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Area's Economy to Fly, But Not as High

Researchers See Washington Continuing to Outperform Nation

By Neil Irwin
Washington Post Staff Writer
Thursday, January 6, 2005; Page E01

The Washington regional economy will slow down from its rapid growth rate of 2004 in the years ahead, according to a forecast to be released today, but will continue to expand faster than the U.S. economy as a whole.

A boom in federal spending caused the region's economy to grow at an exceptionally strong 4.4 percent rate last year, say researchers at the George Mason University Center for Regional Analysis, the fastest pace since 2000. But the researchers expect that federal spending will grow at a more measured pace in the years ahead, and that the impact of low interest rates, skyrocketing housing prices and recent tax cuts will fade. As a result, they forecast that Washington's $299 billion gross regional product -- the total value of goods and services produced in the area -- will rise at just a 4 percent rate in 2005 and its growth will slow further through 2007.

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Economists expect the national economy to grow 3.5 percent in 2005, down from about 4 percent in 2004, as an improving business environment is offset by interest rate increases and the decreasing impact of tax cuts.

"We're going to get back in the old pattern of growth here, which is kind of stodgy," said Stephen S. Fuller, a George Mason public policy professor. "We had all these economic forces stimulating growth in 2003 and 2004 that will dissipate by the third quarter of 2005." Other economists who study the region said that the George Mason forecast is roughly in line with their own expectations.

Fuller expects the region to add 83,000 jobs in 2005 -- a slight acceleration over 2004 -- but anticipates hiring to moderate from there.

Even if slower growth in federal spending prevents the region from repeating the gangbuster expansion of 2004, economists said the area is likely to remain stronger than other regions across the country.

"The types of jobs in Washington are in high-tech industries that are growing, not old industrial companies," said Anirban Basu, chief executive of economic consultancy Sage Policy Group in Baltimore. "And the companies here aren't as subject to pressure from outsourcing jobs as in most places. You can't send most defense and homeland security jobs to India."

According to Fuller's estimates, the Washington region's total output grew at about the same pace as the country's as a whole in 2004, but local employment grew much more rapidly. He said that's because the recovery is further along in Washington than elsewhere in the nation. In most of the country, corporate sales started rising rapidly only in 2003, and so far companies have been able to fulfill new demand by squeezing more productivity out of workers. Job growth accelerated only recently as demand outstripped workers' capabilities, forcing companies to hire.

Washington area businesses went through the same cycle, but they did it earlier, as demand for defense and homeland security work started rising about a year earlier than sales in other industries, in response to the Sept. 11, 2001, terrorist attacks.

Just as a boom in federal procurement has driven the region's economy up in the last two years, the economy will soften if federal spending grows more slowly or contracts in the face of the massive budget deficits the government is now running. Just this week, a leaked Pentagon budget document included proposals to cut defense programs by $55 billion over the next six years. Fuller's projections assume that federal procurement spending in the region, which rose 16.9 percent in the fiscal 2003, will return to its historical average growth rate of about 7 percent.

Executives in the region said they expect the federal government to remain a steady source of growth, budget constraints notwithstanding.

"Some programs may be trimmed, but I don't see anything in the works that would produce a downturn in procurement spending," said Richard O. Duvall, a partner at the Holland & Knight law firm who advises government contractors and chairman of the Fairfax County Chamber of Commerce. "There is pressure caused by the deficit to reduce discretionary spending, but this is largely offset by the expectation that there will be increases in tax revenue from a resurgent economy."

"With President Bush reelected, I think that makes everyone feel that change that might have occurred with a new administration isn't coming, and they can get back to doing business," said Bernard H. Clineburg, chairman of Cardinal Financial Corp., a bank that lends to government contractors. Cardinal funded the George Mason study, which is to be presented this morning at the school's annual economic forecasting conference at the Ritz-Carlton, Tysons Corner.

That doesn't mean there aren't risks for the local economy. In particular, after three years of extremely low interest rates, some economists worry about what might happen now that the Federal Reserve is pushing them higher. "The biggest risk out there right now is that a rise in interest rates happens more abruptly or causes some unforeseen shock," said Steven Cochrane, chief regional economist at consulting firm Economy.com. Other, potentially related, risks are of rising oil prices, a falling dollar and a decline in the value of residential property.

Fuller notes other long-term risks that are unique to the Washington region -- and tied to the continued economic growth he forecasts. The strong local economy creates traffic congestion, bidding wars for employees and soaring prices for housing, all of which lower the region's attractiveness to future employers.

"These are all things that by the end of the decade could force the economy to slow down faster than we're anticipating now," Fuller said.

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