Reagan's Running Recovery

By Alexander L. Taylor III

TIME's Board of Economists expects more growth but worries about deficits

'Tis the season to be jolly. There is little doubt about it. This year has been one of unexpectedly vigorous growth, declining unemployment and low inflation. And TIME's Board of Economists, which met last week in Manhattan, sees business remaining strong next year, while the jobless rate continues to fall and prices inch up only slightly. With an eye toward next year's presidential campaign, Otto Eckstein, chairman of Data Resources, a Lexington, Mass., economic consulting firm, concluded: "The 1984 outlook is very nice, at least for a Republican."

Nonetheless, the TIME board tempered its optimism. Board members are fearful that huge federal budget deficits may drive interest rates up and slow the economy in 1985. Last week Rudolph Penner, director of the Congressional Budget Office, predicted in testimony to the Senate Finance Committee that the deficit would rise to about $250 billion in fiscal 1988 and $280 billion in 1989. Board Member Alan Greenspan, chairman of Townsend-Greenspan, a New York economic consulting firm, and an unofficial adviser to President Reagan, argued that such deficits could do serious damage to the economy. Said he: "I don't think there is any question about the corrosive effect of the deficits."

Statistics released by the Government last week confirmed the vigor of the recovery and the moderate pace of price increases. Industrial production in November jumped ahead .8%, the twelfth monthly increase in a row.

Meanwhile, producer prices actually fell in November by .2%. For the past year, inflation at the wholesale level has been less than 1%.

An upbeat mood about the economy could be seen in the results of a new public opinion poll conducted for TIME by Yankelovich, Skelly and White. While inflation and unemployment remain the uppermost economic problems in the minds of voters, Americans now give President Reagan credit for making progress on both issues. A strong 69% of those polled approved Reagan's handling of inflation, while 50% credited him with doing a good job dealing with unemployment. Those are large increases from just three months ago, when only 58% of those questioned thought Reagan was fighting inflation effectively, and a mere 35% endorsed his handling of unemployment.

The TIME board's outlook for 1984:

Growth. TIME's economists expect that expansion next year will be less rapid than this year, when the economy grew at an annual rate of about 6.5%, but they say growth will still be brisk. The board forecasts that the gross national product will increase by 4.5% in 1984. The driving force behind the recovery is likely to be the consumer, who has rediscovered old spending habits (see following story). One area of strength could be new-car sales. Several board members expect an increase next year from the current annual rate of more than 9 million vehicles to about 10.4 million. That compares favorably with pre-recession levels. In 1978, for example, 11.3 million new cars were sold in the U.S.

Some economic soft spots, though, still exist. High interest rates seem to be stalling housing starts at an annual rate of 1.7 million units. That is much better than the 800,000 pace recorded at the depth of the recession, but far below the 2 million level of the last recovery. Another sign of weakness is that much of the business spending is for computers and other labor-saving equipment that have a relatively short life span. Investments in plant construction and heavy equipment remain comparatively slow. Industrial construction is at an eleven-year low.

Unemployment. The level of unemployment has fallen rapidly this year, and TIME's economists expect it to continue dropping next year, although not as fast. The rate has declined 2.4 percentage points from its peak of 10.8% last December and now stands at 8.4%. The board sees the unemployment level slipping to 8% by June and to 7.7% by the end of next year. The continued drop in unemployment could mean that Ronald Reagan will be running for re-election next year with the jobless rate only slightly higher than it was when he took office. Then, unemployment stood at 7.5%.

Inflation. The 1984 inflation outlook is equally encouraging. Only a few years ago, the U.S. seemed permanently afflicted by built-in, double-digit price increases. Inflation hit 13.3% in 1979. This year the consumer price index is expected to rise about 3.8%, and next year it is forecasted to move upward at only a slightly faster clip of 4.9%.

A series of factors is coming together to keep price hikes low. Wage increases are likely to continue at less than 5% annually, since management is getting tougher on salary raises for white-collar workers and has been demanding pay cuts from unionized employees. Eckstein also said he does not foresee any inflation caused by lack of products or materials. The only potential shortages in the economy are in the defense industries. And despite last summer's drought in the Corn Belt, agricultural supplies are plentiful, and food prices are expected to increase by only 4% to 6% in 1984.

Oil prices, which have stayed stable this year at about $29 per bbl., remain a giant question mark. Some energy experts argue that continued falling demand could send OPEC prices into a sharp decline some time next spring. But the danger of political disruption in the Middle East always remains. Said James McKie, a professor of economics at the University of Texas: "If Iran made some aggressive move in the Persian Gulf, such as closing off the Strait of Hormuz, the speculators could begin to take hold of the market and the price could jump up past $40. The situation is so volatile that oil prices in the next 18 months can be anywhere from well under the current price to well past the old bench-mark record of $34."

Interest Rates. Perhaps the biggest imponderable for the economy in 1984 is Federal Reserve policy. This year the U.S. central bank has kept a firm hand on the availability of credit, clamping down on the money supply in May when it thought the economy was growing too rapidly. As a result, interest rates have remained high all through the year. The prime rate, the key interest charge that banks use for commercial loans, now stands at 11%, in contrast with 11.5% a year ago.

Charles Schultze, chief economic adviser in the Carter Administration and now a senior fellow at the Brookings Institution in Washington, believes that the Fed's top priority is to prevent a combination of large federal budget deficits and strong business spending from generating an excessively rapid recovery. Should inflation begin to heat up again, Schultze thinks the Federal Reserve will squeeze the money supply, even at the risk of stalling the economy. Said he: "I see no reason why interest rates should fall below current levels next year. Indeed if the economy continues to surprise us with its strength, then you could get higher interest rates." Other board members agree. The group predicts that the prime rate will remain stable through the first half of the year and then go up a little to end the year at 11.5%.

Budget Deficits. The main reason interest rates will remain high is the huge federal budget deficit. For more than a year, members of the TIME board have warned that deficits pose a real danger. Eckstein calculates that the expected $200 billion deficits are causing interest rates to be about two percentage points higher than they would be otherwise. The higher rates, in turn, mean 300,000 fewer housing starts annually, 500,000 fewer new-car sales and 4% less business capital spending. Moreover, in the long run, the deficits could damage the structure of the U.S. economy. Investment-starved industries would wither and become easy prey for foreign competition. Said Eckstein: "The future that lies in store for us is a future in which we simply let American manufacturing decline. We'll still have food production, printing and publishing. We will still have local industries. But everywhere else, in fields like chemicals, machine tools and farm equipment, we will steadily lose ground."

Several sources of new revenues are being considered in Congress to reduce the budget gap. And while not denying the need for some tax increases, Greenspan argued that the real problem was Congress's habit of spending money faster than it was willing to increase taxes. Said he: "The key question is whether we are in a situation in which our democratic institutions have been basically distorted." Greenspan maintained that the deficit problem can be solved only by combining large spending cuts with some tax increases. He added that the Reagan Administration will remain reluctant to accept any policy whose major thrust is tax increases.

Walter Heller, former chief economist to Presidents Kennedy and Johnson, defended Congress. Said Heller: "Reagan goes right on accusing Congress of having a mindless tax-tax, spend-spend philosophy, and yet he seems to follow a borrow-borrow, spend-spend policy. No wonder poor citizens go plop-plop, fizz-fizz." Heller credits Congress with adopting nearly all of the budget cuts proposed so far by Reagan. Also, he noted that Congress succeeded last year in passing a bill introduced by Republican Senator Robert Dole that cuts $50 billion a year from the deficits in fiscal years 1986 and beyond.

But Heller, like the other board members, is disturbed by the unwillingness of either Congress or the White House to take any initiative on deficit cutting in an election year. Said he: "The spectacle of a spineless, do-nothing Government fiscally paralyzed for twelve or 18 months before every presidential election certainly can't help but erode confidence in the Government."

What seems likely to most board members is that the deficit problem will defy solution until a crisis atmosphere is reached. Heller said that only when the White House and leaders of Congress are confronted by "trouble they can touch" will budget deficits be reduced.

But there is the danger that the economy will be weakening in 1985, when political leaders get around to cutting the deficit. This would then give politicians a new excuse to do nothing, and the deficits would simply continue growing.

While the U.S. economy looks healthy for at least the next year, the foreign economic scene is less clear cut. Western Europe has been recovering much more slowly from the 1981-82 recession than the U.S., and its prospects next year are not as good. Said Rimmer de Vries, chief international economist for Morgan Guaranty Trust: "The rates of growth that we have been accustomed to in Europe are over." He expects growth there of only about 1.5% in 1984.

The short-term outlook for the less developed nations, on the other hand, is brighter than last year. Foreign loans have been rescheduled, and several countries have begun austerity plans to reduce expenditures and cut imports. The burden of their debt load has been further eased by falling oil prices and slightly lower interest rates. Countries such as Mexico, Argentina and Chile see economic growth of between 2% and 5% in 1984. Looking further ahead, though, most of these countries need additional foreign investment in order to generate the exports needed to make interest payments.

The members of TIME's board believe the value of the dollar, which last week reached record highs against the British pound, the French franc and the Italian lira, will begin to slip next year. Said De Vries: "I think eventually the dollar must come down. We will see a 5% trade-weighted average decline in the value of the dollar in 1984."

A cheaper dollar will help reduce the U.S. trade deficit by making American-made goods less expensive abroad. This year the value of foreign goods imported into the U.S. exceeds the value of exports by $60 billion, and a bigger gap is expected next year. But exports will remain low as long as foreign economies, especially those in Europe, are weak.

It will take political leaders of great character to look beyond the present good economic times to the longer-term problems being created by the large budget deficits. While everything seems in place for an economically happy new year for the U.S., 1985 and beyond will be more difficult unless Congress and the Reagan Administration do something about those $200 billion deficits. It may be bad politics to cut spending and raise taxes in an election year, but it would be very good economics.

--By Alexander L. Taylor III This file is automatically generated by a robot program, so viewer discretion is required.