How long can growth last?

A trio of economic and business leaders predicts more economic growth in 2019, but national headwinds threaten the good times.

From the pages of In Business magazine.

Last year at this time, there was near unanimous agreement that 2018 would be a strong economic year locally, statewide, and nationally, and that’s exactly how things unfolded.

Globally, just about every western economy was growing, the U.S. economy was showing signs of renewed life with the stimulus of tax rate cuts on the way, Wisconsin was approaching record low unemployment with the Foxconn development posing challenges for future workforce development, and Greater Madison was enjoying the fruits of strong growth with the distinction of being the only south-central Wisconsin county that was gaining in population.

As the year progressed, however, more headwinds have developed that now paint a less rosy picture nationally. A temporary truce in the trade war with China offered a bit of a hope, but rising interest rates have the White House worried, a jittery stock market led to some recessionary forecasts, and a continuing labor shortage all have economists wondering how much longer 3-to-4 percent growth can continue.

Meanwhile, local and state economic prospects are still excellent. In this look at the economic forecast for 2019, we spoke to Jim Hartlieb, president of First Business Bank in Madison; Kurt Bauer, president and CEO of Wisconsin Manufacturers & Commerce; and Elliot Eisenberg, an economist, lobbyist, and humorist with GraphsandLaughs.

Local picture: Madison businesses remain optimistic

When local numbers are crunched, it’s hard to think of the economic performance of Greater Madison’s economy as anything but spectacular. The 16th annual First Business economic survey, released last month, not only found that 2018 was the fifth consecutive strong year in terms of sales revenue and profitability, responding businesses are highly optimistic about 2019, as well. Three quarters of them expect overall business performance to further improve in 2019, while only 7 percent expect a decline.

Heading into 2018, Dane County employers were extremely optimistic about the local economy. An overwhelming 99 percent of companies expected improved or unchanged performance, including 79 percent that anticipated improvement. Moreover, just 1 percent of respondents expected a worse overall business performance in 2018 than they had in 2017.

What actually happened? Sales revenue for 2018 tied the historic high from 2014, and profitability was very strong, making 2018 one of the best years in the history of the First Business survey. The percentage of companies adding new employees also marked a new historic high, as did the percentage of companies increasing wages.

“It was an overwhelmingly positive year from the respondents’ perspective,” notes Hartlieb. “We had 75 percent of the respondents report an increase in sales revenue, which was on top of a great year in 2017. In terms of profitability for 2018, 53 percent saw an increase in profitability, which highlights the picture that I see forming here. The demand is there, the business is there, but the biggest challenge that companies are having is finding the labor and the skills to basically produce or execute the service to generate the revenue.”

Stronger business confidence was evident in higher capital expenditures, as 86 percent of companies increased or maintained their capital expenditure levels. “Another thing that struck me was the increase in capital expenditures year over year,” Hartlieb states. “If I looked back to 2016 and 2017, the survey would have shown about 30 percent of the respondents were projecting an increase in capital expenditures. What actually happened in 2018 was that 47 percent, almost half the people, reported an increase, and 39 percent reported the same level, so between the two you had 86 percent of the companies either meet or exceed their level of capital expenditures from the year before, which tells me they are bullish about the future and they are investing in capital expenditures to prove that.”

Looking ahead to 2019, the percentage of companies that project increased sales is slightly higher and, despite a slight decrease in the percentage projecting an increase in profits, profitability projections remain strong. Forty-one percent expect an increase in projected capital expenditures in 2019 (up three points), and the percentage of those who expect capital expenditures to decrease in 2019 is unchanged at 9 percent, a single point above the historic low. Hiring projections mark yet another historic high, and more than three quarters project wages to further increase in 2019.

“We’ve got an even higher number of companies expecting 2019 to be better than 2018,” Hartlieb notes. “Seventy-eight percent expect an increase in revenues, and 15 percent no change, so you’ve got 93 percent of the responding companies thinking it’s going to be at or above, and again that’s coming off of a record year in 2017 and 2016 was very good, as well.

“Profitability-wise, it’s similar to 2018, as about 55 percent expect an improvement in profitability, so it’s slightly higher but not to the same level as the revenue category.”

About 80 percent of companies are expecting an increase in wages, and 60 percent are projecting an increased number of employees. “So again, it’s that pressure on the labor force to be able to meet the demands of their customers that’s going to be a big story that plays out in 2019 and beyond,” says Hartlieb.

Survey respondents were asked to identify their concerns heading into the new year, and they cited labor, tariffs, interest rates, and immigration policy. “I would say generally, it’s uncertainty,” Hartlieb notes. “The tariffs, the trade situation, interest rates, immigration policy and how that might impact labor — all of these things have uncertainty. Business owners, if they know the rules of the game, will win the game. It just seems there may be a higher level of uncertainty as we head into 2019 that might cause some disruption as we go along, and it will force business owners to act on their feet even more so than in the past.”

At some point, Hartlieb adds, there will be a correction that causes the economy to slow down, but employers are better positioned to weather the storm than they were in 2007 because they have less leverage on their balance sheets. “They’ve learned from the recession that having that leverage is going to be harder when there is a correction,” he notes. “They’ve got more engaged employees, they have more automation in their manufacturing processes, and it’s just a much healthier situation in that they will be able to react when and if we do have another correction.”



State picture: New governor, better results?

The day after Tony Evers’ election as Wisconsin’s new governor, WMC’s Kurt Bauer, who has supported many of Gov. Scott Walker’s policies, issued a conciliatory statement. In it, he reiterated that Wisconsin’s workforce shortage is the number one issue facing the Wisconsin business community, and he notes that in his previous capacity as state superintendent of public instruction, Evers worked with the business community on this issue.

Kurt Bauer cites workforce development as the most likely area of collaboration between WMC and new governor Tony Evers.

WMC recently held a Future Wisconsin Summit where the olive branch was extended once again. Evers was in attendance at a reception of WMC and the Wisconsin Education Association Council, two state associations that don’t often see eye-to-eye but have agreed to collaborate on workforce development. One of the things they vehemently disagreed about was Gov. Scott Walker, who might hold the “distinction” of being the only incumbent ever voted out of office with a 3 percent unemployment rate. Consider the following economic metrics:

  • Based on statistics compiled by the U.S. Department of Labor’s Bureau of Labor Statistics, Wisconsin added a statistically significant 32,000 private-sector jobs from October 2017 to October 2018.
  • Wisconsin ranks second nationally and first in the Midwest in manufacturing job gains over the past year. The BLS reports that Wisconsin added 20,000 manufacturing jobs from October 2017 to October 2018.
  • In that same period, Wisconsin’s addition of 9,200 construction jobs over the year ranked 14th nationally.
  • The state’s labor force participation rate of 68.4 percent ranks seventh best nationally and second in the Midwest.

For a state that ranks in the middle of the pack on many economic measures, that performance stands out. Can Tony Evers keep the momentum going in 2019 and beyond?

Late in the gubernatorial campaign, Evers backed off his pledge to put everything on the table in terms of tax increases to pay for transportation improvements, but he has pledged to boost funding for the University of Wisconsin System, which Walker cut to the tune of $300 million, and he committed to eliminating the controversial Wisconsin Economic Development Corp. that Walker created in 2011 to replace the old Department of Commerce. In a Legislative Audit Bureau report, the quasi-public agency came under fire for financial reporting errors and was forced to address shortcomings related to its record keeping.

Others have called for the agency to be reformed, not eliminated. Evers’ eventual proposal regarding the WEDC, which must be approved by the Republican-controlled Legislature, will tell a lot about his economic development strategy for fostering startups and emerging companies, attracting investment, and otherwise creating a business-friendly environment.

Given Evers’ election, some change is inevitable, but voters also maintained Republican majorities in the State Assembly and the State Senate. With that type of ticket splitting, their unmistakable message to leaders of both political parties is: Play ball between the 40-yard lines.

Bauer agrees that both sides will have to negotiate the middle of the field. Bauer notes that Evers will be limited in what he can do “to undo” Walker’s legislative victories, including Act 10 and right-to-work, because the Democratic Party doesn’t control either house of the Legislature. However, as governor, he will have some formidable tools, including a powerful veto pen, especially on appropriation bills. “Evers will be able to use the line-item veto to make creative changes to spending bills,” Bauer notes. “He can also use his veto power as leverage in negotiations with Republican leaders.”

For example, he can agree not to veto legislation the Republicans want in exchange for getting something he wants because Republicans don’t have enough votes in either house to override an Evers veto. In addition, Evers also will make scores of cabinet and subcabinet appointments, and those appointees can have a tremendous impact on a wide range of policies, especially at the Department of Natural Resources, the Department of Revenue, and the Department of Workforce Development.

As for transitioning away from the WEDC, Bauer points out the agency can’t revert back to the Department of Commerce without legislative action, and the Legislature appears skeptical about the change. “Evers will have to make his case that the WEDC model, which attracted Foxconn and Haribo, is somehow broken,” Bauer states. “Either way, I would highly encourage Evers to continue the talent attraction campaign WEDC is conducting in order to draw veterans and Midwestern millennials to Wisconsin. The campaign is also trying to convince people who attended a Wisconsin college or university — and then left — to come back to the state.

“We have worked with Evers at DPI and will work with him as governor,” Bauer reiterates. “Workforce is the most logical area, but I hope there will be others, as well.”

Evers’ interest in reviewing air permits for the Foxconn development is consistent with the Democrats’ belief that environmental review of the project wasn’t thorough enough. However, Bauer notes that Foxconn’s air permit, though granted by the state DNR, is a federal permit. Any changes to the air permit would likely need to be approved by the Environmental Protection Agency, which is unlikely to happen during the Trump administration.

“But there are ways an Evers’ appointee at the Department of Natural Resources can cause mischief for Foxconn and other economic development projects,” Bauer states. “The real question is why would Evers want to jeopardize Foxconn, a project that will create thousands of high-paying technology jobs, both directly and indirectly? Members of his party have stated for years that they want the Wisconsin economy to transition to a tech economy. Doing so organically would have taken decades, if it ever occurred. Foxconn can do it in a matter of years.”

Bauer still feels the state’s economy is headed in the right direction. “I would argue that the Wisconsin economy is strong today not only because of the U.S. economy, but also because of our rehabilitated business climate,” he states. “Wisconsin does very well on business climate rankings of CEOs and site selectors. We encourage Evers to talk to businesspeople directly to learn what factors go into decisions on where to invest for the long term. If he does that, he will hear controlling government-imposed costs and maintaining a fair and predicable regulatory environment are fundamental.”



National picture: Recession looming?

Eisenberg has become an annual feature during State Bank of Cross Plains’ annual economic forecast. The title of this year’s presentation, “The Economy in 2019: Terrific, Turbulent, or Tepid,” captures the good news, bad news environment American businesses operate in.

“Once in a while interest rates get messed up, and the [yield] curve develops a negative slope. That is very bad. Every time the curve’s slope has switched, a recession has followed.” — Economist Elliot Eisenberg

Eisenberg told an Overture Center gathering that he expects economic growth, now over 3 percent, to slow in 2019, and he says a mild recession is possible by early 2020 due to headwinds of a slowing global economy, President Trump’s trade war with China (which he actually finds some merit in), and what he views as an ill-timed tax cut that went into effect earlier this year. While a mild recession is not a catastrophic event, Eisenberg says the U.S. could have difficulty extracting itself from even a tepid slowdown because policymakers have used all the fiscally stimulating bullets in their chamber — a reference to the tax cut and the continuation of robust government spending.

Yet of all economic measures that he’s watching, he’s playing the closest attention to something called the yield curve, which shows the relationship between interest rates and loan length. More specifically, it refers to the difference between returns on long-term treasuries and short-term treasuries, and the reason economists pay attention to it is that long-term investments generally are riskier than short-term investments.

Therefore, the difference is usually positive, but when short-term treasuries are paying higher returns than long-term treasuries, the difference becomes negative and at that point, short-term investments have grown riskier than long-term ones. In November, when Eisenberg spoke in Madison, the yield curve was close to negative territory, and while it can remain too close for comfort for quite a long time, it’s at a very unsettling point — late in an economic expansion.

Due to the Dec. 4 stock market plunge, some inversion already had begun, as two-year versus five-year treasuries inverted, as did three-year versus five-year treasuries. That’s not a full-fledged yield curve inversion — that refers to the yield on the two-year treasury exceeding the 10-year treasury — but it’s a troubling sign.

“Usually, the longer the length of the loan, the higher interest rate you pay,” Eisenberg explains. “That relationship is positive, so the curve is upward sloping, a positive slope. But once in a while interest rates get messed up, and the curve develops a negative slope. That is very bad. Every time the curve’s slope has switched, a recession has followed.”

At the moment, however, Eisenberg says the good news starts with strong gross domestic product growth of 4.2 percent in the second quarter, 3.5 in the third, and expectations for 3 percent in the final quarter of 2018. “You can’t help but notice the trend, but things will slow down more,” he predicts. “Be prepared for what’s going to happen.”

Corporate investment in plants and equipment is okay, but it slowed in the second half of 2018. “Capital goods orders saw strong growth, but we need it to keep going up because it’s the single best way to raise the productivity of our economy.”

Government spending is on fire with tremendous fiscal stimulus, but that’s not necessarily a good thing toward the end of a strong business cycle. “We might pay for it in the end, especially if a recession hits and the fiscal options have been spent,” he reiterates.

In anticipation of tariffs and retaliatory tariffs, exports were “unbelievable” in the second quarter as businesses were rushing to get their goods out in anticipation of tariffs. In terms of GDP, we’re losing 40 to 50 basis points with higher tariffs on imported goods and the retaliatory tariffs they invite. In early December, the U.S. and China announced a cease fire to buy time for a negotiated settlement, as President Trump decided to hold off on tariff increases that were set to take effect in January 2019.

“When we impose tariffs on Chinese goods, we hurt them, and they hurt us,” Eisenberg notes. “When the Chinese retaliate, they hurt themselves, and they hurt us.”

Yet are we right to do it? Yes, Eisenberg maintains, because China needs to be taught a lesson for its unfair trade practices, including currency manipulation and intellectual property theft. “China steals our technology, preventing us from competing fairly, but [a trade war] makes me nervous. The list of things on the down side is long.”

Corporate profits are way up, except for the technology sector, where tumbling shares have caused recent sell-offs, but the global growth rate has slowed and will continue to do so. The U.S. is somewhat insulated so far due to the tax cuts and the rise in government spending.

Manufacturing numbers are strong, but labor shortages and rising tariffs on U.S. exports make manufacturers both happy and nervous. “Nobody knows how the tariff thing will work out,” which only adds to uncertainty, Eisenberg says.

While the tax cuts have supercharged the economy in the short run, he believes they were unwise because the economy was still growing when they were enacted late in the current business cycle. Eisenberg predicted the fiscal boost of tax cuts is likely to gradually fade in 2019 as the economy goes from fiscally expansionary to mildly contractionary. “I believe we stimulated an already stimulated economy,” he says, which will leave the government with fewer fiscal options when the next slowdown occurs.

By the end of 2019, Eisenberg expects GDP to be at 2 percent, and the likelihood of a recession rises as GDP declines. Combined with the headwinds of tariffs and their dampening impact on trade, the overall global slowdown, and the yield curve inversion, we could enter recessionary territory — defined as two consecutive quarters of negative GDP — by early 2020.

“It won’t be that bad a recession,” he says, “but it will be harder to get out of because the fiscal policy options aren’t that numerous.”

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