Ken Troske, the William B. Sturgill Professor of Economics and director of the University of Kentucky's Center for Business and Economic Research, recently spoke with Business Lexington's Editor-In-Chief, Tom Martin, about the state of the economy as it relates to Kentucky in general and to Lexington in particular.†The interview can be heard by clicking on the related podcast below.
TM: Let's begin with your overview of the economy at present.
KT: Clearly the economy at present is slowing down. I think growth in the fourth quarter - we don't know what it is yet - is likely to be substantially slower than it had been previously, around 1.5 percent growth in gross domestic product, which is how we measure growth in the economy. I should point out that growth in the third quarter was extraordinarily high: about 4.5 percent. Growth overall for 2007 (was) probably slower than in previous years, but not outrageously so. I would say growth for the entire economy for 2007 is likely to be on the order of ... about 2 to 2.5 percent, which is reasonable growth but still not great. Clearly the first quarter of 2008 is anticipated as being perhaps even a little slower than that, so right now, the economy is slowing down.
TM: The traditional definition of recession aside (and that would be a couple of consecutive quarters of decline in the gross domestic product), comment and opinion on where we are right now seems to be almost all over the map. Would you agree with that?
KT: ††Well, there are certainly a lot of speculations going on about the growth of the economy. Part of that is simply because we just don't know. Again recession, regardless of how you want to measure it, it implies a contraction or, to use an oxymoron, negative growth. We have not had a contraction where one quarter of the economy has produced less than it had in the previous quarter. So I'm reluctant to say that we are in a recession because we haven't had one quarter of a contraction, much less two. And then ... you have to realize that we are talking about growth, and growth can jump around quite a bit. There's a reason why we measure a recession as two quarters of contractions. Again, third quarter growth was 4.5 percent, fourth quarter it may have been 1.5 percent, so based just on third quarter, we are in a huge expansion. ... Whenever you want to define something, you need a little more certainty than any single quarter's worth of numbers, and so before I'm willing to conclude that the economy is contracting, I'd like to see two quarters of contractions, just like others.
TM: We often hear the phrase related to contemporary news media that "if it bleeds, it leads," and it would seem that there is an awful lot of perceived bleeding going on in the economy on the part of the media. Is there some psychology at play here?
KT: People tend to like to focus on a single number. Unfortunately, we have a very large, diverse economy and no single number gives a complete picture. Now there are a number of numbers that are troubling. Certainly, housing starts is one. People focus a lot on the stock market; obviously when foreign markets went down quite a bit, there was a huge reaction. I think it's interesting to note that the foreign markets are probably back to where they were before the big decline that they had on Martin Luther King Day last week. So clearly, there is a lot of focus on the stock market. The stock market has certainly been very volatile for a variety of reasons. And I think a lot of people are focusing on that. Employment growth had slowed, and we were a little concerned about that. Inflation is up. Now note that when inflation goes up, that doesn't usually lead to a recession, but inflation is higher. Unemployment has gone up a little, to five percent. In historical terms, five percent is low, but it's certainly higher than it has been in recent years. So there are a number of numbers that suggest that the economy is slowing down, but I think fixating on any one, like a sudden change in day-to-day movements in the stock market, does lead to more dire predications than one would make if taking a more complete look at all of the numbers.
TM: Those foreign markets seemed to stabilize rather quickly. Do you think that was a response to the Fed's most recent action on interest rates and also the economic stimulus package proposed in congress?
KT: †I think there were a couple of things. I mean, I think the foreign markets had a somewhat positive reaction to the Fed interest rate cut. One of the things that I think was troubling the market was all of a sudden they saw a lot of selling going on, and it wasn't until we learned that it was being generated by one company as a result of problems in one trader - that's the SociÈtÈ GÈnÈrale - that they learned that's what a lot of the selling was in reaction to. So I think part of it was they learned this one company had a trader that forced them to take $7 billion in losses, and I think that's what added a lot of stability once that news got out and people had a better understanding of what was going on and therefore adjusted their expectations accordingly.
TM: How about the whole subprime picture as it relates to Kentucky?
KT: The subprime picture, I think, is an interesting story, and again, I think the mortgage crisis and the subprime crisis is (about) a lot of problems with the amount of information, or accurate information, that's out there. How you measure subprime mortgages is a problem. Subprime mortgage is suppose to be a measure of the borrower's credit worthiness. There's what's known as a FICO score, your credit score. And if your score is below 620, you're suppose to be a subprime mortgage. It turns out the way we collect data is that we identify subprime mortgages based on the institution that's making the mortgage, not the borrower, when they actually collect the data. So, for example, there will be a company (for example, we'll use Countrywide, because most of their mortgages were subprime mortgages.). So all of Countrywide's mortgages are called subprime, despite the fact that some of them are subprime but some of them are prime. In fact a different lender, Citibank, who happens to hold my mortgage, they're considered a prime lender, and so all of their loans are considered prime, even if some of them are made to borrowers with lower credit scores. So one problem is we just don't know what's going on with the subprime mortgage market. Having said that, when you look at the subprime mortgage, it's gotten bigger, but ... the default rate of subprime mortgages is right now, I think, in Kentucky it's 12 or 13 percent - probably lower than it is in the country as a whole. But the other thing, too, that is interesting in both the U. S. and Kentucky is your default levels have returned to the levels that we saw in the early 2000s. We saw 12- and 13-percent default rates in Kentucky in subprime mortgages in 2002; It's just now subprime mortgages are a little larger percentage of or substantially larger percentages of overall mortgages. In Kentucky, in particular, the housing market and the subprime market is not as severe as they are in the country as a whole. We haven't seen the big run up in prices like they did in the rest of the country, so we are not seeing the big declines in prices, and its the large decline in prices that seem to be at the heart of subprime foreclosures.
TM: It does seem that Kentucky did not experience the real estate bubble that the nation experienced. Is that correct?
KT: Yes, that is true. The housing prices have been much more stable in Kentucky than they have in the nation as a whole. Growth is more stable, seems to be more stable, in Kentucky than it is in the nation as a whole. Growth is lower in Kentucky than it is on average in the nation, but more stable.
TM: In the introduction to last year's 2007 Kentucky Annual Economic Report, you and your colleague, Kenneth Sanford, asserted that "the most important factor in determining wealth is a state's stock of knowledge, the education level of its residents, and the amount of innovative activity that occurs in the state." With deep budget cuts for higher education on the table in Frankfort, are you troubled?
KT: I'm troubled by the overall cuts in any education budget: higher education, K-12 education. I think that we can talk about year-to-year fluctuations in the Kentucky economy and that's one issue, but if you want to talk about more of the long-term, systemic, structural problems of the Kentucky economy, the basic problem that limits growth in Kentucky is the low skill of workers in Kentucky. And so, that has been a problem in Kentucky. You know, Kentucky has been the 44th poorest state in the country since the 1920s and has been at that level since then - for 80, 90 years now. Before we can fix that problem, we have to change the educational attainment of workers in Kentucky, and it's going to be hard to do with budget cuts. So I understand the need to fix the short-term issues with the budget, but we're talking about looking at the long-term growth of Kentucky. And I think making short-terms cuts in education is going to continue to seriously impact the long-term growth of the state and is going to limit our ability to try to rise out of this almost long-term period of poverty.
TM: †It doesn't seem that comprehensive tax reform is even on the table for the current legislative session, but how do you feel about that for the short-term future?
KT: Well, I would agree with you. I don't see comprehensive tax reform in the future. I will say Kentucky suffers from a number of issues concerning how they tax their citizens that I think would be worth examining. One of the fundamental principals in economics suggest that you want to impose taxes on the entity that you're least able to move. You can move workers. You can move yourself fairly easily. You can withdraw your labor from the market or work less than you would otherwise. You can move your business to a different state or choose not to, but the one thing you can't move is land, and that leads to property taxes. Something that we seem to limit - following the lead of California without recognizing that these issues in California are quite serious and they struggle every year because of these - are what I would call artificial limitations to how you assess the tax. ... One of the things I think Kentucky needs to do is sit down and say, "Hey, this is what we want to spend the money on," or "This is how much money we want to spend, these are the programs we think are worth funding, and then this is the best way to fund those programs." ... I would argue that we should take a serious look at how we actually collect revenue in the state, because the occupation tax that a lot of localities rely on is just an incredibly inefficient way to actually collect tax revenue.
TM: Again, from your perspective as an economist and bringing our thinking down to a strictly local view, what do you think is the best thing that Lexington can do for itself as a city in uncertain economic times?
KT: I think, again, the best thing for governments to do is focus on higher priority items, items that they think will affect the long-term growth of their area. I think at a federal level we should be focusing on long-term growth, not short-term growth. Stimulus packages aren't going to have much impact on short-term growth. On the state level, I think we should be focusing on long-term growth, because that's what entities can affect. And so, from Lexington's standpoint, I think Lexington should be focusing on those issues that are going to promote the long-term growth of Lexington and not worry about trying to do things to affect short-term growth, and those are things such as planning, development, fixing infrastructure, which is obviously a very big issue in Lexington. So those are the things that I think Lexington should primarily focus on.
TM: How about the revenue stream? Lexington relies so heavily on payroll tax; 83 percent of its revenue's from payroll. Do you think that's an over-reliance on payroll, and should we perhaps be considering some other form of revenue stream?
KT: Kentucky's cities are fairly unique in their reliance on occupation taxes. The claim is that it's a result of the limitations on property taxes. Yeah, I think that Kentucky, most cities in Kentucky, education systems in Kentucky, would be much better served by a greater reliance on property taxes. But that requires a political commitment that many people aren't willing to make and would require a constitutional amendment. And so what Lexington has adopted is what we would refer to in economics is a "second-best solution." Given that they can't rely on property taxes, they've chosen some other form of taxation and they are limited in the sales tax that they can collect as well. A lot of decisions in the state are very centrally located in Frankfort, which severely limits the flexibility of local governments to respond to specific needs. It's not reasonable to think that Lexington should adopt the same solution as Pikeville or Paducah. Those are very different places with very different resources, and presumably the optimal solution should be different for the three areas. But that doesn't seem to be possible.
TM: Ken Troske, thank you very much.
KT: Thank you.