Gridlock (And Greenspan)

By John Greenwald

Could the closest and most bitterly divisive election in modern American history prove to be a boon to the U.S. economy? Absolutely, say members of TIME's Board of Economists, who gathered in Washington to assess the outlook after the murkiest presidential election in a century. With neither George W. Bush nor Al Gore commanding a clear mandate and the U.S. Senate virtually split down the middle, TIME's experts saw little risk of any broad and possibly destabilizing shifts in economic policy next year--regardless of who becomes the 43rd President.

The panelists agreed that gridlock would consign such bold but risky plans as Bush's proposed $1.3 trillion tax cut to the campaign-promise trash heap. "There won't be any huge tax cuts or entitlement programs, whoever becomes President," says Bruce Steinberg, chief economist for Merrill Lynch. "That means the budget surpluses should remain extremely large, and the national debt will continue to be paid down--all of which is friendly to financial markets."

With the next President almost certain to be hedged in, the most powerful economic leader in Washington next year will be Federal Reserve Chairman Alan Greenspan. The six straight interest-rate hikes he engineered from June 1999 to May 2000 have guided the economy into its present "soft landing." Those rate increases, designed to keep the expansion from overheating, slowed growth from a blistering 5.6% in the second quarter of this year to just 2.4% in the third. And if the economy should falter next year, the Fed could decide to lower rates again. Says Martin Baily, chairman of the President's Council of Economic Advisers: "Everyone believes Greenspan and his colleagues should continue to do the superb job they have been doing."

Today, with the rate hikes behind us, the TIME board forecasts a sunny 3%-to-4% expansion rate in 2001, together with an easing of inflation from some 3.3% this year to under 3%. And while unemployment may creep above 4% as the economy decelerates, jobs should remain plentiful. Says Martin Regalia, chief economist for the U.S. Chamber of Commerce: "The biggest concern of businesses from high tech to trucking is, 'Where will we get the workers to keep growing?'"

In other words, despite the palpable slowdown, the consensus of the Time economists was that the lengthiest business expansion in U.S. history will continue in 2001. Says Baily: "I don't see any reason for it to run out of steam if the policy environment is right."

Yet no economic forecast is risk free, and there are plenty of risks to darken the outlook, particularly if the U.S. should be jolted by what economists call an "exogenous shock," like Iraq's 1990 invasion of Kuwait, which helped trigger the last U.S. recession. Current hazards range from the slowing growth of after-tax corporate profits--down from nearly 15% this year to a projected 8% in 2001--to renewed violence in the Middle East to sharply higher energy prices (see following story). Add to that a floundering stock market, a projected trade deficit of some $400 billion and record levels of consumer and corporate debt, and some board members feel that the country still runs the risk of a much bumpier landing that could lower growth below 2% and perhaps even lead to an out-and-out slump. Some disquieting hints of a pullback appeared right on cue last month, when the Conference Board reported that its widely watched Index of Consumer Confidence had fallen to its lowest level since October last year.

What steps--in addition to doing no harm, can gridlocked Washington take to lessen the economic risks for 2001? A spirit of cooperation would certainly help, and Montana's Max Baucus, who will be the ranking Democrat on the Senate Finance Committee, thinks he can spy signs of that mood even in the smog of postelection bitterness. "There's a strong feeling in the Senate that we've got to join hands and work together," says Baucus. "We're as sick of the partisanship as the people are--maybe more so."

There's no shortage of work to be done if the lawmakers really can surprise themselves and everyone else by cooperating with one another. Baucus points to the possibility of passage of measures ranging from a subsidized prescription-drug plan to a reduction of the so-called marriage penalty--the quirk in the tax code that pushes some working couples into a higher bracket than two single earners with the same income. Other Time panelists expect modest tax cuts next year, particularly if the economy worsens.

As for Bush's plan to shift some Social Security funds to private accounts, TIME's economists say, "Forget it"--at least for next year. Aside from the lack of a majority to carry the proposition in Washington, the slump on Wall Street makes stocks and bonds look like anything but a safe haven for America's retirement dollars.

In fact, the destruction of trillions of dollars of investment wealth this year could ultimately threaten the expansion. Although the bull market has been winding down since April, the gains of the past five years have still encouraged consumers, whose purchases account for two-thirds of GDP, to act like big spenders. Economists call that tendency to spend when feeling rich the "wealth effect." But with the market--and especially tech stocks--skidding, those same consumers may decide to sit on their wallets. "We have never seen a wealth effect of this dimension in the history of the world," says Daniel Yergin, chairman of Cambridge Energy Research Associates. "But what happens now if this wealth effect goes into reverse?"

Not to worry, says Steinberg, who calls the evidence for a wealth effect "very debatable." He argues that rising wages and incomes have done more to boost consumer outlays than big rises in the NASDAQ index. And besides, Steinberg says, "you have to hit Americans over the head with a hammer before they stop shopping."

Still, tanking stocks have already created the makings of a credit crunch. The collapse of tech shares has crippled the market for initial public offerings and shut off the financial oxygen to young companies. And a growing fear of defaults has forced the junk-bond market to virtually cease functioning.

The vast U.S. trade gap increases the risks by causing the economy to become addicted to foreign capital. Every dollar in the deficit is counterbalanced by investments flowing into the U.S. If the holders of those funds should decide to take back their money, that would worsen any credit crunch. "When you're borrowing [the equivalent of] 4% or more of your GDP," says Regalia, "there could be a problem."

But other panelists say the powerful U.S. economy will remain a magnet for foreign investment for a long time to come. "We have a trade deficit," Steinberg notes, "because we grow faster than anybody else." That creates in Americans a bigger appetite for imported cars, cameras and vcrs than foreigners have for U.S. goods. Thus, "getting rid of the trade deficit by growing slower than everybody else would not be a desirable outcome."

A better remedy would be to further expand trade relations with other countries and thereby open new markets for U.S. companies. But Baucus warned of "populist stirrings" that have put mounting pressure on Congress to block new global trade agreements. Speaking on the one-year anniversary of the "Battle in Seattle," when protesters clashed with police outside meetings of the World Trade Organization, Baucus cited the animosity to trade pacts in his own state. In Montana, he notes, ranchers and farmers insist that the North American Free Trade Agreement (NAFTA) continues to drive down prices for cattle and grain. "You can't convince them of the facts," he laments.

Overcoming such resistance to trade agreements could prove one of the toughest tasks for the new Administration. "Many Americans believe trade expansion hurts jobs and the environment," Baily says. "The next President will have to convince Congress and the American people that he understands these concerns--and be able to push toward a more open world economy at the same time."

The first test could come quickly next year, when Baucus and congressional allies press for renewal of the so-called Fast Track authority, which Congress refused to give to the Clinton Administration in 1997. That hotly controversial item, which allows a U.S. President to negotiate treaties without the threat of crippling amendments from Congress, had helped Clinton craft NAFTA. Says Baucus: "It's very important to build a consensus [around environmental and labor concerns] to help get Fast Track passed."

How important? Without the spur of global competition, the U.S. might never have achieved the remarkable gains in productivity that have buttressed the current expansion. From 1973 through the mid-1990s, the output of goods and services per worker rose at a barely detectable pace. But since then it has climbed nearly 3% a year. Says Baily: "The explosion of new technology has reversed the collapse of productivity growth that began in 1973."

The benefits of that microchip-driven technology have spread rapidly throughout U.S. industry. "Much has been written about how the only real productivity gains have been in the technology sector," says Regalia. "But I think that's a data error. The economy is assimilating the new technology, and it's creating improvements everywhere."

The result, Steinberg says, is "an incredible dynamism and flexibility" that no other economy can match. That may sound Pollyannaish, but there was remarkably little dissent on the part of other panelists. Particularly since the next occupant of the White House will be too busy building bridges to disrupt the economy.

--With reporting by Bernard Baumohl/Washington

With reporting by Bernard Baumohl/Washington