Montana economy still strong despite national economic downturn.

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The U.S. economic news continues to be bad. Many economists believe that the country may fall into recession because of problems in housing, credit, and financial markets along with increased gasoline prices and other energy costs. The National Bureau of Economic Research--which determines when the country is experiencing an official recession based on % significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales"--has not yet classified the economic slowdown as a full-fledged recession. Even so, Montanans continue to wonder how these national economic events will impact them.

Compared to other states, Montana has not been hit very hard by the economic slowdown. Montanans already have experienced the bursting of the house price bubble and mortgage foreclosures, but not nearly to the extent of other states. Another possible impact of recession is that state tax revenue growth may moderate because Montana taxation is more influenced by national conditions rather than local economic trends.

But overall, the national economic slowdown is not likely to have significant impacts on Montana because the U.S. industries hit hardest by recession are not major players in Montana's economy. These industries include durable manufacturing (particularly autos) and financial services.

Despite the national downturn, Montana's economy is still strong, and the Bureau forecasts that it will continue to grow. Nonfarm labor income grew 4.5 to 6 percent per year from 2005 to 2007, and it should rise 4 percent per year out to 2010. Nevertheless, Montana has felt the impact of the national slowdown.

Housing and Real Estate Impacts

This U.S. downturn began in the housing market. The bursting of the house price bubble and the dramatic increase in foreclosures have been featured in news stories for months. Figure 1 (page 10) shows the trends in house prices since 1998. The house price bubble--which occurs when market participants push prices of homes higher than their basic values would appear to merit--is clearly seen in the U.S. data, which show a sharp acceleration in 2004, a peak in 2006, and deceleration in 2007.

Montana's house price changes were similar to the national trends, with house prices accelerating in 2006 and reaching a peak in 2006. The deceleration in 2007 was not quite as severe as the nation's deceleration or as the neighboring states of Oregon and Washington.

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Figure 2 presents house price trends within Montana. Missoula, Cascade, and Yellowstone counties are the three Metropolitan Statistical Areas, or geographic entities with populations of 50,000 or more, that the U.S. Office of Management and Budget uses for statistical purposes. The U.S. house price increases are presented for a benchmark. The house price bubble was most pronounced in Missoula, but all three Montana counties experienced less of a deceleration than the national average in 2007. Flathead and Gallatin counties are not graphed because they are not Metropolitan Statistical Areas. Realtors in the Kalispell and Bozeman areas report their house prices were even more volatile, suggesting that the house price bubble may have been more pronounced in these areas.

Montana has not escaped the foreclosure crisis, as evidenced in the map (Figure 3) that illustrates county data from www.realtytrac.com. On the map, the redder the color, the greater the foreclosure rate. Some of the hotspots for foreclosures include Las Vegas, Los Angeles, Phoenix, Detroit, and most of Florida. But there are large rural areas, mostly in the upper Midwest, where there was very little foreclosure activity. As of April, Montana ranked 44th out of the 50 states in the number of foreclosures. Nevada ranked first, with California and Arizona following. Among the bottom states for foreclosures are West Virginia at 48th, North Dakota at 49th, and Vermont at 50th.

In Montana, foreclosure rates are much different in the eastern and western portions of the state, as shown in the map. The eastern part of Montana is largely rural and has very little foreclosure activity, while the western part of the state is more urban and has a higher foreclosure rate. Further research may indicate why there is such a big difference in rural and urban areas. Some economists speculate that rural areas have a smaller population and fewer unsound lenders than urban areas.

The highest 2007 foreclosure rates were in Flathead, Ravalli, and (surprisingly) Fergus counties. The other major urban areas experiencing foreclosures include Missoula, Gallatin, Yellowstone, and Lewis and Clark counties. Economists are uncertain why certain counties have higher foreclosure rates than others.

Montana's 2007 foreclosure rates (based on their shade of red) are similar to those in Boise, Spokane, and along the I-5 corridor in western Washington and Oregon.

State Revenue Impacts

Another area that may be impacted by this national slowdown is Montana state revenues.

Recent news stories from Helena warn of tighter state government budgets for the upcoming legislative session. Much of Montana's state revenue is derived from income taxes, and there are components of income that are more dependent on national economic trends rather than local conditions. Specifically:

* Dividends, interest, and rents. The Federal Reserve is now lowering interest rates to promote economic activity. This is good news for borrowers because they have lower costs. But it means that lenders are receiving less income. Also, businesses typically pay lower dividends during a recession. Both lead to lower personal income, and hence lower state income tax payments.

* Capital gains. The stock market has plummeted since late 2007. Capital gains have turned into capital losses. Again, lower state income tax payments.

* Corporate profits. Montana corporations pay tax (Montana Corporate License Tax) based on their nationwide (and even worldwide) profits. As these profits have decreased because of the national and worldwide economic slowdown, so have Montana corporate profit tax obligations.

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Industry Impacts

After four straight years of 4 percent growth or greater, Montana should again dodge recession bullets.

Nonresident travel, agriculture, manufacturing (including wood products), mining, and the federal government (including the military) are Montana's "big five" basic industries and account for almost 90 percent of the state's economic base. With the exception of the wood products industry, none of these industries is likely to be significantly impacted by the current national slowdown (see the Spring 2008 issue of the Montana Business Quarterly for extensive industry reports).

The causes of Montana's current economic boom are not hard to find: Almost all of the state's basic industries are performing well. Following is a brief summary of industry conditions.

The Big Five

Nonresident travel continues to increase at roughly 2 percent per year, despite record-high gas prices. The declining value of the dollar has stimulated European visitors, and the Canadians have returned to Hi-Line communities.

Agriculture now joins the list of prosperous basic industries. Wheat was $8/bushel in the fall of 2007 and has risen to as high as $12 or $13/bushel. These prices have meant quick injections of new funds into the agricultural sector.

Manufacturing (except for wood products) continues to grow in contrast to national trends in this industry. This is illustrated by the continued growth of small high-tech industry centered in Gallatin and Flathead counties as well as significant expansions in sectors such as the oil refineries in Billings. The wood products industry has suffered for a variety of reasons including the national housing decline, weak markets, and timber shortages.

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Mining (which includes both metallic and nonmetallic mining as well as oil and gas exploration) continues to boom. Energy and commodity prices began to accelerate quickly beginning about 2004, mostly due to rapid economic growth in China and other developing counties. The changed worldwide conditions that led to higher energy and commodity prices have meant increased oil and natural gas exploration, the reopening of copper mines in Butte and Lincoln County, and continued expansion at platinum/palladium and other mines. Some observers believe that these prices are already at speculative and unsustainable levels. Up to now, there has been no hint of moderations in commodity and energy prices.

Federal government employment has increased. Homeland security remains a high priority with an increased number of U.S. border patrol personnel along the Hi-Line and higher staffing levels at Malmstrom AFB.

Other Important Sectors

Construction activity remains strong in contrast to the national trend. U.S. statistics show a sharp deceleration in construction activity since the peak of the house price bubble in 2006, but that hasn't happened in Montana. While state statistics are not as detailed as U.S. statistics, economists speculate that Montana commercial construction has more than made up for weaknesses in residential construction.

Financial services have felt some of the downturn's impacts. Throughout the nation, the financial services industry has experienced significant cutbacks associated with the subprime mortgage situation and other factors. Most of job losses have been in major financial centers such as New York and Los Angeles rather than in rural areas, in Montana, a mortgage-related call center recently closed in Great Falls and another announced some cutbacks in Billings. But, for the most part, the financial service industry recession impacts will be small in Montana.

Overall, Montana's economy continues to prosper. A few risks that could upset this scenario are as follows.

1) Worldwide economic trends, especially the fast growth in developing countries, are the single most important factor behind the Montana's recent growth. Anything that would slow growth in these countries would decrease demand for commodities and energy and have an impact on Montana. Many of the developing countries are not democracies and/ or have immature financial systems. Therefore, political unrest or financial crises could result in slower economic growth.

2) The U.S. downturn (recession) takes an unexpected turn and starts to impact industries important for Montana. Recessions are a lot like wars; one never knows what will happen. As of now, the 2008 downturn appears to be concentrated in financial services and durable manufacturing. Should something happen and other industries fall into recession, Montana's growth rates could be influenced.

3) Montana construction activity nosedives. As mentioned earlier, Montana's construction industry continues to outperform the national average. This may not continue, and the factors leading to the U.S. construction slowdown may be felt here.

Paul Polzin retired as director of the Bureau of Business and Economic Research on June 30. He continues as a research associate.