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2014 economic outlook -- surprising optimism

For the first time since the advent of the Great Recession in 2007, the new year begins on a welcome note of optimism for the economy. In a narrow sense, 2013 was a good year for the U.S. economy. Growth accelerated in the second half of the year after falling to a near standstill in the last quarter of 2012 and prospects for 2014 are good.

The economy, however, still has a long way to go to return to its pre-recession levels of unemployment. More than four years after the end of the recession, it is apparent that the economic downturn and financial crisis were not only unusually severe, but the recovery has been among the most anemic in post-war history.

The national unemployment rate has fallen to 7 percent, beginning the year at 7.9 percent and down from a post-recession high of 10 percent in October 2009. This is welcome news, but the rate is still far above the 2006-2007 levels that held in the 4 to 5 percent range. For continued progress on the unemployment front, GDP growth must continue well above 2.5 percent because productivity growth has advanced at more than 2 percent per year.

The economic recovery has been hindered by a number of factors that have come to be known as headwinds. Fortunately, many of these forces have receded recently. Most importantly, the lingering uncertainly in regard to the overall financial system has been largely resolved. There is still great concern about the recovery, but there is little worry about the overall soundness of the financial system. Even though the lingering European financial problems have not been resolved, they appear to have been contained. Based on the profitability of the corporate sector, equity markets have been surprisingly strong, more than doubling since the low point in March 2009 and up around 25 percent in 2013. An unexpected plus for the economy comes from the surprising increase in domestic oil and gas production coming from the wider use of fracking extraction methods, saving both consumers and businesses money while reducing dependence on foreign oil.

Even the ongoing drama of the federal budget process that has resulted in "fiscal cliffs" and real or threatened government shutdowns seems to have been subdued with the December 2013 two-year agreement in Congress. Unfortunately, the agreement falls far short of dealing with the nation's long-term fiscal imbalance, but it does provide some near-term stability.

One unabated headwind is the uncertainty resulting from the rollout of the Affordable Care Act. While the long-term effects of the ACA are still not known, the implementation process has been and promises to be a disruptive force in the economy for some time. Uncertainty is damaging to the economy and the ACA process has clearly added to this.

The relatively rosy outlook for the next year is a welcome change, but there are important longer-term issues such as how to maintain continuing high rates of economic growth and how to address the looming structural deficits resulting from promised entitlements.

In some ways, the Illinois economy in 2013 mirrored the national economy. Growth picked up and the unemployment rate fell. However, Illinois continued to lag the U.S. economy in a number of dimensions, most notably the unemployment rate. Illinois faces the challenge of not only riding the general wave of recovery, but also of finding a way to make up the ground lost to other states. Illinois has a long-term structural deficit (even after pension reform) that needs to be addressed through long-term fiscal discipline. This will likely require changes in the tax structure along with a reduction in the rate of growth of spending. A sounder fiscal situation is not the solution to all of the state's economic challenges, but it is an important first step.

Economist J. Fred Giertz is on the faculty of the University of Illinois' Institute of Government and Public Affairs. He can be reached at 217-244-4822 or jgiertz@uillinois.edu.

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