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16 HARTFORDBUSINESS.COM | JANUARY 9, 2023 Economic Forecast Is CT's economy finally recovering? Possibly, but jury's still out By Fred Carstensen T he rainy day fund is full, giving the state a nice cushion against future deficits. The state budget is delivering large surpluses that are going to reduce the challenging unfunded mandates Connecticut faces. All four credit-rating agencies have raised Connecticut's score, thus cut- ting the interest rate investors demand on its bonds. This fiscal health flowed from huge federal COVID-relief measures and an ebullient stock market. The state has not enjoyed such fiscal health since the Rowland administration. But the state budget's robustness has come at a cost. Funding for higher education has been massively cut, for UConn by more than 75%, contributing to a sharp decline in its ranking as a research university and weakening the ability of the entire system to gen- erate the skills our businesses need. Municipalities face more than a thousand unfunded state mandates, imposing a heavy burden on local property taxes. Perhaps most serious, many state agencies are now understaffed, most notably the Department of Revenue Services, which is now able to do at most a third of the tax audits that should be done. The state is surely failing to collect taxes due, well into the hundreds of millions. Going forward, that weakness will likely compound itself. When deficits return — which seems likely — it means they will be worse than they could be if the state simply collected what is due. It also means those who actually pay their taxes are carrying a heavier burden than they should. Economic uncertainty The most striking fact about the state's robust fiscal health is the con- trast with the anemic state economy. Employment is still below 2008 lev- els; as of October 2022, the shortfall was 52,000 jobs. State real product (our GDP) is still below 2007 levels; as of the second quarter 2022, it fell more than $7 million short. Simply put, Connecticut has never recovered from the Great Reces- sion. Nor has it recovered, unlike the nation and nearly all states, to the levels achieved pre-COVID shut- downs, when employment was nearly 35,000 jobs higher. It has been the worst-performing state economy in the last decade, whether measured in jobs or real output. Looking forward, the trajectory is changing. Connecticut's 30 years of decline began in the early 1990s with drastic cuts in defense spending following the Soviet Union's collapse and end of the Cold War. Connecticut suffered the worst recession of any state as it was second only to Califor- nia in reliance on defense spending. However, unlike California, Con- necticut lacked a diversified economy and singularly failed to adapt to the emergent data-dependent, digitally driven internet economy. It has only recently adopted legislation to make it competitive to hyperscale cloud data centers, central to offering a competi- tive IT infrastructure. The state's recovery, measured in job creation, was painfully slow, got progressively weaker, and ended with the Great Recession. But current-day rising international tensions, particu- larly a newly aggressive China and Putin's war on Ukraine, mean a dra- matic increase in defense spending, a significant share of which is now and will in the future flow to Connecticut. Electric Boat will likely generate the largest impact on the state, both because of its planned hiring of 9,000 net new employees (nearly an 80% expansion) and the impact that will flow through its hundreds of Con- necticut suppliers. Sikorsky and Pratt & Whitney also have significant military contracts. Add to this ASML's $200-million investment in Wilton that will create another 1,000 jobs directly and more through supply chain and multiplier effects. Both legacy companies and new- comers are also making investments, promising to put Connecticut on a new trajectory. And the state itself has begun unprecedented initiatives in workforce development, looking to create the skilled workforce upon which expansion depends. These investments and jobs are far more valuable to the health of the state's economy than the fulfillment center and logistic investments of which we have seen so much. Those invest- ments have weak multiplier effects and virtually no supply chain benefits. The danger is that Connecticut — assuming this new defense-driven trajectory delivers sustained growth and the state does not fall back into persistent deficits — will fail to make the sustained investments and pursue strategies to diversify away from its defense-driven economy. Will Connecticut learn the lessons of its own history? Fred Carstensen is the director of the Connecticut Center for Economic Analysis and a professor of finance and economics at UConn's School of Business. Fred Carstensen U.S., CT economies should expect slow down, possible recession in 2023 By Fred McKinney P redicting the future is some- thing we all do, but it is easier to be wrong than right most of the time. The question of what is likely to happen in 2023 with the global, U.S. and Connecticut economies will be determined by several factors that are also unknown at this time. Chief among those factors are the actions of the Federal Reserve; international developments in China, Ukraine, Iran and possibly some other country that is not currently a hot spot; and developments in partic- ular domestic markets like housing, finance, insurance, energy and labor. The Federal Reserve Without doubt the primary deter- minant of if, when, how long, and how deep a recession there will be in 2023 rests firmly with the Federal Reserve Board of Governors. The Fed is simultaneously the biggest risk to the future health of the economy and key to taming genera- tionally high inflation. The federal funds rate was pushed to near zero in early 2020 as a result of the pandemic. In 2022, the Fed started raising that rate by three-quarters of a percent for six consecutive meetings. Now the federal funds rate is over 4%. As a result of the Fed's actions, the rate on 30-year fixed mortgages more than doubled from 3.29% in early 2020 to over 7% in November. As of early December, the 30-year fixed mortgage rate fell back below 7%. The overall increase in the cost of financing a home will lead to declines in housing prices, something happen- ing now in Connecticut and around the country. Credit card rates are also increas- ing, which will push consumers into greater debt and put pressure on their spending behavior. Ironically, this is exactly what the Fed is trying to do. Slowing down consumer spending and cooling off the housing market is a reaction to the aggressive expansionary mon- etary and fiscal policies that were necessary to keep the economy from crashing because of the pandemic. However, those policies, combined with other issues like supply chain bottlenecks, caused the inflation we are currently experiencing. Economic policy operates with lags. The Federal Reserve's inter- est rate increases have not had a dramatic effect on inflation yet, but consumer prices are leveling off. Recently, Fed Chair Jerome Powell stated that future interest rate hikes may not be as large as previous ones. That proved to be true in December when the Fed announced a half-point rate hike. My projection is that the economy will slow in 2023 and be pushed into recessionary territory. I do not think the recession will be too long or deep because just as the economy slows down and inflation abates, the Fed will begin lowering interest rates to spur economic growth. International developments There are always unknown interna- tional shocks that can have dramatic impacts on the U.S. economy. There are three areas that economists and policymakers are paying attention to. The first is Russia/Ukraine, fol- lowed by China, and then there are always surprises that are not on our radar screen. If the Russian/Ukraine war is resolved in the next 12 months, energy prices would likely fall, taking inflation- ary pressure off the U.S. as well as the rest of the world. If the war escalates, energy prices will remain high. China appears to be going through a major internal political situation. China's position as the world's low-cost factory is threatened by global competition from lower-cost economies and the natural effects of economic growth. When economies grow and incomes rise, people, regardless of the political ideology of the rulers, demand greater freedom to use those higher levels of income. Chinese citizens want unimpeded internet. They want to travel. They want to read what they want to read. They want personal liberties that are currently restricted. We do not know at this point how this will be resolved, but it could be an important X-factor to the U.S. and global economy in 2023. The Connecticut economy is likely to track with the U.S. economy. Based on anticipated actions by the Federal Reserve and international and local market developments, I predict the U.S. and Connecticut economies will experience a slow down by the third quarter of this year with declining real GDP and declining inflation. Fred McKinney is the co-founder of BJM Solutions, an economic con- sulting firm. He is emeritus director of the People's United Center for Innovation & Entrepreneurship at Quinnipiac University. Fred McKinney