Bruce Norris is joined again this week by Dr. Robert Kleinhez. Dr. Kleinhez directs the Kaiser Center for economic research, which conducts research on the regional state and national economies. He has over 25 years of experience and expertise in the private and public sectors’ academia working as a private consultant. He has spoken to local, state, and national audiences, and is a frequent contributor to media coverage on the economy. He has a Masters and a Doctorate degree from USC, all in economics.
The last things Bruce and Robert touched on was the subject of uncertainty. Taking a look at real estate volume, there was an expectation we were going to be in the mid-400s. For most of the year except for the last month, we have been around the mid-300s. Bruce wondered about the role uncertainty plays in somebody saying they are not comfortable making a decision. Robert said it is important for both households and businesses to understand what is out there. If they do not understand it or are not certain or have some sense of where things are going, in many instances the best strategy is to sit on your hands and do nothing. To some extent, that is the set of circumstances we are facing in housing, both in the existing and new home market.
On the existing home market side of things, would-be sellers have been reluctant to put their homes up for sale because they are hearing mixed signals about what is happening in the housing market. We have seen the rate of price appreciation slow, so they may have been able to recover some of the lost equity from the Great Recession housing crisis in 2012 and 2013. In 2014 they may not be sure what direction the housing market will take. On the supply side for existing homes, home sellers are somewhat reticent to list this year counter to what was expected. On the supply of new homes side of things, they are going to take their cues from what is happening in the existing home market to some extent. This includes what is happening with price gains and sales volume. Robert thinks there is a spillover effect that is working against the new home market and builders at the present time.
On the consumer side, the demand side of the equation, everything they hear about the housing market right now suggests that prices are going up. This means by their calculations affordability is only getting worse. Usually that creates a sense of urgency, at least for a period of time. Individuals or households try to get a home before home prices go up any higher. He does not sense that this is happening right now. You could argue that the low interest rate environment, especially the recent drop in interest rates, may be reducing some of that urgency to get out there and buy a home. All of the players right now are dealing with a set of market conditions that is full of uncertainty. While there are certain fundamentals that seem to be working in favor of the housing market, things are not moving where they should be here in 2014.
When you take a look at builders, the one thing they have to have is certainty as far as what is on the horizon. They are in for a stretch of time. If they decide to buy a piece of land that will be built upon and converted into lots, they are talking about at least a three-year horizon. This is what might be missing for them. If you take a look at some of the longer-term calculations about new household formation, both nationally and in California, all signs point to an increased need for new homes. We are seeing that as the economy gets better, younger but working members of households may be leaving their parents’ household and forming their own. They may rent initially but also possibly buy. This may be a growing trend over the next few years. At the national level, it is estimated by some that we should be forming households at a rate of about 1.7 million per year. We are only adding a little bit more than 1 million units per year, and the expectations are that we will be adding about 1 million units this year and over the next couple years. This suggests that the long-term prospects for builders should be positive, and there is going to be demand for that product when it finally reaches the market.
The lenders also have a little bit of a problem because for a lot of the fines they are being asked to pay for, including actions in 2006 and 2007, the fines are just coming down the pike and not small. Bruce wonders if they are not also uncertain about what we can safely do. What are the rules of engagement, and what programs are safe enough to do where they are not worried about getting fined anymore? Robert said he is not a financial institutions expert, but he thinks it is safe to observe that capital requirements for lending institutions have increased. This means they have to hold more capital in reserves against their deposits as a result of Dodd-Frank and the regulations that apply to the various lending institutions around the country. That is making it more difficult for them to lend out as much volume as they may have been able to lend out in years past. On top of that, you may find that they are also facing stiffer standards when it comes to whom they can lend money. They will be very reticent to lend out to businesses, developers, and consumers who have any hint of being an above normal credit risk.
At least some institutions, the bigger institutions, have fines that they have either paid or anticipate paying. This plus there could be other outcomes of legal action that is still pending that may lead them to hold back from fully becoming involved from really getting the wheels of the economy going again. Bruce asked Robert when you are an employer and you look at the future and sees uncertainty, how does he react as far as staff? Robert said the first thing you are going to do is look at your current staffing and see how long you can go and how far you can stretch yourself with your existing staff. If you see that you are going to be able to increase your activity and sales, you are probably going to rely first on increases in part-time staffing to the extent that it is even a feasible solution. At some point the increases you read from only goes so far, and it is at this point you realize you need to add additional full-timers. Robert believes we are at the point in this economic cycle where we should see increases and full-time staffing over and above what we have been seeing for the last couple of years. The wow card here is how firms in various industries are responding to the affordable care act requirements.
Bruce asked Robert if you are an employee and you have uncertainty how that changes his habits as far as being an employee. What does he do and not do? Robert said during the worst of the recession when uncertainty was greatest, many employees who might have thought about changing jobs under normal circumstances simply hunkered down and decided to stick with their current employer until the coast was clear. We are in no way back in circumstances we faced a few years ago during the worst days of the recession. There is a lot more mobility in the labor market today than there was a few years ago both in terms of job openings. There are options for people who want to change jobs. There also has to be the willingness on the part of the employees to actually get out there and change jobs. If there is some sense that the outlook over the next few months is less certain than it was in the last six months, then people will be moving a little bit more cautiously than they otherwise would.
Bruce asked what the effect is of having a minimum wage hike and if the hike in places such as Seattle is significant for them. He wondered if there is any connective tissue to a state’s minimum wage and an increase in migration to that state. Robert said if there is a higher minimum wage in one metropolitan area, perhaps it will attract workers from out of the area. The theory behind those who are proponents of higher minimum wage is that if it can enable more people in the local economy to earn more, they will spend more. This in turn is going to help support the local economy. The real question is whether or not this will have an adverse impact on hiring as a whole.
In a thriving local economy where you clearly have a lot more businesses demanding employees at that entry level and low-wage tier, there will be a lot more firms demanding those employees than there are employees to fill the positions. You can probably have an increase in minimum wage and little to no adverse impact on employment. In a place like Los Angeles County he is not sure this would work out the same way nor in other parts of Southern California, notably the Inland Empire. The standard theory that most economists adhere to is if you are going to raise the price on something, people or businesses are going to want to buy less of it. In the labor market, this translates into lower overall employment in the very simple analysis of how labor markets respond to higher minimum wages.
Bruce asked what happens to the people who are currently making about $9 and you have a $15 an hour worker, then the minimum wage is raised to $15. What would generally happen to the people who have been there a long time and making $15? Would they keep this spread from the $9 to the $15, and how inflationary is it? Robert said in California the minimum wage is $8, but it will go up to $9 an hour as of July 1. After this it will go up to $10 an hour in about 2016. Different businesses react to the increases in minimum wage and how that creates an accordion effect throughout the wage structure of their employees. From what he can tell, it does seem to depend on the employer and their ability to react to the higher cost of the lower wage workers. Just looking at things objectively, you may be paying what you think is a fair wage for an employee in a particular capacity. All of a sudden, with a higher minimum wage the person below that employee who you think is being paid fairly is receiving a higher wage. With that gap between the two narrows, your ability to make adjustments to the employees’ fair wage really depends on how much margin with which you have to work.
Robert said we are in a very competitive set of economic conditions at the present time. Profit margins for a lot of the industries are narrow and probably growing to where we were a few years ago. However, profit margins are still under pressure, and it is hard to say exactly how firms across the border are going to respond when they are not going to uniformly raise the entire wage structure as the minimum wage increase goes into effect. If they are going to have to test the water and see what the market will bear. Bruce asked if a minimum wage increase will have a big effect on manufacturing. If it really raised the cost of manufacturing, how would that effect the California or America’s competitiveness with foreign countries trying to produce very similar goods? Robert said he does not know the answer to this directly, but he conjectures that the increase of the minimum wage by about $1 dollar an hour would squeeze profit margins, especially in manufacturing.
To the credit of manufacturers in the United States, this sector of the economy has been very good at harnessing technology to economize and save on costs. This often means automation will displace workers. If we are seeing an increase in the manufacturing wage to working in a factory, there will be incentive for owner of the factory to figure out a cheaper way to make things. It could mean displacing some workers with increased use of technology and automation. Even that takes some time to bring into effect, so this technology piece is really working in favor of the manufacturing sector. Robert never thought we would be able to make that observation in the United States right now. It does not happen in a vacuum since so many of our goods are being manufactured in places like China and other parts of Southeast Asia where wages are much lower than they are here. The gap between the two is shrinking, and we are hearing increasingly about the restoring of some manufacturing here to the United States.
One index Bruce has never heard about before is the Gini Index. The Gini coefficient measures the extent to which economies have income inequality or equality. If all of the wealth of a national economy happened to be in the hands of one person, the Gini coefficient would be one. The more spread out the distribution of wealth is across the population in a given economy, the lower than Gini coefficient will be. Bruce asked Robert what we would consider a healthy Gini index. Robert said he is not sure there is an accepted norm. Typically what is seen in the academic literature, the distribution of income is a comparison across countries over time. Over the last twenty years the Gini coefficient for the United States has increased, meaning the wealth has become increasingly concentrated in the hands of fewer people.
The fact of the matter is we go through long waves in our economic and demographic cycles where the distribution of income changes quite markedly. Right now that concentration is growing and has been for almost twenty years. A lot of that owes to this long wave of information technology that dates back to the advent of the pc, a little bit before the 1980 mark. It continued with the internet revolution, and today we have social media. So many of these developments on the technology, internet, and social media front continue to change the way people do business. It also changes the compensation patterns to workers in our economy. He would imagine that if we looked at another 10-15 years the Gini coefficient will probably edge down. This seems to be the intent for a lot of politicians, and it may be part of the natural cycle of things.
Bruce asked how foreign economies affect a state like California or areas such as Los Angeles. He also wondered how well you can predict what their changes might be. Robert said California and Southern California are both very much reliant on the United States trade relationship with major trading partners. Partly because a number of things made in the United States are actually made here or their headquarters are here. Generally our areas of information technology, beginning with Apple, and also HP and other companies have headquarters here. This is largely talking about manufacturers. What is good for our trading partners is often times good for the California and Southern California economies. Similarly, as many economies around the world are industrializing and becoming more developed, the standard of living improves and they turn to the United States for all kinds of products that reflect a more affluent lifestyle. They come to California as tourists, and they go to local movie theaters and view movies that were made in California. There are many linkages between the economies here in the state of California and locally between these areas here and so many of the trading partners around the globe.
In the 1970s Japan had a tremendous real estate boom, and this went through the end of the ‘80s. Afterwards, it had a big problem. The Japanese used to invest in a lot of California real estate, and they have been replaced by other countries such as China. Right now there are rumors China has a real estate bubble, so a lot of Chinese investors are pushing money into the California market and are a healthy percentage of what is being purchased. Bruce asked Robert if he considers this any problem as far as if they in fact do have a bubble. He also wondered what the effect of it would be on our market. Robert said there is concern about a bubble in Chinese real estate. For a period of time there was easy access to capital for the building of residential and non-residential properties. That access to capital has been tightened over the last year, and the Chinese government is trying to contract that and take the air out of that bubble in order to not cause collapse in the Chinese real estate markets.
Meanwhile, at least some of that money that would have otherwise been invested in Chinese real estate is making its way across the specific to Southern California in particular. Many parcels in the downtown L.A. area have been purchased by Chinese investors, either private or by government real estate investment companies. They view this as very favorable here in Southern California. You have to keep in mind that the biggest cities in California are nowhere close in size to the metropolises of Shanghai and Beijing in China. Real estate on a price per square foot basis is fairly cheap here compared to over there. There is a lot of upside, so this is a pretty attractive place.
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