Strong Fundamentals Should Bolster the State Economy from a Cyclical Slowdown
Article by The Wells Fargo Economics Team
The Texas Economy Appears Well Poised to Navigate Potential Turbulence
Summary
- We expect the dual headwinds of tighter credit conditions and rising interest rates to produce a nationwide recession toward the second half of this year. If a downturn does occur, Texas’s record of sturdy population and job growth should equip the state economy to withstand a national slowdown relatively well.
- From 2010 to 2020, Texas posted the largest average annual population expansion of any state. Over that same period, Texas ranked fourth in terms of average annual real GDP growth. These strong fundamentals should provide a tailwind for growth.
- Texas experienced a shallower economic contraction than the nation during each of the prior two downturns. The Texas economy will likely moderate in coming years, but once again appears poised to outperform the nation. We forecast real GDP growth in Texas will downshift to 3.2% in 2023 and 2.2% in 2024.
- Texas has been one of the major beneficiaries of the post-pandemic acceleration in migration to more affordable areas in the South. Texas gained 231,000 net new residents from other states in 2022, a step up from its pre-pandemic annual average. Texas also registered the single largest population expansion from natural causes of any state over the last two years, which gives it another demographic edge.
- Texas’s growing working-age population is a lure for employers in the midst of scarce labor supply. Texas recuperated its pandemic labor force declines in only five months. Meanwhile, the nation’s labor force did not return to its prior peak until August 2022. As of March 2023, the state’s labor force sits 6.1% above its pre-pandemic level, marking the third largest labor force leap in the country.
- The state economy recovered the pandemic employment losses registered in early 2020 in October 2021, eight months before the national job recovery. Hiring has kept pace since. In Q1-2023, the pace of hiring in Texas exceeded the rates averaged before the pandemic and was higher than the national average.
- The state has experienced substantial growth in technology payrolls as a wide variety of technology companies continue to expand their footprint in the state. Semiconductor manufacturers have also looked to Texas to boost domestic capacity.
- We expect employers in the state will pull back on hiring as the effects of higher interest rates and tighter credit conditions set in. We look for job growth to slow from the robust 5.8% pace in 2022 to a more modest 2.9% increase in 2023 and 1.0% in 2024. We expect the unemployment rate to trend up alongside slower job growth, rising from 3.9% on average in 2022 to 4.3% in 2024.
- A collapse in energy prices during the pandemic dealt a blow to Texas’s oil sector. Although crude production in the state has steadily grown since hitting a low point in May 2020, output remains below its pre-pandemic peak. The state’s lagging recovery in production has resulted in slower growth for oil and gas extraction, pipeline construction and support payrolls.
With Dark Clouds on the Horizon, Texas Is Poised to Shine
The Texas economy currently appears to be firing on all cylinders. Real GDP in the state expanded 3.4% during 2022, the fifth fastest pace among all states and faster than the United States as a whole. Of course, the Lone Star State is no stranger to robust growth. Since 2012, the state population has increased by close to 4 million new residents, a 15% cumulative gain. The knock on effects of the pandemic only appear to have shifted population growth into a higher gear. An influx of new residents and businesses from all over the country has propelled a strong pace of economic growth throughout the state, in particular in advanced services such as tech and financial services. Meanwhile, post-COVID structural shifts such as supply chain fortification, manufacturing reshoring and constrained global energy supplies have been a boon for the state’s energy, manufacturing, logistics and trade sectors.
The Texas economy is growing at a strong pace, but clouds are forming on the horizon. Banking system volatility looks to be leading to stricter lending standards. Businesses confronted with tighter credit conditions could potentially pull back on hiring and investment in the months ahead. On top of tighter credit conditions, the cumulative effects of the Fed’s year-long bout of monetary tightening in order to tamp down inflation have yet to be fully realized. Nationally, we forecast a modest recession to materialize in the second half of this year. We expect real GDP growth to slow and begin contracting in Q3, leading businesses to begin shedding payrolls in the fourth quarter. Although we do not expect the national recession will be long-lived, we forecast real GDP to decline by 1.2% on a peak-to-trough basis. Furthermore, we expect the U.S. unemployment rate to rise to peak of 5.1% in Q2-2024.
If our expectation for a national recession is realized, the Texas economy would likely hold up relatively well. The state’s robust population growth is a strong tailwind. Figure 1 demonstrates that Texas has been a front-runner in average population growth and state-level real GDP growth between 2010 and 2020. During that period, Texas posted the largest population expansion of any state and added roughly 400,000 new residents per year on average. During the same time, the real GDP in the state grew an average of 2.9% annually—the fourth fastest rate in the nation. More recently, population growth amounted to 1.6% in 2022, making Texas the fourth fastest growing state in the nation.
Texas Continues to Benefit from the Affordability Migration
Historically, population growth holds a close link to economic growth. In the past two downturns, strong population growth has been one factor which has helped bolster the Texas economy from the effects of a national recession. In 2008 and 2009, real GDP contracted by 2.3% on a peak-to-trough basis, a better outcome than the 4.0% national decline. Likewise, Texas experienced an 8.4% peak to trough decline in real GDP in 2020 during the pandemic downturn—a shallower drop than the 9.6% nationwide decline. Population growth has also boosted the economy more recently. The latest data show that the Texas economy grew at an annualized 7.0% in Q4-2022, a faster pace than any other state and more than twice the 2.6% rate experienced in the U.S. as a whole. Texas’s relatively rapid population growth will likely continue to support the state’s economic performance should the national economy enter into a contraction as we currently expect.
Net domestic migration has been a major driver of Texas’ rapid population growth. The pandemic accelerated migration patterns away from expensive coastal cities to more affordable areas in the Sun Belt and South. Texas has been one of the major beneficiaries, with the state experiencing an upshift in net domestic migration over the past few years. The state registered gains of 193,000 and 231,000 net new residents from other states in 2021 and 2022, respectively. During this period, Texas was second only to Florida in terms of net domestic migration. This pace is a significant step up from the 124,000 average level recorded from 2011 to 2019 (Figure 3). As shown in Figure 4, the vast majority of post-pandemic population growth has been concentrated in the Texas Triangle. Roughly two-thirds of Texans live in the Dallas-Fort Worth, Houston, Austin and San Antonio metro areas, and these metros were responsible for over 90% of the state’s overall population growth from 2019 to 2022.
Texas’s favorable demographics within the state is another economic edge. With a median age of 35 as of 2021, Texas is tied for the second youngest state in the nation. Texas has also registered the single-largest natural population expansion of any state over the last two years. A recovery in international migration further bolstered Texas’s population gains last year. Texas gained roughly 119,000 net new foreign-born residents in 2022, the highest level in more than two decades.
The ability to attract residents from out-of-state has become a major competitive advantage for the Texas labor market. The state economy recovered the sharp employment losses experienced in the early months of the pandemic in October 2021, eight months before national payrolls returned to the prior peak in June 2022. Hiring has kept pace since, with Texas adding an average of 52,500 jobs per month in 2022. This pace was a slight step down from the 63,000 average monthly gain in 2021, however it is nearly 2.5 times higher than the average monthly gain in 2019. The hiring streak carried over into 2023 when employers in the state added an average of 35,200 jobs per month in the first quarter of the year. The 3.1% annualized pace of hiring in Q1-2023 exceeded the rate averaged before the pandemic and was higher than the 2.7% national average during the same period.
Driving the Texas economy’s ability to sustain such a rapid pace of hiring has been a relatively strong rebound in the state’s labor force. The Texas labor force contracted by 5.2% from February to April 2020, roughly on par with the 5.0% national contraction. Texas completely recuperated the labor force decline in only five months, while the national labor force returned to its prior peak in August 2022. Texas’s labor force sits 6.1% above its pre-pandemic level as of March 2023, which marks the third largest labor force leap in the country. As Texas’s labor force has grown, so has its labor force participation rate. After declining sharply in 2020, the labor force participation rate fully recovered in December 2021 (Figure 5). The state’s labor force participation rate ticked down over the course of 2022. However, as of March 2023, it stands at 63.9%, over one percentage point above the national rate of 62.6%.
Robust labor supply has created somewhat looser labor market conditions in the state. Texas’s seasonally adjusted unemployment rate measured 4.0% in March 2023, higher than the national rate of 3.5% (Figure 6). Not every metro shoulders the same labor market slack, however. We note that the most up-to-date labor market data at the metropolitan statistical area level are not seasonally adjusted. Midland, located in the heart of West Texas’s oil and gas fields, has the lowest unemployment rate in the state at 2.6% as of March. Comparatively tight labor market conditions prevail in Austin, which boasted a 3.5% unemployment rate during the same month. Dallas-Fort Worth registered a 3.9% unemployment rate as of March, slightly lower than the state as a whole. That noted, labor supply in the Austin and Dallas metros has surged above their February 2020 levels, amounting to post-pandemic labor force expansions of 14.1% and 9.4%, respectively. Houston and El Paso each recorded relatively higher jobless rates of 4.4% and 4.6%.
Firms Hang their Hat on the Texas Economy
Employment growth has been remarkably broad-based recently. Measured against pre-pandemic levels, Texas’s payroll growth has outpaced the nation in nearly every major industry (Figure 7). A myriad of corporate relocations and expansions has propelled Texas’s upsurge in employment. The state’s relatively lower business costs and more favorable regulatory environment are significant motivations for firms. In addition, Texas’s growing working-age population is a strong lure for employers in the midst of scarce labor supply. For example, according to LinkedIn, Dallas-Fort Worth and Austin have ranked among the top destinations for new workers nationwide since the professional networking site first started publishing metrics in 2017.
The professional services sector has been a major force behind the Lone Star State’s economic momentum. Texas added over 275,000 professional & business services industry jobs from February 2020 to March 2023, a 15.1% increase. This marked the largest absolute gain and third-largest percentage gain of any state. Fueling the expansion was a 23.2% rise in professional, scientific and technical services. Texas also registered an 11.9% gain in information payrolls, which is another sector that captures employment in the tech industry.
The Austin metro area has become a tech standout. The metro has attracted a wide variety of major technology firms such as Oracle, Hewlett Packard and Amazon over the past few years. As of March 2023, the Austin metro registered a 37.5% leap in professional, scientific & technical services and information industry payrolls above pre-pandemic levels, a larger gain than either of the tech hubs in the San Francisco MSA (12.6%) and Seattle MSA (15.0%). Although the sector is still growing, higher interest rates and economic uncertainty have led industry employment growth to downshift more recently. Tech payrolls in Austin rose at an 1.1% three-month annualized rate in March 2023, down considerably from the 15.6% pace recorded in September 2022.
Texas’s finance sector has been another growth area. Finance and insurance payrolls in the state have risen over 11% since February 2020. Much of the industry growth appears to be concentrated in the Dallas-Fort Worth metro area, which is home to the largest base of finance and insurance employment outside of the New York-Newark-Jersey City MSA. Although finance and insurance payrolls in Dallas-Fort Worth are about 40% smaller than in the New York City MSA on an absolute basis, industry headcounts are growing at a much faster pace in the Dallas-Fort Worth MSA. As of February 2023, the metro’s finance and insurance payrolls ballooned 14.6% over pre-COVID levels, outshining the 4.7% gain in the New York City MSA. Texas’s burgeoning financial services sector may increase its exposure to financial system volatility in the near term. That said, the state’s diversification into finance represents a positive shift in the industry landscape that will likely benefit in the Texas long-term.
Texas has also experienced strong gains in manufacturing employment. Manufacturing payrolls in the state have expanded 4.1% above pre-pandemic levels as of March, outpacing the 1.5% U.S. expansion over the same period. Advanced manufacturing has been a notable growth area. Tesla relocated its global headquarters to Austin in 2021 and employs 5,000 workers at its Austin “Gigafactory.” The electric vehicle manufacturer signaled the intention to invest an additional $717 million to expand the plant in the near future. Semiconductor producers have similarly looked to Texas to fortify and expand domestic capacity amid the global chip shortage. Texas Instruments recently broke ground on a new chip fabrication plant in Sherman, the first of a planned $30 billion four-building development. Samsung, meanwhile, is currently deploying its largest-ever U.S. investment at its semiconductor facility outside of Austin.
So far, it seems that Texas manufacturers have weathered rising interest rates relatively well. According to the Dallas Fed’s Manufacturing Outlook Survey, manufacturers in the 11th Fed district on net have expanded production nearly every month since the Fed began raising interest rates in March 2022. The state is not immune to national headwinds, however. As of April 2023, net new orders for manufactured goods have contracted for 11 consecutive months, nearly the entire length of the Fed’s tightening cycle (Figure 9). It is likely that tighter credit conditions coming down the pipeline will keep the manufacturing sector under pressure this year.
A collapse in energy prices during the pandemic dealt a blow to Texas’s oil sector. The state’s crude production dropped from 5.4 million barrels per day in March 2020 to 4.2 million in May 2020. Although production has grown since hitting a low point, the recovery has been fairly sluggish. As of January 2023, Texas was producing 5.2 million barrels of crude output per day, which is still 3.9% below its March 2020 level. Rotary rig activity in the state has nearly recovered from its pandemic drop, however there are roughly 30 fewer rigs in operation today than in February 2020 (Figure 10).
Lower oil production does not appear to be result of lower prices. As of this writing, the price of West Texas Intermediate is relatively high at about $75 per barrel. For context, firms in the most recent Dallas Fed Energy Survey from Q1-2023 indicated oil prices would need to be $37 per barrel, on average, to cover costs and between $56 and $66 per barrel for new drilling to be profitable. Instead, responses from the same Dallas Fed survey suggest that labor shortages, environmental concerns, supply constraints and regulatory uncertainty may be factors holding back production.
Texas may not be entirely back to its pre-pandemic stride, but the oil giant remains the national leader in crude production. Crude output in Texas quintupled from 2010 to 2019 thanks in large part to booming production in the Permian Basin spanning West Texas and Southeast New Mexico. Although Texas’s oil output still lags, the Permian has bucked the trend. In this regard, New Mexico’s ramp up has more than made up for Texas’s slower recovery. As of May 2023, the region was producing 15.8% more crude output per day than its prior peak in March 2020. This jump makes the Permian one of only two oil-producing regions tracked by the Energy Information Administration to surpass its pre-pandemic crude production, with the Appalachia Basin as the other.
The state’s lagging oil recovery has left a dent in oil-related payrolls. Only two of Texas’s major industries have not outpaced the nation in terms of post-pandemic job growth. The first is construction, where headcounts are up 3.6% over their pre-COVID levels as of March, roughly in line with the 3.7% national expansion. The relatively slower growth compared to other industries can be largely attributed to tepid growth in oil and gas pipeline construction employment. Similarly, mining & logging payrolls in Texas remains 9.3% below pre-pandemic levels as of March 2023, which is a shortfall owed to lower oil and gas extraction and support activity payrolls.
In contrast to pipeline construction, building construction payrolls in Texas have expanded alongside a flood of residential and commercial real estate investment in the state. Non-seasonally adjusted building construction employment reached a peak in October 2022 when it sat 7.5% above its February 2020 level. Since then, payrolls have declined 1.9% through March 2023. The drop has occurred alongside higher mortgage rates, reduced housing demand and a pullback in new home construction. Residential construction employment could remain under pressure as home builders reassess the future demand environment. Nonresidential construction could also likely be challenged as tighter credit conditions and a looming downturn weigh on commercial real estate development.
Conclusion & Outlook
If past is prologue, the Texas economy should hold up relatively well if the nation enters a recession as we currently anticipate. The state averaged one of the fastest real GDP growth rates in the country in the ten years leading up to the pandemic and outperformed the nation during each of the prior two downturns. That said, we expect higher interest rates and tighter credit conditions to drag on economic growth in Texas. We forecast the Texas economy to grow 3.2% in 2023 and 2.2% in 2024, a step down from the 3.4% real GDP growth rate in 2022. On a quarterly basis, real GDP in Texas is likely to trend lower in the second half of 2023, but remain in positive territory. While moderating, real GDP growth is likely to be a bit stronger than for the U.S. economy, which we expect to contract in the last two quarters of 2023 and first quarter of 2024.
Slower output growth will likely be accompanied by a more moderate pace of hiring. Specifically, we forecast payrolls in the state will rise at a more modest 2.9% annual rate in 2023 and 1.0% in 2024. Consequently, we expect the unemployment rate to trend upward over the next two years, but by a smaller magnitude than the U.S. average. We expect the jobless rate to average 4.1% in 2023 and 4.3% in 2024, up from 4.0% currently. Robust population growth is likely to remain a powerful tailwind. Texas continues to welcome an influx of residents, and while the stream may slow in event of a downturn, a still-sturdy pace of job growth is likely to bolster net domestic migration to the state. Meanwhile, the recovery in international migration is likely to continue in 2023. These factors fuel our expectation for 1.7% population growth this year.
