HOW FAST SHOULD WE GROW?

By GEORGE J. CHURCH

To consumers, workers and politicians--especially in an election year--growth is a magic word. It means more--more goods, more jobs, more money. Among economists, though, the word can start a fight. Past a certain point, many insist, growth means more price increases, and then more still, until inflation snatches away all the goodies.

Ah, but past what point? Is any rise of greater than 2% to 2.5% in national output dangerous, as the conventional wisdom has long held? Or has inflation been so tamed that output can safely grow at a rate of 3% to 3.5%, as more and more economists and businessmen now think? After all, the U.S. has enjoyed four years of inflation below 3%, the longest spell of price stability in three decades. Could the economy perhaps race ahead at 4% or even more, as a few radicals contend?

The debate has bread-and-butter implications for everyone. In a $7 trillion economy, what seems to be tiny differences in percentages is in fact enormous. "Adding just half a percentage point to the growth rate over the next eight years would generate approximately 400,000 jobs per year, boost real wages by $7,000 per family and add around $200 billion [in tax collections] to the U.S. Treasury," says Jerry Jasinowski, president of the National Association of Manufacturers. The N.A.M. urges a national target of 3% growth year after year, vs. the 2.5% projected by the Clinton Administration for 1996.

To Stephen Roach, chief economist of the Morgan Stanley investment firm, that is a prescription for disaster. He thinks growth even this year may speed up to 3%, leading to rapid inflation in 1997 and possibly to a recession in 1998. And last Friday's financial-market action showed how widely his views are shared on Wall Street. Huge May increases in factory orders and new-home sales had made it obvious that growth is accelerating sharply from the anemic 2.2% pace of early 1996; estimates put the second-quarter rate at 4% or even 4.5%. Then on Friday, the government reported that the unemployment rate fell from 5.6% in May to 5.3% in June, its lowest level in six years.

To bond traders, that sounded like the crack of doom. They bid prices down so rapidly that the interest rate on long-term Treasury bonds rose to 7.1%, up 6.9% on the day and more than a point above the start of the year (bond prices and yields always move in opposite directions). Stock prices got dragged down too; the Dow Jones industrial average plunged 115 points, to a close of 5588.

Bond buyers, to be sure, have special reason to be terrified of inflation. A bond that pays 6% interest may yield a comfortable return if prices are rising 2.5% a year, as they did in 1995. But the real return shrinks drastically if the inflation rate rises to, say, 4%. Bond investors, however, are not the only ones who fear that unemployment is getting so low as to force big wage increases that in turn will jack up prices.

So far that has not happened, and its nonoccurrence is the strongest evidence cited by the faster-growth-is-safe school. Says Laura D'Andrea Tyson, President Clinton's National Economic Adviser: "A couple of years ago, most economists thought the noninflationary unemployment rate was 5.9% to 6.1%. If you told them we could stay below that for more than 18 months [actually 22 months now], they would not have believed it. But we've done it." James Annable, chief economist of First Chicago NBD Corp., a major bank, says, "My guess is you could take it down to 5% and not generate significant wage inflation." But even if he is right, 5.3% is getting close.

Those who think it is too close are pinning their hopes on the Federal Reserve Board to cool the economy by raising interest rates more than bond traders already have. But the Fed at a meeting last week decided for the moment to do nothing. One reason: Chairman Alan Greenspan is not at all the antigrowth fanatic he has often been called. He is known to believe the key signals of inflationary danger are bottlenecks in the economy: shortages of labor or goods that drive up wages and prices. Apparently he sees no conclusive signs yet that such bottlenecks are developing, so the Fed has put off any action on rates, perhaps until its Aug. 20 meeting.

If the Fed raises rates then, it seems sure that it will dismay both the Republicans, who will have just officially named Bob Dole their candidate, and the Democrats, who will be about to convene and reanoint Bill Clinton. Dole is assailing Clinton for being willing to settle for inadequate growth, as evidenced by the 2.5% 1996 forecast. Dole's advisers think a promise of faster acceleration, to be achieved largely by tax cuts, may be just the thing to bring the President down. Clinton boasts that he has already achieved robust growth--10 million new jobs since his Inauguration--and his advisers promise to push it beyond 2.5% in future years.

To politicians, of course, speaking against rapid growth in an election year would be roughly equivalent to praising violent crime. To economists the issues are far muddier.

Oddly, the National Association of Manufacturers provides the pithiest summary of the limits-to-growth case that it opposes. The "conventional wisdom," says an N.A.M. statement, is that "potential growth is fixed at the rate of labor-force growth [currently around 1.2% a year] and the average annual increase in productivity [which was 1.1% through 1995]." That adds up to total growth of 2.3%, and "anything more than that will only feed inflation." Most true believers would include only minor qualifications, such as putting the upper speed limit at 2.5%.

To opponents, these equations "are based on an economy that doesn't exist anymore," in the words of Jared Hazleton, director of the Center for Business and Economic Analysis at Texas A&M. To begin with, many think that productivity is growing faster than the official figures show, a suspicion publicly voiced by Greenspan. One reason: the official measures are based largely on output of things--numbers of autos, board feet of lumber--and may be overlooking computer-driven gains, especially in service industries. "It's very hard to measure electronic bits floating around in the atmosphere," notes Hazleton.

A faster-than-measured rise in productivity may be a reason that falling unemployment so far has not triggered inflationary wage boosts. Not the only reason, however. Toughening global competition makes many workers fear that if they win raises big enough to force price boosts, they will lose out to lower-wage foreign labor. Relentless corporate downsizing further dampens any trend toward labor belligerence. The unemployment rate in Atlanta is below 4%, and Jim Young, chief economist for BellSouth, says the telecommunications company is having "occasional problems finding people we need." Even so, he adds, "labor is still worried, and the fact that people are unsure is keeping wages under control."

The operating rate of U.S. factories, mines and utilities, currently 83.2%, leaves room to fill rising demand without inflationary shortages--the more so because computers enable businessmen to keep production and inventories closely in line with sales and avoid the sudden shortages and panic buying that used to result in gray markets. If bottlenecks do develop, foreigners should be able to fill at reasonable prices any orders for steel, copper or even accounting services for brokerage houses that U.S. suppliers cannot meet.

Finally, say some fast-is-safe theorists, even if quickening growth should push the inflation rate up a bit, well, so what? "The economy did pretty well" in the past at "inflation rates in the 3.5%-to-4% range," says Ray Perryman, economist at Southern Methodist University in Dallas.

To horrified traditionalists, that is heresy. In their view, once inflation starts accelerating it tends to ratchet up and up and up. Roach of Morgan Stanley, for example, fears that if prices rise even 4% next year, that might be the first step in a leap to 6% or 8%. Others, though, think psychology has changed radically since the double-digit inflation of 16 years ago. It is hard to imagine speculators frenziedly bidding up the prices of oil, minerals and even potatoes and sugar, as they did in the late 1970s after a decade of inflation had convinced them that anything tangible was worth more than paper money. Nowadays "the track record of low inflation tends to breed low inflation," says Young of BellSouth.

Even so, Young favors trying to hold growth to 2.5% a year, on the theory of better safe than sorry. And he makes a disturbing point. A few indications of inflationary shortages are developing--spotty, but unsettling. For example, Morrison Products, a Cleveland-based maker of blower fans for air conditioners and furnaces, needs 20 more workers. Chairman Daniel Holmes Jr. says they need have only a high school diploma and to be able to add and subtract and pass a drug test. Nonetheless, he feels he may need to raise the starting wage at three of the company's plants $1 or $1.50 above the present $7 an hour to lure applicants who can meet even these modest tests. Such situations may be rare now, but traditionalists argue that the time to crack down on inflation is before it gets a head start; if the Fed and the rest of the government wait until the signs of accelerating price increases become unmistakable, it may be too late.

Perryman of S.M.U. and others counter that in economics as well as military affairs, governments have a strong tendency to fight the last war. Even some staunch advocates of faster growth, however, are uneasy. Very few would contend that there is no limit to noninflationary growth--and if the old 2%-to-2.5% standard is obsolete, where should a new line be drawn? "This is new territory for us," says Annable, the Chicago bank economist. Given the potential payoff, letting growth accelerate seems a gamble at favorable odds, and one well worth taking. But it remains, and irretrievably, a gamble.

--Reported by Marc Hequet/Detroit, Thomas McCarroll/New York, Brian Reid/Atlanta and Adam Zagorin/Washington

With reporting by MARC HEQUET/DETROIT, THOMAS MCCARROLL/ NEW YORK, BRIAN REID/ATLANTA AND ADAM ZAGORIN/WASHINGTON