ECONOMIC ANALYSIS: Enjoy growth while it lasts, because change is afoot

There is good news for the Indiana economy. Strong spending by businesses on capital goods in the national economy in 2004 translated into the best year for output and hiring we’ve seen in the state economy in more than five years.

And it’s showing up in tax revenue as well. On a year-over-year basis, Indiana’s collections from income and sales taxes were up 8.3 percent in the last quarter of 2004, better than the national average and significantly better than any other Midwest state.

Smiles and cheers are certainly in order here. But before we get carried away, we should remember this: The capital goods spending spree that’s fueling all the growth won’t last much longer. When businesses throttle back on their spending plans, as they must do eventually, Indiana’s growth will more closely resemble its historical trend. And making a meaningful change in our trend growth rate is proving to be a very tough nut to crack.

A look at the kinds of things businesses are buying in the national economy gives some insight as to why our fortunes have been looking up lately. Through February, durable goods orders are up 7.7 percent from the same month a year ago, and are almost 21-percent higher than their low point in April 2003. In the last year, new orders for construction equipment are up 43.5 percent, iron and steel mill products orders are up 30.2 percent, and fabricated metals products orders are up 13 percent.

For most durable goods manufacturing industries, a variety of factors have come together to keep demand strong. Certainly the recent spurt in business spending reflects the 2-1/2-year drought in spending that preceded it as much as anything. In the immediate aftermath of the recession, order books for manufacturers of capital goods were empty as businesses cut to the bone. That was a harsh blow to the Indiana economy, but it left open the possibility of a strong rebound when, and if, the climate for spending ever improved.

The stronger export climate, helped in part by the decline in the U.S. dollar, has played a role as well. Although import growth has been stronger, the substantial increase in the value of goods and services shipped abroad has occurred due to stronger demand, as well as the relocation of production here in response to currency revaluations.

Finally, the upswing in merger-andacquisition activity on Wall Street, which frequently results in the paring of payrolls, often has the opposite effect on capital spending. That activity, which shows no signs of abating, promises a continued stimulus to plant and equipment manufacturers for the next six months at the very least.

Yet not all pieces of the industrial puzzle are sharing in the prosperity. For the motor vehicle industry, choked by overcapacity, expansion and new investment are not exactly at the top of the agenda. The production cutbacks announced by GM and Ford will reverberate through the state economy to the extent that suppliers here cannot look to the foreign-owned transplant manufacturers to make up the difference. And the appliance industry has had only mediocre growth, despite continued strong growth in housing.

In a sense, this is all a very old and familiar story. The up-down cycle of the national economy has more impact on our fortunes than anything we might say or do within our own state. I have always said-only partially in jest-that the most useful thing any governor of Indiana can do for the state economy is to grab a pom-pom and cheer on the national economy.

But the fact that this brisk growth is coming at a time when gasoline prices have hit $2.25 a gallon tells us something is different. If we ever needed a reminder that the U.S. economy is now dominated by the production of services, and less energy-dependent than it once was, this should serve as one. And that fact has implications for what kind of growth we can expect to see statewide when this spending spree winds down and the state economy reverts to a more sustainable trajectory.