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Danger: Fiscal Stimulus Ahead


Economic Trends

DANGER: FISCAL STIMULUS AHEAD

States cut taxes, boost spending

With unemployment at its lowest level in a generation and economic activity still on the high road, about the last thing the economy needs is a shot of fiscal stimulus. And so far, there's little sign that it's getting much from Washington. Although the temptation to spend the expected federal budget surplus (which some analysts think could hit $30 billion this fiscal year) or to dole it out via tax cuts is strong, so is the pressure to use it to reduce the national debt and strengthen Social Security.

At state and local levels, however, notes economist Mitchell J. Held of Salomon Smith Barney, such constraints are far less apparent. "Just as at the Treasury, revenues have been streaming into state and municipal government coffers," he says. "But in this case, the inevitable reaction has been to cut taxes and boost spending."

Last year, the combined state and local operating budget surplus hit $36.4 billion, its highest level in more than a decade. And this year, according to Standard & Poor's DRI, a unit of The McGraw-Hill Companies, the combined surplus is likely to surge by 22%, to $44.7 billion (chart).

As the money rolls in, observes economist Mark Zandi of Regional Financial Associates, states and cities are unlikely to hang on to a lot of it very long. For one thing, many are required to maintain balanced budgets once their "rainy day" funds are filled. For another, a projected surge in grade school and especially high school enrollments over the next decade is already triggering higher educational spending. Finally, 30 governorships are going to be up for election this fall--"a potent political recipe for new tax cuts and spending programs."

Up to now, fiscal stimulus has mainly taken the form of tax relief. Thirty-four states cut taxes last year (vs. 14 that raised them), and the Center for the Study of the States at the State University of New York in Albany, predicts that more than half the states will enact sizable tax cuts this year.

But spending is rising, as well. Indeed, strong state revenue growth has already accelerated a number of infrastructure projects, including Boston's "Big Dig" tunnel, Texas' I-35 highway expansion, and the massive rail-and-highway project linking the ports of Los Angeles and Long Beach.

More is on the way. Mitchell Held notes that funds raised by states and localities hit a 10-year high last year, and debt issues so far this year are running 35% over 1997's pace. Historically, he says, such new money increases almost always foreshadow sizable pickups in government infrastructure outlays. "Unfortunately," he warns, "such project spending may kick in just when the economy needs more restraint."BY GENE KORETZReturn to top

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OVERTIME VS. NEW FACTORIES

Why industrial building has ebbed

Here's a riddle: Housing outlays are booming, and commercial construction is picking up steam. But industrial construction, which surged in the late 1980s, has been declining steadily over the past three years--even though manufacturing output has been growing far faster than it did a decade ago. Why the disparity in investment in bricks and mortar?

A big part of the answer, according to economist Michael J. Montgomery of Standard & Poor's DRI, appears to be the sharp rise in the use of overtime for factory workers. While some facilities, such as steel mills and petrochemical plants, typically run around the clock, he observes, others don't normally work three shifts or run on weekends. When they do, they obviate the need to build an extra plant.

In the late 1980s, industrial overtime averaged about 3.8 hours per week. In recent quarters, it has averaged about an hour more than that. DRI calculates that investment in industrial structures would have had to have been boosted sharply in recent years if factory overtime had not risen steadily over that period. Indeed, according to Ward's Automotive Reports, 6% of vehicles assembled in North America last year resulted from overtime production --equivalent to the output of an additional 4.4 auto plants running on straight time.

Thus, at least over the short run, manufacturers have not only saved on fringe benefits and hiring expenses by resorting to overtime. According to DRI, they have also avoided spending millions and probably billions of dollars on new plants. Whether this strategy proves wise over the long run or costs some manufacturers market share when the global economy picks up steam, however, is another question.BY GENE KORETZReturn to top


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