Despite challenges, state can influence 2012 economic outcome

Connecticut’s economy crawled out of the Great Recession at a snail’s pace in 2011, and the New Year isn’t expected to bring much change.

But while Connecticut’s economic fate rests largely with global factors, economists say state policymakers’ responses to five crucial challenges could shape whether that recovery accelerates, or grinds to a halt.

Key segments of Connecticut’s economy — including financial services, gaming and defense contracting — face big stumbling blocks in the new year while rising recession fears in Europe could curb foreign appetites for Connecticut exports.

Businesses remain wary of adding new jobs while consumers, despite early reports of a sound holiday shopping season, continue to safeguard their limited discretionary dollars.

Meanwhile, the threat of significantly reduced federal dollars flowing into Connecticut — both state government and its businesses — looms large.

But gloom and doom aren’t everywhere. Inflation remains modest, oil prices are below their 2011 peaks, and household spending rose this holiday season.

“There’s never been a time in my 30 years when there have been so many wild cards on the table,” Don Klepper-Smith, chief economist at DataCore Partners in New Haven, said this week. “I can’t recall a time when we’ve had so many risks out there, both upside risks and downside risks.”

“I don’t think we’re out of the woods yet,” said Fairfield University economist Edward Deak, who also serves as Connecticut model manager for the New England Economic Partnership. “It all goes back to jobs, and we haven’t had much of a jobs recovery yet.”

The University of Connecticut’s Center for Economic Analysis projected that the state’s real gross domestic product — the value of its economic output after adjustments for inflation — would finish 2011 with 2.64 percent growth.

Though that’s still below the 3 percent or 3.5 percent growth economists generally say is needed to seriously reduce unemployment, there’s s silver lining in that cloud. Connecticut’s output at least topped a national real GDP just below 2 percent.

But the center also warned in late November that Connecticut’s productivity likely would slide below the national level in 2012, and the U.S. outlook is sluggish at worst, modest at best.


That’s partly because one of the nation’s — and Connecticut’s — best customers, will likely be holding onto its euros in 2012.

Goldman Sachs, a Wall Street-based, global investment banking and securities firm, recently warned that European nations are responding to debt crises there by slamming the brakes on spending, rather than cushioning the economy with the stimulus approach employed here.

For Connecticut that would mean fewer sales of transportation equipment, other machinery and fabricated metals, computer and electronic products and chemicals.

“The European situation is really scaring,” economist Fred V. Carstensen, director of the UConn center, said. “The European leaders have done just enough to stave off immediate collapse, but they’ve lacked the political will to address the real problems.”

“The European Central Bank is not stepping up, which means while the U.S. opted for monetary stimulus during the recession, Europe is opting for austerity,” Klepper-Smith said. “And in a global economy, when Europe catches a cold, we are at risk.”

Though state officials tout the bipartisan unity that produced a package of job growth initiatives in late October, Carstensen and others said the best Connecticut solution to the European crisis doesn’t even require a vote.

State economic development officials “need to play a bigger role in guiding businesses to new markets,” Carstensen said. “There are more sophisticated global market analyses they can use to link Connecticut businesses with new markets and it doesn’t even take a new law.”

For example, Carstensen said, Connecticut has one category for tracking beer-related import and export data. Germany has 21. “They are serious about beer, lagers, ales, dark brews, light brews,” he said.

But in 2012, economists said, Connecticut needs to focus more on what consumers and businesses are serious about in China, Japan, South Korea and new emerging markets.

“There are a heck of a lot of export markets that are out there and we need to explore them more,” Peter Gioia, chief economist for the Connecticut Business and Industry Association.

Gov. Dannel P. Malloy’s administration spent much of 2011 focusing on helping existing Connecticut businesses preserve and grow jobs.

But Malloy’s economic and community development commissioner, Catherine Smith, said broadening Connecticut’s overseas sales base is a top priority in 2012.

“The international component is definitely a part of the strategy,” Smith said. adding that an outreach plan should be completed within the next three months. Asia, in particular, “is a huge opportunity for us,” she said.


Malloy already took crucial steps to accelerate Connecticut’s recovery, Carstensen said, when he and the legislature decided this past year to invest $864 million to revitalize the UConn Health Center’s Farmington campus, then committed another $291 million in an October special session to help develop a new genetic research facility for Jackson Laboratory on the campus.

Though Connecticut’s economy is not dominated by defense, insurance and financial services as it was three decades ago, it badly needs to diversify, economists said, adding that these and some of the old standbys face a bumpy road in 2012.

The New York state comptroller’s office issued a report this fall predicting 10,000 job losses by the end of 2012 and a decline in profit margins for Wall Street’s securities industry.

“My suspicion is those cuts on Wall Street are going to be a painful awakening here,” Deak said. State government relies very heavily on those earnings, most delivered by residents of Fairfield County, to prop up state income tax receipts.

National defense spending could be pulled back significantly in the new year as the American military presence in the Middle East is curtailed.

And nonpartisan state legislative analysts warned last week that plans to open new casinos in Massachusetts could strip away significant business — and nearly one-quarter of Connecticut’s share of video slot revenues — from Indian casinos in Ledyard and Montville.

“There’s not a whole heck of a lot the state of Connecticut can do about that,” Gioia said. And though Malloy recently indicated he wants to work with the tribes to help safeguard their share of the gaming market, the CBIA economist said Connecticut’s resources would be better spent promoting tourism in general, and investing in other areas that make the state attractive to businesses.

Plans also are progressing for a $567 million rapid transit bus line linking New Britain and Hartford, a project expected to relieve commuter congestion on Interstate 84 in Greater Hartford.

Carstensen’s center estimates that work on this initiative and the Jackson Lab-related project will add another 7,000 direct and indirect jobs to the already expected job creation of 11,000 over the eight quarters from September 2011 to September 2013,  particularly through the addition of construction jobs.

The administration also announced last week it had selected an internationally recognized port and harbor consulting firm to develop a comprehensive economic strategy for deep water ports in New London, New Haven and Bridgeport.

“Connecticut’s maritime industry is a vital piece of our state’s economy, accounting for tens of thousands of good jobs,” Malloy said. “Unfortunately, without a comprehensive strategy in place, we can’t know where the best chances for us to promote economic development exist.”

But transportation isn’t the only network businesses rely upon that needs attention in the new year, Carstensen said.

“New England is incredibly weak in terms of its information technology processing capacity,” Carstensen said, adding that with two major insurers — W.R. Berkley and Aetna — moving IT operations to Delaware, “we’re incredibly vulnerable as a region.”

The state’s financial services businesses need data processing services to back up all of their operations, and a similar demand is growing in biomedical pharmaceutical and digital animation fields, Carstensen said.

“Jackson Labs is going to demand a tremendous amount of computational processing capacity,” he said, adding that Connecticut should focus its tax credits and other financial incentives on plugging this gap now. “There is a tremendous hunger among businesses for this and we have nothing in Connecticut. How can you compete in the information age when you don’t have world class data processing capacity?


Unemployment hovered close to 9 percent in Connecticut for nearly all of 2011, and economists said businesses won’t start adding jobs in large numbers until they see profit growth they think will last, and unless they are convinced that the state can meet their needs.

“Businesses don’t add new hires until demand really starts to pick up,” Klepper-Smith said. “There is really very little incentive to add new hires. You make do with existing staff.”

Diversifying Connecticut’s economy will help add jobs over the long haul, but Gioia said there is something businesses need over the short-term: a break from new taxes.

Malloy and the legislature added $1.5 billion in new state taxes in 2011 to help close a record-setting budget deficit, and gave towns roughly another $100 million in revenue-raising authority to help keep their budgets in balance.

And though there’s been not a whisper about further tax increases in 2012, Gioia said that’s not good enough. State government has to show it’s serious about avoiding them in the future, and there’s still lots more work to be done on this front, he added.

Roughly one-quarter of the $700 million savings that Malloy’s concessions deal with state employee unions must produce this fiscal year is supposed to come from cost-saving efficiencies identified by three labor-management panels.

But two of the three panels hadn’t even met until the fiscal year already was nearly four months old. Rather than wait, the administration drew up its own blueprint in October, assigning each agency a share — regardless of whether these panels recommend any efficiency strategies.

Critics already have questioned whether the process really will produce programmatic cuts that will save money year after year. The University of Connecticut, which saw its budget reduced nearly $45 million this fiscal year, responded with a four-stage tuition and fee increase that will raise an extra $50 million per year by 2016.

“The administration really needs to fast-track that” efficiency panel effort, Gioia said. “If anyone thinks they’ve really found many savings ideas yet, they’re nuts. Believe me, the business community doesn’t just pay attention to taxes. It is very locked into the spending side of the equation.”

Another problem plaguing businesses, Carstensen added, is an “insanely complex” sales tax system. With a base rate of 6.35 percent, Connecticut forfeits about $3 billion annually exempting dozens of goods and services, while officials added new higher, luxury sales tax rates on expensive vehicles, boats and jewelry.

Malloy and the legislature missed a golden opportunity during the 2011 budget crisis to close out many of these exemptions and simultaneously reduce the overall rate by at least 2 percentage points, Carstensen said.

“It drives companies nuts and it drives consumers nuts,” he said. “It’s not good for jobs.”


And if businesses aren’t ready to add jobs or dole out raises, economists said, consumers aren’t ready to spend.

Therein lies another challenge for the Connecticut economy, Klepper-Smith said, because consumers aren’t feeling much better than businesses are.

An NBC News/Wall Street Journal poll released in November found that 25 percent of the nation expects the economy to improve in 2011, while 28 percent looks for things to get worse and 47 percent expect them to stay the same.

Consumer poll


The same poll also found 36 percent of respondents describing their personal economic situation in November 2011 as worse than it had been the prior year. Just 16 percent said it was better and 48 percent said it was the same.

The need for state officials to avoid tax increases in 2012 is important for more than just business confidence, Klepper-Smith said.

Between 1987 and 2009, state spending grew by 284 percent, he said, while personal income in Connecticut rose by 172 percent.

“The average citizen is not in a position to pay more for government,” he added. “Government has yet to make the spending adjustments that the private sector has.”

Most economists say the best measure of consumer spending power is real disposable personal income — the amount of income available after taxes and living expenses for discretionary spending.

For nearly three decades, this has grown by an average of 2 percent, and by as much as 4 percent to 6 percent in good economic times, Klepper-Smith said. In 2011 is rose by 1 percent, and next year it’s slated to rise by 1.2 percent.


Consumer confidence might have taken a hit last month had Congress and President Obama not reached a temporary compromise to extend a payroll tax cut through February. But if that relief goes away in 2012, it could be the first of many fiscal retreats by the federal government, economists said.

Federal aid accounts for more than $3.6 billion, or nearly one-fifth of all revenue in the state budget. And state analysts project it will approach nearly $4.2 billion by 2014 as Connecticut tries to take greater advantage of matching federal reimbursement programs, particularly for health care.

But Gioia said that once political gridlock begins to ease up on Capital Hill, any serious effort to reduce the federal budget deficit likely will include significant reductions in state grants, particularly in big areas like transportation and health care. “They’ve got to come to grips in Connecticut with the fact that aid from Washington will decrease,” he said.

“We’ve already seen some of this,” Deak said, referring to cuts in federal funding for winter heating assistance for the poor. The state legislature already agreed to supplement the program with state funding, and likely will face a decision later this winter to add more dollars or reduce benefits.

Klepper-Smith also said that significant cuts in federal aid may be coming sooner than state leaders expect. Lowering interest rates, an oft-used approach to stimulate the economy, really isn’t on the table, he said, since rates already are at an all-time low. And given partisan differences in Congress, the chances of another multibillion-dollar federal stimulus program for states are nil.

“The traditional tools you have for stimulating the economy are either politically not viable or ineffective, since you can’t really lower rates much more,” he said.

The prospect of reduced federal spending also could mean less work for Connecticut’s defense industries and others that rely on federal contracts.

How can Connecticut deal with declining federal spending, especially if it hopes to avoid raising state taxes? Get a bigger share of whatever federal dollars are left, Carstensen said.

But to do that, he added, state policymakers would have to shake up a political hornet’s nest they have avoided for two decades: reforming the state’s constitutional spending cap.

State officials too often forfeit federal funds to avoid the technicalities of the cap system, which tries to keep annual spending hikes in line with the growth in personal income.

But critics say things don’t always work as planned.

In 2000, the legislature and then-Gov. John G. Rowland approved an $85 million cut in hospital taxes, matched by an almost equal cut in state aid to the industry. This fiscal swap was designed to take advantage of a technicality: lost tax revenues don’t count as spending under cap rules, but grants to hospitals do count.

But what got less attention at the time was that the $85 million cut in state spending on hospital assistance disqualified Connecticut from about $40 million in federal reimbursements.

“We actually prefer to spend state taxpayer money on a discretionary basis than federal money,” Carstensen said. “We can’t afford that any more.”