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Northwest economy emerging from funk

By Drew DeSilver
Seattle Times business reporter

MIKE SIEGEL / THE SEATTLE TIMES, 2002 Business spending: A 747 is put together at Everett's Boeing plant. Businesses nationwide that delayed buying equipment and expanding during the recession are now upgrading — which is expected to fuel demand for things like airplanes and software.

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Whether it's cool new software, moody-yet-aggressive rock music or $4 double-decaf cappuccinos, Puget Sounders pride themselves on being ahead of the curve. But when it comes to economic recovery, the Seattle area — and Washington state as a whole — have dragged behind the rest of the country.

But that's about to change, according to a bevy of economic forecasters. While the U.S. economy as a whole is likely to grow more slowly in 2005, they say, the Northwest should kick into a higher gear.

And the same factors that have helped keep the region in an economic funk long after the rest of the country rebounded are poised to lift us out again, even as the national economy shows signs of slowing down:

• Business spending, which underpins much of the demand for things such as airplanes and software, has bounced back from the depths of 2001-02.

• Exports are benefiting from strong Asian economies and the weaker U.S. dollar — good news for a trade-dependent state such as Washington.

• Companies that spent heavily on technology and telecommunications gear in the late 1990s, and then stopped after the tech bubble burst, are finally adding or upgrading equipment again.

• The drought of venture-capital investment, which helped doom many young Northwest tech companies, has abated.

"This community was ground zero of the recession, but it is where the bounce back will be the strongest," said Lake Oswego, Ore.-based economic consultant William Conerly.

Conerly's Washington forecast, for job growth of 1.9 percent this year and 2.6 percent in 2005 (compared with a paltry 0.2 percent last year), is echoed by other analysts.

The state Economic and Revenue Forecast Council predicts that Washington will have added 45,500 payroll jobs by the end of this year, and another 53,300 next year. After three years when the state lost a total of 53,600 payroll jobs, that would be the best performance since 2000.

Per capita income, adjusted for inflation, is expected to grow 1 percent this year and 2.1 percent next year, after falling for the past two years. The unemployment rate, however, is forecast to edge up slightly, as more people start looking for work and are once again counted as part of the work force.

The good news extends south of the Columbia River, too, where Oregonians have been suffering through an even deeper recession than Washington. (Washington and Oregon both have lagged the nation, which has been adding jobs since the middle of 2003.)

Tom Potiowsky, Oregon's state economist, said that after three consecutive years of job losses — and an unemployment rate that, at 7.2 percent, is tied with Alaska for second-highest in the nation — his state should grow jobs by 1.8 percent this year and 2.1 percent in 2005.

Like Washington, Oregon's economy is based heavily on capital goods — mainly semiconductors. And as Potiowsky noted last month at the Northwest Economic Outlook Symposium, "this was really a business-investment, manufacturing-centered recession, and Oregon got hit harder than anyone else."

Nation as a whole

Stephen McNees, formerly an economist at the Federal Reserve Bank of Boston, once said that "the regional economy floats on a national sea, while being buffeted by local tides and winds." Despite the quirks and peculiarities of the Northwest economy, recovery here depends foremost on how the nation as a whole is faring.

Right now, it's faring fairly well. Last week, the federal Bureau of Economic Analysis said gross domestic product (GDP) — the sum of all goods and services produced in the nation — rose at an inflation-adjusted annual rate of 3.9 percent in the third quarter. That's down somewhat from the torrid pace set last year, but still good compared with the anemic growth in 2001 and 2002.

Economists generally expect the U.S. economy to slow down somewhat next year, with GDP growing 3 to 3.5 percent, compared with 4.4 percent or so estimated for this year.

But while the U.S. index of leading economic indicators fell 0.3 percent in October — its fifth consecutive monthly decline, suggesting slower growth ahead — the Washington state leading index rose 1.3 percent, further evidence that the state is pulling ahead of the nation as a whole.

A big reason is the turnaround in business spending — important to the Boeings, Paccars and Microsofts of the world. Private-sector investment in equipment and software grew at a 17.2 percent annual rate in the third quarter, the second-strongest quarterly figure since the beginning of 2001.

Corporations are flush with cash right now, Conerly pointed out, and profits should be sustainable enough that they can afford to replace aging equipment bought during the last boom.

During the recession, he said, business investment "was the worst-performing sector of the national economy, and helps explain why Washington had such high unemployment. Now that that's rebounding, Washington should finally pull out."

There's one cloud, though: A special tax provision, enacted in 2002 to encourage capital expenditures, expires at the end of this year. That could mean this year's business-spending numbers have been boosted by companies racing to beat the tax deadline, and hence that capital spending could dip next year.

The world view

Not much behind the U.S. economy, the world economy is crucially important to how — and how well — this region lives and works. Seattle economist Dick Conway, co-publisher of the Puget Sound Economic Forecaster newsletter, estimates that at least a quarter of jobs in the metro area depend directly or indirectly on international trade, making this the most trade-dependent region in the country.

For those folks, the U.S. dollar's plunging value against foreign currencies is a godsend, no matter how much pain it causes American tourists traveling overseas. The reason is simple: The weaker the dollar, the cheaper American goods and services are for overseas buyers.

So far this year, the dollar has fallen 5.2 percent against the euro and 3.9 percent against the yen. Due to the United States' persistently large budget deficit and trade deficit, and absent any central-bank intervention, most observers expect the dollar to stay weak.

In the short term, that should benefit the local economy — not just aerospace, by far the state's leading export industry, but agricultural products, electronic and industrial machinery, wood products and software.

Conway, for one, expects employment in the four-county Puget Sound region to grow by 2.6 percent next year, compared with 1.9 percent this year and actual shrinkage of 0.4 percent in 2003. Personal-income growth in the region should accelerate to 5.8 percent, he says, twice the rate of the past two years.

In the longer run, however, most economists say the twin U.S. deficits are unsustainable at their current levels. By making imports more expensive, a weak dollar could trigger inflation and, as a response, higher interest rates; some observers worry that foreign investors will decide to stop financing the deficits by buying U.S. debt.

Conerly, though, told a Viking Bank luncheon audience last month that foreigners will continue to see the United States as an attractive place to invest. If anything, he said, he's more concerned about China's attempts to rein in its galloping economy.

	JIM BATES / THE SEATTLE TIMES, 2002 State exports: Busy cargo traffic — such as at the Port of Tacoma — reflects the key role that international trade plays in the Puget Sound area economy. Exporters in the state benefit from Asia's explosive growth and the weak U.S. dollar.

China, which has been growing at more than 9 percent a year, has fueled much of the surge in exports, as well as high prices for oil, steel and other raw materials for industry. That country's leaders now are trying to slow its growth to something more sustainable, but Conerly said they could easily miss their mark.

"The Chinese don't understand economics very well," he said. "They've done a good job with economic growth, but they don't really know why. I think the odds of the Chinese engineering a soft landing are pretty slim."

Peak to housing boom?

The housing market has been one of the pillars of the local and national economies. New-home construction has pumped billions of dollars into the system, construction jobs in Washington have risen 5.1 percent over the past year, and homeowners have taken advantage of low interest rates to refinance their mortgages and, as often as not, taken out cash for other spending.

But Glenn Crellin, director of Washington State University's Center for Real Estate Research, said the housing boom may have peaked.

"I suspect 2005 and 2006 are going to be less active housing markets than we've seen in 2003 and 2004," as mortgage rates move higher, Crellin said at last month's forecasting symposium. In almost every Washington county, Crellin noted, real-estate activity this past October was lower than in October 2003. And soaring housing prices (the King County median price was $329,000 this past quarter, 9.7 percent above the same period in 2003) have outpaced personal-income growth and more than offset still-low mortgage rates.

	BARRY WONG / THE SEATTLE TIMES, 2000 Housing construction: New-home construction in the state rose 5.1 percent over the past year and sales of existing homes also soared. But analysts expect the housing market to slow as first-time buyers get priced out of the region.

"The housing market is in some jeopardy of seeing declines in activity because first-time buyers are finding it increasingly difficult to participate in the market," he said.

As for commercial real estate, downtown Bellevue appears to be in the strongest position heading into 2005, said Carolyn Davis, research associate at Cushman & Wakefield in Seattle.

Lured by cheap rents and hundreds of thousands of square feet of empty office space, companies have come back to Bellevue. With the city's vacancy rate expected to fall below 10 percent by the end of this year, developers such as Equity Office Properties and Bentall are dusting off mothballed projects.

"There is a good chance the first one or two out of the ground will make a good return" on their investment, Davis said.

But, she added, in many cases corporate tenants, such as Symetra Financial and drugstore.com, are moving to Bellevue from other Eastside suburban locations, meaning those markets will have higher vacancies going forward. (The vacancy rate could go much higher, should Cingular decide to downsize or vacate the Redmond offices of the former AT&T Wireless.)

In downtown Seattle, she said, commercial tenants are playing a real-life version of "Trading Spaces" — moving from one office building to another without affecting overall vacancy rates or rents very much.

The new federal courthouse has taken a lot of government workers out of rented space, she said, enough to help push downtown's vacancy rate back over 16 percent by the end of this year.

Since the third quarter of 2002, according to Cushman & Wakefield's research, downtown vacancies have hovered around 15 to 16 percent. With Washington Mutual building a new headquarters tower and the San Francisco Federal Reserve Bank branch heading to Renton, the near-term trend is for more empty space, not less.

Translation: Don't expect any more new projects to change Seattle's skyline anytime soon.

"In downtown Seattle [new development] is more difficult — some more stars will have to align," Davis said. "There is quite a bit of new construction sitting on the market that has not yet been absorbed by tenants."

Drew DeSilver: 206-464-3145

or ddesilver@seattletimes.com

Copyright © 2004 The Seattle Times Company

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