If There Is A Recession In 2023, Some Cities Could Take A Decade To Recover

The Fed’s efforts to slow inflation seem to be working, at least a little bit. The labor market is cooling down, putting less pressure on wages, while housing prices and new construction have both declined. Unfortunately, this slowdown in economic activity will likely come with a cost: According to Bloomberg’s December 2022 survey of economists, there is a 70% chance of a recession in 2023. A recession may be necessary to tame inflation, but research shows the harms of recessions are not distributed equally. In some cities, it may be a decade or more before their economies get back on track.

Employers created 223,000 jobs in December, down from 256,000 in November and 263,000 in October. Average hourly earnings rose by 0.3% from November to December and 4.6% over the previous year, which was below expectations. The labor market slowdown combined with the slowdown in new housing construction are signs that the Federal Reserve’s interest rate increases are reducing economic activity.

Less consumer spending and investment are signs that excess money is being pulled out of the economy. This should lead to lower inflation over time since inflation is caused by too much money chasing too few goods. Reducing inflation is a worthy goal and the Fed should focus on hitting its 2% target to maintain credibility. The downside, however, is that a slowdown in economic activity means less output and thus less employment and often lower wages. In the past, the economy has typically gone into a recession after periods of relatively high inflation, as shown below.

The United States is a large country, both geographically and in terms of population. So even if the country is technically in a recession, not every area will feel the same amount of pain. In a 2016 study, the authors analyzed the 50 most populous metropolitan statistical areas (MSAs) to see how often each had a recession over a 26 year period. There were three national recessions over this period, but several MSAs only experienced one or two recessions. The Oklahoma City MSA was the only one to not experience a single recession.

While it is possible for some areas to avoid a national recession altogether, most local economies will experience at least some pain, and this pain could persist for years. In a 2020 study, economists Brad J. Hershbein and Bryan A. Stuart analyze MSA employment and population declines following five different national recessions going back to the 1970s and through the Great Recession of 2007. They find that MSAs hit hardest by recessions over this period had lower employment rates and lower populations than similar MSAs that were less impacted, and that in some cases these slower growth trends persisted for a decade. Their figures below show the impact of a 1% greater employment loss during a recession on the employment rate over time for the three most recent recessions excluding the Covid-19 recession. In a complete recovery, the solid blue line would return to 0 (dashed lines are confidence intervals).

After the 1990 and 2001 recessions, harder hit MSAs had slower subsequent employment growth for over a decade. Employment rates in the harder hit areas recovered a bit faster after the Great Recession, but in many places, they were still lower as late as 2015 (bottom figure). As the authors state:

“areas that lost 5% more of their employment during a recession have employment rates one to two percentage points lower, even up to a decade later. For a typical metropolitan area of 150,000 workers, that’s 1,500 to 3,000 fewer people with jobs.”

It is hard to predict which areas will be most impacted by a national recession. The causes of the recession matter, as do the local characteristics of the area. Different industries are impacted differently during recessions, and places with stronger economic ties to the most impacted industries—such as more industry employment—will be hurt more than places with weaker ties. The authors provide a map (shown below) that shows the decline in employment during the Great Recession for each MSA.

MSAs in the Midwest, southeast, and the west were hit harder on average (darker red) than MSAs in the Great Plains and northeast. The housing bust was a big part of the Great Recession so it makes sense to see bigger impacts in the southeast and west where housing price declines were largest. The auto industry also took a beating, which helps explain the big employment impacts in Michigan, Ohio, and other states with a lot of auto industry workers.

It would be foolish for local policymakers to try to predict when their economy will be hit hardest by a recession. Instead, they should focus on how to make their economies more resilient. Resilient economies are not reliant on one industry and have policies in place that incentivize work and new business formation.

It is natural for some businesses to fail during a recession. Like wildfires, recessions help clear up the underbrush of low-performing businesses so workers and capital can be reallocated to more productive businesses and industries. High taxes that discourage investment and work impede this process by decreasing the number of businesses in the area and encouraging workers to stay on the sidelines rather than retrain to find a new job. Simpler tax codes with flatter rates and broader bases can improve local economic resiliency.

Similarly, regulations that prevent firms from starting in the first place hinder the reallocation process. Policymakers who want to make their economies more resilient should reduce unnecessary and complex regulations so it is easier for people to open restaurants, stores, or start homebased businesses. Land-use reforms would also make it easier to convert old warehouses into housing or retail space, or old retail space into manufacturing space, etc. As economic fundamentals change, the best use of buildings often changes, too, and local land-use regulations should facilitate adaptation.

Policymakers should also eliminate zoning regulations to make housing cheaper. This would make it easier for people to move to places with the most productive and resilient local economies which would reduce the pain they experience from recessions.

Many economists are predicting a recession in 2023, but we have been wrong before. But if not in 2023, another recession at some point is inevitable. Local policymakers and voters should make their economies more resilient now so when the next recession occurs, they will not be the ones suffering for a decade or more.