August 2007

Texas Economy Takes a More Moderate Path

The Texas economy picked up slightly in the second quarter. Employment registered an annualized 2.3 percent in the second quarter, up from weaker growth of 1.7 percent in the first (Chart 1). The July Beige Book also reflected a slow first quarter with an uptick in the second. Despite the quarterly improvement in the employment picture, most indicators suggest economic growth has slowed this year from the vigorous pace recorded in 2006.

Growth in the Dallas Fed's Texas Business-Cycle Index, a broad measure of the state's economic health, has decelerated this year. Year-to-date expansion in the index has averaged 3.5 percent, which compares with 4.2 percent last year.

The Texas Labor Market Remains Tight
Data and anecdotal reports point to a very tight labor market. The Texas unemployment rate is the lowest on record, and unemployment insurance claims are holding steady at low levels. Beige Book continues to report widespread shortages of workers with specific skills.

Goods-Producing Sector Sees Job Growth Slow in 2007
Texas is not getting the boost from the goods sector that it did last year. In the first half of 2007, service-sector employment growth was a respectable 2.2 percent, but the goods sector saw a dramatic slowdown, from 5.3 percent in 2006 to an annualized pace of 1.3 percent year-to-date (Chart 2). Although the employment figures are still subject to revision, anecdotal evidence also supports a softening in goods-sector growth.

The slowdown in goods-sector job growth has occurred in all three major industry categories—energy, construction and manufacturing. Growth in the construction and manufacturing sectors has been hindered by weakness in the housing sector, according to Beige Book and recent data. While energy activity remains at very high levels, growth in the sector has recently been restrained by lower natural gas prices, a tight labor market and higher costs, including wage pressures.

Housing Becomes a Drag
The housing sector is becoming a drag on Texas economic growth, as homebuilders across the state continue to curb new home construction in response to weaker demand and high inventories (Chart 3). Single-family building permits have fallen 34.5 percent from June last year, and starts are down 12.2 percent. Single-family contract values are 20 percent below June 2006 levels. The Texas housing market remains better off than many other areas of the country, and home prices have held up relatively well. Still, in the July Beige Book, homebuilders were less optimistic, expecting the inventory correction to continue into next year.

Manufacturing Bears Brunt of Housing Decline
Manufacturing employment improved in the second quarter, after falling in the first quarter. Still, year-to-date employment in the sector is down 1.1 percent, despite strength in some industries.

Job growth has been strong in the transportation equipment and chemical industries so far this year (Chart 4). However, the gains were not enough to offset job declines in the high-tech, construction-related and electrical equipment manufacturing industries, which together make up about 25 percent of Texas' manufacturing jobs.

Job declines in the computer and electronic products industry reflect ongoing outsourcing and restructuring in Texas' high-tech sector. Construction-related manufacturers, which include lumber, cement, brick and steel-producing firms, are reducing staff due to a falloff in orders related to the housing downturn. Likewise, appliance manufacturers report a decline in housing-related demand.

Texas Economic Outlook Remains Positive
Despite the housing-related weakness, much strength remains. Texas commercial construction activity is robust, with strong demand for space coming from many industries, especially those in the service sector. Texas exports rebounded in May, and data and anecdotal reports suggest retail sales are better in Texas than in other parts of the country, even though higher gasoline and food prices have taken a larger share of consumer's disposable income.

The outlook for the Texas economy remains positive. The Dallas Fed's Texas Leading Index suggests job growth of 2.8 percent in 2007, slightly slower than last year's pace, but right at the historical average.

—D'Ann Petersen and Laila Assanie

About the Authors Petersen is an associate economist and Assanie is an assistant economist in the Research Department at the Federal Reserve Bank of Dallas.