THE NEW MEXICO ECONOMY: WHERE DO WE GO FROM HERE? Tim R. Smith Senior Economist Presented to 1996 New Mexico Economic Forums Albuquerque, New Mexico September 26, 1996 Denver Branch of the Federal Reserve Bank of Kansas City The New Mexico economy is in its fourteenth year of economic expansion. Few states in the nation can claim such a stellar record. During this long expansion the state avoided the energy and agriculture-related recessions endured by its neighboring states in the mid-1980s. To some extent, the state was insulated from these problems by its strong ties to defense spending. But more recently, the state has loosened its ties to the federal government and significantly expanded its employment base in manufacturing and services. As a result, the New Mexico of the 1990s is markedly more diversified than the New Mexico of the 1970s or 1980s. As the title of my talk suggests, my purpose today is to assess the outlook for the New Mexico economy. I think one of the best ways to get a handle on where we are going is to take a look at where we've been. I also think it is important to look at the performance of key sectors--or building blocks--of the state economy. Therefore, my presentation will proceed in three steps. First, I will provide a broad overview of recent performance of the New Mexico economy. Then, I will take a closer look at five key sectors of the state economy: agriculture, energy, services, manufacturing, and construction. In each case I will review recent performance and give my view of the outlook. At the end of my talk, I will try to wrap it all together to--hopefully--provide some insight into the broad outlook for the state economy. Recent Economic Performance: A Durable Expansion Rapid job growth in 1994 and 1995 prompted many analysts to characterize the New Mexico economic situation as a boom. More than a few headlines announced the boom here and elsewhere in the Rocky Mountain corridor. But as I said a moment ago, the New Mexico economy appears not to be in the midst of a short-lived boom, but many years into a durable expansion that began after the national recession back in 1982. This picture of job growth shows what I mean. The state has been adding jobs in each of the last 14 years. Job growth over the entire period averaged 3 percent--well above job growth in the nation. Growth in employment slowed during the recession in 1991, but bounced back sharply, reaching well above 4 percent last year and the year before. Some slowing has occurred this year, but the pace of job growth remains more than two percentage points above the national pace. I should make one important note here. When a state's economy either starts to speed up or slow down, the survey commonly used to estimate employment can overstate or understate employment growth. This appears to be the case in New Mexico currently. Brian McDonald and his staff at the University of New Mexico's Bureau of Business and Economic Research have recently compared the employment numbers coming from a more reliable count of all employees covered under the state's unemployment insurance laws with the more familiar published estimates. The comparison suggests that the published employment data that I am showing today have been overstating job growth since the fourth quarter of last year. Keep in mind, then, that when the employment data are rebenchmarked at the end of the year, they will almost certainly be revised downward. With that important caveat in mind, let me proceed with my overview, before taking a look at the state's individual sectors. One way to check the trends in the employment data is to look at other broad measures of economic performance. One such measure is income growth. This chart compares growth in real personal income in New Mexico with income growth in the nation. From 1993 to 1995 income rose close to 5 percent per year in real terms. However, there was some slowing of income growth in the first half of this year, likely due to the slowing in job growth. But the pace of income growth still remains slightly above the national pace. So the New Mexico economy has been expanding for more than a decade, and growth during the 1992-95 period was especially strong. Growth has been propelled by a relatively attractive business climate which attracted new manufacturing and service businesses from other parts of the country and encouraged the expansion of existing businesses. We have seen some slowing in the pace of employment and income growth in 1996, but before we can establish a pattern I think it is important to look at the performance of the key sectors of the state's economy. I've selected five sectors of the New Mexico economy to highlight today. I chose three of the sectors--services, manufacturing, and construction--because of their lead role in the state's current expansion. In terms of size, these three sectors make up the lion's share of the state economy. I've also added agriculture and energy, because recent developments in these natural resource sectors may have serious implications for some of the state's smaller communities and their lenders. One obvious omission from my list is the government sector. While still a big influence on the state economy, the government sector has been growing only slowly for several years. As a consequence, the story behind the current expansion is really a private sector story. Energy: Staying the Course Recent events in Iraq have focused attention once again on the energy industry. Here in New Mexico, energy production and other mining account for about only about 3.5 percent of total earnings in the state. Nonetheless, because the location of energy production is determined by mother nature, cyclical variation in energy prices and production can impact communities that depend heavily on this mining activity. This chart is intended to show that most of the action in the energy industry in New Mexico is in natural gas. While the state produces relatively small shares of the nation's coal and oil, it produces 8 percent of the nation's natural gas and holds more than 10 percent of the nation's gas reserves. Overall, energy activity in the state has been lackluster since the mid-1980s. To understand the source of this steady picture, let me show you how energy prices have been behaving recently. Oil prices have clearly been trending up, as this chart shows. And in recent weeks, tensions in Iraq and the postponement by the United Nations of humanitarian oil sales have pushed oil prices about $3 per barrel higher than the last point shown on the chart. Meanwhile, natural gas prices have been in a slump since the beginning of the year. Yet despite the recent slump, gas prices remain above their level during the previous two years. The net effect of these price movements has been some recent improvement in drilling activity in the state. But looking back over a somewhat longer time horizon shows that New Mexico's rig count has been hovering around 35 rigs for the past three years. Though the situation is stable, the level of activity pales in comparison to the peak reached in late 1981 when 160 rigs operated in the state. The stability extends to mining employment which has been relatively steady for the past several years after dropping sharply during the oil price crash in the mid-1980s. The short-term outlook is for the higher oil prices to bring some additional drilling activity to the state. However, world oil production is expected to be large enough in 1997 to bring prices back down to their levels before the most recent uptick. And while the firming oil prices will lend some support to natural gas prices, the upside for gas production is longer term. As environmental concerns stimulate more widespread use of natural gas in commercial and industrial applications, the value of gas production in New Mexico should turn up. But again, the industry will stay the course during the next year with little upside or downside influence on the overall condition of the state economy. Agriculture: A Better Year Ahead The farm sector in New Mexico is relatively small, accounting for only about 2 percent of total earnings in the state. Nonetheless, the fortunes of the state's ranchers can impact the state's rural communities and the indirect effects of swings in farm income can reach to the state's trade centers. Most of New Mexico's $1.5 billion of agricultural output comes from the state's cattle ranches. Less than a third of the output is from crops. Needless to say, this has not been a good year for farmers or ranchers in New Mexico. But things may be looking up somewhat in the year ahead. Drought has severely limited output of feed crops in the state. But prices are high due to low nationwide stocks. For example, this chart shows that smaller than expected corn crops in 1996 have only narrowly boosted grain stocks that remain near historic lows. As a result, grain producers will enter the new year with prices near record levels. I realize that corn is not a big crop in New Mexico, but higher corn prices have had a big impact on the profitability of the state's cattle industry, pushing up the cost of commercial feed in the midst of a drought that has reduced grazing opportunities. However, conditions in the cattle industry should also slowly begin to improve. After a two-year slump, the cattle industry is poised to return to profitability. The cattle industry has been cutting back in response to all the red ink, and cattle feeders are once again close to breaking even. This chart compares the price of fed cattle with the price required by feeders to break even, given the current high cost of feed. As supplies continue to tighten, profit margins should widen, especially if the new year brings a bigger corn crop and lower feed prices. Although the market fundamentals are pointing in the right direction, profits for ranchers will remain elusive and recovery will evolve only slowly over the next couple of years. The impact of the problems in the cattle industry can be seen in New Mexico farm income. This chart maps farm and ranch income in the state. As you can see, income was down sharply in 1994 and 1995 and there is little doubt that it will fall again in 1996. But note that 1992 and 1993 were very good years for New Mexico agriculture, leading to balance sheet improvements that will help the sector ride out another weak year. Services: Leading the Way Several important economic sectors are often collectively referred to as service-producing sectors. To get a better idea of the importance of this large segment of New Mexico's economy, I'll turn to a chart showing the shares of total employment accounted for by major economic sectors. To focus in on services, I've excluded government and the goods-producing sectors--construction, mining, and manufacturing. What's left highlights the service-producing sectors which together account for almost two-thirds of the state's jobs. The largest of these sectors is narrow services, accounting for nearly 30 percent of total employment. I know the nomenclature is somewhat confusing, but narrow services includes a diverse collection of industries-- ranging from consumer services like health care, personal services, and recreation to producer services like business and legal services. The other service-producing sectors are (in order of size): retail and wholesale trade; finance, insurance, and real estate; and transportation and public utilities. Not only do the service-producing sectors represent a large share of the New Mexico economy, they have been a key factor behind the state's recent expansion. Taken together, New Mexico service-producing sectors added jobs at an average pace of almost pace of 6 percent in 1994 and 1995, while nationwide growth was only 3.7 percent. One of the fastest growing service-producing sectors has been the narrow service sector. Service employment growth peaked at 8.6 percent last year, almost 4 percentage points above national job growth in services. However, job growth in services has slowed significantly in 1996. And while service growth will remain robust, it is likely to slow further before leveling off at something closer to its average in the late 1980s and early 1990s. Service firms in New Mexico and across the nation are benefiting from improvements in communications and information technology. For example, engineering and management services have benefited from growth in high-technology manufacturing. And entire new businesses are sprouting up around new technological developments. To see what I mean, consider how the development of the personal computer spawned the computer software industry. Or look at the influence of the Internet and online services, which spawned the new America Online facility here in New Mexico. Another important service-producing sector includes retail and wholesale trade. Employment growth has also been strong in the state's retail and wholesale establishments. Employment in retail and wholesale establishments in the state rose 6 percent last year, almost double the national rate of growth. Strong income growth helped boost spending by both New Mexico natives and tourists. I don't have to tell this audience about New Mexico's vast array of recreational amenities and other tourist attractions. Nor should it come as surprise that tourism has helped bolster job growth in both services and retail trade. Growth in New Mexico's service-producing industries are expected to continue to slow, but are still expected to grow at a healthy pace for the remainder of this year and again in 1997. Growth in some consumer-service industries may slow somewhat with the overall slowing of the state economy, and may slow further if accumulating household debt causes consumers to cut back on discretionary spending. And growth in health care services appears to be slowing from the rapid pace set over the past few years. But I expect technology-driven producer services to continue generating jobs in the state. Meanwhile, the big expansion in the state's retail sector looks to be largely behind us, but some modest growth should continue. Manufacturing: On the Upswing The manufacturing sector in New Mexico has been more volatile than other sectors over the course of the long expansion. While most other sectors avoided job losses during the national recession in the early 1990s, the state's factories suffered two years of sharp declines in employment. This chart illustrates this point. Employment in manufacturing fell almost 4 percent in 1991 and 2 percent in 1992. Then, however, manufacturing employment rebounded sharply with job growth in excess of 4 percent in 1993 and 1994. But employment growth in manufacturing has moderated recently as the pace of expansions and relocations from other states has slowed. The recent strength in the state's manufacturing sector has come from expansion in both durables and nondurables industries. Over the past three and half years, the state has attracted many new small high-tech manufacturing business and seen the expansion at larger plants like Intel. The white bars in this chart show the strong growth in durables industries through most of the period. Nondurables industries, which are dominated by dairies and food processing in the southeastern part of the state, enjoyed very robust growth in 1993 and 1994, but have slowed considerably the past year and a half. Nondurables industries are shown in the chart by the yellow bars. As we look forward, the outlook for manufacturing in New Mexico is still quite good. Continued expansion among the state's high-tech firms should keep factory employment growing at a moderate pace. Nondurables industries will probably remain stable, but expected moderation in the state and national economy may limit gains in food processing. All in all, most of the action in the manufacturing sector will remain among the high-tech firms in the Albuquerque metropolitan area. Construction: Solid Growth After several years of declining employment in the late 1980s, the construction sector in New Mexico has made a strong comeback. By all measures, the construction boom here far exceeds the strength shown by the nation's construction sector in recent years. Robust homebuilding, commercial construction, and public infrastructure building have pushed construction job growth in the state into double digits for the past three years. This chart compares growth in construction employment in New Mexico and the nation since the mid 1980s. As you can see, the state lost construction jobs until 1992 when job growth in the state pulled ahead of the nation. Construction job growth peaked at almost 17 percent in 1994. Since then, job growth in construction has fallen by a third as major industrial and retail projects have drawn to a close. Nonetheless, the pace of construction job growth in New Mexico remains 6 full percentage points above growth in the nation as a whole. The outlook for construction is pretty good. The pipeline of construction projects looks to be large enough to keep building activity at healthy levels through the remainder of the year. The Cottonwood Mall is completed, but public construction of roads and sewers will continue to bolster construction in the Albuquerque area. Low office vacancy rates in the area should also stimulate additional commercial construction. And industrial expansion, while certainly not at the torrid pace set back in 1993 and 1994, is expected to provide a modest number of new jobs in the Albuquerque area. Homebuilding will likely lead the state's construction sector during the remainder of the year. As this chart shows, housing permits have dropped off somewhat since peaking last summer, but they remain at historically high levels. Summary Well, I promised to tie this presentation up and tell you where we go from here. By now you have probably caught on to a recurring theme of moderating growth. Yes, I think the New Mexico economy will slow overall, to a more sustainable pace. The past few years have been very good years in the state, but the rapid growth has placed serious strains on the state's infrastructure and its ability to provide public services. Slower growth should give the state a little more breathing room. Sector-by-sector: energy activity will remain more-or-less flat; higher cattle prices should eventually bring relief to the state's cattle ranchers; technology-driven business services will bolster service job growth; further expansions at high-tech factories will keep growth in manufacturing moderate; and these expansions plus solid residential building should sustain growth in construction employment. So, where do we go from here? The answer is up, but the ascent in the year ahead will be considerably slower than it has been for the past several years. Nonetheless, I see nothing to suggest that the economic performance in store for 1996, or 1997 for that matter, won't add another two years to New Mexico's long economic expansion.