central part of the country. The Southeast may next be in line as its manufacturers, export-based producers and transport hubs find renewed footing. The industrial Midwest will ultimately find renewed stability from a significantly smaller domestic auto industry. Its surplus of skilled labor and its auto-related research facilities eventually will form a base from which moderate growth can emerge.

California, the Southwest and Florida will depend heavily upon stabilization in their housing markets. Much will depend upon how quickly foreclosures liquidate the excess supply of homes. California holds an advantage in its demand factors and its administrative process for foreclosures, which moves more quickly than Florida's judicial process. In and around California, links to Asian trade also lend upside potential to the region's recovery. Already, evidence is emerging of an increased flow of exports through West Coast ports. But all U.S. ports at this point are hungry for business, and competition is fierce.

New York faces the greatest near-term risk for two reasons. First, income and employment growth are extremely uncertain in the region as financial services continue to restructure. Second, without clear guidance regarding a new regulatory environment, the financial services industry may expand very cautiously over the coming year.

State fiscal conditions add further risk to regional economies, as revenue is likely to fall through the end of the 2010 calendar year, even as direct federal aid contained in the stimulus program begins to fade. States at greatest risk are those that depend highly upon income taxes, including California, Connecticut, New York and Massachusetts.