The Arkansas economic outlook for 2008.

[ILLUSTRATION OMITTED]

The Arkansas economy expanded in 2007 despite mixed signals and abundant evidence of declining growth going into 2008. The main source of weakness stemmed from ongoing struggles in the large manufacturing base in the state. While manufacturing represented a larger share of total employment as compared to the national share, it experienced the first cyclical period from the last recession without rebound or employment contribution to the state in modern economic times. Although output is up and several sectors are doing well, the overall manufacturing base has been impaired.

Within manufacturing, the issues include current national housing problems impacting demand and inventory adjustment for construction materials, appliances, and HVAC equipment production. Other problems include longer-term structural shifts to foreign production centers in appliance production and plant closures among secondary parts producers for Detroit-based auto manufacturing and aftermarket products. Higher rates of employment loss in the Arkansas manufacturing base largely account for the state's higher unemployment rate and overall underperformance in employment growth compared to the nation. The state unemployment rate was 1.0 percent higher than that of the nation in November 2007, just prior to the notable up-tick in U.S. unemployment.

There are several sources of growth in the state's manufacturing base that bode well for the state's economy in 2008. These include primary steel producers in the state with national and international market scope, an expanding corporate jet finishing cluster in Little Rock, auto parts operations geared to the regional growth of Asian auto manufacturers in the South, and multinational companies in general with expanded export opportunities. In addition, new sources of growth are emerging from international investment plays in the state, exemplified by LM Glasfiber from Denmark and Welspun Group from India. Their investment announcements follow on the heels of some notable misses in the super project category for auto assembly projects and an integrated steel project. The recent addition of a Fast Action Closure Fund for use in sealing economic development deals bore fruit in the mid-size project space in 2007 that will lead to construction, training, and hiring phases in 2008 and 2009. Although 2008 will be a challenging period for new project announcements and project financing in general, the Fast Action Closure Fund will play a part in future activity.

Beyond manufacturing, added economic weakness is evident in residential housing construction, heavy construction, and civil engineering projects. Although home sales and new home construction starts are down in most metropolitan areas of the state, the formerly hot markets in northwest Arkansas are presently the leading drag on the market and the state's economy. Continuing population and investment shifts within the northwest Arkansas market prevents generalizations about the area, but all of the formerly stellar submarkets have cooled. Meanwhile, the heavy construction market has fallen off as a result of completion of the multi-year interstate highway improvement program. Calls for a renewed funding push for highway programs are underway.

In the state's housing markets, speculative building was most noticeable in northwest Arkansas where growth in building permits in parts of the area was projected to double the units and population of some outlying communities in the area of growth. Also, compilations of subprime mortgage exposure by metropolitan areas across the country identified moderate to elevated exposure in Little Rock and northwest Arkansas, the two largest metropolitan areas in the state. As an overall indicator of housing transaction volume, the Arkansas real estate transfer tax series was down 7.9 percent in 2007 and 11.2 percent year-over-year in the final quarter of 2007. Building permits and other measures of new housing construction were down by much higher rates, particularly in northwest Arkansas.

With the growing list of problem sectors in the state, the natural gas development rush in the Fayetteville Shale play has gained importance incrementally. The state's economy is benefiting from a rapid increase in drilling activity, field support centers, and contracted technical services in a target set of north and northwest of the Little Rock metropolitan area. This development rush shows no sign of abating in 2008 as the primary investment groups redeploy financial assets from other prospects to take advantage of the unique combination of relatively safe drilling success rates and superior rates of return in the core development zone of the Fayetteville Shale natural gas field. Positive economic impact is noted even in state-level indicators for the high-wage sectors of Oil and Gas and also Professional and Technical Services. Average wages in these sectors exceed the state average and manufacturing average by 50.0 percent or more. In addition, measures of growth in retail sales in the core counties of the play appear elevated in 2007. This consumption boost for a six-county area will continue in 2008 if investment programs and drilling plans proceed as planned.

Worsening economic indicators and increasing numbers of recession forecast assessments at the national level in early 2008 bode ill for the Arkansas outlook. The state's track record on recessionary swings is one of leading the nation into recessions from an industrial perspective and a coincident decline in consumer spending patterns. With the state manufacturing base already shedding jobs at a faster rate than that of the nation and declining activity levels as a result of construction material manufacturing weakness, the stage is set for a consumer retrenchment led by the national example. The degree of impact is still in question given the long-term erosion of volatile sectors in the state's economy and the relative strength of service sectors and export markets. The farm economy is also bolstered by high commodity prices and a blend of strong export markets and domestic market prospects driven by the ethanol production impact on prices and crop allocations. Profit margins at poultry processors would be expected to play the role of victim in this scenario except that automation has been the main push in the sector as a result of overcapacity problems followed by input price inflation. Employment decline in the state's important food processing sector will continue in 2008.

Translation of employment growth and other factors to personal income has not been so dire for the state in recent quarterly income measures. The state grew marginally faster than did the nation during the second and third quarters of 2007. Given the fact that the Wage and Salary income component consistently underperformed the national growth rate, the state has relied on certain non-wage categories, including Transfer Payments and Dividends, Interest, and Rent. Farm Proprietor income has logged high growth at both the state and national levels. The outlook for personal income in 2008 is one of guarded concern for both Wage and Salary income and Nonfarm Proprietor income. More significant deterioration in labor markets and conditions among small business will come at both the state and national levels as part of a general pattern of weakness.

Financially, state government in Arkansas has not suffered from economic weakness as of year-end 2007. A conservative forecast and budget process allowed for a set of tax reduction efforts from the 2007 legislative session to proceed in combination with an extended pattern of deceleration in revenue collections. The state was $97.1 million or 4.6 per cent above forecast at the end of 2007.

In summary, the Arkansas economy has already been staggered by a variety of long-term and cyclical problems in manufacturing. The potential for sidestepping any national recession with local factors of growth appears more unlikely than was the case in other recent business cycles. Some mitigating factors include the relative lack of overbuilt housing markets and the lack of financial sector layoffs in the state. An energy play also helps in the absence of other sector growth.

by John Shelnutt, Ph.D., Adminsitrator, Economic Analysis and Tax Research, Arkansas Department of Finance and Administration

Dr. John Shelnutt is Administrator for Economic Analysis and Tax Research with the Arkansas Department of Finance and Administration (DF&A). His work involves economic analysis at the state level and revenue forecasting and tracking in support of the state budget process. He provides research and revenue reports to senior finance officials and the governor. His research and advisory unit is also involved in tax research and revenue impact assessment studies in combination with other divisions of DF&A.

Prior to his move to DF&A, Dr. Shelnutt was a Senior Research Economist and Director of Research with the University of Arkansas at Little Rock (UALR) Institute for Economic Advancement in the College of Business Administration. He was also director of the grant-funded EDA University Center of the U.S. Economic Development Administration at UALR.

Dr. Shelnutt received his Bachelor's degree from the University of Missouri at Rolla. He received his Master's degree and Ph.D. in Resource Economics from the University of Arizona. Chart 1. Annual Growth in Arkansas Real Estate Transfer Tax Collections, 2001-2007 2001 7.4% 2002 9.7% 2003 22.8% 2004 21.6% 2005 19.7% 2006 -0.2% 2007 -7.9% Note: Table made from bar graph. Chart 2. Arkansas Employment Growth, Total and Selected Sectors, 2005-2007