The State of the Union: A Primer for Real Estate Investors
In his State of the Union address tonight, the president is expected to refocus his national policy agenda on the competing challenges of job creation and the precarious condition of our public finances. Exacerbating the lack of progress in the labor market and in developing concrete plans to address the deficit, last November’s election results and the buildup to the next campaign necessitate more visible efforts on both fronts.
Property investors have a clear stake in these efforts and in their outcomes. A sustained improvement in labor market trends, in particular, remains a crucial missing piece in the real estate recovery. In New York, more than in any other market in the country, the current investment trajectory anticipates an acceleration of job growth that has yet to evidence itself. Improvements in pricing that are supported by competitive inflows of debt and equity risk decoupling from fundamentals if the job market does not show increased vigor.
Linking the Deficit and Jobs
With the recession now over for longer than it lasted, federal spending remains at unsustainably high levels, undermining the long-term economic competitiveness of the nation. In advance comments over the weekend, President Obama signaled that he will concede this point in his address. In creating the bipartisan deficit commission—formally, the National Commission on Fiscal Responsibility and Reform—the administration has attempted already to clarify that the issue is rising in its order of policy priorities.
How is it possible that the deficit, which ballooned in response to the threatened collapse of the financial system, remains so far above its trend level in the denouement of the crisis? The large-scale interventions in support of the financial system and key industries, such as the auto sector, have been winding down for some time. In the initial stages of the financial crisis, federal commitments on these fronts accounted for a large share of the growth in outlays. But many of those commitments have subsequently been repaid, in whole or in part. Now, apart from the serious structural gap between revenues and expenditures, the excess budgetary imbalance is largely attributable to the recalcitrance of the labor market.
In spite of strong growth in corporate profits, firms remain resistant to adding new workers. As of December, 14.5 million Americans were unemployed, within range of the all-time high set in October 2009. Lost income tax revenue, alongside the costs of social support and job-creation programs, have precluded a narrowing of the deficit. Federal unemployment compensation, for example, is estimated at $194 billion for fiscal year 2010, more than five times the level in 2007. Overall, the Income Security budget has ballooned to $685 billion, nearly doubling from levels that prevailed before the recession began. To tackle the deficit, policy makers must address the structural imbalance between spending and revenues but must also ensure that high rates of unemployment do not become an entrenched feature of our economy.
The Wind at Our Backs
Serious progress in entitlement reform is the ultimate basis for long-term sustainability in public finances. In the near and medium term, getting Americans back to work is part of the solution as well. It is unclear how much of current unemployment is related to the business cycle and how much might persist as a structural drag. As such, steering policy in support of private-sector labor markets has become increasingly critical.
Efforts to spur job growth are moving policy to the center, especially in the aftermath of the midterm elections. For example, the administration’s stance on key issues of concern for business is moderating just as gestures are being made to allay business concerns about the administration’s ideological position on the rewards to entrepreneurship. Making the formal announcement of Jeff Immelt’s appointment to chair the Council on Jobs and Competitiveness during an address at the GE plant in Schenectady, the president offered that “the past two years were about pulling our economy back from the brink. The next two years, our job now is putting our economy into overdrive.”
Supporting current initiatives, the job-growth agenda has the wind at its back. The economy appears to be rousing, irrespective of any shift in policy. Notwithstanding its negative implications for deficit management, the extension of the Bush-era tax cuts has positively impacted the near-term economic outlook, especially in states where budgets are reasonably balanced. Even apart from the favorable tax environment, the current data warrants a modestly more optimistic baseline outlook for economic growth and for jobs. The Commerce Department will release advance estimates of fourth quarter G.D.P. on Friday. Consensus projections anticipate the report will show a 3.5 percent annualized rate of growth, up from 2.6 in Q310.
The Temptation to Invest
Given the high level of unemployment and the administration’s desire to encourage infant industries and the retraining of the existing workforce, some level of strategic investment in education and promising technologies is inevitable. And so policy makers may announce new, targeted spending initiatives even as they seek to rein in spending.
The balancing act will be difficult. Ultimately, the private sector is best suited to innovation and job creation and to directing capital to its highest and best uses. Government may be able to identify key areas that warrant investment over and above what the market will provide. But policy makers must exercise caution at this juncture, stopping short of the spending levels that imply higher business costs in the future and lower business confidence in hiring in the present. To do otherwise would be to undermine the very efforts we seek to move forward.
Sam Chandan, Ph.D., is global chief economist and executive vice president of Real Capital Analytics and an adjunct professor of real estate at Wharton.