Inland Empire Economic Forecast and Analysis 2018

Inland Empire Economic Forecast and Analysis 2018

The Inland Empire Center for Economics and Public Policy provides independent expertise and in-depth analysis to promote economic prosperity and good governance in the Inland Empire.

Tuesday, Thursday, March 27th 24, 2015 September

2018 The Sun Also Rises in Inland Empire Housing

Inland Empire Economic Forecast and Analysis 2018 March 2018 Lowe Institute of Political Economy and Public Policy Robert Day School of Economics and Finance Claremont McKenna College 500 E. Ninth Street Claremont, CA 91711

Copyright © 2018 by Claremont McKenna College Reproduction of this publication or any portion therein is prohibited without the expressed written permission of the Lowe Institute of Political Economy at Claremont McKenna College.

Cover photo “Wind Farm Palm Springs Claifornia” used from Amanderson2 via Flickr 2

CMC Inland Empire Forecast and Analysis

The Sun Also Rises in Inland Empire Housing

2018

CMC Inland Empire Economic Forecast and Analysis

table of contents

Mr. T as Captain of the U.S. Economy: Any Icebergs in the Fog Bank Ahead?

4

The Sun Also Rises in Inland Empire Housing

40

Stock Market Correction Leads to Minor Fall in Inland Empire Consumer Sentiment

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CMC Inland Empire Forecast and Analysis

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2018 Mr. T as Captain of the U.S. Economy

Mr. T as Captain of the U.S. Economy: Any Icebergs in the Fog Bank Ahead?

By Manfred Keil, Ph.D.

Photo Credit: Deputy Secretary of Defense Patrick M. Shanahan via Flickr

The current economic expansion is 105 months old, or 8 years and 9 months. In April it will become the second longest economic upswing in the post World War II era, surpassing the March 1961 – November 1972 episode. If the current period of uninterrupted growth lasts beyond August 2019, as many forecasters, including us, project, then it will surpass the 120 month Clinton period from March 1991 to February 2001. Let us stress upfront that, while life teaches that good times eventually end, there is no relationship between the length of an expansion and the likelihood that it will end in the next year.

Expansions do not die of old age. Australia, for example, has not seen a recession since 1991.

Figure 1 shows all economic expansions since 1854 dated by month.

Think of the U.S. economy as a very large container ship, oil tanker, or aircraft carrier. The captain is on the bridge as the “USS Economy” enters a thick fog bank.

His first officer stares carefully at the radar screen. The question is whether or not there

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CMC Inland Empire Forecast and Analysis

are icebergs hidden in there because it takes quite some time from turning the wheel until the oil tanker actually changes direction. In economic analysis, policies which change the direction of the economy are called instruments and the desired effects are called targets. It is well known and frequently lamented that instruments affect targets with a long lag.

Thus it is imperative that we peer into the fog to see icebergs before they are upon us.

What types of radar are available to us?

Ignoring certain individuals who tell us what they see in their mysterious crystal balls or tea leafs, we can basically look at either leading economic indicators or large econometric models. Leading economic indicators (LEI) are basically economic data series that turn down before the broader economy does, and rebound first at the end of a recession. They are the canaries in the coal mine. The Conference Board has a series of ten national LEI including housing starts, the stock market and initial unemployment claims, among others. Figure 2 shows one of these, U.S. Housing starts.

The shaded area in the graph represent

Mr. T as Captain of the U.S. Economy

2018

Figure 1: Expansionary Phases of Business Cycle, U.S.

recessions. As you can see, housing starts typically decline before the economy enters a recession. In the past, they typically showed improvements before the end of the downturn.

Note that the increase was quite small in the case for the current expansion (more on this later in our housing report).

The rule of thumb is that when the LEI turns down for three consecutive months,

then there will be a recession after another six months. Figures 3 and 4 show that neither the LEI of the Conference Board nor the one produced by the Lowe Institute for the Inland Empire have declined for the last three months.

These radar screens suggest no trouble ahead, and indeed, continue to signal improvements for the latest reading ( January 2018).

Figure 2: Housing Starts Total, New Privately Owned Housing Units Started, U.S. 1959M1-2018M2

U.S. Housing starts are a leading economic indicator, typically signaling a turning point before general economic conditions change.

CMC Inland Empire Forecast and Analysis

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2018 Mr. T as Captain of the U.S. Economy Figure 3: Leading Economic Indicator, U.S. 120

100

Conference Board LEI

80

60

40

20

0 1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

2013

2016

Year

Currently, there is no sign for the end of the expansion for the U.S.

Respected economist James Hamilton (UC San Diego) calculates probabilities of an oncoming recession (“Econbrowser Recession Indicator Index”). His current estimate is an extremely low 2.4% probability. Few of you would carry an umbrella if the weather forecast suggests anything less than a 50% chance of rain.

The second type of radar screen, large econometric models such as the one used by UCLA’s Anderson Forecast, also do not hint at any sort of trouble for the next two years (through 2020). In their forecast release earlier this month, there are no suggestions of a recession for the near forecast horizon (until 2020), although the Anderson School forecasters predict somewhat of a slowdown for that last year of their forecast (2020). The upshot so far is that there is no end in sight of the current economic expansion. These episodes typically end as a result of oil shocks; inventory cycles in housing, automobiles, or consumer durables; or a monetary contraction. To paraphrase former Federal Reserve Chairman William McChesney Martin, “the Federal Reserve... is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.” There are no obvious signs of any of these po-

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CMC Inland Empire Forecast and Analysis

tential blows.

Of course all the wizards could be wrong.

Ben Bernanke, then Chair of the Federal Reserve, famously declared in May 2008, 5 months into the recession, that the Federal Reserve was more concerned about inflation than unemployment. He was clearly focused on the wrong set of indicators, akin to someone having his ear to the rails while ignoring the ever larger light approaching from the other end of the tunnel.

Here is our national forecast for the next 12-months period: • Accelerated real GDP growth from the current 2.5% growth rate for 2017 to 3.5% for 2018. California and the Inland Empire will show even slightly higher rates of growth.

• Three 0.25% interest (“federal funds”) rate increases by the Federal Reserve. While there is some noise of the Fed now planning for a forth rate hike, we don’t believe that President Trump replaced Janet Yellen with his own favorite, Jerome Powell, because he was looking for an inflation hawk.

• Oil prices will remain fairly stable around the current level of $60 per barrel. As a result, we do not see gasoline prices rising over the coming

Mr. T as Captain of the U.S. Economy year. This is important to Inland Empire commuters because dramatic increases in gasoline prices greatly reduce their spending power.

• Employment growth will continue, although not at the current breathtaking pace, neither for the U.S. as a whole, and especially not for the Inland Empire. However, job growth will remain solid, with further expansions centered on construction. We expect the U.S. unemployment rate to fall to 3.4% by the end of this year, with California’s rate settling at 3.9% and the Inland Empire at 4.0%.

• There will be an increase in housing starts.

While we will not see the record levels experienced in the run up to the housing bubble, the increase will be significant, especially for the Inland Empire (more on this in the housing section).

• Consumer Confidence levels, as measured nationally by the University of Michigan Consumer Sentiment Index, are almost at record high levels currently (there was a single month in 2004 which saw a higher level). We will introduce the CMC-Cadence Capital Consumer Sentiment Index for the Inland Empire later in the program. Let us stress here that neither consumer sentiment for Los Ange-

2018

les nor for the Inland Empire are nearly as bullish.

• We would not dare to forecast either stock market prices or exchange rate markets since we believe that both markets are efficient, and hence the best predictor is the forward exchange rate for the U.S. dollar and today’s stock prices (plus a small growth).

• The inflation rate will go above the 2% Federal Reserve target during the first half of 2018 and we expect it to end up at 2.5% for the year.

• Following the relaxation of regulations and the tax cut, we strongly feel that President Trump will attempt to push through an infrastructure program at the federal level, on top of the currently agreed upon other increases in government (especially military) expenditures. It needs to be seen if he can accomplish this and we remain skeptical.

• Minimum Wages, while still at $7.25 since 2009 at the nationwide, increased to $11.00 in California on January 2018 (in Los Angeles County, they will reach $12.00 in July 2018). We expect capital labor substitution at an accelerating pace in the Leisure and Hospitality Industry, and a strong negative effect on teenage employment coinciding with increased automation.

Figure 4: Leading Economic Indicator, Inland Empire 130 125 120

Inland Empire LEI

115 110 105 100 95 90 85

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

80 Year

Data Source: Data source: Employment Development Department, Federal Reserve Economic Data. Calculation by author .II

Currently, there is no sign for the end of the expansion for the Inland Empire.

CMC Inland Empire Forecast and Analysis

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2018 Mr. T as Captain of the U.S. Economy

The National Economy We held our last Inland Empire forecast conference in October 2016. What was the economic situation then and how has it changed since? Table 1 presents some of the major economic statistics that are of interest for the Inland Empire.

As a resident in the Inland Empire, why should you care about these numbers and the forecast? In the past, we sometimes received comments such as

“I want to know how the national economic trends impact my business/city. If they don’t, then spare me with the information, since I have enough on my plate to digest.” We have taken this into account and will focus on national, state, and regional variables that represent a relevant input into your decision process.

Table 1: General Economic Conditions, Fall 2016 and Now

2016 Q4

Now

Obama

Trump

17,930 (early November)

24,682 (March 21)

Consumer Sentiment

87.2

99.7

Annual U.S. GDP Growth

1.5%

2.3%

URUS

4.8 (October)

4.1 (February)

URCA

5.3

4.4

URIE

5.8

4.3

Inflation

1.6

2.1

Oil Prices

$46.83

$62.49

1.31

1.30

Federal Funds Rate

0.25 - 0.50

1.25 - 1.50

Housing Starts U.S.

1,328

1326

President Stock Market (Dow Jones)

$CAD/$US

8

Baseball

Dodgers on Vacation

Weather

$16.1 Billion Damage

CMC Inland Empire Forecast and Analysis

Dodgers Win World Series Germany Wins World Cup Not another $186.8 Billion Damage

Mr. T as Captain of the U.S. Economy Very few political forecasters, including some of the stars such as Nate Silver or Ray Fair, even came remotely close in predicting the 2016 election outcome. What has happened since the evening of November 8? We know that the national, state, and our regional Inland Empire economies have done well, but many commentators have remarked that this is due to policy actions put into place by the Obama administration and the Federal Reserve’s monetary policy resulting from actions taken under Janet Yellen’s leadership. However, there are two national variables whose behavior is clearly not due to decisions made by past policy makers because they are forward-looking indicators: (i) the stock market, and (ii) consumer con-

2018

fidence (sentiment). We display their behavior in Figures 5 and 6 starting in January 2016.

Both graphs show that there was a significant uptick after the election night in how the Stock Market and consumers looked at the future.

Note that both variables enter the Conference Board’s LEI, and hence it is not surprising that this forward looking index also sends us positive signals. As suggested earlier, the take-home from these two graphs is that both the American consumer and the stock market believe the good times will continue to roll. Since consumption makes up roughly 70% of GDP, this is a solid signal for fu-

Figure 5: Dow Jones Industrial Average, 2016M1 – 2018M3

The Stock Market has seen a 45% appreciation from November 8, 2016 to its new record high on January 26, 2018; it was still 36% higher by March 16, 2018.

Figure 6: Consumer Sentiment Index, 2016M1 – 2018M2

Consumer Sentiment shows a 14% increase since election day; the increase is not smooth and at times, the increase was minimal over the entire period.

CMC Inland Empire Forecast and Analysis

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2018 Mr. T as Captain of the U.S. Economy Figure 7: Unemployment Rate, U.S. and CA, 2016M1-2018M1

Both the U.S. and the CA unemployment rate show a trend decline over the last two years. Both have settled at historically low levels.

ture economic growth. As Figure 5 shows, despite the recent stock market jitters, the big picture is significant, sustained appreciation over the past 15 months.

What about the most general, but also not that easy to understand, measure of economic well-being – (real) Gross Domestic Product? Historically (since 1896), real GDP, which is closely related to total income in the U.S. economy, had shown average growth rates of roughly 3% per year. Since the U.S. population grows at approximately 1% per year over the same period, this means that your command over goods (per capita GDP) increases at a rate of 2%. There has been much talk recently of a slowdown of per capita GDP growth to 1% per year due to significantly slower real GDP growth.

But who cares about 1% difference (a percentage point), right? Well, at 2% growth, you will be able to buy twice as much for a given hour of work within 35 years; at 1% growth, this doubling of your purchasing power takes 70 years. A small change of 1 percentage point makes the difference of whether the average consumer sees their living standard double once in their life time or twice. President Trump promised, at first, to increase real GDP growth rates to 4% a year. This was quite unrealistic given the current demographic changes in our society (baby boomers retiring, smaller labor force growth rates, aging population). He since has settled for 3%, the old average, and there are some signs that his change

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CMC Inland Empire Forecast and Analysis

in regulations and tax reform will achieve that, and a bit more, for 2018. As for 2017, growth remained significantly below 3%. Since the Trump policies will only show their full effect this year, we forecast real GDP growth to be 3.5% for 2018 and do not forecast a decline (recession) for the near future (our forecast horizon ends in 2020).

This type of growth (above 3%) may not be normal for the US, but the International Monetary Fund (IMF) has just revised upwards its economic growth forecast for the world as a whole to 3.9%.

There are currently only three countries in the world experiencing a recession: Venezuela, Equatorial Guinea, and North Korea.

The popular press typically focuses on an easier to understand economic indicator of well-being: the unemployment rate (percent of labor force that is unemployed). However, we want to warn you up front that the unemployment rate is not always a good measure of how well the economy is doing.

Here are two situations when it can be misleading: (i) at times of structural change, when employment shifts between industries; and (ii) when there are large numbers of discouraged workers or individuals who do not work during the survey week and who claim that they are not looking for work. Figure 7 shows the U.S. and California unemployment rate since January 2016.

The two unemployment rates have settled at historically low levels: the last time U.S. unem-

Mr. T as Captain of the U.S. Economy ployment rates fell below 4.1% was in December of 2000 (3.9%) and before that in the ‘60s. California unemployment rates have never been this low (4.4%) in previous booms (state unemployment rates were not collected prior to 1976). However, we do not believe that the U.S. economy has reached full employment yet and that the unemployment rate will reach 3.4% by the end of 2018 (with California’s rate being slightly higher at 3.9% by then).

Most economists will tell you that we should see significant (real) wage increases as we approach full employment (when everyone who wants to work at the going wage rate has a job). Why is this not happening now, when unemployment is at a historic low? The typical list of explanations centers around declining unionization rates, increasing numbers of contract restrictions even for lessskilled workers, lack of federal minimum wage

2018

increases, automation and outsourcing sapping worker bargaining power, and low productivity growth. We see the main reason in the unemployment rate currently being a very inaccurate measure of the tightness of the labor market. We feel that the employment to population ratio is a more objective measure of labor market tightness. It is a more objective indicator of the labor market because the decision to search for work (and hence be counted as unemployed) depends a great deal on the conditions of the labor market. The unemployment rate thus counts only a subset of the people who might be willing to work if the labor market were at full steam. Meanwhile, comparing the employment rate to previous heights gives a better sense of how many potential workers might conceivably be pulled back into the market, and thus how much latent competition exists to allow firms to stave off wage demands.

Figure 8: Employment to Population Ratio, U.S., 25-54 year olds

Employment to population ratios increase during booms, and retract during recessions. There was a trend increase from 1947 to 2000. The U.S. economy is close to, but has not returned, to the previous peak figure.

Figure 8 shows the employment to population ratio for the prime labor force (25 – 54 year olds). The long trend increase in this ratio from 1960 to 2000 was due primarily to women joining the labor force in increasing numbers. Note that limiting to the prime labor force insulates this ratio from the effect of baby

boomers’ retirement.

The key point is that the employment to population ratio decreased following the dot-com recession and never fully recovered prior to the Great Recession. It then really went south starting in 2008, particularly in states that showed the steepest economic

CMC Inland Empire Forecast and Analysis 11

2018 Mr. T as Captain of the U.S. Economy

decline. The most recent national observation puts it within 0.4% of the last month before the start of the last Great Recession, November 2007, but it remains significantly lower (3.7 million people) than the peak of April 2000. This explains why we have observed relatively large increases in monthly employment coinciding with large increases in the labor force while the unemployment rate has remained relatively stable at historically low levels.

Workers who exit unemployment by finding jobs are replaced by workers reentering the labor force.

It also explains why we have both historically low unemployment and modest wage growth: firms can pull workers back into the market rather than paying higher wages.

Coinciding with the puzzle as to why we have not seen significant wage increases at this stage of the recovery is the question about the absence of higher inflation rates. Figure 9 shows the U.S. inflation rate since the beginning of 2016.

The Federal Reserve’s preferred measure of inflation is the rate of change in the prices of “Personal Consumption Expenditures Excluding Food and Energy� for which its target is 2% per year. That measure currently stands at 1.5% when measured

from a year ago, and even looking at the more erratic month-to-month changes only shows numbers above the target rate very recently. The booming condition of the economy coupled with the slow upward drift in inflation rates explains why the Fed is going to raise interest rates several times this year from historically extremely low levels.

Why should you care about inflation? Increases in inflation typically coincide with higher (nominal) interest rates. In the words of a fellow forecaster, why should households invest in housing at 5% when they did not do so at 4%? Note, however, that it is real interest rates (nominal interest rates minus expected inflation) that determine investment, including residential investment. When the Fed raises the Federal Funds Rate (the interest rate on loans between banks which they can closely control), this usually raises the real interest rate incurred by households and businesses. Interest rates are not the sole determinants in household decisions to undertake physical investments. Lending restrictions by commercial banks have played a major role in limiting investment, although rolling back parts of the Dodd-Frank act for smaller banks, as is currently discussed in Congress, could ease those regulations.

Figure 9: Consumer Price Index, Percent Change from a Year Ago, 2016M1-2018M2

Consumer price inflation has steadily increased since June 2017 and is higher than on election eve. It has only been above 2% recently since September 2017.

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CMC Inland Empire Forecast and Analysis

Mr. T as Captain of the U.S. Economy

2018

Figure 10: Canada/U.S. Foreign Exchange Rate, 2008M3 – 2018M2

The U.S. Dollar has appreciated substantially against the Canadian Dollar over the 2011 to2016 period and is still 30% higher than it was at parity.

We expect inflation to continue to rise slowly, and to end up at 2.5% by the end of the year.

There are three reasons why we don’t expect them to go beyond that level: (i) wages will not increase significantly, (ii) increases in productivity will keep unit labor costs (wage growth minus productivity growth) at low levels, and (iii) oil prices will not rise much above the currently observed level of around $60 a barrel. We believe that 2018 will see the first significant fruit from the 4th Industrial Revolution (artificial intelligence, machine learning, robotics).

There are a few signs of this when you look at recent productivity increases. Of course, we could be wrong and it will take longer for these effects to take hold, but when you see robots in hotels delivering room service and hamburger flipping machines in commercial use, then we must be close. It is in this sense that the increase in minimum wages may actually result in productivity growth in addition to lower turnover rates for the workers who keep their job.

This brings us to our last indicator of economic well-being, the exchange rate. There are many exchange rates, but we will focus here on two, the Canadian Dollar Exchange rate (Figure 10) and the Chinese Yuan (Figure 11). The Chinese exchange rate matters for U.S. imports, which are a central determinant for employment in the logistics industry of the Inland Empire.

Why should you worry about the Canadian exchange rate? After all, how many times do

you travel to Canada or sell your products to Canadian customers? But there is a part of Riverside County, namely the Coachella Valley, which significantly depends on Canadian “snow birds” flocking from the Western provinces of Canada down to Palm Springs every year. Their costs of visiting the Coachella Valley increased by 46% from 2011 to 2016. For a family of four, that makes the romantic evening in front of a fire place at home and the weekend social at the curling ring somewhat more attractive despite the freezing conditions.

Even more interestingly, consider Trevor McKenzie and his wife Nadine Gagnon buying a house for $300,000 in Palm Desert in 2011. Together with their daughter Tayga Marie, they have enjoyed the relatively warm winters in Southern California, and Tayga also is part of the crowd of 125,000 young people attending the Coachella Valley Festival in April every year. The McKenzie-Gagnons decided to sell their house in 2016 since Tayga has moved out of the house and the annual travel budget has increased substantially. Their house has not increased in value, and initially they have problems finding a buyer at the listed price. They decide to lower the asking price to $280,000 and close the deal within a week. Other residents grumble that the Canadians are selling below market value and ruining the housing market. But Nadine simply points out that they are exchanging the $280,000 for C$392,000, having made a 31% profit over 5 years. Not too bad.

CMC Inland Empire Forecast and Analysis 13

2018 Mr. T as Captain of the U.S. Economy There are many stories like this if you speak with real estate brokers in the Coachella Valley and they certainly care about movements in the Canadian Exchange rate. But what about the other 84% of the Inland Empire?

A staggering 40% of all U.S. imports, let me stress “all,” enter through the Ports of Los Angeles and Long Beach. There is no space left close to the coast for large warehouses. A significant fraction of the imported containers is moved to the Inland Empire before it is shipped out further to the rest of the U.S. Hence the Inland Empire employment in the logistics sector has always crucially depended on

real GDP growth in the rest of the U.S. For example, employment in the logistics sector fell dramatically during the Great Recession but was one of the first sectors to recover as the U.S. economy emerged earlier than California’s from the severe downturn.

This area also depends to some extent on exchange rates. When the U.S. dollar appreciates, it makes foreign goods relatively less expensive, leading to more imports and more business for the logistics sector of the Inland Empire. U.S. exports play a relatively minor role for the logistics sector of the Inland Empire since railway connections lead straight into the port terminals.

Figure 11: People Republic of China/U.S. Exchange Rate, 2001M1 – 2018M2

The Yuan has depreciated almost 25% since 2001, although it appreciated by 14% between 2014 and 2016.

President Trump has started to slap serious tariffs on steel and aluminum imports. While China is by far the largest steel producer in the world, it exports less steel to the U.S. than South Korea or even Brazil. As for aluminum, China ranks behind Canada, Russia and even the United Arab Emirates in fourth place. These tariffs certainly could lower imports from China; and much of the Chinese exports come through the Ports of LA and Long Beach. It is therefore possible to see a decline in

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CMC Inland Empire Forecast and Analysis

imports through these two harbors with effects on employment in the Inland Empire. However, we predict a general widening of the U.S. trade deficit resulting from the currently strong expansionary fiscal policies pursued by the Trump administration. Americans will continue to consume more than they produce with coinciding increases in imports. Hence the logistics industry in the Inland Empire and employment in general will continue to benefit from the trade deficit.

Mr. T as Captain of the U.S. Economy

2018

The Comparative Economic Performance of the Inland Empire While it is important to keep in mind the national economy when analyzing the local economy, this report is really about the Inland Empire, or San Bernardino County and Riverside County. The area is officially known as the Riverside-San Bernardino-Ontario Metropolitan Statistical Area (MSA).

What do you need to know about the Inland Empire to understand its economic significance?

And what are the special circumstances that make it interesting and somewhat difficult when it comes to analyzing its dynamics? Well, to begin with, there are a lot of people living there. The U.S. has 391 MSAs, and ranking them by population, the Inland Empire

is in 13th place with over 4.5 Million people. Within California, it is the 3rd most populous MSA, behind Greater Los Angeles (Los Angeles-Long Beach-Anaheim, or Los Angeles County and Orange County) and San Francisco-Oakland-Hayward (with a mere 350,000 residents more than he IE). Note that the Inland Empire ranks ahead of the San Diego MSA. Roughly 10% of all Californians live in the Inland Empire.

The bottom line is that there are a lot of people in the area. Figure 12 shows the relative populations of the 19 largest U.S. MSAs. What else is remarkable about the area? Traf-

Figure 12: Metropolitan Statistical Areas by Population Size, 2016, U.S. Census 25000000

20000000

Population

15000000

10000000

5000000

0

Metropolitan Statistical Areas

The Greater Los Angeles MSA is the 2nd largest in the U.S. The Inland Empire, with 10% of Californians, is the 3rd largest MSA in California.

CMC Inland Empire Forecast and Analysis 15

2018 Mr. T as Captain of the U.S. Economy fic and commuting. Approximately 40% of the labor force that lives in the Inland Empire works elsewhere.

Of these 40%, the vast majority (85%) commute along the I-10, I-210, CA-60, CA91 or by Metrolink into the Greater Los Angeles area (“all roads lead to Los Angeles”), while 15% travel on the I-5 into San Diego County. Average commuting times are available by city, but mask the fact that many employees

drive relatively short distances to work. To give you a better idea of what the commute means to the typical person, we have selected a few interesting routes and listed their commuting times during the hours of the day with the heaviest traffic density, according to Google. For example, driving to work and back from Upland to Downtown LA on a Thursday during peak hours takes 4½ hours.

Table 2: Commuting Times for Selective Routes, Inland Empire Start

16

End

Distance in Miles

7am Thursday

5pm Thursday

12pm Thursday

Moreno Valley

Anaheim

47

2:00

2:20

1:00

Victorville

Rancho Cucamonga

45

0:55

1:05

0:45

Upland

Downtown LA 38

2:10

2:20

1:00

Colton

Azusa

41

1:!5

1:40

0:50

Riverside

Pasadena

55

2:20

2:30

1:15

Corona

Escondido

67

2:00

2:00

1:10

CMC Inland Empire Forecast and Analysis

Mr. T as Captain of the U.S. Economy It is fair to assume that very few of us receive pleasure from commuting. Then why do so many of us do it? The answer can partially be found in Figure 13, which displays per capita GDP for the Top 15 of the MSAs plus the Inland Empire and those ranked close to it.

GDP, or roughly the value of everything being produced (“goods and services�) in a certain area, measures value added regardless of the residence of the employees. Los Angeles GDP, for e x a mple, i s produc ed by m a ny residents of the Inland Empire. To give an

2018

example, think of a person called Manfred Keil, who lives in Upland but works in Claremont.

His output is attributed to Los Angeles County while he is counted as a being part of the San Bernardino population. For that matter, if he was laid off, the unemployment rate for the Inland Empire would increase (by a miniscule amount) while that of Los Angeles County would be unaffected. Keil is not a t ypica l commuter, it takes him less than 5 minutes to drive to work regardless of the time of day he drives (he really should walk more).

Figure 13: Real GDP Per Capita, Selective MSAs, 2016, Bureau of Labor Statistics 160,000.00

140,000.00

120,000.00

GDP per capita

100,000.00

80,000.00

60,000.00

40,000.00

20,000.00

-

Metropolitan Statistical Areas

Following the large swings prior and following the recession, total payroll has seen healthy gains recently. Source: Employment Development Department.

Ranking the MSAs by per capita GDP produces a very different picture. Silicon Valley now moves into the second slot behind a mining and capital intensive producing area (Midland, Texas).

The Greater Los Angeles area barely holds on to the number 14 slot. The Inland Empire, on this statistic, falls all the way in the ranks to No. 346, surrounded

by Beckley (WV), Valdosta (GA), Muskegon (MI), and Albany (OR). How is this possible? The answer lies in the fact that 40% of those who live in the Inland Empire and work have found employment in the more coastal counties. As explained above, most of what these commuters produce must be more

valuable than what is produced in the Inland Empire because their pay is higher. However, it is not counted as GDP for the Inland Empire, but instead for the coastal regions. In other words, these official GDP figures do not properly reflect the spending power of Inland Empire residents, which would include the income that the commuters bring back home.

We can make the point by considering a single city within the Inland Empire, Indian Wells.

The city is one of the richest in the United States.

87% of the residents of Indian Wells who currently work have a job elsewhere. Hence only 13% live CMC Inland Empire Forecast and Analysis 17

2018 Mr. T as Captain of the U.S. Economy there and work there. On the other hand, 97% of those who work in Indian Wells come from one of the other 8 cities in the Coachella Valley. If we constructed a GDP for Indian Wells, it would be quite low, since the majority of work done within the city consists of lower skilled service jobs. Income of its residents is very high, on the other hand, since the jobs that Indian Wells residents hold are on the upper pay scale. Hence Indian Wells would have a low per capita GDP but a higher per capita income for

its residents.

What the numbers for the Inland Empire reveal so far is the obvious need to plan for the future settlement of firms that have a higher value added.

Commuters would love to spend less time on the road or the train if they could make the same salaries as they are able to bring home from the coastal regions. They would even be willing to take a small reduction in their incomes if, as a result, they could reduce their commuting times.

The Inland Empire Labor Market Figure 14 shows the Inland Empire’s unemployment rate relative to the state and national economy numbers.

15.0

Figure 14: Unemployment Rates, U.S., California, Inland Empire, 1990:M1-2018:M1

14.0 13.0 12.0

Unemployment Rate (%)

11.0 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0

Recession

IE

California

U.S.

Unemployment Rates are highly cyclical. California and the Inland Empire typically experience higher unemployment rates than the nation over this time period.

Focusing on the Great Recession first, note that the unemployment rate for the Inland Empire increases prior to the state and national unemployment series; and that it takes longer for the unemployment rate of the Inland Empire to return to its full employment level. This is referred to as “First In – Last Out” 18

CMC Inland Empire Forecast and Analysis

(FILO). It is what we would expect given our analysis so far: commuters from the Inland Empire, who cannot afford to live in the more coastal regions since they are not endowed with as much human capital as employees who live there (put differently, they do not have sufficiently high salaries), will be the first ones to

Mr. T as Captain of the U.S. Economy

2018

Figure 15: Unemployment Rates, U.S., California, Inland Empire, 1990:M1-2018:M1 62.0%

60.0%

Employment to Population Ratio

58.0%

56.0%

54.0%

52.0%

50.0% 2005

2006

2007

2008

2009

2010 IE

2011

2012

2013

2014

2015

2016

US

The employment to population ratio is pro-cyclical, decreasing significantly during the last recession. It has not recovered to the 2007 levels. The ratio is quite a bit lower for the Inland Empire than for the nation.

be laid off in a recession. These workers then come home to the Inland Empire and spend less money at local restaurants, home improvements, department stores, etc., which in turn results in lay-offs for people who live and work in the Inland Empire.

During the last recession, this became apparent in the Inland Empire as early as 2006. Finally, as the recession deepens, employees who live and work in the coastal areas will lose their jobs. The reverse happens in a recovery. The workers who live on the coast tend to be higher skilled and are rehired before the workers who commute from the Inland Empire. The analogy is that of a lake freezing from the periphery (the Inland Empire). The revers happens when it begins to thaw: the periphery will be the last area free of ice.

Note how much longer it took the Inland Empire, and to some extent California, to recover from the relative mild national recession in the early ‘90s.

The “peace dividend� hurt the aerospace industry in the Inland Empire and the coinciding closure of air force bases and cutbacks at firms indirectly benefitting from high military expenditures added to the pain. The dot-com recession, on the other hand, had very little effect on the Inland Empire, since its repercussions were centered up north.

As with the nation and the state, there could be some concern regarding serious labor shortages given the historically low unemployment rate in the Inland Empire. However, as we pointed out earlier, the unemployment rate may not be a very good indicator of the tightness of the labor market during the later phases of the current expansion. Figure 16 shows the employment to population ratio for the Inland Empire and the nation for the prime age cohort of 25 to 54 year olds. The consistent difference between the Inland Empire and the rest of the country is due to socio-economic differences in the respective populations.

Similar to the national picture, we can see that the Inland Empire has not recovered fully from the last recession. There is still some room to grow, even at these relatively low unemployment rates. Furthermore, the peak in 2007 is significantly below the previous peak at the beginning of the new millennium. We want to stress that this does not imply that there are no shortages in certain industries, such as construction, where some of the more qualified workers have migrated elsewhere after the decline of the industry during the recession and the lack of significant housing starts during the earlier parts of the recovery. Also, there is significant variation in CMC Inland Empire Forecast and Analysis 19

2018 Mr. T as Captain of the U.S. Economy unemployment rates between cities of the Inland Empire. Clearly the labor market in Redlands, say, is tighter at the moment than in Adelanto or the City of Coachella. But these local differences are not as important as one might think, since workers are willing to commute between communities to some extent.

How well is the Inland Empire doing in terms of employment growth compared to the previous peak in employment in the summer of 2007? Figure 16 shows that the employment picture has very much improved indeed since 2014. The Inland Empire initially experienced a much more severe decline in employment (Phase I) than the nation or the state.

This is not surprising since we were one of the epicenters of the housing bubble (Nevada and Florida being the other two most affected states). Employment dropped earlier (“FILO”) even as forecasters for the state and the nation were speaking of another “Great Moderation” type recession (the previous two national recessions were relatively mild and the expansions since the early ‘80s were uncharacteristically long). This changed following the Lehman Brothers bankruptcy in September 2008. The employment picture improved marginally for the state and nation during Phase II, but remained bleak for the Inland Empire. At that point, every 8th worker in the area had lost her/his job (well actually, mostly “his” since this was a “mancession” – most jobs lost

were in male dominated industries such as manufacturing and construction).

It was only in Phase III that we started to see the light at the end of the tunnel. Note that it took the Inland Empire much longer to recover the jobs lost, but then it surpassed job growth experienced at the state and national level in an impressive manner. A decade after escaping the depth of the Great Recession, plenty of jobs have been created in the Inland Empire.

Our previous analysis of strong employment growth in the Inland Empire does not imply that all jobs lost were recovered and indeed have expanded subsequently. It could well be that certain sectors have outperformed others, and that, as a result, the quality of jobs may not be the same as they were before the Great Recession. To investigate this, we plot employment losses from the peak employment to the trough in that sector, and the subsequent recovery.

Figure 17 displays the sectors with the highest employment level for the Inland Empire in 2007 from left to right. For example, there were some 233,000 workers in the Retail and Wholesale Sector in San Bernardino County and Riverside County before the start of the Great Recession.

Several facts stand out: • Construction and Manufacturing were the two most negatively impacted sectors. Between

Figure 16: Percentage Change in Employment, U.S., California, and the Inland Empire, 2007:M7-2017:M12.

15.0%

Phase I

Phase II

Phase III

Phase IV

5.0%

0.0%

Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17

Cumulative Percent Change in Employment

10.0%

-5.0%

-10.0%

-15.0%

U.S.

California

Employment declined earlier and more severely in the Inland Empire. It took the area longer to recover to pre-recession levels. Since 2012, employment growth has been stronger in the area than at the state and national level. This has continued recently.

20

Inland Empire

Data source: Federal Reserve Economic Data (2017)

CMC Inland Empire Forecast and Analysis

Mr. T as Captain of the U.S. Economy

2018

Figure 17: Employment Losses and Subsequent Gains, Inland Empire, 2007:M7-2018:M1 110,000 90,000

Net employment loss, July 2007 - Sector's Trough Net employment gain, Sector's Trough - Jan 2018 Employment recovery, Sector's Trough - Jan 2018

148,586*

* Employment in July 2007

70,000

Change in Employment

69,930* 50,000 30,000

132,957*

225,616* 232,604*

10,000 -10,000 -30,000

49,477* 146,328*

118,852*

-50,000 113,570* -70,000

Construction, Trade, Manufacturing, and Professional and Business Services experienced the Reserve largest Economic job lossesData, during the of recession.

Education and Source: Federal Bureau Labor Statistics Health, Logistics, Leisure and Hospitality, and Government have seen the largest net gains in employment during the recovery.

these two, almost 80,000 jobs were lost.

• Showing the same graph over the years, it is only now that construction has seen large increases in employment. For a long time, the industry continued to show the largest net losses in employment.

Growth has been spectacular over the last year (more on this later).

• Health and Education (mostly Health) never lost any jobs throughout the recession. Indeed, that sector added the most number of employees.

• Logistics experienced some small job losses initially, but came out of its decline as soon as the U.S. economy recovered and showed further appetite for imports. This industry is the most sensitive to national trends in income and output.

• Leisure and Hospitality generated the third largest increase in employment. As people lose their jobs, they obviously spend less on hotel stays and restaurant visits. However, the industry recovered fairly quickly and now is in a boom.

• Finance, Insurance, and Real Estate (FIRE) is still below employment levels seen in July 2007.

However, the sector is relatively unimportant in terms of total employment numbers.

• Higher paying jobs in Professional and Business services have continued to decline.

The big picture is that relatively high paying jobs in construction (a carpenter makes $20/hour) and manufacturing were lost during the recession.

It is only recently that construction has seen large employment increases. These higher paying jobs have been replaced by lower paying jobs in Education and Health (a home care worker makes $11 an hour) and Leisure and Hospitality (minimum wages). Think of two workers who lost their employment in construction and manufacturing. Even if they found jobs right away as a parking attendant and selling clothes in Cabazon at the factory outlets, and therefore the number of jobs would have remained the same, output (measured as value added) and income in the Inland Empire would have declined. Higher paying jobs were replaced by lower paying jobs. This is why we have to look beyond employment changes and analyze movements in (real) GDP to get a deeper understanding, especially during times of sectoral shifts.

How would this picture change if we looked at the state (Figure 18) and the nation (Figure 19)? As with the Inland Empire, California and the U.S. saw the largest declines in Manufacturing, Construction, and Trade. These sectors also have seen some recovery, but manufacturing is a laggard. It is tempting to attribute the rather small increases in Retail employment to the restructuring of that sector and the decline of non-electronic purchases. However, the U.S. picture looks quite different. As in the Inland Empire, there have been strong expansions in the Health and Education sector, and in Leisure and CMC Inland Empire Forecast and Analysis 21

2018 Mr. T as Captain of the U.S. Economy Hospitality. What really stands out, however, is the number of jobs gained in Professional and Business Services. These are relatively high paying jobs, and as a result, GDP in both California and in the U.S.

has bounced back further in terms of GDP than in the Inland Empire. We will have a more detailed look at this below.

Figure 18: Employment Losses and Subsequent Gains, California, 2007:M7-2018:M1 650,000

Net employment loss, July 2007 - Sector's Trough Net employment gain, Sector's Trough - Jan 2018 Employment recovery, Sector's Trough - Jan 2018

550,000

* Employment in July 2007

450,000

1,971,700* 1,561,600*

Change in Employment

350,000

250,000

2,270,500*

150,000

453,700* 50,000

2,498,000*

-50,000

-150,000

897,800* 1,475,200*

-250,000

2,407,939* 899,400*

-350,000

Source: Federal Reserve Economic Data, Bureau of Labor Statistics

California saw large employment declines in Trade, Professional and Business Services, Manufacturing, and Construction during the recession. The recovery in Professional and Business Services is remarkable, together with the gains in Education and Health, and Leisure and Hospitality.

Figure 19: Employment Losses and Subsequent Gains, United States, 2007:M7-2018:M1 5,000,000

Net employment loss, July 2007 - Sector's Trough Net employment gain, Sector's Trough - Jan 2018 Employment recovery, Sector's Trough - Jan 2018

18,691,000*

4,000,000

* Employment in July 2007

3,000,000

Change in Employment

17,959,000*

13,417,000*

2,000,000

1,000,000

4,539,100* 21,570,900*

0

22,171,000*

8,370,000*

-1,000,000

-2,000,000

13,889,000*

7,660,000*

-3,000,000

Source: Federal Reserve Economic Data, Bureau of Labor Statistics

The national picture resembles that of California: large employment losses in Trade, Professional and Business Services, Manufacturing, and Construction. The strongest sectors in the recovery are Education and Health, Leisure and Hospitality, and Professional and Business Services.

22

CMC Inland Empire Forecast and Analysis

Mr. T as Captain of the U.S. Economy

2018

The Good, The Not So Good, and the Ugly

Figure 17 does not give us the month-tomonth developments in the various industries. The next series of graphs (Figures 20-26) shows monthly employment changes for the various sectors.

We will start “The Good” part of the displays with the Health and Education sector. Part of the increase in jobs in Health can be attributed to Obamacare. Almost 80,000 new positions were created since mid-2007 and the sector did not shrink at all during the recession. If there are planned cut backs in health expenditures, they certainly have not become visible so far.

Figure 21 shows the second engine of job creation during the last decade for the Inland Empire, the Logistics Industry. Since the fortunes of that sector heavily depend on imports into the U.S., we would have expected to see an early contraction starting with the onset of the national recession in December 2007, and a recovery coinciding with the end for the national recession in July 2009. This is almost exactly what the graph shows. This industry has seen the second largest net gain in employment

for the Inland Empire. Tariffs resulting in redirecting imports away from Asia, which potentially could shift US imports toward East Coast harbors, are a potential danger to this sector.

Similarly to the state and nation, this sector experienced small employment losses during the Great Recession. However, the sector started to add jobs immediately at the end of the national recession. The gains were fairly small initially, unable to offset the losses occurred earlier. The industry then shifted into a higher gear starting in the middle of 2011. Some of the recent monthly employment gains have been quite impressive. Figure 22 shows the employment changes in the last of the better performing sectors, Leisure and Hospitality. Employment losses during the recession were significant at 13,000 but the sector has more than made up for the decline by adding over 53,000 positions since the beginning of 2010.

The last sector in “The Good” category is Government (see Figure 23). This sector was the

Figure 20: Education and Health Services Employment, Inland Empire, 2007:M72017M12 7,000 79,700 6,000

Change in Level of Employment

5,000 4,000 3,000 2,000 1,000 0 -1,000 -2,000 -3,000 2007

2008

2009

2010

2011

2012

Health and Education has seen an almost uninterrupted increase in jobs even during the recession. The sector has created almost 80,000 new positions.

2013

2014

2015

2016

2017

Data Source: Federal Reserve of Economic Data.

CMC Inland Empire Forecast and Analysis 23

2018 Mr. T as Captain of the U.S. Economy second largest employer in the Inland Empire before the recession. It has now caught up with the Retail and Wholesale sector as the largest employer in the area. The employment gains/losses for this sector are very different from those in the private sector. Some of its behavior can be explained by the fact that the government budget is typically based on revenues from the previous year. Hence it is not surprising to see the government sector act in a countercyclical fashion during the last recession and until mid-2012. Jobs creation during the downturn was subsequently eliminated. However, since mid2012 there have been solid gains of roughly 25,000 positions.

Figure 24 displays the first of “The Not-SoGood” sectors: Retail and Wholesale Trade. Much has been written about the recent decline in employment in the traditional parts of the industry, including large department store layoffs. From January 2017 to January 2018, the retail industry in the nation did not expand at all; it actually shed

37,000 jobs over that period nationally during the boom. The Inland Empire is not immune to this national trend. The graph shows several months recently where the industry actually experienced monthly declines in employment. However, these declines are small especially when compared to the heavy bloodletting experienced during the recession. Note that the sector did recover the jobs lost through 2009.

Construction was one of the two sectors, together with Manufacturing, that were most impacted by the Great Recession (see Figure 25). This is especially true for the Inland Empire, where the sector played a much larger role than for the nation. While the sector still has not recovered the over 56,000 jobs lost during the downturn, it is almost there. Much of the employment growth has occurred over the last 16 months, and we no longer classify it at “The Ugly.” This sector is one of the major reasons for the superior performance of employment growth shown by the Inland Empire when compared to other MSAs in California over the last year.

Figure 21: Transportation and Warehouse Employment, Inland Empire, 2007:M72017M12 4,000

47,900

Change In Level of Employment

3,000

2,000

1,000

0

-1,000

-4,000 -2,000 2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Data Source: Federal Reserve of Economic Data.

Employment changes in Logistics fairly much reflect spending patterns of imports for the nation. There were cutbacks during the recession and hiring during the national expansion.

24

CMC Inland Empire Forecast and Analysis

Mr. T as Captain of the U.S. Economy

2018

Figure 22: Leisure and Hospitality Employment, Inland Empire, 2007:M7-2017M12 4,000

53,100

Change in Level of Employment

3,000

2,000

1,000

0

-1,000

-2,000

-13,000 -3,000 2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

Data source: Federal Reserve Economic Data

Employment changes in Logistics fairly much reflect spending patterns of imports for the nation. There were cutbacks during the recession and hiring during the national expansion.

Figure 23: Government Employment, Inland Empire, 2007:M7-2017M12 5,000

25,200

13,700

4,000 3,000

Change in Level of Employment

2,000 1,000 0 -1,000 -2,000 -3,000 -4,000 -15,700 -5,000 -6,000 2007

2008

2009

2010

2011

Employment changes in Logistics fairly much reflect spending patterns of imports for the nation. There were cutbacks during the recession and hiring during the national expansion.

2012

2013

2014

2015

2016

2017

Data source: Federal Reserve of Economic Data.

CMC Inland Empire Forecast and Analysis 25

2018 Mr. T as Captain of the U.S. Economy Figure 24: Retail and Wholesale Employment, Inland Empire, 2007:M7-2017M12 4,000

42,890

3,000

Change in Level of Employment

2,000

1,000

0

-1,000

-2,000

-3,000

-4,000

-30,600 -5,000 2007

2008

2009

2010

2011

The largest employer in the Inland Empire saw heavy declines in employment during the recession. Since then, the sector not only has recovered the jobs lost, but added some. Most recently, there have been several months of declining employment.

This leaves us with “The Ugly” sectors, FIRE and Manufacturing. We will ignore the smallest sector, FIRE, in the discussion because, at less than 50,000 employees, it is sufficiently low numbers that even dramatic percentage losses have little effect on the overall employment . Employment in Manufacturing is shown in Figure 26. Manufacturing, along with Construction, was one of the two sectors that experienced the greatest losses during the recession and first few years of the national expansion. To this day, Manufacturing still has only recovered roughly half of the jobs lost. While there were small monthly job gains since 2011, these are often interrupted by significant layoffs. Given the national trend in Manufacturing, it is unlikely that this sector will return to its pre-recession strength any time soon. This sector no longer sees V-shaped or even U-shaped recoveries – instead they resemble the letter L: employment decreases during recessions are not subsequently recovered. Jobs in this sector seem to increasingly become lost to either automation or outsourcing.

This completes our more detailed discussion of the sectoral behavior of employment since

26

CMC Inland Empire Forecast and Analysis

2012

2013

2014

2015

2016

2017

Data source: Federal Reserve of Economic Data.

the start of the recession.

There are two related facts worth pointing out. Figure 27 displays the employment generating behavior of the various sectors over the last year.

The graph shows that of the almost 50,000 jobs generated in the Inland Empire over the last 12 months, more than ⅔ came from just three sectors: Construction, Leisure and Hospitality, and Health and Education. While almost all other sectors showed employment increases, these were small by comparison.

Where does that leave the Inland Empire compared to other MSAs in California? Figure 28 looks at employment gains over the last 12 months in the 10 largest MSAs in the state. Regardless of whether you use the residency based Current Population Survey (CPS) or the place-of-work based Current Employment Statistics (CES), the Inland Empire is the leader of the pack, when you go by raw numbers. This statement ignores population size of the area or, for that matter, population growth To clarify, adding 50,000 jobs in the Inland Empire is more impressive than adding the same number in the Greater Los Angeles area. The area

Mr. T as Captain of the U.S. Economy

2018

Figure 25: Construction Employment, Inland Empire, 2007:M7-2017M12 5,000

53,100

4,000

Change in Level of Employment

3,000 2,000 1,000 0 -1,000 -2,000 -3,000 -4,000

-56,400 -5,000 Data source: U.S. Bureau of Labor Statistics.

Construction lost the most jobs during the recession and in the first few years to follow. The sector took a long time to recover some of the jobs, but recently has outperformed other sectors in job creation.

Figure 26: Manufacturing Employment, Inland Empire, 2007: M7-2017: M12 2,000

15,900

1,500

Change in Level of Employment

1,000 500 0 -500 -1,000 -1,500 -2,000 -2,500 -3,000 Sep 07

-34,500 Sep 08

Sep 09

Sep 10

Sep 11

Manufacturing experienced massive job losses until 2011, but since then roughly half the jobs have been recovered.

Sep 12

Sep 13

Sep 14

Sep 15

Sep 16

Sep 17

Data source: Federal Reserve Economic Data

CMC Inland Empire Forecast and Analysis 27

2018 Mr. T as Captain of the U.S. Economy Figure 27: Contribution to Total Employment Growth by Sector, Inland Empire, 2016:M12-2017:M12 18,000

49,017 Gain in Employment

16,000 14,000

Change in Employment

12,000 10,000 8,000 6,000 4,000 2,000

0

-2,000

Source: Federal Reserve Economic Data, Bureau of Labor Statistics

Figure 28: Percentage Change in Employment, California, 10 Most Populous MSA, 2016:M11-2017:M11 3.50%

3.00%

2.50%

2.00%

% Change in CES % Change in CPS 1.50%

1.00%

0.50%

0.00% Los Angeles

28

Stockton

San Diego

United States

Bakersfield

San Jose

California

CMC Inland Empire Forecast and Analysis

San Francisco

Fresno

Sacramento

Oxnard

Inland Empire

Mr. T as Captain of the U.S. Economy even outperformed Silicon Valley in terms of employment generation for the year, and certainly has performed better than the state and the nation. To a large extent, this is due to the surging burst of employment in construction (more on this in the Housing Section).

We end the section with a cartoon from the Los Angeles Times, which was not published such a long time ago. At that time, we were

2018

observing a bi-furcated recovery, with the more coastal areas booming, while the Inland Empire and inland areas up north, such as Stockton and Sacramento, were not doing as well. We are eagerly awaiting a new cartoon reversing the two sides.

CMC Inland Empire Forecast and Analysis 29

2018 Mr. T as Captain of the U.S. Economy The Inland Empire Labor Market In the last section, we have shown that employment in the Inland Empire grew by a relatively large amount over the last year if you look at the raw numbers. However this change in employment was not scaled by either the population or the labor force. For example, seeing a number such as 50,000 jobs being created has a different meaning if there are 4 million people living in the area (The Inland Empire), 12 million (Greater Los Angeles) or 750,000 (North Dakota). To see a given change in employment is more impressive when the base, the labor force, is relatively small.

Looking at the change in the unemployment rate fixes that problem. The unemployment rate will decrease if either employment grows or if the labor force (employment plus unemployment) shrinks.

It is possible that there is no employment growth while the unemployment rate falls. This would be the case if there were a large number of discouraged

workers, or individuals who have stopped looking for employment. In the U.S., the unemployment rate for February 2018 remained constant despite employment growth of over 300,000. This was the result of the labor force increasing by the same amount due to individuals starting to look for work again. In general, it is fairly easy to show that the change in the unemployment rate is the difference between labor force growth and employment growth. A healthy economy will see unemployment rates decrease even when the labor force grows, because employment growth outpaces the growth in the labor force.

Figure 29 plots the changes in the unemployment rate for four areas: the Inland Empire, the Greater Los Angeles Area, California, and the U.S. (note that the graph was drawn in Excel and it is an optical illusion for the horizontal axis to look tilted).

Figure 29: Percentage Change in the Unemployment Rate and its Decomposition, Inland Empire, Greater Los Angeles, California, U.S., 2016:M11-2017M11 Inland Empire

Los Angeles

California

U.S.

3.0%

2.7% 2.4%

2.5%

2.0%

1.8% 1.5%

Percentage (%) Change

1.5%

1.3% 1.1%

1.1%

1.0%

0.6% 0.5%

0.0%

-0.5%

-0.5% -0.7%

-1.0% -1.2%

-1.1%

-1.5%

Unemployment

Labor Force

Employment Source: Federal Reserve Economic Data

Changes in the unemployment rate equal the growth in the labor force minus the growth in employment. The Inland Empire has the most impressive performance over the year when compared to the other three areas listed.

30

CMC Inland Empire Forecast and Analysis

Mr. T as Captain of the U.S. Economy

2018

Figure 30: Percentage Change in the Unemployment Rate and its Decomposition, All MSAs in California, 2016:M11-2017M11 5.0%

Rest of CA Greater LA, San Diego, Inland Empire U.S., California

4.0%

3.0%

% Change in Labor Force

Napa 2.0% Redding

LA-OC

CA SB

1.0%

IE

U.S SF

-2.0%

-1.0%

SD 1.0%

0.0% 0.0%

Fresno

Modesto

2.0%

3.0%

4.0%

Bakersfield LF Size in Oct 2017

-1.0%

El Centro

1,000,000 100,000 10,000

-2.0%

UR in Oct 2017 20% 15% 10% 5%

% Change in Employment

The Inland Empire has seen a drop in its unemployment rate over the previous year despite a relatively high growth in the labor force when compared to the other MSAs in California, and especially relatively to the largest MSAs.

Of the four areas, the Inland Empire shows the largest decline in the unemployment rate from a year ago. What is impressive is that the area was able to do this despite a strong growth of the labor force of 1.5%, meaning that employment had to grow faster than that in order for the unemployment rate to decrease. The Inland Empire certainly outperformed the state and national economy.

Perhaps there are other areas in California that are equally impressive with regard to these measures of labor market performance. Figure 30 shows the same measures for all MSAs in California. Note that the labor force growth is on the vertical axis and employment growth is on the horizontal axis. The 45 degree line therefore lists all points where the unemployment rate does not change. The further to the Northeast you move in the graph, the better the performance of the MSA with respect to the change in

the unemployment rate. We also approximated the size of the labor force by the size of each “bubble,� meaning that the Greater Los Angeles area observation will have a larger dot than Fresno, say (we did not do this for the California and U.S. observations for obvious reasons). Again the Inland Empire outperforms most of the other state MSAs on this dimension, and certainly the more populous ones. We also fitted a trend line through the observations, and here the observation for the Inland Empire is exactly on the line, meaning that the growth in employment corresponds to the growth in the labor force in the same proportion as it does for the other MSAs, although those show smaller growth rates.

The Employment Development Department (EDD) provides a statewide map of county unemployment rates in different shades of blue. The darker the shade, the higher the unemployment rate.

CMC Inland Empire Forecast and Analysis 31

2018 Mr. T as Captain of the U.S. Economy Imperial County, to our south, has unemployment rates of 17% even at this stage of the business cycle.

The map shows that there are some coastal areas that have lower unemployment rates than the Inland Empire, but in general, the area is doing relatively well.

Having an MSA-wide unemployment rate in the low 4% does not imply, of course, that all cities within the Inland Empire are doing equally well.

Table 3 lists the unemployment rates for cities in the Inland Empire with a population of over 25,000.

You note than many of the cities with the lowest unemployment rates, such as Redlands, Chino Hills, Upland, Temecula, and Rancho Cucamonga, are situated in the Western parts of the MSA, or in the south of Riverside County. However, there are others, such as La Quinta, Palm Desert, and Beaumont, that are quite some distance to the East of the Inland Empire.

Figure 31: County Unemployment Rates, California, 2017M12

32

CMC Inland Empire Forecast and Analysis

Mr. T as Captain of the U.S. Economy

2018

Table 3: Unemployment Rates by City, Inland Empire, 2016 City Name

Abbreviation

%

City Name

Abbreviation

%

Adelanto

Adl

11.2

Colton

Col

6.7

Coachella

Coa

11

Banning

Ban

6.3

San Jacinto

SJa

10.6

Highland

Hgh

5.8

Perris

Per

10.4

Cathedral City Cat

5.8

Hemet

Hem

9.9

Palm Springs

PSp

5.8

Hesperia

Hes

9.1

Montclair

Mcl

5.7

Twentynine Palms Desert Hot Springs Rialto

TwP

8.6

Norco

Nor

5.7

DHS

8.5

Murrieta

Mur

5.7

Rlt

7.9

Corona

Cor

5.6

Indio

Ind

7.7

Chino

Chi

5.1

Lake Elsinore

Lel

7.6

Temecula

Tem

5.1

Moreno Valley MrV

7.6

Palm Desert

PDe

5.1

Fontana

Fon

7.2

Ran

5

Victorville

Vic

7.2

Rancho Cucamonga Upland

Upl

4.9

Apple Valley Town Yucaipa

ApV

7.1

Chino Hills

ChH

4.9

Yuc

6.8

La Quinta

LaQ

4.5

Riverside

Riv

6.8

Beaumont

Bmt

4.2

San Bernardino Ontario

SBD

6.7

Redlands

Red

3.9

Ont

6.7

CMC Inland Empire Forecast and Analysis 33

2018 Mr. T as Captain of the U.S. Economy In analyzing city unemployment rates, we find that there are two major determinants: (i) distance to the nearest county line if that county is within reasonable driving range (not more than 50 miles away), and (ii) a measure of human capital, basically the high school graduation rate but also taking into account higher education levels of the residents.

Figure 32 shows the geographic relationship: Ontario, for example, has a lower unemployment rate than Moreno Valley because it is closer to the Los Angeles County line. Geography cannot be the only explanation because Redlands, for example has a lower unemployment rate than even Upland. This is where the second factor comes into play, educa-

tion levels.

Figure 33 shows that, controlling for the distance to the nearest county line, education levels play a major role when it comes to explaining unemployment rate differences between the major cities in the Inland Empire. For example, Chino Hills and Murrieta have significantly lower unemployment rates than Adelanto and the City of Coachella. In some ways, we are stating the obvious here: while cities cannot control their geography, they can certainly try to increase the level of education of the average resident, and by doing so, they will have a higher educated labor force which results in lower city unemployment rates.

Figure 32: City Unemployment Rates, Distance to Greater Los Angeles or San Diego County Line, Inland Empire, 2016 14.0

12.0 Adl Per

10.0

Unemployment Rate(%)

SJa Hem Hes

8.0 Fon Ont

6.0

Mcl

Cor Tem Chi Upl

Rlt Lel Col

Mur Nor Ran

Vic

MrV

SBD Riv

Yuc

ApV

Ban

Hgh

ChH

4.0

Bmt

Red

2.0 0

10

20

30

40

50

60

70

Distance (mi)

Source: Employment Development Department, American Community Survey

Cities closer to the nearest county line have, on average, lower unemployment rates than those further away. Geography does not play a role for cities that are more than 50 miles

34

CMC Inland Empire Forecast and Analysis

Mr. T as Captain of the U.S. Economy

2018

Figure 33: City Unemployment Rates, Human Capital Index, Inland Empire, 2016 12.0 11.0

Adl

Coa

SJa Per

10.0 Hem Hes

Unemployment Rate(%)

9.0 8.0

Ind

Rlt Ont

7.0

TwP

MrV

Lel

Vic

Fon

Riv

SBD

Ban

Col

6.0

ApV Yuc

Hgh

Mcl

Nor

Cat

Cor

PSp

Tem PDe

Chi

5.0

Mur

Upl

LaQ

Bmt

4.0

ChH

Ran

Red

3.0 2.0 95

100

105

110

115

120

125

130

135

140

145

Human Capital Index

Source: Employment Development Department, American Community Survey

Figure 34 Cities with higher education levels have, on average, lower rates of unemployment.

Output

While employment statistics make the headlines, measures of output and income, such as the (real) Gross Domestic Product (GDP) are usually the most comprehensive measures of economic performance of a geographical area. Unemployment rates, for example, can be misleading when there are large numbers of commuters. As mentioned earlier, if a resident of the Inland Empire is working in the coastal areas and is laid off, then the unemployment rate in the Inland Empire goes up while the unemployment rate of Greater Los Angeles or San Diego County is unaffected.

Perhaps more importantly, the unemployment rate does not tell us much about the quality of jobs.

For example, losing high paying positions in Manufacturing and Construction, and replacing these with lesser paying ones in Leisure and Hospitality, or Heath and Education, will leave the unemployment rate unaffected, but will lower aggregate income in the region. This is exactly what we have seen in the Inland Empire since the peak of economic activity in 2006. Furthermore, higher paying jobs in Professional and Business Services, which have sprung up in

other parts of California and in the U.S. as a whole, are conspicuously absent in the job creation machine of the last few years in the Inland Empire. We have observed a large structural shift in the Inland Empire economy, and the unemployment rate is simply not a good measure to capture it.

GDP is somewhat abstract and therefore often not a preferred measure of economic activity by business persons and politicians when judging the performance of an economy. We could simply overcome this by saying the GDP is the same as total income, and surely everyone agrees that we would be happier as a region if we could find ways to increase everyone’s income by 10%, say. While equating GDP with income makes sense for the U.S. economy as a whole to some extent, it is problematic when talking about regional economies or cities. Having a large number of commuters means that the income brought home by many residents is measured as part of the GDP elsewhere. We brought up the example of Indian Wells in the Coachella Valley previously. The GDP produced in that city is relatively low, since most jobs in Indian Wells are not very high paying service CMC Inland Empire Forecast and Analysis 35

2018 Mr. T as Captain of the U.S. Economy jobs performed by residents of the other cities in the Coachella Valley (97% of those who work in Indian Wells, have a residence elsewhere). On the other hand, of those people who live and work in Indian Wells, 87% work elsewhere, and it is fairly safe to assume that they are getting paid more than the workers in Indian Wells. Why not work in Indian Wells otherwise? Hence GDP for Indian Wells would be relatively low while household income is fairly high.

Keeping these caveats in mind when talking about GDP for the Inland Empire, here is what GDP growth for the area has looked like since these statistics were made available by the government.

Figure 34 shows that from 2002-2005 the Inland Empire’s economic growth outpaced that of California and the U.S. by a substantial margin. Even this is an understatement of the value added by its residents, since the GDP produced by Inland Empire residents working in the coastal regions is misattributed. The regional economy experienced the Great Recession earlier and it was affected more severely than the rest of the state and the nation.

At the depth of the recession, output in the Inland Empire had fallen by a staggering one-eighth. The recovery has been uneven for the Inland Empire,

but growth rates have typically been smaller than those for the state and the nation. Data for 2017 will not be available until early in the fall of 2018.

We predict that the growth rate of the Inland Empire for 2017 will be higher than those shown for California and even the U.S. Which industries are the main contributors to the growth we have seen in the Inland Empire?

Figure 35 tries to answer that question by looking at the contribution of different sectors of the Inland Empire economy. The graph shows that the high growth in the early part of the century was primarily driven by the goods producing sectors of manufacturing and construction, and also by retail and wholesale trade. Not surprisingly, manufacturing and construction were also responsible for most of the real GDP losses during the Great Recession. Since construction employment has not grown significantly until last year, it is not surprising to see the absence of manufacturing and construction during the current recovery. Instead, retail and wholesale trade and other services, including Leisure and Hospitality and Health, were the greatest contributors to economic growth in the region. FIRE finally shows some signs of life in 2016.

Figure 34: Real GDP Growth Rates, U.S., California, and Inland Empire, 2002-2017 8.0

6.7

6.4

6.3

6.0

4.0

4.0

3.9

% change in real GDP

4.4 4.0 3.3

2.5

2.0

4.2 3.8

2.8

3.7 3.2 3.1 2.7 2.2

1.8

2.5

1.8 1.6

2.1

2.4 2.2

1.6 1.4

2.5 1.5

1.7

2.7

2.4

3.8

2.6

2.9 2.5

2.6 2.4

1.6

0.9 0.4

0.0

?

-0.2

-0.3

-2.0 -2.2 -2.8

-4.0

-3.6 -4.4

-6.0

-8.0

-7.2

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Inland Empire California Growth rates in real GDP were extraordinarily high in the earlier parts of the century only to collapse heavily during the Great Recession. The recovery has been uneven.

36

CMC Inland Empire Forecast and Analysis

2012

U.S.

2013

2014 2015 2016 2017 Source: Bureau of Economic Analysis * Predicted

Mr. T as Captain of the U.S. Economy

2018

Figure 35: GDP Contribution by Industry, Inland Empire, 2006-2016 15.0%

10.0%

5.0%

0.0% 2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

-5.0%

-10.0% Government

FIRE

Logistics

Trade

Goods Production

Goods production (manufacturing and construction) have played a significant role in the pre-recession period and during the Great Recession.

Retail and wholesale trade have featured prominently during the current expasion.

Unfortunately Figure 34 paints an unnecessarily optimistic picture for the earlier years 2001 to 2005 for a reason unrelated to commuting: much of the earlier GDP growth was driven by an expanding population in the Inland Empire. To explain the wealth of a nation, you need to consider output or income per person. Think of China: the country now has the second largest GDP in the world, but lags behind much further when it comes to per capita GDP. As the average person, you would prefer to live in Norway rather than in China, glamourous pictures from life in Shanghai, Beijing, or Hong Kong notwithstanding.

How does the picture change when we take into account in-migration to the Inland Empire?

Figure 36 shows growth rates of the same economic measure minus the growth rate of the population (per capita real GDP growth rates). While population growth in the U.S. is fairly steady at around 1% a year, this is not the case for the Inland Empire. As a result, growth rates of per capita GDP for the earlier parts of the century look ordinary at best, and become alarmingly low during the Great Recession. Even the last boom year of 2006 shows quite a low growth rate. We know that employment in the Inland Empire peaked in the

Other Services

% Change in Real GDP

Source: Federal Reserve of Economic Data

summer of 2007 but that employment in construction reached its maximum a year earlier. The Lowe Institute dating committee has determined that the local economy went into a recession as early as late fall 2006 (dating of recessions by the NBER is only done for national economy, not even for the state).

Given the relatively small growth rates in per capita GDP for the post-recession recovery, a worrisome question presents itself almost naturally: are we better off than we were 10 years ago in the Inland Empire? Or have we experienced a lost decade similarly to what Japan suffered from in the ‘90s? Well, we know that we have recovered the job losses seen since employment peaked in the Inland Empire in the summer of 2007. But what about the sum of all goods and services produced per person in the Inland Empire?

Figure 37 answers that question. For the national and state economy, output recovered earlier than employment. However this is not the case for the Inland Empire, where we were still over 5% below the pre-recession level by 2016. When the data for 2017 becomes available later this year, we expect the number to shrink to 4% and to get down to roughly 1% by the end of 2018. It is sad but true to state that the area has indeed seen a

CMC Inland Empire Forecast and Analysis 37

2018 Mr. T as Captain of the U.S. Economy

lost decade, and the quality of jobs created has not been the same as those for the state and nation.

This partially explains why the number of commuters has not diminished despite the long com-

muting times into the coastal areas. There are, of course, other reasons for the continued commutes, and we will address those in the housing section.

Figure 36: Per Capita Real GDP Growth Rates, U.S., California, Inland Empire, 2002-2016 6

4.1 4

2.8

2.5 2

2.6

3

3.5 2.9

2.8

2.2

1.7

1.4 0.6

% Change in Real Per Capita GDP

3.5

3.4

1.7

1.7

1.3

0.8

0.60.5

0.2

0.20.3

1.7

1.2 0.7 0.7 0.4

0.6

1.5 1.5

2.7

2.3 1.8

1.4

0.8

0.8

0 ?

-1.3

-1.3 -1.5

-2

-3.6

-4 -4.2

-4.6

-5

-6

-8 -8.3

-10 2002

2003

2004

2005

2006

2007

2008

Inland Empire

2009 California

2010

2011

U.S.

2012

2013

2014

2015

2016

Source: Bureau of Economic Analysis

Per capita growth rates are substantially lower for the Inland Empire from 2002 to 2009, and also for most of the post recession recovery.

Figure 37: Percentage Change in Per Capita Real GDP since 2007, U.S., California, and Inland Empire 0.10

Percent Change from Start of Recession

0.05

0.00 2007

2008

2009

2010

2011

2012

2013

2015

2016

U.S.2007 -0.05

CA 2007 IE 2007

-0.10

-0.15

-0.20

Per capita GDP for U.S. and California caught up to pre-recession levels in 2014. The Inland Empire still has not recovered.

38

2014

CMC Inland Empire Forecast and Analysis

Mr. T as Captain of the U.S. Economy

2018

Our Forecasts

Here is our forecasts for real GDP growth and the unemployment rate for the U.S., California, and the Inland Empire until 2019 (actual numbers for the Inland Empire for 2017 will not be available until the fall of 2018).

Note that we are at the high end of other forecasts. The Federal Reserve forecast for real GDP growth was revised upwards to 2.7% (2018), 2.4% (2019), and 2.0% (2020). The Blue Chip consensus forecast is 2.7% (2018) and 2.4% (2019). The Economist magazine poll for 2018 indicates growth of 2.8% for the year. UCLAs Anderson School forecast is 2.9% (2018), 2.6% (2019) and 1.6% (2020).

As for the U.S. unemployment rate, the Federal Reserve Forecast is 3.8% (2018), 3.6% (2019), and 3.6% (2020). UCLAs Anderson School forecast is 3.9% (2018), 3.5% (2019) and 3.8% (2020).

Table 4: GDP Forecast, U.S., California, and Inland Empire, Percentage Change From Previous Year 2017

2018

2019

United States GDP

2.3 (Actual)

3.5

3.2

California GDP

2.9 (Actual)

3.7

3.5

Inland Empire GDP

3.2

3.8

3.5

United States UR

4.4 (actual; average)

3.4 (end of year)

3.3 (end of year)

California UR

4.8 (actual; average)

3.9 (end of year)

3.7 (end of year)

Inland Empire UR

5.1 (actual; average)

4.0 (end of year)

3.9 (end of year)

CMC Inland Empire Forecast and Analysis 39

2018 The Sun Also Rises in Inland Empire Housing

The Sun Also Rises in Inland Empire Housing

By G.U. Krueger

Photo Credit: R. Nial Bradshaw via Flickr

The Inland Empire housing market emerged from its slumber in 2017, and in line with the positive 2018 and 2019 Claremont McKenna U.S. forecast, we expect this progress to continue and even accelerate during the next two years. This will happen despite some emerging structural problems such as eroding housing affordability in all segments of the Inland Empire housing market. Entitlement difficulties and high impact fees, which contribute to declining affordability, especially in new ownership housing, are expected to persist. In a sense we are seeing an echo in the Inland Empire of the housing shortage in coastal Southern California counties as the jobs per housing ratio stands at 3.7 – significantly below what is considered to be the normal range of between 1.2 and 1.5. Meanwhile, months of inventory of existing homes remain extremely tight.

While the recent housing data in the Inland Empire is quite impressive, current volume levels rather pale when compared to past values. Going back all the way to

40

CMC Inland Empire Forecast and Analysis

1968, we find both new ownership home sales and total housing permit activity to be still either significantly below or barely above previously observed trough levels in housing cycles. We forecast that the situation will change for the better as we expect a shift towards multifamily and apartment housing some of which are already experiencing strong growth as they become the more affordable alternative to more expensive ownership housing.

For Inland Empire housing permits we forecast a strong 50% increase by 2019 to 20,400 units from the level of 13,600 units in 2017. This increase will be propelled by a continued shift to multifamily permits, which will increase by 70%, while singlefamily permits will rise by almost 44%. That will bring total housing units back to 1999 levels, when Inland Empire housing permits finally started to overcome the massive aerospace recession of the late 1980s and early 1990s. That downturn, in the Inland Empire, was almost as painful as the more recent experience and had a lingering

The Sun Also Rises in Inland Empire Housing effect for the region similar to the impact seen by the Great Recession.

Coinciding with the rather positive outlook we expect further growth in construction jobs, which are already close to the July 2007 level, when total employment peaked in the Inland Empire (construction jobs started to decline a year earlier). By 2019, it is likely that employment in the construction industry will approach

2018

or go beyond numbers seen in the heights of the previous boom as construction may well become a major driver for overall employment growth, as it has already done so for the last year.

Here are some highlights of recent trends, which underlie our forecast of a shift towards multifamily permits and apartment construction:

New and Existing Home Sales According to DQnews, new home sales rose 9.7% in 2017 to 8,800 units from 2016 levels. Even sales volume in existing homes, which weakened somewhat after the boom as a result of foreclosures between 2007 and 2009, is now back on track and increased by 5.3% in 2017 to 66,900 units. Especially new home sales saw significant gains between 2011 and 2017,

when transactions more than doubled.

However, this is less impressive when we look back to previous housing cycles.

Those numbers reveal that the level of new home sales during the current recovery in the Inland Empire continues to be well below levels previously experienced even during the Southern California aerospace collapse. Figure 1 shows that existing

Figure 1: Home Sales, Seasonally Adjusted, Inland Empire, 1985-2017 30,000 Existing Homes 25,000

New Homes

20,000

15,000

10,000

5,000

0

New home sales level are significantly below levels experienced in the ‘90s during the structural adjustment period following the 1991 recession. Existing home sales are doing significantly better.

CMC Inland Empire Forecast and Analysis 41

2018 The Sun Also Rises in Inland Empire Housing home sales fared much better even with the aforementioned drop after the foreclosure sales boom.

The figure also shows that during both, the earlier aerospace (“peace dividend�) recession of the ‘90s and for the Great Recession, home sales were a leading economic indicator. Not surprisingly, this was not the case for the dot-com recession at the turn of the century, since there was more of an impact up north. As for the 2007-2009 national recession, it was not surprising to see early signs of the collapse in the Inland Empire, since it was one of the epicenters of the housing bubble and the subsequent burst. Housing prices in Los Angeles peaked during the summer of 2007 but earlier in the Inland Empire.

The subsequent foreclosure crisis eroded the balance sheets of many households

and resulted in a collapse of consumer spending. The decline in new home sales then led to a collapse of the local housing industry, which had a multiplier effect on other industries including the finance and real estate sector, and professional and business services.

The puzzle as to why the volume recovery in new home sales has been so low since 2011 remains. The market share of new home sales was only 11.6% in 2017:Q4, which is significantly below peak levels of 30% plus seen previously. It is also below the historical average of 19% observed since 1985.

We hope to provide at least a partial answer to the puzzle by looking at recent home price and housing affordability trends.

Median Home Price Trends and Housing Affordability Median home prices in the Inland Empire have been strong lately. For the existing housing market, prices rose by 8.1% in 2017 to reach $320,000. When you compare this number to 2011, then existing home prices are 89.4% above that level.

New home prices climbed to $443,000 in 2017. They have grown by 4.6% from the year ago. Compared to 2011, they are now 154% higher.

Given the difference in prices between new and existing homes, it is clear that a significant gap has emerged. In terms of median home prices, this gap now stands at over $120,000. Since 2009, the price difference has always been between $110,000 and $120,000. Figure 2 shows median home prices for new and existing homes since 1985. New home prices tend not to decline by as much as existing homes prices during periods of declining prices.

They also tend to recover faster and earlier compared to existing homes. Furthermore, the median price for new homes in 2017 has

42

CMC Inland Empire Forecast and Analysis

exceeded the housing bubble peak, while existing homes were still about 14% below it.

The table sets out to determine the minimum annual income required to afford the Inland Empire median rent, existing median home prices, and new home prices.

In the case of ownership homes, standard underwriting criteria are used such as a 20% down payment, prevailing mortgage interest rates, taxes and insurance, and a standard income ratio. The minimum income is then compared with data from the Inland Empire income distribution to arrive at the percentage of households that can afford to rent or to buy. The results of these calculations are shown in the last three rows of the table. The conclusion is both enlightening and somewhat depressing: all housing categories experienced a decline in their affordability between 2011 and 2017, some of them being quite substantial.

A mere 27.9% of Inland Empire households could afford the median new home price

The Sun Also Rises in Inland Empire Housing

2018

Figure 2: Home Prices, Existing Homes and New Homes, Seasonally Adjusted, Inland Empire, 1985:Q1-2017:Q4 $450,000 $400,000

Existing Homes

$350,000

New Homes

$300,000 $250,000 $200,000 $150,000 $100,000

2017 Q1

2016 Q1

2015 Q1

2014 Q1

2013 Q1

2012 Q1

2011 Q1

2010 Q1

2009 Q1

2008 Q1

2007 Q1

2006 Q1

2005 Q1

2004 Q1

2003 Q1

2002 Q1

2001 Q1

2000 Q1

1999 Q1

1998 Q1

1997 Q1

1996 Q1

1995 Q1

1994 Q1

1993 Q1

1992 Q1

1991 Q1

1990 Q1

1989 Q1

1988 Q1

1987 Q1

1986 Q1

$0

1985 Q1

$50,000

There is a significant gap in prices between existing homes and new homes.

New home prices tend to recover faster and earlier when compared to existing home prices.

Table 1: Changes in Housing Affordability, Inland Empire, 2011 and 2017, Income Distribution Based Home Type

2011

2017

%change/difference

Annual Zillow Rent (All Homes)

$18,768

$21,636

15.3%

Existing Home Price

$170,440

$322,849

89.4%

New Home Price

$281,160

$443,989

57.9%

Rent Minimum Income Required

$56,867

$65,570

15.3%

Existing Homes Minimum Income Required

$37,870

$68,757

81.6%

New Homes Minimum Income Required

$62,472

$92,426

47.9%

Affordability Zillow Rent (All Homes)

50.9%

43.9%

-7.0%

Affordability Existing Home Price

67.1%

41.5%

-25.6%

Affordability New Home Price

46.7%

27.9%

-18.8%

Sources: Zillow, DQNews, Freddie Mac, ACS Income Distribution

CMC Inland Empire Forecast and Analysis 43

2018 The Sun Also Rises in Inland Empire Housing in 2017. The numbers are a little less distressing for the other two categories.

These show an affordability rate of 41.5% for existing homes and 43.9% for rental dwellings during the same year.

There seems to be only one logical conclusion after doing these calculations: rental properties are becoming the affordable alternative for ownership

homes. Moreover, we should only expect moderate volume increases for new and existing home transactions. To some degree any volume increases will depend largely on increased migration of higher income households from the coastal communities into the Inland Empire (more on this topic further below).

The Market for Apartments The moderate strengthening of the region’s residential market also occurred in the apartment segment. In 2017:Q4, the vacancy rate stood at 3.9%. This is the second lowest vacancy rate in the Nation, according to CBRE. Figure 3 shows apartments under construction in the Inland Empire. There was an increase of almost 59% in 2017 in apartment construction. These reached

a level of 3,660 units which represents a mini boom and could be an indication of rising apartment vacancy rates coinciding with a slowing in rent increases for the next two years. This is an additional reason why we believe that apartments will be the affordable alternative to house purchases in the near future.

Figure 3: Apartments under Construction, Inland Empire, 2006-2017 7,000

6,000

5,000

4,000

3,000

2,000

1,000

-

2006

2007

2008

2009

2010

2011

2012

Apartment construction has seen a revivial from the depressed 2009 to 2012 levels. 2017 has seen a mini boom.

44

CMC Inland Empire Forecast and Analysis

2013

2014

2015

2016

2017

The Sun Also Rises in Inland Empire Housing

2018

Housing Permits and Their Composition

Figure 4: Total Housing Permits and Nonfarm Job Changes, Inland Empire, 1968-2017.

80,000 60,000 40,000 20,000 0 -20,000 -40,000 -60,000

Housing Permits Changes in Nonfarm Jobs

-80,000 -100,000

Housing permits are at low levels by historical standards. The current situation may resemble the period following the aerospace decline period of the ‘90s.

According to the California Building Industry Association (CBIA), total housing permits rose 37% in 2017 to 13,600 units.

This increase is the result of the moderate recovery in housing in the Inland Empire.

This boost comes on the heels of the 2016 increase of 75% to 9,940 units. The higher level of housing permits in 2017 was partially the result of an 80% increase in multifamily homes, which reached 3,290.

By contrast, single-family homes saw a 27% increase. The permit data confirms that we are experiencing a shift towards multifamily and apartment construction in the Inland Empire as households struggle with low housing affordability.

Figure 4 displays the housing permits in the Inland Empire since 1968. Current permit levels are rather low by historical standards, and this is despite 7 years of

positive job gains, which have accelerated during the last 5 years. Only recently, have housing permits shown any signs of life.

The recent behavior in housing permits makes it difficult to predict the future. It is as if we have observed a structural break, a “new world� of experiences. However, we believe that there may be a parallel between the historical permit activity during the post-aerospace economic recovery in 1994 and the current housing permit situation. In 1994, we witnessed accelerating job gains without any significant signs of a housing market improvement until 1997. This is quite similar to the current cycle leading up to 2016. In both cases, there were increases in employment without coinciding growth housing permits. The situation changed in 1997 and 1998 with increases in permit numbers. By 1999, housing permits had

CMC Inland Empire Forecast and Analysis 45

2018 The Sun Also Rises in Inland Empire Housing reached almost 22,000 units in the Inland Empire. We forecast that Inland Empire total housing permits will reach a level of 20,400 units in 2019. Furthermore, our forecast assumes that the mini-boom in multifamily housing units and apartment construction will continue as multifamily

housing permits increase by 5,600 units by 2019, an increase of 70% compared to 2017.

We also expect single-family units to rise almost 44% between 2017 and 2019. As a result, the share of multifamily permits in total permits will jump from 32% to 38%.

The Importance of Net Domestic Migration

Figure 5: Net Domestic Migration and Total Housing Permits, Inland Empire, 1991-2017 100,000 Total Housing Permits 80,000

Net Domestic Migration

60,000

40,000

20,000

0

-20,000

Net domestic migration and total housing permits tend to correlate quite highly.

Recall that we established serious affordability constraints in Table 1 above. As a result of this, it is hard to justify our forecasted rise in single-family permits to the levels we feel are likely. The reason for our optimism can be found in the likely patterns of net domestic migration (in-migration minus out-migration).

There appears to be a historical correlation of higher migration numbers coinciding with sharply rising housing permits, while migration tends to be weak when permits are at a low level (see Figure 5).

Net domestic migration into the Inland Empire is very important, because it ref lects 46

CMC Inland Empire Forecast and Analysis

affordability migrations from Southern California coastal communities as low housing affordability becomes increasingly unbearable there. It also results in an inf low of higher income households relative to the income level of existing local households. We believe that net domestic migration in the Inland Empire is at an inf lection point, where affordability migrations pick up significantly from levels seen in the recent past. The in-migration of households from coastal counties into the Inland Empire will support higher new and existing transaction volumes than otherwise.

The Sun Also Rises in Inland Empire Housing

2018

Construction Jobs

If we are right regarding our housing permit forecast, then the construction industry will regain its prominence as a major driver in job creation. Dr. Keil, in his section, points out that construction jobs are not that far off from their pre-recession peak levels in the Inland Empire. We forecast that employment in construction will reach an annual level of over 116,000 by 2019, a 19,000-worker increase compared to level of 97,000 jobs in 2017. What this means is that possibly sometime during the year 2019, monthly construction jobs will match their previous peak in early 2006.

We are making the case here for a continued recovery in the Inland Empire housing market. In particular we forecast a significant increase in housing permits, which will be the result of a shift to multifamily units. There will also be higher housing permits for single-family units, but these will not be as important. We have indicated that housing affordability plays an important role in this shift and that net domestic migration will likely be an important driver for all housing segments.

Final Thoughts on the Recent Affordability Debate Gubernatorial candidates Antonio Villaraigosa and Gavin Newsom have recently announced that they want developers to build 3.5 million homes by 2025. This has been criticized as impossible to achieve. The criticism misses the crucial point that both candidates are signaling that there will be a serious debate regarding California’s housing shortage. This policy debate is clearly developing and longheld policy barriers to large-scale housing, such as Proposition 13, The California Environmental Quality, and the exclusive local control over local development decisions may well be up for discussion.

Both candidates were inspired by a 2016 report on California’s housing problems by the McKinsey Global Institute.

The McKinsey consultants attempt to quantify how many additional housing lots could be created through developments near transit stations, increased building on lots already zoned for residential housing, and adding more units to single-family sites. Doing massive quantitative research, McKinsey suggests a total of 3.5 million possible housing unit sites.

We believe their findings are encouraging but we are concerned both about the singular focus on urban sites and the under appreciation of the housing development potential in the California interior such as the Inland Empire. According to Metrostudy, there are currently over 255,000 future lots available in the Inland Empire just for ownership homes. This would result in a number that represents over 7% of the 3.5 million goal in the Inland Empire alone. Given the affordability crisis in urban centers, politicians should take this situation into account seriously.

What are the implications for the Inland Empire? There appears to be an enormous opportunity to address the emerging affordability problems in the Inland Empire. Given the importance of the upcoming debate, therefore, we feel that all real estate stakeholders in the Inland Empire should be getting ready to sit at the table once the debate starts in earnest, regardless of whether they are for or against the set goals and policy issues that are on the agenda.

CMC Inland Empire Forecast and Analysis 47

2018 Inland Empire Consumer Sentiment

Stock Market Stock Market Correction Leads to Correction Leads to Minor Fall in Inland Minor Fall in Inland Empire Consumer Empire Consumer Sentiment

Sentiment

By Cameron A. Shelton, Ph. D.

By Manfred Keil, Ph.D.

Photo Credit: Free Pictures of Money via Flickr

What is an index of consumer sentiment?

A consumer sentiment index is a forwardlooking indicator of economic strength that enables business-people, administrators, and economists to better forecast and plan.

Roughly 70% of all spending comes from households; thus understanding the mood and financial position of households is crucial to economic forecasting.

Why do we need an index of consumer sentiment for the Inland Empire?

Our consumer sentiment index is a forward-looking indicator of economic strength in our local region, unparalleled in its specificity. Many data used in economic forecasting are regional or national, affording little specific information of the local economic conditions. For instance, the spread between long and short-term interest rates is a good indicator of bank profits, but the whole country faces the same interest rates. By contrast, consumer sentiment can,

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CMC Inland Empire Forecast and Analysis

by sampling households within the area of interest, be finely targeted to a specific region so that one is measuring the local economic climate directly. Thus, our measure of local consumer sentiment enables us to tailor our forecasts to local conditions. As far as we are aware, this is the first sentiment index for a metropolitan area.

How is the sentiment index calculated?

Every quarter, for each of the three regions, we ask a series of 7 questions of a sample of 500 individuals. The individuals have been randomly selected in proportions that ensure the samples as a whole are demographically representative of the regions in question along several dimensions including age, income, gender, and race. We contract with Kelton Global to ensure this sampling is done accurately to minimize sampling error. To aid comparability, our questions mimic those employed by well-known national indices of consumer sentiment. We ask consumers about how they see broad business conditions

Inland Empire Consumer Sentiment and their own personal finances evolving at present and over the next year. We then tally responses and compose an index which measures the degree of optimism among local households.

IE Consumer Sentiment Declines 4.1% over 2018Q1 as a result of stock market jitters.

This is our inaugural release of the CMC-Cadence Capital Inland Empire Consumer Sentiment Index. We have now compiled four quarters of data. Today we will discuss the changes over the past quarter, 2018Q1. Between the third and fourth quarters of 2017, the index rose from a value of 97.3 to a value of 104.8, a 7.6% rise. We believe this is the result of a positive response to the tax cuts passed at the end of the year. However, over the course of the 1st quarter of 2018, the index fell by 4.1% to its current level of just a touch over 100.

2018

As we will explain, we believe this is due to the significant stock market correction that began in late January from which markets had not fully recovered by the beginning of March when our data were collected.

As we look at the breakout by question, we can see the declines are steepest in the questions pertaining to personal finances such as Question #1 in which respondents are asked to project their personal finances over the next year and Question #7 asking whether it is a good time to purchase an automobile.

On the other hand, those questions focused on business conditions and the job market remain strong. This is consistent with financial apprehension based on portfolios rather than employment. Moreover, when we separate by age of the respondent, the decline in consumer sentiment is clearly centered on those nearing retirement. These households have typically gathered a nest egg, invested in the stock market, and are projecting their retirement income based on the performance

Figure 1: Inland Empire, Consumer Sentiment By Employment Status, 2017Q2 - 2018Q1 1.15

1.10

1.05

Consumer Sentiment Index

1.00

0.95

0.90

0.85

0.80

0.75

0.70 2017Q2IE Full-Time

Part-Time

2017Q3IE Self Employed

Homemaker

2017Q4IE Student

Unemployed

2018Q1IE Unable to Work

Retired

This figure shows the trend of consumer sentiment for different employment statuses in the Inland Empire.

CMC Inland Empire Forecast and Analysis 49

2018 Inland Empire Consumer Sentiment Figure 2: Inland Empire Consumer Sentiment By Income, 2017Q2 - 2018Q1 1.25

1.20

Consumer Sentiment Index

1.15

1.10

1.05

1.00

0.95

0.90

0.85 2017Q2IE Less than 25K

2017Q3IE 25k-35k

35k-50k

2017Q4IE 50-75k

75k-100k

2018Q1IE 100k-150k

150k+

This shows how each income division feels about their financial situation in the near future.

of their portfolio, to which they likely pay significant attention. Naturally, a 10% decline in the S&P 500 index over a two week period followed by a partial recovery and the reappearance of daily volatility will leave this set of consumers apprehensive. By contrast, those just entering the labor market, aged 1824, remain upbeat.

In general, consumer confidence is the filtering of economic news and personal circumstances through psychological and political frames., Optimism is associated with a strong connection to the labor market and a higher household income but may also be related to gender or marital status. Responses to specific events can be governed by partisan affiliation. This is partly because people of different partisan affiliations have different beliefs about which policies will be effective.

Another explanation may be people choosing news outlets that match their outlook which leads to receiving very different coverage of the same policy. Finally, it can also be

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CMC Inland Empire Forecast and Analysis

the result of people taking their mood from whether their political team is winning. All of these explanations have an effect on economic evaluations and spending behavior.

The breakout by income shows a clear pattern that the higher income categories remain the most consistently optimistic.

If we do this by employment status, then, unsurprisingly, the strength of connection to the labor market is an important contributor to consumer sentiment. Notice that full-time workers and the self-employed consistently profess more positive sentiment. Meanwhile, part-time workers are more optimistic than students and home-makers who in turn have a more positive outlook than those unemployed or unable to work.

In sum, over the first quarter of 2018, the stock market stumble and continuing jitters have led to a modest, 4.1% decline in consumer sentiment in the Inland Empire.

This effect was concentrated among those nearing traditional retirement age, 55-64.

Inland Empire Consumer Sentiment

2018

%Change Between 2017Q4 and 2018Q1

Question #1: Do you think that a year from now you and your family will be better, worse, or similarly well-off financially?

-5.5%

#2: Do you think that business conditions in the United States during the next year will be better, worse, or about the same?

2.9%

#3: During your last few months, have business conditions in the Inland Empire improved, worsened, or had no effect on your economic situation? #4: Are current business conditions in the Inland Empire better, worse, or the same as a year ago? #5: A year from now, do you expect that overall business conditions in the United States will improve, worsen or have no effect on your family’s economic situation? #6: Compared to today, if you lost your job within the next year you think you would have a better, worse, or about the same chance at finding a new job? #7: Do you think the next year will be a good or bad time to buy an automobile?

Age

%Change 2017Q4-2018Q1

18-24

0.3%

25-34

-1.5%

35-44

-4.4%

45-54

-1.6%

55-64

-17.5%

65+

-2.7%

-1.9% -3.2% -3.5%

-2.3% -12.2%

CMC Inland Empire Forecast and Analysis 51

2018 Inland Empire Consumer Sentiment

Principal Authors v

Manfred W. Keil is an Associate Professor of Economics at the Robert Day School of Economics and Finance at Claremont McKenna College (CMC). His areas of expertise include banking, comparative economic performance, macroeconomics, and statistics. Professor Keil is a Fellow at the Rose Institute of State and Local Government and a Research Associate at the Lowe Institute for Political Economy at CMC. He has a history of working on various aspects of business cycles and comparative economic performance (Journal of Macroeconomics, Oxford Economic Papers, Southern Economic Journal, and Canadian Public Policy). More recently, Keil has written papers on the employment effects of minimum wages and the recession of 2009. Both papers were listed among SSRN’s top ten downloads in their respective categories. Professor Keil earned his M.A. at the University of Texas, and his M.S. and Ph.D. at the London School of Economics.

Cameron A. Shelton Director of the Lowe Institute of Political Economy, is the McMahon Family Associate Professor of Political Economy and George Roberts Fellow at CMC where he teaches courses in macroeconomics and political economy.

Professor Shelton’s research addresses whether and how the institutions that structure political competition affect macroeconomic policy and outcomes. His research, often with students, has been published and cited in highly regarded journals in both political science and economics. His research assistants and thesis advisees have gone on to doctoral work in political science and economics at Stanford, Harvard, Princeton, and other prestigious programs.

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CMC Inland Empire Forecast and Analysis

Inland Empire Consumer Sentiment

2018

GU Krueger is principal economist and founder of HousingEcon. com, a housing and economic advisory firm for institutional investors, developers, builders, and state and local governments. His work ranges from project specific to strategic analysis of housing supply and demand. Before founding HousingEcon.com, GU Krueger was a Senior Vice President and the head of IHP Capital Partners' (IHP) Market Research. Prior to joining IHP, he was Deputy Chief Economist with the California Association of Realtors. He also worked as an industry economist for the Conference Board in New York City. GU has served in an economic advisory role for various Mayors of Los Angeles, the California Department of Finance, and the California State Controller. He is Past President of the National Association of Business Economics, LA Chapter and past Chairman of the Economic Advisory Council of the California Chamber of Commerce. He lives and works in Los Angeles and has written several articles and Op-Ed pieces. He has done consulting work for the Olson Company, Shapell Homes, LDC Advisors, IHP Capital Partners, CalPERS, Hearthstone, AirBNB and the Controller of the State of California.

ACKNOWLEDGEMENT Conference Staff Claremont McKenna College Kelly Lockhart Spetnagel, Admin. Asst., Lowe Institute Claremont McKenna College Research Assistants Mackenzie Bradford ‘19

Ryan Chakmak ‘19*

Evelyn Chen ‘20

Richy Chen ‘20*

Chloe Cho ‘19

Nick DeGallier ‘19

Pallavi Deshpande ‘19

Stanley Fan ‘20

Eamon Gallagher ‘19

Back Hoang ‘19

Lisa Hao ‘20

Amanda Kandasamy ‘20

Jahnavi Kocha ‘19

Kate Layman ‘18*

Luke Livingston ‘20

Sarah Malott ‘19

Ricardo Mateos ‘20

Sam Peterson ‘18

Harrison Sattley ‘19

Meredithe Thieme ‘19

Danny Wang ‘18

John Xia ‘19

Mike Yoo ‘18

Wenonah Zhang ‘18*

*Student Managers

CMC Inland Empire Forecast and Analysis 53