Slower growth, sluggish borrowing expected to impact South Dakota economy

Higher interest rates, inflation, a cooling housing sector and a dip in consumer spending are expected to slow economic growth in South Dakota, according to the state Bureau of Finance and Management.

The agency’s projections for two years of lower growth in the state came during Wednesday’s meeting of the Governor’s Council of Economic Advisers.

The state’s general fund revenue is also $1.2 million lower than the South Dakota Legislature’s adopted budget had anticipated, though that represents less than a percentage point of the state’s nearly $2 billion in annual revenue.

A drop in lottery revenues, as well as dips in sales and use, tobacco and severance taxes are to blame for the shortfall, according to State Economist Derek Johnson, though he said the most recent figures fit within the typical ebb and flow of tax dollars.

The overall growth projections speak to a slowdown several lawmakers cited as a concern during debates over the reduction in the state’s sales and use tax from 4.5% to 4.2%. That tax cut ultimately passed both the House of Representatives and Senate on its way to the desk of Gov. Kristi Noem, who signed it into law in March. The reduction will take effect on July 1.

Voters may be asked to cut the sales tax on food during the 2024 general election, if petition circulators gather enough signatures to put it on the ballot. Gov. Kristi Noem’s proposal to exempt food from sales taxes failed during the legislative session last winter, and a dry-up of federal dollars was also a talking point during that debate.

Johnson’s presentation didn’t reference the sales tax cut directly, but it did factor in the federal money issue. The state’s coffers swelled from an influx of one-time stimulus dollars during the pandemic years, but that spending has ceased. Higher Medicaid reimbursement rates are phasing out, as well.

During the pandemic, Johnson said, federal payments to individuals leapt to as high as 30% of U.S. gross domestic product, which is the sum of goods and services produced within the nation. Prior to that, those payments held steady for years at 10-12%.

“It’s come back down closer to that range, although it’s a little bit elevated from where it was from 2012 to 2020,” Johnson said.

Worker issues top of mind in SD

The members of the Council of Economic Advisers, however, were most concerned about staffing, housing and interest rates. Council members include bankers, a hotel developer, investment advisers, state finance staffers and a farm economist from South Dakota State University. Their charge is to review the bureau’s projections and the national and local metrics that color them, and to offer insight on local conditions and emerging concerns. 

Following Johnson’s rundown of state and national economic trends on Wednesday, each of the advisers had a turn to offer those provincial points of view.

Several advisers noted that slowing growth for housing development and worries about an increasingly sluggish pace of borrowing – an outgrowth of higher interest rates – are concerning trends for South Dakota. The housing problems factor into a lack of workers, according to Caleb Arceneaux, the CEO of Liv Hospitality, a Rapid City-based hospitality management group.

Were it not for federal foreign worker visas, Arceneaux said, the Black Hills wouldn’t be prepared for summer tourism. The J-1 and H-2B visa programs have drawn 130 workers to temporary West River jobs in his facilities, he said.

“Without that program, we would be really hurting,” Arceneaux said. “We would ask you all to clean your own rooms.”

Adviser Doug Sharp of Watertown, who runs a car dealership and employs about 70 people, mentioned housing as an issue for the labor market, but also talked about child care and nursing home closures as factors undercutting employers’ ability to recruit and retain talent.

Sharp could use a half dozen or more mechanics and auto body specialists, but he’s yet to find the right candidates.

“There’s a lot of people out there who I think would go to work if they had reliable child care,” Sharp said. “That’s as big a part of keeping our small towns going as anything I can think of.”

Caring for older relatives because of a nursing home shortage also contributes, he said. 

Jim Terwilliger, commissioner of the Bureau of Finance and Management, pointed out that lawmakers took steps to firm up the finances of nursing homes this session.

“Nursing homes got a pretty good injection of funding in the ’24 budget cycle,” Terwilliger said.

Even so, he added, the funding increase doesn’t fully solve the problem.

Carla Gatzke, a human resources executive for Daktronics, trumpeted the success of Brookings in terms of housing development and general growth trends. Increasing wages and the proliferation of remote work options have complicated hiring, though, particularly with manufacturing jobs and others that require an employee to be physically present at the job site. 

Gatzke would like to see the state collect more data on the shifting balance between remote and on-site employment trends for South Dakota in the coming years.

It’s more common for South Dakota companies, including Daktronics, to employ people who don’t live within the state’s borders for jobs that don’t require their physical presence.

“The internet enables companies to source from anywhere and enables many people to choose to live anywhere, and we do see an outmigration of folks from South Dakota elsewhere,” Gatzke said.

Interest rates, debt ceiling debates

Interest rate hikes, pushed by the Federal Reserve as an antidote to inflation, loomed large over the roundtable portion of Wednesday’s meeting, as did the March collapse of two mid-sized banks, Silicon Valley Bank of California and Signature Bank of New York.

Those failures came after the council’s February meeting, and the discussions on potential banking regulations that followed at the federal level put South Dakota Bankers Association President Karl Adam on the defensive.

“I spent an inordinate amount of time talking to the media and putting out comments to our member banks,” said Adam. “Our financial system in South Dakota and across the country is resilient and strong. These were outlier situations.”

A hike in capital requirements for small banks would be unfair to smaller community banks, Adam said.

On the interest rate side, financier John Hemmingstad of Avalon Capital Group said worries about another quarter-point hike in rates would further slow lending for a host of large-scale projects.

The Federal Reserve had signaled a willingness to hold off on further hikes, but the most recent inflation figures suggest that another round of interest-rate increases to cool off a hot economy isn’t out of the question.

“Don’t underestimate how high those rates can go,” Hemmingstad said.

Near the end of the discussion, SDSU Economist Evert Van der Sluis offered an update on agricultural conditions – farm incomes are expected to drop, but not precipitously – before pivoting to concerns about the debt limit. 

The U.S. House was set to take a vote on a debt limit compromise on Wednesday, but had yet to take up the issue as the advisers spoke.

Van der Sluis talked about the significant global impact a debt default could have, at least according to the national economists “in the know” on the issue.

The potential for a loss of Social Security income, for example, could constrain economic growth. A drop in consumer confidence and a hit to the value of the stock market could also follow a default if Congress fails to approve the debt ceiling deal hammered out between House Speaker Kevin McCarthy and President Joe Biden.

A hit to the nation’s credit rating is also a concern, Van der Sluis said.

“That isn’t something we should take for granted. We in the U.S. are one of the few countries with a high credit rating,” Van der Sluis said.

Projections on the impact of a default are “educated guesses,” Terwilliger said, since the nation has never defaulted. South Dakota’s balanced budgeting is preferable to the ballooning debt rates common at the federal level, the commissioner said, which should help inoculate the state from the worst effects of such a crisis.

“Hopefully we can avoid any major negative economic fallouts from that, but time will tell,” Terwilliger said. “It’s out of our hands at this point.”

The debt default dust-up in Washington, D.C., has echoes of far too many previous near-crises in recent years, said Curt Everson, a former director of the Bankers Association who remains on the council. The longest government shutdown in history took place in late 2018 and extended 35 days into 2019. The threat of further shutdowns has flared up several times since then.

“A significant part of the population of this country has just kind of gotten to the point where we don’t expect Congress and the administration, regardless whether it’s Republican or Democrat, to be able to easily come together and find solutions and do the right thing,” Everson said. “We’ve come to expect that we’re just going to have one impasse after another because both sides believe it’s politically expedient, from their perspective, not to come to agreements. That, in my view, is not a good situation.”