$6.2 Trillion of Unintended Consequences for Commercial Real Estate
Federal spending cuts seem inevitable. While no one knows the exact figure, the House of Representatives recently voted to cut $6.2 billion from the federal budget over the next 10 years. Though it was defeated, it provides a starting point regarding how much the federal Budget could be reduced. So what would be the impact of $6 trillion in federal budget cuts on employment and thus demand for commercial real estate (“CRE”)? Likely very different from what you think it would be.
Surprising Impact of Cuts
From 1969 to 2009 the federal budget increased from approximately $823 billion (inflation adjusted basis) to an estimated $2.88 trillion. However, while the federal budget has been rapidly expanding since 1969, federal payrolls have actually been shrinking ‘” yes shrinking – by more than 30% since 1969.
According to the Office of Personnel Management, federal payrolls were reduced from 6.5 million in 1969 to 4.3 million in 2009 ‘” a 33% reduction. The federal government has reduced its payrolls by more than 2 million people. Additionally, according to the CoStar Group, the square footage of office, industrial and retail properties increased by more than sixteen billion square feet ‘” that’s a lot of construction jobs, concrete, air conditioners and carpet supplied by the private sector.
Conversely, during this period of rapid growth in the federal budget, private sector payrolls grew from more than 76 million in 1969 to more than 142 million in 2009 ‘” an 85% increase. A reduced federal budget could have the largest impact on private sector payrolls, not federal payrolls.
If federal spending increased over the last 40 years, yet federal payrolls contracted, and private sector payrolls nearly doubled, it seems reasonable to assume that a material amount of the increase in federal spending went to private sector companies. It also seems reasonable to assume that if the private sector benefitted from the federal budget growth, they will also suffer when it is cut.
So how much would $6.2 billion in federal spending cuts impact private sector payrolls? While we can’t quantify this exactly because we don’t know where the cuts will eventually occur, we can get a sense of the potential severity of the impact.
According to the Office of Personnel Management, from 1969 to 2009 Uniformed Military Personnel payrolls shrank from 3.499 million to 1.591 million. Undoubtedly many of those positions just went private to companies like Blackwater, (AKA Xe,) and Halliburton.
This outsourcing, in combination with recent reporting, indicating that Republicans would consider defense budget cuts would seem to indicate a direct loss of private sector jobs as a result of federal budget cuts.
In addition, private sector payrolls will decline as a result of other defense cuts to areas such as weapon system programs. Payrolls at defense contractors like Lockheed Martin, Northrop Gruman, Boeing, Raytheon and General Dynamics among many others would be impacted. These are the top five government contractors according to Washington Technology. They collectively had nearly $50 billion in government contracts in 2010.
PRIVATE SECTOR PAYROLL CUTS COULD BE WIDESPREAD
Private sector defense industry payrolls were not the only ones to benefit from increasing federal expenditures over the last 40 years. Industries like consulting, healthcare, engineering services, communications equipment, professional services, systems integration, telecommunications, information technology, construction and education all received significant dollars through federal contracts.
For example, according to Washington Technology, the management consulting firm Booz Allen had $3.7 billion in government contracts as of 2010; Dell Inc. $2.2 billion; Verizon Communications $1.8 billion; IBM $1.6 billion; Deloitte $1.2 billion; Accenture $837 million; AT&T, $664 million; Xerox $428 million; Oracle $229 million.
Education industry payrolls would not be immune either. The Department of Education estimates that approximately 368,000 school-related jobs were saved as a result of the federal stimulus money during the 2009-2010 school year. And what if money for prescription drugs is cut from the federal budget as a result of the healthcare debate? The federal government buys a lot of prescription drugs. This supports drug company payrolls. Clearly, $6.2 trillion of federal spending cuts would have a far-reaching and material impact on private sector employment.
CORPORATE AMERICA TO THE RESCUE?
However, there is a potential silver lining — Corporate America.
According to the Wall Street Journal, Corporate America stockpiled more than $1.84 trillion in cash and other liquid assets as of the end of March 2010 ‘” a remarkable 26% increase, the largest ever increase.
It would seem corporate America is well-positioned to offset the likely declines in federal spending. This could be an ideal scenario: Reduced government spending resulting in reduced tax burden on American taxpayers who also happen to be the economy’s shoppers giving consumers more income to spend. But this leads to two questions: First, will corporate America increase its business investment and second, even if it does, can it offset $600 billion of reduced federal spending?
Let’s start with the first question. To this point corporate America has been reticent to significantly increase its business investment levels and, more importantly, hiring levels. This is a real Gordian Knot. Supply side economics posits that record corporate coffers should lead to increased investment, driving increased employment ensuring the sustainability of the economic recovery. However, corporate America is waiting to see if the recovery is sustainable. This circular logic problem would first need to be resolved before federal spending cuts could be offset by increased business investment.
Now for the second question, does corporate America have the financial wherewithal to fully offset $600 billion of annual Federal spending cuts? The $1.84 trillion of cash previously referenced certainly can’t be exhausted without putting companies in danger of tripping financial covenants. So how much does corporate America currently spend on business investment annually?
Fixed, non-residential investment was approximately $1.4 trillion in 2010, down from its 2008 peak of approximately $1.6 trillion. The largest annual increase from 1995 to 2010 was 12.1%. Assuming a 12.1% increase from the 2010 level, that would only increase corporate spending by $181 billion dollars, or approximately $419 billion short of the potential $600 billion in annual federal spending cuts.
Will corporate America dip into their cash reserves to make up this difference? This is unlikely as $419 billion a year would wipe out their current cash balances in less than five years.
QUANTIFYING THE IMPACT
Assuming a $15.5 trillion US economy, $419 billion equates to 2.7% of GDP. Considering that GDP in the first quarter was 1.9% that would be a problem. It would be great if $600 billion of spending was transferred from the federal government and thus from taxpayers to corporate America. However, that will require corporate America to realize their investment and hiring levels will determine the sustainability of the economic recovery and corporate America setting new records as it relates to their investment levels. CRE needs corporate America to set new records if the CRE recovery is to be accelerate. The future of CRE is in the hands of corporate America.