Regular Features

New York Region: Asian Crisis and Poor Demographics Pose Short- and Long-Term Exposure

• The New York Region's economy continues to prosper while the national economy booms.

• Fallout from the Asian crisis may harm selected industries, but so far the effects appear muted in the Region.

• Unfavorable demographic trends may hinder long-term economic growth in housing and retailing.

Region's Economy Continues to Thrive

Chart 1

In contrast to other Regions, where economic and job growth has been faster but perhaps more volatile, a slow and steady pace has characterized growth in the New York Region. Reflecting the job gains, unemployment rates throughout the Region continue to fall. Except for Puerto Rico, which is experiencing a job slowdown, most states have been reporting their lowest unemployment rates in almost a decade. However, most state unemployment rates are still above the national average. The exception is Delaware, with a 3.4 percent unemployment rate in the first quarter of 1998, one of the lowest rates in the nation.

Despite the positive trends, two important factors threaten the Region's economic growth and expose financial institutions to risk. The short-term factor is the Asian crisis, which in the next two years could dampen export growth and hurt Regional industries whose products compete directly with Asian goods. The second factor, which has longer term implications, is the lack of population growth in general, but especially in the age cohort between 25 and 34 years old. Most household formation begins during these ages, starting the demand for homes and family-related retail products and ultimately for banking services. The Region has been experiencing less demand for housing and retail products than other parts of the nation as this cohort has continued to decline.

Local Effects of the Crisis from the Asian 10 Countries¹

The financial and economic crisis in Asia resulted from a number of factors, including weak financial oversight, inability to maintain domestic currencies pegged to the dollar, and growth in speculative investment (see The Asian Economic Crisis: Implications for the U.S. Economy). It is still too early to assess the specific financial effects of the Asian crisis on industries in the Region. Nevertheless, the crisis has potential adverse consequences for industries that export goods to Asia if demand for their products is reduced.

When measured in terms of gross state product, merchandise exports to the Asian 10 countries represent only a small component of each state's overall economy (see Chart 2). However, 1997 statistics from the Federal Office of Trade and Analysis show that the Region exported $26 billion in merchandise to the Asian 10 countries, representing nearly one-quarter of the Region's total exports. As a percentage of total goods export dollars, Delaware has the highest exposure to the Asian 10 countries, followed by New York and New Jersey (see Chart 3). Asian export exposure in Delaware is centered on chemical products. In New Jersey and Pennsylvania, export exposure is primarily focused in the manufacture of drugs and allied chemical products and electronic equipment. In New York, export exposure lies in the industrial machinery, chemical, and agricultural industries. In addition, the apparel industry, a leading manufacturing sector and major employer of blue-collar workers in New York City, is very sensitive to the currency valuation pressures stemming from the Asian crisis. Because the apparel industry requires very quick turnaround and has relatively light plant and equipment requirements, manufacturers can shift production locations quickly.

Chart 2

Chart 3

Despite Limited Exposure to Asia, Risks Remain

Another major concern is that the crisis will spread to other parts of the world, such as Latin America or even Europe. Analysts have already noted outflows of cash from Latin American mutual funds, while forecasts of 1998 Latin American corporate profits are being reduced. If the Latin American situation worsens, exposure by the Region's banks would be far greater because exposure to Latin America is much higher than exposure to Asia. While the effects on Latin America are not yet clear, a recession there would pose an additional threat to banks.

The continuing volatility of the world's stock markets and a closely linked global economy also mean that the U.S. stock market could suffer if investors perceive a sharper than expected decline in U.S. corporate earnings. Because of this Region's dependency on Wall Street and the financial sector in general for jobs and income, a sharp and sustained sell-off in the stock market resulting from instability abroad would have serious consequences for its economy. A worsening of the Japanese economy, in particular, could have detrimental economic and political consequences for the United States and the Region. In the first quarter of 1998, the Japanese economy shrank 5.3 percent compared with the previous quarter, worse than even the most pessimistic forecasts. The Japanese economy is in its worst recession in more than two decades.

Demographic Trends May Pose Longer Term Risk

Chart 4

More important, the age cohort between 25 and 34 is declining faster in this Region than elsewhere. This cohort is essential to long-term economic growth because it forms the basis of future demand for items such as housing, automobiles, and purchases related to child-rearing. Most households make an initial move into homeownership between the ages of 25 and 34. The number of individuals entering the housing market for the first time drives demand and allows existing homeowners to trade up. Partly because of the decline in this age cohort, permits for the construction of new single-family homes in the New York Region have lagged behind the nation (see Chart 5). Although other factors such as interest rates, employment, and availability of space are important determinants of housing demand, this basic demographic limitation will continue to lessen demand for new homes and may eventually curtail construction, home equity, and residential real estate loans (see Current Regional Banking Conditions).

Chart 5

In addition, the unfavorable demographic trends combined with fewer new homes being built and purchased mean that fewer dollars will be spent on retail goods. When a household buys a home, it generally increases retail spending in order to furnish the home. When children are born, retail spending also increases to meet the needs of a growing family. As the population ages, some of this spending is reduced, going instead for services such as health care. Partly as a result of these demographic trends, retail sales in the Region have lagged behind the nation during the 1990s. Economists expect that this trend, too, will continue to limit banks' local market lending opportunities (see Chart 6).

Chart 6

New retail space combined with slower absorption has pushed up vacancy rates throughout the Region (see Chart 7). Over 8 million square feet of new retail space was added to the New York Region market in 1996 and more than 9 million in 1997, increasing vacancy rates from 7.2 percent in 1995 to 7.8 percent in 1997. This trend mirrors trends in the nation. Moreover, according to the FDIC Real Estate Report, a large number of retail real estate projects are in the planning stage throughout the Region. For example, in the Philadelphia area, efforts are in the final planning stage to add over 1.5 million square feet of new retail space, while in the Washington, D.C., area, efforts also in the final planning stage would add over 1.3 million square feet of new retail space. While the suburban economies around these cities have been growing, the central-city areas have experienced declining populations and weak economies over the past decade.

Chart 7

In view of the unfavorable demographic trends, competition among banks for a slow-growing pool of consumer and business loan applicants may intensify. Competition may lead to looser underwriting standards to sustain growth. With potentially less demand for residential real estate, consumer, retail business, and retail real estate loans, banks may have to rely more on other forms of revenue enhancements, such as increased fees or additional services, to maintain profitability. Retail real estate projects should be scrutinized to ensure feasibility, particularly in relation to other planned projects and the ability of the local markets to sustain economic growth.

Norman Gertner, Regional Economist

For More Information

Office of the State Deputy Comptroller for the City of New York. The East Asian Economic Crisis. Technical Memorandum 1-99. April 27, 1998.

Regional Economic Studies Institute. 1998 Economic Outlook Conference. Baltimore, Md.: Towson State University, December 1997.