More Growth Ahead in '86

By Barbara Rudolph

Any three-year-old economic recovery is vulnerable to a host of debilitating troubles. Growth has been going on for so long that an unexpected development like poor Christmas sales or a falloff in auto production could tip the economy into recession. After good growth of 3.4% in 1983 and 6.6% in 1984, the U.S. economy in 1985 expanded just 2.4%. Nonetheless TIME's Board of Economists offers an optimistic forecast for American business, predicting steady if unspectacular growth in the coming year. Board members declared that the economy will move forward and avoid a recession in 1986.

The expansion showed some signs of life last week. The Commerce Department estimated that the economy grew at an annual rate of 3.2% during the fourth quarter.

TIME's economists predicted that the gross national product, after adjustment for inflation, will rise 2.9% next year. Even that modest pickup may be enough to cause a slight drop in the unemployment rate. Board members estimate that in 1986 the rate of joblessness will fall to 6.8% from today's 7% level. The current rate represents a marked decline from the November 1982 peak of 10.7%.

The board's measured optimism reflects its expectation that the Federal Reserve Board will continue to keep interest rates low, thus encouraging corporate investment and consumer spending. The prime rate has fallen from 11% to 9 1/2% during the past twelve months. Said Charles Schultze, a senior fellow at the Brookings Institution: "One essentially bullish aspect to the outlook is the expectation that the Federal Reserve will work actively to avoid a recession. It will intervene and push down rates if it judges that necessary to keep the economy from stagnating."

In forecasting moderate growth for next year, board members assumed a continued downward drift in the foreign exchange value of the dollar. The U.S. currency has already fallen 17.5% since it peaked last February. The highflying dollar was the primary cause of a huge trade deficit because it made American exports expensive for foreigners and imports cheap for U.S. consumers. Last week the Commerce Department reported a $33 billion shortfall between America's exports and imports for the third quarter. By year's end the trade deficit will probably reach $145 billion. As the dollar weakens, the deficit should diminish. Said Alan Greenspan, a New York City-based economic consultant: "The share of imports in the American markets will start to flatten out and that will remove a negative factor that is pressing down the economy."

The board credited Government intervention in the currency markets with facilitating the dollar's recent depreciation. On Sept. 22 the U.S. reached an agreement with Britain, France, Japan and West Germany to help drive down the value of the dollar. Said Rimmer de Vries, chief international economist for Morgan Guaranty Trust: "The intervention has been extraordinarily well timed." The dollar has dropped 7.6% since the agreement was announced. Still, the board cautioned, the dollar must decline by an additional 10% to 15% in order to narrow the yawning trade gap.

The weakened dollar will unfortunately work its magic slowly. It normally takes less than a year for the price of imports to begin rising in response to the dollar's decline, but it is about twice as long before the cost of exports falls enough to attract foreign buyers. Walter Heller, the chief economic adviser to Presidents Kennedy and Johnson, added that even with a lower dollar, American exporters will not recapture lost overseas business without a struggle. Said he: "We are going to have to pitch really hard in order to regain our foreign markets." The board thus does not expect any major improvement in the American trade balance until late in 1986.

A falling dollar traditionally brings fears that inflation will climb as import prices increase, but the economists are sanguine this time. Said Heller: "I don't see anything that would cause an outbreak of inflation." The Consumer Price Index has been rising at a 3.5% annual rate so far this year. TIME's economists projected that it will creep up a notch next year, to a 4% annual rate.

Depressed oil prices are a powerful anti-inflationary force. In the wake of OPEC's threat to slash prices to bolster its market share, the price of West Texas intermediate, the U.S. benchmark crude, has fallen 9% in the past two weeks. The news heartened most economists. Said Schultze: "I never met a low oil price I didn't like."

Martin Feldstein, a Harvard economist who served from 1982 to 1984 as chairman of the Council of Economic Advisers, speculated that falling energy prices would make it easier to pass some type of oil import tax, which would help shrink the $200 billion annual federal budget deficit. Said he: "Congress will be tempted by this tax, although it probably won't have that name. It could be called something like a 'price stabilization surcharge.' "

Declining oil costs, though, could prove a mixed blessing for the world economy. Energy-producing nations, including Mexico, Venezuela and Nigeria, would obviously suffer as their incomes fell. Many U.S. oil companies would see profits fall if oil prices were to decline. Western banks, which have made large loans to both petroleum countries and U.S. oil firms, would be hurt if the oil producers were not able to make loan payments. Some board members speculated that if prices were to plummet suddenly below $15 per bbl., a major banking crisis might erupt. Lester Thurow, an M.I.T. economist, pointed out that many loans to American oil companies are at risk. Said he: "You are talking about loans to thousands of small oil companies. This problem will be hard to wrestle with." De Vries, though, insisted that such fears were exaggerated. Said he: "Banks have done their homework and have renegotiated their loans in expectation of a lower price of oil."

The uncertain outlook for oil was not the only concern of TIME's economists as they assessed the future of the world economy. The board was pessimistic about the prospects of a strong expansion in Europe and Japan. De Vries estimates that Japan's economy will grow by no more than 3.5% in 1986, after steaming ahead at a 5% rate for the past two years. West Germany, the heartiest of European economies, will expand at roughly the same rate. Since business in Western Europe is growing only modestly, unemployment will remain stuck at relatively high levels; the jobless rate now ranges between 9% and 15%. Even Japan has experienced an increase in unemployment, to 2.8%.

Japan came in for some strong criticism by the board for failing to stimulate its economy in the face of slackening growth. "Japan is doing the opposite of what it is supposed to be doing," said De Vries, citing high Japanese interest rates and the government's restrictive fiscal measures. Greenspan, though, suggested that the U.S. was not in a position to pass judgment on Japanese policies. Said he: "The Japanese are running the best major economy in the world. We, who are running our economy less well, should not suggest to them what they should be doing."

The economists agreed that relatively slow growth in the U.S., Europe and Japan exacerbates the problems of the Third World debtors. Latin American nations must boost their exports in order to pay off their foreign currency debt. If the developed countries are not growing quickly, they will not be importing as much from the Third World.

Nonetheless, the board concluded that some progress has been made in defusing the international debt bomb. The economists generally praised Treasury Secretary James Baker's plan to increase lending to Third World countries by $29 billion during the next three years. Some $20 billion would come from commercial banks; $9 billion more would be raised largely from the World Bank. The plan specifically calls for the World Bank to assume greater responsibility in supervising the borrowers, providing long-term assistance and guidance. While the board applauded this goal, De Vries warned that the bank will not move eagerly to take over this role. Said he: "It is going to be very difficult to get this colossus, this totally motionless organization, to change."

One board member did not entirely share his colleagues' cautiously optimistic forecast for all of next year. Greenspan argued that a recent borrowing binge by American corporations could thwart the U.S. recovery. He predicted that economic growth will sputter in the final quarter of 1986. Said he: "While the short-term outlook is one of improvement, the system is in a state of slow deterioration."

The problem, Greenspan reasoned, is that companies are borrowing too much. In 1984 the debt of U.S. corporations grew 16%; it was up an additional 7% for the first nine months of this year. As companies continue to use more of their income for interest payments, they can be badly hurt by a slowdown in growth. Another sign of corporate weakness, a decline in capital investment, may soon appear. A Government survey released last week reported that U.S. businesses, after adjusting for price increases, will curtail their spending in plant and equipment by 1% in 1986. This year, in comparison, it is estimated that these expenditures will have risen by more than 5%. In 1984, when the recovery was at its peak, capital investment surged by 15.3%.

Companies, however, are not the only frantic borrowers. Several board members pointed out that Americans today generally owe more and save less. Nonmortgage consumer debt is nearly 19% of disposable income, an all-time high. The rate of personal savings has fallen from 6% of disposable income at the end of 1984 to 3.7% in the third quarter of this year. Depleted savings coupled with increased debt could cause a slowdown in consumer spending, which could be particularly bad for retailers during the important Christmas season. That could damage the entire economy.

But Schultze and other board members argued that the personal debt load is not as heavy as it appears. Schultze explained that in calculating consumer debt, the Government includes credit-card purchases, which account for some 20% of the total. Yet many consumers pay their monthly bills immediately, before incurring any interest charges. Said Schultze: "That really shouldn't be counted as debt. They are using their cards for convenience."

Lester Thurow in his new book, The Zero-Sum Solution, examines how the U.S. could improve its competitiveness in the world economy. He briefly discussed his book at the meeting, saying that Japan and many European countries enjoy a competitive advantage over the U.S. because of their higher savings rates. Thurow argued that more savings would help the U.S. in many ways, including a strengthening of the labor force. He asserted that the level of education and skills for Japanese or German workers is higher than it is for American employees. If corporations were not so deeply in debt, they would probably be inclined to invest more in worker training. Asked Thurow: "How can we have a competitive economy with a labor force that just does not measure up?"

If the current recovery continues through next year, this economic upswing will become one of the longest on record, having begun in December 1982. The average postwar recovery has lasted only three years, so the current one is now already longer than normal. Still the economy has a long way to go to surpass the remarkable growth of the 1960s. In the longest recovery since World War II, the U.S. economy steadily expanded from 1961 to 1969, a record 105 months in a row.

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*Forecasts by TIME's Board of Economists