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Forecast: foggy with slippery conditions

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Wednesday, April 01, 2009

Why were the state’s economic forecasts so seriously off the mark?

Is there a more sure-footed way to predict the state’s fortunes?


By ABRAHAM HYATT
Cloud

It was August 2008, five months after the collapse of Bear Stearns and the federal takeover of Fannie Mae and Freddie Mac, and state economist Tom Potiowsky was still bullish on Portland's housing market. Prices could recover by mid 2009, he told the media. The economic slowdown would turn around about the same time. "The bloodletting is coming to an end," he was quoted as saying.

He was wrong. Last year marked the beginning of one of the most explosive economic crises in world history. And for much of that year, Potiowsky and his Office of Economic Analysis were cautiously optimistic about how Oregon would fare in the coming years. In September, as the global crisis spread and Lehman Brothers declared bankruptcy, Potiowsky told reporters he didn't think state unemployment would top 8.5% during the slowdown; by March, it had already hit 10.8%. He held off assessing that the state was in a recession until October, and only after Gov. Ted Kulongoski and the state's treasurer had made their own pronouncements that Oregon had indeed reached that stage.

In each new forecast over the past year, the metrics that show the health of the state and help officials plan for its fiscal future were revised downward again and again. In December 2007, the forecast showed the state would have a $207 million surplus in the current biennium. By February this year, that cheery figure had imploded into an $855 million deficit, one that is predicted to turn into a $3 billion pit for the 2009-2011 budget. Employment was expected to grow 1.7% in 2009; by December that had been revised to -1.5%. General fund revenue, taxes, video lottery sales, personal income growth — each new quarterly report was a downward revision of the last.

It's arguable what impact the incorrect forecasts have had on the private sector. Ryan Deckert, president of the Oregon Business Association, says that since rural economies are more dependent on public spending, the massive cuts on the state and local level have hit rural businesses hard.

On the other hand, J.L. Wilson, VP of governmental affairs at Associated Oregon Industries, argues that the forecasts had little impact since business owners do not depend on the state to plan for the future.

"They're too busy busting their butts trying to find ways to survive this economy and keep their people employed," he says. "They see the reality on the ground far better than any politician and they don't need a revenue forecast to tell them the economy is contracting."

But the same cannot be said for state agencies, schools and anyone else dependent on state money. The ramifications for those groups was simple: Instead of being able to make budget adjustments over the last year and a half — which correct forecasting would have allowed — they were forced to cram brutal cuts into the last few months of the biennium.

To fill the $855 million hole in this biennium's budget, legislators used state money and federal stimulus funds, and sliced millions of dollars from state agencies and programs. From the moment the budget cuts began, it was evident who was going to get hit the hardest: publicly funded universities and K-12 schools. Oregon spends 40% of its budget on education; in a recession that money is far from sacrosanct. While the Legislature was able to find federal money to soften the blow, K-12 schools had to find a way to cut $116 million before the end of the school year. As a result, an estimated one-third of districts will cut school days.

The threat of a major reduction in K-12 services drew more than 5,000 people to a protest rally in Salem in February. But in many ways it was too late. The planning that was needed to avoid dramatic cuts should have started 12 months earlier.

"Had we known what was going to happen, it would have made it easier on us," says Di Saunders, a spokesperson for the Oregon University System.

"Now the only thing we can do is make cuts," says Rep. Peter Buckley, the Democratic representative from Ashland who co-chairs Ways and Means. "If we had known in September or July the significance of the shortfall, schools could have planned differently — we could have planned differently."

Saunders and Buckley lament the lost chance to take pre-emptive action. For instance, instead of closing early this year, schools could have spread those lost days out over the course of a school year. Spending could have been frozen earlier. Hiring freezes could have been put in place. Schools could have ended the 2009 school year better equipped to face the rest of the recession, rather than in a state of panic.

Weather Who is to blame for the inaccuracies? At the end of the day the economic forecast is Potiowsky's responsibility. But he doesn't create it alone. As he develops each quarterly report he regularly consults with the Governor's Council of Economic Advisors, a 10-member advisory body comprised of economists picked for their individual expertise in economic planning and knowledge of Oregon's various sectors. While some members had a more bearish attitude over the course of 2008, members say there was never a radical disagreement between Potiowsky's work and their own opinions.

Potiowsky also heavily relies on data that he doesn't compile. Oregon's forecast is derived from national data the state buys from Massachusetts-based Global Insight, the world's largest economic firm, at an annual cost of $31,000. Those national numbers have, in the past, created an accurate base for how Oregon will perform, Potiowsky says. This time, however they didn't. And therein lies the answer that state legislators and economists interviewed for this story give when asked about 2008's forecasts. How, they say, could the state economist be expected to know something that so many other economists didn't?

"It's not clear to me that you can blame Potiowsky for the national forecast being off. I don't know anyone who was predicting what was going on," says Joe Cortright, VP of Portland's Impresa Consulting and a member of the Council of Economic Advisors.

In fact, many people were predicting what eventually happened. But predicting that the economy was going to tank and mathematically showing how that was going to happen using time-tested economic forecasting models are two very different things. Cortright is right: Based on anecdotal evidence from news reports and interviews with economists, it appears that no state economist in the nation accurately forecasted what happened. The current crisis is a once-in-a-lifetime event that blew all the established models out of the water.

Potiowsky sounds a little frustrated when he talks about last year. No, he says, he doesn't think he could have done anything different.

"With hindsight, maybe I should have thought more about the downside risks and changed the forecast," he says. "But that's only because of what I know now."

It would be easy to assume that rosy forecasts are influenced by political pressure placed on the state economist. Terrible economic news, after all, isn't seen as a stimulator of growth. However, state representatives and senators, the governor's office, and economists who sit on the Governor's Council of Economic Advisors all maintain that Potiowsky is under no such pressure. There is unanimous consensus that he works with complete autonomy.

Economists such as Howard Wial, a fellow at the Washington, D.C.- based Brookings Institute, argue that a state economist would gain little by sugar-coating their analysis. "No one is going to oversell a forecast," he says. The risk of having to face scrutiny as to why their reports didn't follow their established, publicly available forecasting models is too great.

"It is notoriously hard to predict massive turning points in business and economic cycles. At this point, everyone is just guessing," says Wial. "What these [forecasting] models do is help. But as the situation gets worse, nobody can be really confident in predicting when the nation or a state or a local region will come out of the recession or when job growth will change."

Weather2
Even before the recession began, economists and legislators were thinking about how to improve Oregon's economic forecast.

One idea would be to change how the state extrapolates its data from national figures. Randall Pozdena is head of consulting firm ECONorthwest's Portland office and sits on the Governor's Council of Economic Advisors. He and Potiowsky have discussed the possibility of the state creating its own national data that would be used alongside the Global Insight data. It could allow the state to be "in total control of the tool," he says. That idea hasn't gone beyond the discussion phase.

Rethinking the state forecast first came up in 2007 when the Legislature convened the revenue restructuring task force; reevaluating the forecast's methodology was one of its goals. The task force released its final report in January. It didn't address the state creating its own data or altering the methodology. Instead, it focused on ways to compensate if the forecast is wrong, specifically formalizing the Rainy Day fund. In other words, rather than try and change how predictions are made, the task force suggested that there should be more wiggle room in the budget for when the forecast is off.

Portland Democratic Rep. Jules Bailey likes that approach. Bailey has a unique view of the recession: He works as an economist at ECONorthwest and is a vice chair of the Legislature's revenue committee.

"We have an absolutely insane system. We're asking the economist to come up with predictions two years in advance," he says.

"If we were able to smooth the [fiscal] cycle, if our forecast was wrong we could shift resources," he says. "It would allow us to make tweaks from biennium to biennium."

Bailey says the topic of forecast reform has been brought up informally between some members of the 2009 Legislature, but that no specific ideas have been discussed, other than that any changes will likely need to be ratified by Oregonians.

Everyone agrees the system is flawed, but there's no fixing the inherent problem: trying to predict the economy so far in advance.

"We all need to recognize this is not chemistry, it's not as simple as repairing a transmission," says Randall Bluffstone, chair of Portland State University's economic department. "It's not a cookbook. There is no cookbook in a time of flux."

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