By Manfred Keil and Ivan Kolesnikov | Inland Empire Economic Partnership
Perceived wisdom has it that the Inland Empire has been one of the major success stories in the post-COVID19 economic recovery, at least when it comes to job creation. Driven by the logistics sector (Transportation, Warehousing, Wholesale Trade), our Metropolitan Statistical Area, or MSA, had the second highest job recovery rate among the 10 largest California MSAs in January 2023; we were at 105% of the employment level of February 2020, the last month before the coronavirus downturn. Only the Stockton-Lodi MSA saw a faster recovery. By contrast, the state as a whole has not recovered all employment losses nor is its labor force at pre-pandemic levels. Many workers have either retired or moved elsewhere.
Our area was in the spotlight after The Economist referred to the region as the largest warehouse capital of the world. Add to that the fact that we passed the San Francisco MSA as the 12th most populous in the U.S. (next step: Boston-Cambridge), and setting aside the environmental worries by some, the party was on.
At the same time, there was concern at the national level: driven by the massive 2020 rescue package, the inflation monster reared its ugly head, reaching almost 9% by June 2022.
After initially dismissing the high inflation rate, the Federal Reserve was not going to tolerate it when its inflation target was 2% and, as the saying from former Chairman William McChesney Martin goes, it took away the punch bowl — quickly raising the Federal Funds Rate from the 0%-0.25% range to 5%-5.25%, increases typically coming at half a percentage point. This partially tamed the beast through a slowdown in economic activity with inflation down to 4% by May 2023.
First to feel the pain was the housing sector, specifically housing starts: nationwide, these fell by almost 450,000 units from March 2022 to March 2023, and are now substantially below the long-term average of 1.5 million units a month. More importantly for the Inland Empire, consumers have been buying less due to higher inflation and interest rates. Hence the logistics industry, in the business of delivering purchases, has been challenged. Note the current cost-cutting measures, for example, at FedEx.
The majority of economists, including those on the Inland Empire Economic Council, have predicted a national recession, most likely to start during the third quarter of 2023 and lasting at least to the end of the year. A minority of forecasters have painted a much rosier picture claiming household overhang from the federal spending spree will prevent the national economy from turning south.
Recessions can be very painful. Knowing a downturn is about to arrive is useful so preparations can be made to lower the imminent pain (think of having received a diagnosis of a medical disease). What are the current warning signals, if any, of a downturn? Like volcanologists attempting to predict an eruption, we must look at sensors. Most of these (index of leading economic indicators, consumer confidence, change in housing starts, change in average hours worked in manufacturing, etc.) are ringing the alarm bell now, indicating we are in the last 12-months-phase of the current economic expansion. The Inland Empire itself provides us with another signal since the area has the attribute of “First In, Last Out” when it comes to economic downturns (the coronavirus episode notwithstanding).
Looking at the household labor survey, which includes commuters, raw employment in Riverside and San Bernardino counties has been stagnant since December 2021, and has actually fallen by almost 50,000 since December 2022. This is not quite as bad as it sounds since the Employment Development Department only releases labor market numbers for the Inland Empire that are not seasonally adjusted. This means they can be distorted due to temporarily high holiday season employment or seasonally low summer jobs (think of the Coachella Valley). Adjusting these numbers accordingly, we actually see a small increase in Inland Empire Employment of roughly 1,500 since December, and a larger increase of almost 50,000 employees since December 2021. Nonetheless, employment creation has slowed dramatically but not fallen.
Some espouse the idea that there will be a “soft landing” or “painless disinflation,” meaning a slowdown of the economy and coinciding decline in inflation rates without an outright recession. Former Treasury Secretary and Harvard President Larry Summers pointed out that we have never seen a “soft landing” when the inflation rate exceeded 4% and the unemployment rate fell below 5% for the post World War II period — still there are proponents of the idea. Even those who forecast a recession only see a mild decline in economic activity, meaning a downturn of not more than 1% annualized real GDP; in other words, nothing resembling the large declines seen during the Great Recession and the coronavirus downturn. Such analyses presume the Federal Reserve will only raise the Federal Funds Rate two more times to the 5.5% to 5.75% range. We doubt this is sufficient to reduce the inflation rate to its 2% target, since the Federal Funds Rate is still below the rate of inflation and not at levels sufficiently high enough to inhibit spending and thereby drive down inflation significantly. To stress the point, while 5% nominal interest rates may seem high to some, they are actually not biting at all if the inflation rate is at a similar level. While real interest rates have risen, they remain modest by historic standards. There is still a punch in the bowl.
When we focus only on people who both live and work in the Inland Empire (data from the establishment survey), we see an even rosier picture. According to these data, employment of people at Inland Empire firms has risen by over 3,000 since December 2022 and by over 66,000 since December 2021. This suggests the household survey numbers are significantly lower because commuters from the coastal areas, who make up over 30% of the Inland Empire labor force, are not finding jobs as quickly as those working in the Inland Empire.
The discrepancy stems from the fact that commuters are more sensitive to economic fluctuations. After all, the reason for commuting, assuming you do not get pleasure out of it, is that you do not have a sufficient amount of human capital to afford working and living in the coastal areas. When the Greater LA area experiences a slowdown, these are the first workers to be laid off — before firms let go of the workers who can afford to live and work in the coastal areas. Hence this becomes an alarm signal as well and explains the “First In, Last Out” characterization; think of a lake that freezes from the periphery.
We saw signals turn from green to yellow around the beginning of the year when we switched our forecast from continued expansion to upcoming recession. We see no reason to change our prediction at this point and expect a downturn starting in the third quarter of 2023.
Manfred Keil is chief economist, Inland Empire Economic Partnership, Associate Director, Lowe Institute of Political Economy, Robert Day School of Economics and Finance, Claremont McKenna College
Ivan Kolesnikov is senior analyst, Lowe Institute of Political Economy, Claremont McKenna College.
The Inland Empire Economic Partnership’s mission is to help create a regional voice for business and quality of life in Riverside and San Bernardino counties. Its membership includes organizations in the private and public sector.
