SoCal faces economic challenges ahead

Despite showing economic resilience, Southern California is likely to follow the nation into a recession and faces several challenges ahead, including potential new supply chain constraints, labor and equitable growth, according to the latest quarterly update from the Southern California Association of Governments' Economic Roundtable.

The Roundtable, a consortium of regional economic experts, met recently to update the region’s economic outlook and discuss challenges and opportunities facing the six counties that comprise SCAG. The consensus was that the region and nation continue to face significant economic uncertainty during what has been an uneven post-pandemic recovery:

Inflation

• While the roundtable expects inflationary pressures to continue to moderate as we approach the summer months, new or increased disruption in the supply chain poses a potential risk to the currently easing inflation.
• Continued growth in COVID cases in China adds further risks to the global supply chain, potentially adding additional inflationary pressures. However, COVID increases resulting from the end of the strict lockdown policy in China will likely result in a return of higher demand growth abroad, which could result in inflationary pressure from the demand side.
• Inflation has had a significant impact on the region’s residential real estate market. According to data from the California Association of Realtors, Southern California sales of existing single-family homes decreased 48.3 percent as of December 2022, year-over-year. The region’s real estate market is likely to remain sluggish with interest rates at current levels and personal savings rates at historic lows. A slowdown in the labor market may increase the risk of foreclosures.

Logistics Sector

• Firms, independently of government intervention, are responding to the supply chain risks by diversifying their supply chains, shifting to domestic production following recent legislation (e.g., Bipartisan Infrastructure Bill, Inflation Reduction Act, and CHIPS Act). Some of this will result in increasing warehousing capacity in Mexico. This change has both positive and negative implications for Southern California, particularly for its logistics sector in the Inland Empire.
• The cost of shipping freight has decreased back to pre-pandemic levels. Moreover, shipping to competing ports in Texas requires transit through the Panama Canal, which adds several days of travel, additional fuel and imposes restrictions on Capesize ships.
• The shift in the supply chain to Mexico has created opportunities for other regions to compete with Southern California in the logistics sector, notably southern Texas, and Georgia. The impacts of diversification on the logistics sector in Southern California are not yet known and other factors may play a role as well.
• Artificial Intelligence in the form of automation and robotics will continue to disrupt the logistics sector in Southern California, particularly in Riverside and San Bernardino counties. SCAG Roundtable member, Manfred Keil says, “The Inland Empire will suffer in a significant way from automation. COVID has accelerated the timeline of this from 2030 to now.”
• Another factor impacting the logistics industry in Southern California is the tension between the need for continued job growth in the Inland Empire and concerns about increased pollution from the expansion of the transportation and warehousing sector in the Inland Empire, which disproportionately affects lower income people and people of color.

Labor

• Investment in education and skills training is essential for building economic resilience to automation. SCAG Roundtable member Shaun Fernando notes, “The share of workers with bachelor’s degrees in the entire region is higher than ever. The `brake’ on this growth includes cost of attendance and balancing STEM degrees vs. liberal arts degrees vs. trades. We’re adapting to automation by putting more money into the salaries of the more creative and high-skilled folks. But this may be an inflationary pressure.” Manfred Keil adds that this is not the case in the Inland Empire, where the share of workers with bachelor’s degrees is uniquely low.
• SCAG Roundtable member Shannon Sedgwick of LAEDC notes that “There are industries and jobs which you can automate rather easily, but it is still capital intensive to substitute labor, particularly in the trades. The extent of automation in professional services is happening rather quickly. Over the years, we’ve seen automation hit many industries, and they’ve largely adapted, for example, electricians who can fix new automatic cranes. Moreover, management, wisdom, and experience are value drivers.” The hope is that automation will bring back some of the jobs lost to overseas production due to lower labor costs abroad.

Environmental

• Recent storms have brought much-needed water to the State, but the region is still in drought. According to the U.S. Drought Monitor, all six SCAG counties face moderate or severe drought conditions. If the weather patterns from a year ago repeat themselves, with little to no rain for the rest of the rainy season, then we are still only at about 80% of normal annual rainfall in Los Angeles County.
• SCAG Roundtable member, David Roland-Holst explains, “The storms are a minor reprieve for now, but adaptation and infrastructure improvement needs not to take its foot off the gas. Spring runoff will make a difference for the Colorado River, but even this will be temporary. Shovel-ready opportunities are to develop water storage in Southern California.”

Housing

• The housing sector continues to bear the impact of increased interest rates. Existing home sales are down significantly, and prices are starting to drop modestly as affordable housing is selling disproportionately.
• SCAG Roundtable member Michael Bracken expresses concern about the slow-down in the housing market attracting housing investors, “As we enter this mini housing crisis, institutional money sitting on the sideline will gobble up otherwise owner-occupied stock.”

Public Sector

• The state deficit is currently estimated to be at $22.5 billion but this figure is expected to grow. SCAG Roundtable member Wallace Walrod says, “It will grow much higher than the current $22.5 billion. It’ll be a $50 billion state deficit.”
• Roundtable member, Mark Schniepp reminds us, however, that state revenues rely heavily on income and sales taxes, the vast majority from payroll taxes. Although capital gains taxes are expected to shrink this year due to poor market performance in 2022, if labor markets remain strong and consumer spending continues, the state budget is well-positioned to weather a slow-down.
• The state deficit does raise concerns for local governments. When the state budget gets tight, the squeeze goes to cities, localities, and especially school districts. Local government employment is down.
• Manfred Keil notes, “Cities are worried about their future financial situation due to labor market issues – flexibility in hours, hiring, etc.” Typically, more tradition-bound public sector jobs could struggle to adapt.