Recovery on a Tightrope

TIME's economists see no boom, no bust ahead

More than two years after coming out of the deep 1973-75 recession, the nation's economic recovery has reached middle age--and is feeling all the crotchets of that stage of life. Its youthful bounce is now just a memory, and its progress is marked more by caution than boldness. Its future looks unexcitingly predictable at best, a little worrisome at worst: relatively modest gains in production, a very gradual reduction of high unemployment, continuation of a distressing but not immediately dangerous inflation rate.

A touch of hypochondria has entered the outlook too. After robust growth during the first half of the year, the economy has paused during the summer. The leading indicators that are supposed to foretell the future course of business have been down slightly for the past three months in a row. In August, industrial production declined for the first time since January, and the unemployment rate rose slightly to 7.1%; joblessness among blacks equaled its post-World War II high. All that has stirred talk of lasting slowdown in the economy--or even a new recession.

But there will not be a recession, say members of TIME's Board of Economists, who gathered in Manhattan last week for a daylong session. Not all were satisfied with the outlook, by any means. Arthur Okun, senior fellow at Washington's Brookings Institution, noted that Washington policymakers, fearful that the rapid advance needed to cut unemployment would plunge the nation into still worse inflation, have kept the economy "on a tightrope." But the economists agreed to a man that business will come out of its summer slowdown--indeed, is already doing so--into a period of steady no-boom-no-bust expansion. Said Walter Heller, University of Minnesota professor: "The middle-aged recovery has gone through its mini-pause."

In general, board members expect real G.N.P. to increase at an annual rate of about 4% to 4.5% from now through December--bringing the average for all 1977 to a bit under 5%--and to continue at about that pace through the middle of next year. Among the more optimistic is Otto Eckstein, a Harvard professor and president of Data Resources, Inc., a producer of computerized forecasts (TIME, Sept. 26). He predicts a 4.8% advance in G.N.P. for all of 1977, and an average increase of 5% in the first half of 1978. Eckstein foresees that the economy, after slowing somewhat in the second half of next year, will be spurred by the $15 billion tax cut envisaged in President Carter's tax-reform bill and will register a gain of 3.5% for the whole of 1979.

Least sanguine is David Grove, chief economist of IBM. Though he anticipates slightly under 5% growth this year, he looks for a decline in expansion rates during the second half of 1978, and in the third quarter of 1979 an anemic increase of just 2% to 3%. Says Grove: "We will have a fragile economy as we get into the latter part of next year. When that happens, it doesn't take much in the way of external shocks to push the economy downhill fairly fast."

Even without such shocks, there are troubles aplenty. The production growth that board members expect would bring the jobless rate down only a smidgen below 7% by the end of this year, and perhaps to a still high 6.5% by the close of 1978. Main reason: the last recession pushed joblessness so high--8.9% in May 1975--that a long period of above-normal growth would be needed to return it to comfortable levels. Says Okun: "Basically, we have had a single-size recovery from a double-size recession." Changing the metaphor, Robert Nathan, a Washington economic consultant, adds: "We have had some degree of pneumonia, and we have been trying to recover as if we had only had a cold."

Nor will consumers and businessmen get any quick, lasting relief from inflation. In August, consumer prices rose at an annual rate of only 3.7%, the smallest rise in nine months, largely because bin-busting harvests held down food prices. But board members view the respite as only temporary. Though they differ on the reasons, they expect prices next year to go up at an average rate of 6% to 6 1/2%--about the same as in 1976, or even a trifle faster. Still, the outlook cannot be called gloomy: production, profits, jobs and incomes will keep rising. Heller and Alan Greenspan, a Manhattan business consultant who headed the Council of Economic Advisers under President Ford, are especially heartened that the economy shows none of the imbalances--excessive inventory accumulation by businessmen, heavy speculation, shortages of basic goods such as steel and paper--that historically precede a downturn. Says Greenspan: "Recession almost invariably requires that there be such imbalances in the system."

Consumer spending, after sagging through the late spring and early summer, has revived again and is expected to remain strong throughout the rest of the year. Auto sales raced to a new monthly record in August. General Motors Chairman Thomas A. Murphy for two years in a row has caused skeptics to tut-tut at his optimistic projections, only to be proved right both times. Now he is forecasting record sales of 11.75 million cars and 3.75 million trucks in the 1978 model year, eclipsing the peak of 14.5 million vehicles sold in 1973. New housing construction continues torrid; the annual rate of housing starts in August topped 2 million for the second month in a row.

Business spending for new plant and equipment, which lagged in the first two years of the recovery, is at last showing moderate strength. Board members are agreed that capital outlays this year will top 1976 by about 9%, even when discounted for inflation. Okun, who calls himself a "nervous optimist," believes that corporate spending for new production facilities will rise at an annual rate of 10% in the first half of next year.

Joseph Pechman, director of economic studies at the Brookings Institution, points out that state and local governments, which were financially strapped during the recession and had to retrench, are now running large surpluses and are increasing their purchases of goods and services, giving the economy a needed lift.

For every strength, though, there is an offsetting weakness. A pervasive sense of uncertainty grips businessmen and investors. They worry about the impact of Government policy on inflation and interest rates. In Greenspan's view, the many uncertainties are preventing businessmen from making needed investments, such as expanded research programs to develop new sources of energy. Executives see such serious risks that they will start only projects promising a high, and quick, profit. Says Greenspan, borrowing a football term: "The market system's ability to adjust to perceived future imbalances is being blind-sided by these very high risks."

One cause of wariness is the President's energy program now working its way through Congress. The plan seeks to curb fuel use through a combination of taxes and price boosts that is all but certain to raise living and business costs. Businessmen are holding back on spending commitments until the final version of the bill is approved and they can assess its effect on earnings.

Another reason for uncertainty is President Carter's tax "reform" program. He was supposed to send it to Congress next week, but the Bert Lance affair so badly distracted and delayed his decision making that the tax package will not be unwrapped until a week or so later. The President is expected to propose cutting tax rates for all individual taxpayers and corporations,* giving business a more generous investment tax credit, and easing the taxation of corporate dividends--but also taxing capital gains as ordinary income and cracking down on expense-account deductions. Businessmen are unsure of not only what the effects would be on their companies, but also whether Congress will enact the proposals favorable to them as well as those that are not. Their view, observes Washington University Professor Murray Weideribaum, is that on taxes "the feds giveth, and the feds taketh away."

Another source of confusion is the Federal Reserve Board's management of the money supply. This year the money supply has been expanding at a rate that some economists consider inflationary, and it has been gyrating from month to month and even week to week. In the past three weeks, the money supply first grew by $3 billion, then dropped $800 million, then rose another $2 billion (to a seasonally adjusted daily average of $331.6 billion). In an effort to ward off inflationary pressures, the Federal Reserve will have to try to hold down the growth, and that will push interest rates up further--how far and fast is unclear.

Nowhere is uncertainty more pernicious than in the stock market. The Dow Jones industrial average, down more than 16% so far this year, closed last week at 839.14, down 17.67, its lowest level since December 1975. Some members of the Board of Economists are fearful that the drop will have an unsettling psychological effect on the whole economy. One reason is that the market is regarded as a highly visible--but far from infallible--indicator of future business trends. Studies have shown that over a 100-year period, of 43 expansions and recessions, stock prices anticipated 75% of the business cycle turning points.

There are more tangible weaknesses too. U.S. imports are likely to exceed exports by $27 billion or more this year. Such a sharp increase of imports over exports tends to cause the exchange rate of the dollar to decline in world markets. A cheapened dollar boosts the price of imports and fuels domestic inflation. Worse, a declining dollar could prompt the oil-producing nations to seek even higher world prices. Nathan figures that the nation will spend $45 billion for foreign oil this year, about a third of all imports. He grumbles: "I think we are becoming so totally insensitive to what is happening in the energy field and so completely relaxed because of oil imports."

Then, too, for some industries the recovery has been little more than a rumor. Steel has been especially hurt by imports (see following story). Textile sales are also soft, largely because of slow apparel sales, especially in men's clothing. Says Irwin Kellner, vice president of Manufacturers Hanover Trust Co.: "People have got to eat and pay the doctor and the barber, but they can put off buying clothes."

The most serious question arising out of the welter of conflicting signals is this: Is a steady but moderate recovery accompanied by high unemployment and high inflation the best that the nation can do? Or should the Government stimulate business to faster expansion by more and quicker spending and/or tax cuts? (The $15 billion reduction promised by Carter's tax-reform program will take at least a year to push through Congress.)

A somewhat muted debate on that subject is now beginning within the Carter Administration. CEA Chairman Charles Schultze contends that the recovery is about on schedule and no further stimulus is needed at the moment. Says he: "When all the caveats are listed, the weight of evidence strongly suggests that the months ahead will see a continuation of recovery." Secretary of Labor Ray Marshall disagrees. "The evidence is already clear that we are not meeting our goals with respect to black and youth unemployment and that additional stimulus targeted on these groups is necessary."

The debate echoed much more loudly at the meeting of TIME's Board of Economists. Generally, the more liberal members--Heller, Nathan, Okun, Grove and Pechman--favor a basically expansive fiscal-and monetary-policy strategy to get jobless rates down faster. They contend that there is enough slack in the economy to accommodate more rapid growth without boosting prices faster than they would go up anyway. Board members argue that much of the inflation threat to the system comes not from fiscal policy but from a series of price-boosting regulatory and legislative moves in Washington--or what Okun terms "self-inflicted wounds." Among them: an increase in the minimum wage from $2.30 to $2.65 an hour effective Jan. 1, voted by the House two weeks ago; the farm subsidy program; and the cargo preference bill, which requires that eventually at least 9.5% of U.S.-bound oil be carried in expensive-to-run American ships.

To hold inflation in check while raising production faster, Okun suggests a novel form of wage-price restraint: "bribing" business and labor through the tax system. Under his plan, management and labor within any firm would pledge to hold price and wage raises below a certain level--perhaps 6% a year for pay, 4% for prices. The Government would then cut payroll taxes for both the company and its workers.

The board's conservatives--Greenspan, Weidenbaum and Beryl Sprinkel, executive vice president of Chicago's Harris Trust & Savings Bank--insist that the Government will have to keep economic stimulus to a minimum for at least 1 1/2 to two years. In their opinion, inflation has become so embedded in the economy that a long period of conservative policies--trimming the budget deficit, holding a rein on money supply--is needed to stop it. A speeding up of inflation, they fear, could bring on another recession.

Sprinkel also challenged the assumption that slow economic growth is the major cause of high unemployment. Another reason for joblessness, he says, is that under welfare, food-stamp and other social benefit programs, "marginal workers are paid a lot not to work. If they go to work, they make less than if they didn't go to work. But since they must register as searching for a job [to qualify for the benefits], they are counted as looking for work." According to Sprinkel, a Government policy of pumping out money to get unemployment down, while at the same time raising benefits for not working, would result not in less joblessness but in more inflation.

Such assessments will do little to ease the political pressures on President Carter to work for the creation of more jobs, especially for poorly trained blacks and other minorities. Yet the continuing threat of inflation and the general edginess of business offer the President few options. The chances for any dramatic Washington initiatives on unemployment, inflation or growth are dim. For the time being, the economy will just have to go on walking its tightrope.

*The highest bracket for personal income, so-called unearned income from dividends and the like, would be reduced from 70% to 50%. Top rates on earned income--primarily salaries--would also be lowered from their present 50%. The lowest rate would be cut from 14% to 10%, and there would be cuts in all brackets in between. The corporate rate, now about 48%, would be reduced by as much as three points.

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