THE OKLAHOMA ECONOMY: WHERE DO WE GO FROM HERE? Tim R. Smith Senior Economist Presented to 1996 Oklahoma Economic Forums Durant, Duncan, Enid,Tulsa, and Oklahoma City October 7-16, 1996 Oklahoma City Branch of the Federal Reserve Bank of Kansas City The Oklahoma economy is in it's ninth year of economic expansion. Since the severe economic problems encountered here in the mid-1980s, the state has become considerably less dependent on its traditional natural resource bases of energy and agriculture. That's not to say that these economic sectors do not continue to exert wide-ranging influence on the state's economy. They do. But other sectors, such as services and manufacturing have grown in relative importance. As a result, the Oklahoma economy is somewhat more complex than it was 10 years ago. As the title of my talk suggests, my purpose today is to assess the outlook for the Oklahoma 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 Oklahoma 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: Solid Expansion I think the Oklahoma economy can fairly be characterized as stable and growing at a moderate pace. After climbing slowly out of its mid-1980s years of recession, the state has achieved what appears to be a durable economic expansion. This chart compares employment growth in Oklahoma with employment growth in the nation. As you can see, job growth in Oklahoma rebounded in 1988 after several years of declining or flat employment growth. Since then, job growth has been in excess of 2 percent in each year except 1991 and 1992. But even during those years, the 1 percent gains in Oklahoma compared favorably to the job losses incurred by the nation during its recession. And during the last three years shown on the chart, employment growth has been edging up toward 3 percent. 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 Oklahoma with income growth in the nation. While income growth in the state has been improving during the past few years, it remains sluggish and somewhat below income growth in the nation as a whole. However, a couple of bad years for agriculture probably account for most of the recent disappointing income performance. So the Oklahoma economy has been expanding for eight years, with employment and income growth reasonably stable over the period. Growth in the state has been aided by a relatively attractive business climate, attracting new manufacturing and service businesses from other parts of the country and encouraging the expansion of existing businesses. While not expanding at the robust pace of nearby states like New Mexico and Colorado--where job growth has been running in the neighborhood of 4 percent--the Oklahoma economy appears to be on solid footings. Clearly, one reason for the state's steady performance in the 1990s is the relative stability of the energy sector. The energy sector has not been the source of volatility it once was, but neither has it been a source of growth. Instead, growth has come from other sectors. This chart shows how the shares of Oklahoma Gross State Product accounted for by major economic sectors has changed since 1980. The shares of output accounted for by services and government have increased markedly, and the shares of all other sectors except mining and construction have also increased. Note that the most recent data available are for 1992. More recent data would no doubt show an even greater diversification of the Oklahoma economy away from mining. The greater diversification of the Oklahoma economy positions it differently in national and international markets. Although not as dependent on wide swings in oil prices, the state may be more dependent on conditions elsewhere in the United States or elsewhere in the world. So let me take a closer look at some of the state's key economic sectors. I've selected five sectors to highlight today. I'll start with agriculture and energy because they still have big direct and indirect impacts on the state economy. Moreover, recent developments in these natural resource sectors may have serious implications for some of the state's smaller communities and their lenders. I chose the other three sectors--services, manufacturing, and construction--because of their key role in the state's current expansion. In terms of size, these three sectors make up the lion's share of the state economy. Energy: Staying the Course Recent events in Iraq have focused attention once again on the energy industry. Here in Oklahoma, energy production and other mining account for about 5 percent of total earnings in the state. And it is no secret that 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 Oklahoma is in natural gas. The state produces about 4 percent of the nation's oil, but it produces almost 10 percent of the nation's natural gas and holds more than 8 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 a tropical storm in the Gulf of Mexico have pushed oil prices to their highest levels since the Gulf War. 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 Oklahoma's rig count has been hovering around 100 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 872 rigs operated in the state. Meanwhile, oil production continues to decline and natural gas production has only recently begun to level off from the declines of the past few years. As a result, mining employment--which is dominated by oil and gas extraction--continues to decline in Oklahoma, dropping about 1.5 percent in 1995 and during the first half of this year. 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 Oklahoma 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 remains an important influence on the Oklahoma economy. While the farm sector accounts for less than 2 percent of total earnings in the state, the fortunes of the state's farmers and 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 and metropolitan areas. Over half of Oklahoma's 4 billion of agricultural output is in cattle. About a third of the output is from crops. Needless to say, this has not been a good year for cattle or crop producers in Oklahoma. But things may be looking up somewhat in the year ahead. Drought has limited output of wheat and feed crops in the state. But prices are high due to low nationwide stocks. For example, this chart shows that smaller-than-expected wheat 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. In addition, higher feed 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 Oklahoma 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. The yellow part of the 1996 bar indicates a possible range for farm income, but all indications point toward the lower end of that range. Note, however, that 1992 and 1993 were very good years for Oklahoma 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 Oklahoma'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; transportation and public utilities; and finance, insurance, and real estate. Not only do the service-producing sectors represent a large share of the Oklahoma economy, they have been a key factor behind the state's recent expansion. Taken together, service-producing sectors added jobs at an average pace of over 3 percent in 1994 and 1995, about equal to nationwide growth in this broad service category. One of the fastest growing service-producing sectors has been the narrow service sector. A sharp acceleration in service employment growth led the state's recovery in the late 1980s and continued growth has helped sustain the state's expansion. Service employment growth peaked at 7.5 percent last year, more than 3 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 early 1990s. Despite the slowing, service firms in Oklahoma and across the nation will continue to benefit 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. Another important service-producing sector includes retail and wholesale trade. Employment growth has also been strong in the state's retail and wholesale establishments. Retail and wholesale jobs grew 3 percent last year, about a percentage point above the national rate of growth. Part of the expansion in retail and wholesale establishments can be traced to the proliferation of discount outlets and large "category-killer" stores across the state. Another part of the expansion can be traced to tourism and retirement-related activity, particularly around the lakes in the northeast and southern parts of the state. Growth in Oklahoma's service-producing industries are expected to continue to slow, but these industries 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 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: A Mixed Picture The manufacturing sector in Oklahoma has been considerably more volatile than other sectors over the course of the state's expansion. This chart illustrates this point. While most other sectors avoided job losses during the national recession in the early 1990s, the state's factories suffered a sharp decline in employment in 1992. But the 3 percent decline lasted only one year, compared to four years of job losses in the nation's manufacturing sector. In 1993, manufacturing employment rebounded sharply. Since then, growth has slowed to a snail's pace. The recent volatility in manufacturing can be traced mainly to the state's nondurable industries. Chief among these industries is the food processing industry. While production of nondurable goods was a big contributor to job growth in 1993, some of those gains have been reversed in 1995 and 1996. However, employment in factories that produce durable goods has been more stable, growing moderately over the past three years. As we look forward, the outlook for manufacturing in Oklahoma is mixed. Growth prospects will vary from industry to industry and from location to location. With growth prospects improving for many of our trading partners in the year ahead, industries with foreign customers have a fairly bright outlook. An improved outlook for foreign exports from the state should offset the influence of moderating growth in the domestic economy, especially in the food processing industry. Meanwhile, activity among the state's producers of durable goods should remain steady, generating some new jobs. A recent survey of manufacturers in the state conducted by our Bank suggests most manufacturers are reasonably optimistic about the near term outlook. Construction: Solid Growth After several years of declining employment in the 1980s, the construction sector in Oklahoma has made a solid comeback. Until very recently, construction activity here had generally been outpacing construction activity nationwide. Robust homebuilding, commercial construction, and public infrastructure building have helped generate healthy construction job growth the past three years. This chart compares growth in construction employment in Oklahoma and the nation since the mid 1980s. As you can see, the state lost construction jobs until 1998. In 1989, job growth in the state began to pull ahead of the nation. Construction job growth peaked at almost 10 percent in 1990 and again in 1994. In between, the national recession led to a one-year decline in construction jobs, but the decline was considerably less severe than in the nation as a whole. More recently, the construction sector appears to have cooled a bit in Oklahoma, with job growth slightly below the national pace. 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. Let me show you a couple of leading indicators of construction activity. The first indicator is construction contract awards--which include residential and nonresidential building contracts, and nonbuilding infrastructure projects like roads, sewers, and bridges. Total contract awards have decreased recently, but they remain well above a year ago and above the average level of the past few years. Likewise, housing permits have dropped off since peaking last summer, but remain at high levels not unlike those of the past three years. The permit data suggest a significant backlog of homebuilding activity exits to help provide construction jobs through the fall and winter months. Summary Well, I promised to tie this presentation up an tell you where we go from here. By now you have probably caught on to a recurring theme of a stability and moderate growth. Yes, I think the Oklahoma economy can sustain its moderate pace of economic growth. The past few years have been reasonably good years in the state. The outlook calls for more of the same. Sector-by-sector: energy activity will remain more-or-less flat; a good wheat crop and higher cattle prices should eventually bring relief to the state's farm sector; technology-driven business services will continue to bolster service job growth; the state's factories will likely continue to operate at high levels of capacity, but expansions will be mixed across industries and locations; and, finally, the construction sector may loose a little more momentum, but remain healthy overall. So, where do we go from here? The answer is up, but there's no reason to expect the ascent in the year ahead to be any faster than it has been for the past several years. But 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 Oklahoma's economic expansion.