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THE UJS. ECONOMY IN 1985 AND BEYOND Remarks o f Mr. Robert P. Forrestal President Federal Reserve Bank o f Atlanta To the Sixth Southern Center Regional Conference on U.S. National and Global Competitiveness in the 1980s Williamsburg, Virginia February 28, 1985 I am delighted to have an opportunity to take part in this symposium. My interest in the role o f international trade is long-standing, and I believe that our nation's competitiveness in the global marketplace is a paramount concern for the 1980s. The aspect o f that issue that this conference will highlight—management and industrial relations—is an important one, deserving o f greater attention. I would like to talk tonight about the economic outlook for 1985 and, in a broader context, the longer term prospects for the U.S. economy, including factors that are likely to influence our productivity and global competitiveness. National Scene The outlook for 1985 cannot be adequately assessed without reviewing the economy's performance in 1984 and evaluating what the underlying conditions at year's end portend for the next 12 months. A t the beginning o f last year many economists had serious doubts about the recovery's strength and durability, and most were predicting rather modest GNP growth. In addition, expectations were widespread that inflation would be higher than in 1983. On the brighter side, many economists forecast a decline in the exchange rate o f the dollar and, hence, some improvement in our nation's international trade situation. My views were generally similar to this consensus outlook. -2A t that time, I projected that the economy was likely to slow to a growth rate o f around 5 percent and that unemployment would probably hover at the 8 percent level, perhaps dropping to 7 1/2 percent by the end o f 1984. In addition, I expected inflation to pick up to about 5 percent. Although these projections were not far o ff the mark, it was my happy experience to have erred on the side o f underestimating the enormous growth in GNP while overestimating both the inflation and unemployment that we actually experienced in 1984. As you all know, 1984 brought heady economic growth. GNP expanded at a rate far in excess o f what had been anticipated, and the full-year growth rate was nearly 7 percent, the highest in over 30 years. This expansion was led by consumers, whose purchases o f homes, cars, appliances, and a myriad of durable and nondurable items spurred businesses to increase production, expand their work forces, and build their inventories in anticipation o f continued strong sales. Businesses also served as a dynamo o f growth by sharply increasing their spending on capital goods. Business investment, particularly in machinery and other equipment and, to a lesser extent, in new plants, contributed significantly to the expansion we witnessed in manufacturing as well as construction. Despite a sharp slowdown in the third quarter that rekindled doubts about the longevity o f the expansion, we finished the year on a strong note. The annual growth rate o f GNP revived to 4.9 percent from the third quarter's sluggish pace o f 1.6 percent. Consumers regained confidence and increased their spending almost 4 percent in the fourth quarter after essentially standing pat from the second to the third quarter. An important factor underlying this revival o f consumer spending was the continued growth o f employment and personal income. Business investment, especially in plants, o ffic e -3buildings, and other structures rather than machinery and equipment, also contributed to growth in the fourth quarter. Largely because o f the advances in consumer spending and capital investment by businesses, final sales rose over 8 percent in the last three months o f 1984 after declining 1 percent in the third quarter. growth was only half that o f the third quarter. Meanwhile, inventory This combination o f higher sales and lower inventory accumulation enabled producers and retailers to adjust their stocks to more desired levels, thereby setting the stage for renewed growth in factory orders, industrial output, and employment. Indeed, these developments have already begun, and, as a result, the proportion o f our nation’s productive capacity being utilized continued to edge up in January for the third consecutive month. A t the same time the economy was regaining its momentum, consumer prices continued to moderate, rising at a 2.3 percent yearly rate in December, compared to increases of around 3 1/2 percent in earlier months. Competition from imports and oil price reductions accounted for much o f this year-end deceleration in inflation. Yet even service prices, which had been rising more rapidly than the overall price index, abated in December. Although January's unemployment rate rose slightly to 7.4 percent, this change was due largely to a faster increase in the labor force than in employment. While we all would have preferred a fa ll in the jobless rate, the reasons for the latest increase betoken renewed confidence in the economy. The return to economic growth probably brightened people’s attitudes about the prospects for finding employment and caused them to enter the labor force in search o f work. Thus, concerns voiced only a month or two ago that our expansion might not last much longer have been quelled, and expectations are now widespread that growth will continue at a moderate but respectable pace throughout 1985. It now seems clear -4that the weakness manifested in the third quarter was part o f a transition from the very rapid, potentially inflationary, and unsustainable growth in early 1984 to a more sustainable pace in 1985. Few imbalances or weaknesses currently exist in the economy. Healthy monetary growth and lower interest rates together with the nearly complete inventory correction have laid the groundwork for economic growth in the coming months. Consumer purchases, investment by businesses, and expenditures by the government all should contribute to making 1985 a good year, with real GNP growth probably in the range o f 3 1/2 to 4 percent. Consumer spending is likely employment continue to advance. to remain healthy since personal income and The only current cause for concern is the rapidly rising level o f consumer debt, which now stands at over 17 percent o f disposable personal income. This level is the highest since April 1980. Moreover, its implications are somewhat more troubling since the lower level o f inflation that we are enjoying today will not reduce the burden o f this debt as it did in the period o f the previous peak. This high level o f debt could eventually place a constraint on consumption. Business spending on capital goods should continue to fuel expansion in 1985, even though the growth rate in business investment, like that o f consumer spending, probably w ill be slower than in 1984. Last year's legislative modifications o f the tax treatment o f business investment did not substantially alter the favorable climate for spending on capital goods established by Congress and the administration a few years ago. Recent Treasury Department tax reform proposals, which would eliminate many special provisions designed to spur investment, could, ironically, catalyze investment in equipment this year. Businesses may try to take advantage o f such provisions before they are rescinded or modified. Currently lower interest rates and slowly rising capacity -5utilization should provide sufficient impetus for ongoing growth in business investment this year. In addition, business investment in inventories w ill likely rebound somewhat, following the sharp deceleration in the fourth quarter o f 1984 and the improvement in final sales. A third source o f short-term strength is fiscal policy, which is highly stimulative. Defense expenditures in particular should help maintain substantial momentum in the nation’s factories, even if cuts are applied to defense as well as other federal programs. M ilitary projects approved in the past few years should maintain strong activity through at least 1985 and possibly into 1986. in 1984. Another stimulus is the interest rate decline late Monetary growth rebounded smartly in recent months after a previous weakening, particularly in the growth o f M l. This growth and the concomitant decline in interest rates should encourage economic growth in 1985. Even though residential construction tends to lag behind other changes, some o f this e ffe c t has already been observed in the housing sector. By making it relatively cheaper for builders to undertake new projects, reduced credit costs should spark at least a temporary revival in home building. Housing starts did jump almost 15 percent in January, although apartments and other multifamily building accounted for this growth. for housing has been filled. Much o f the pent-up demand Consequently, a return to the booming single-family construction that we saw in the recovery stage is unlikely. O f course, some potential problems and weaknesses loom in the months ahead, and certain sectors o f the economy are less likely to be sources o f expansion this year. Perhaps the foremost area o f continuing weakness is the international sector. The high exchange value o f the dollar and the slower recovery abroad have sapped considerable strength from American manufacturing. Producers o f textiles, apparel, lumber, and -6other goods that are sensitive to foreign competition experienced weak growth in 1984, and their condition probably will not improve in 1985. In addition, industries with a heavy dependence on exports, such as agriculture and machine tools, cannot hope for much stimulus from foreign demand. In contrast to recent business cycles in which the adverse e ffe c t o f high real rates has been fe lt as "crowding out" o f construction and capital investment, the foreign trade sector has suffered the most in this business cycle. While capital spending and residential building proceeded apace despite high real interest rates, the merchandise trade deficit for 1984 totaled over $123 billion, far higher than the previous record shortfall o f $69 billion in 1983. a decline in the value o f the dollar is uncertain. The outlook for Despite narrowing interest rate differentials and large trade deficits, the trade-weighted index of the dollar has risen considerably just since the beginning o f 1985. Even if the dollar were to decline, it would take time to have a substantial e ffe c t on trade patterns. A second potentially dampening factor is fiscal policy. Significant alterations, particularly in the tax system, could adversely a ffect financial markets. Many businesses are concerned that efforts to reduce the deficit w ill lead to higher corporate taxes, which would tend to lim it long-term investment. Uncertainty about potential tax changes may cause businesses to defer planned investment, particularly in the near term, until the nature o f tax changes likely to be enacted becomes more evident. Because o f these weaknesses and the likelihood o f slower growth in consumer spending and business investment, unemployment will probably decline much less this year than it did in 1984. percent mark. Still, I am quite hopeful that it will fa ll below the seven Import competition, lower oil prices, and bountiful harvests should hold -7price increases to 3 1/2 to 4 percent, close to recent trends. Overall, I look for respectable economic growth consonant with this stage o f the business cycle. Outlook fo r the Southeast Businesses and workers here in the Southeast are likely to share the fruits of this anticipated economic expansion. However, because o f the nature o f many state economies, which tend to be concentrated along lines o f local comparative advantage, particular strengths and weaknesses that a ffe c t the national economy may have a more pronounced impact spending—will be in of certain particular areas. One importance source to of many national strength—defense southeastern states where defense-related manufacturing o f electronics and transportation equipment is important. The healthy e ffe c t o f lower interest rates on auto sales augurs well for car assembly plants in this region. Finally, a continuing population influx should help many southeastern states outperform national averages by sustaining the need for new homes, apartments, and o ffic e buildings. A growing population also boosts demand for business and personal services. Agriculture, a sector o f substantial importance to many parts o f the Southeast, faces a somewhat clouded year. Weak foreign sales, low prices for many crops and livestock, and high real interest rates make it difficult for farmers to improve their credit situation, and no substantial change in these conditions appears in the offing. The unusually high exchange rate of the dollar is aggravating problems o f the Southeast’ s energy sector by making its products more expensive in world markets, and improvement appears unlikely in the near term. The dollar’s high value is also intensifying the foreign competition faced by steel producers in the region. Moreover, many southeastern -8states also have a large concentration o f textile and apparel industries that have been hard hit by imports, whose prices are discounted by the current value o f the dollar. The textile and apparel industries are likely to remain weak in 1985. Notwithstanding probable weaknesses in some aspects o f the southeastern economy, on the whole, most residents o f this region should enjoy a year o f economic prosperity as good as, if not better than, that experienced by the rest o f the nation. Problems I am basically optimistic about the future, but some areas remain weak and in need o f change in the next few years. These problems include inflation, unemployment, the deficit, real interest rates, and international trade. The rate o f price increases did decelerate dramatically in the early 1980s and has remained a moderate four percent despite the rapid economic growth we experienced last year. Nonetheless, little more than a decade ago four percent was deemed sufficiently high to warrant the imposition o f wage and price controls. Clearly, we have room for more improvement on this front. Similarly, the progress we have made toward reducing the unemployment rate from double-digit levels is cause for enormous satisfaction with our economy’s capacity to rebound. Still, the current 7.4 percent jobless rate is far from the full-employment level o f 4 or 5 percent to which we as a nation have been committed since the end o f World War n. Moreover, unemployment remains much higher than seven percent in many industries and areas. Certainly, we must strive to lessen the human suffering and unrealized economic potential implied by these statistics. -9A third problem is the very large federal budget deficit. As macroeconomic growth moderates and the d eficit increases in absolute terms, the federal budget deficit, even adjusted to the level that could be expected if we had full employment, is likely to remain around 3 1/2 to 4 percent o f GNP throughout 1985 compared to an average o f about 1 percent since the mid-sixties. reasons. rates. This deficit is extremely troubling for several Large federal budget deficits tend to exert upward pressure on real interest High real rates increase business costs generally and discourage investment. Consumer demand for houses, autos, appliances, and home furnishings is also dampened in such an environment. D eficit problems a ffe c t the international sector as well because high real U.S. rates make dollar-denominated investments more attractive to foreigners. The higher return from holding dollars raises our currency's exchange rate and thereby worsens our trade deficit by raising prices foreigners must pay for exported U.S. goods and lowering prices Americans pay for imports. I have already mentioned that the dollar's strength is seriously hurting American exports and sharply increasing imports, exacting a considerable toll on American manufacturers in a wide variety o f industries ranging from labor-intensive apparel plants to capital-intensive steel mills. A continuation o f the current international situation could result in a resurgence o f protectionism. Many firms have been holding on by a thread, hoping the exchange rate o f the dollar will decline. It is understandable that firms in such straits would welcome protectionist measures to help them ride out what most economists view as an abnormal situation. However, protectionism tends to adhere to Newton's Third Law in the sense that action by one country is usually followed by countermeasures in other countries. It may take years o f negotiations to return to the degree o f free trade that prevailed at the outset, even when protectionist policies are conceived as mere interim measures. Moreover, -10by postponing necessary reforms, protectionism ultimately weakens the very businesses and workers it is intended to protect. Another adverse consequence o f protectionism today could be to snuff out the weak economic recovery in many developing countries by reducing their access to American markets, eliminating a major source o f the limited growth they have achieved. The situation in developing nations is important for another reason. Many less developed countries are heavily indebted, and while default by a third-world nation is highly unlikely, the problem o f LDC debt is a serious and long-lasting one. It requires continuing surveillance and careful consideration as we fashion or modify policies intended to correct domestic economic problems and promote growth in the United States. Longer Term Outlook L et me turn now to the outlook for the future in a broader context and over a longer term period, say, to the end o f the century. Looking beyond 1985, it is, o f course, much harder to project accurately how the economy will fare. Nonetheless, it is possible to identify the fundamental forces o f strength and weakness as well as changes that seem to be occurring in the structure o f the economy. In my judgment, there are at least three critical environmental factors at work in our economy and our society generally that will shape our destiny for years to come. demographic changes, and the evolution o f a global economy. these in turn as well as their implications for public policy. These are technology, I w ill discuss each o f -11When historians and other observers look back in another 50 years to the era of the 1980s, they will no doubt compare our technological revolution to the industrial revolution o f the 1800s. Even though, in typical human fashion we are becoming used to our new technology and even taking it for granted, the fa ct remains that we are witnessing and living through a miraculous time in history in terms o f technological breakthroughs—going into space, computerization, miniaturization, to say nothing o f the advances in medical science and associated surgical procedures such as the mechanical heart. These are truly wonderful developments that w ill enrich the lives o f people everywhere. In economic terms, the application of new technology generally results in higher productivity and greater economic growth in the aggregate. historically been a technological leader. The United States has Experiences o f the last two decades have made us forget that terms like ingenuity and innovation are virtually synonymous with America and that technological leadership is fundamentally related to our political and economic leadership among nations. In the last recession, American businesses learned, or rather relearned, the importance o f investing in technologically advanced equipment and methods in order to compete in the global marketplace. yet fe lt the full e ffe c t o f that investment. year, the postwar average Nonetheless, we have not Productivity grew about two percent last rate for the second year o f an expansion. productivity gains have not been consistent. However, In the third quarter, productivity fe ll 1.1 percent, and the fourth quarter gain was only 1.7 percent. Although the considerable investment that has taken place could render performance this year better than in the typical mature phase o f the business cycle when productivity gains usually slow, the longer term challenge will be to find ways to supplement technology-related productivity gains, especially in the service sector. This part o f the economy is likely to provide a -12vast portion o f the new jobs in the future, and services historically have been less amenable than manufacturing to technology-induced productivity advances. A second environmental factor that will a ffe c t demographic changes that are occurring in our society. us and our policies is the First, we have the "graying" of the population and, second, the maturing o f the postwar baby-boom generation. The aging o f our population has profound implications for the way in which we structure our work force, retirement, Social Security, and our health care and health delivery systems. With respect to the "baby-boomers," absorption o f these men and women into the labor force is virtually complete. Consequently, finding entry-level jobs should be less difficult than over the last decade and a half. As the postwar generation passes through its peak spending period, demand for all sorts o f consumer goods should be strong. Productivity should also increase as a larger proportion o f the nation's work force consists o f experienced workers, who tend to be more productive. Since the number o f students now entering school is generally less than when the baby boomers were moving through the educational system, the need to invest in bricks and mortar to accommodate larger student populations should abate. That will leave a larger share o f public funds for improving the quality of education, a trend that should add to gains in productivity expected from other factors. A third environmental factor is the evolution o f a truly global market economy. We have come to realize, I believe, that the United States is no longer able to buy and sell only within its own borders. With the possible exception o f the Soviet bloc, the world is truly one marketplace. The obvious implication o f this development is that U.S. industry and business must learn to compete more effe c tiv e ly with foreign producers. I do not for a moment believe that we need to berate ourselves, as we often do, about -13our performance relative to other economies. In the first place, our manufacturing sector is not nearly as bad o ff as some would have us believe, and the potential for significant advances in productivity is at hand. I firm ly believe that American management is as good as, if not better than, management anywhere in the world. Nevertheless, improvement can be made, and we do need to raise our productivity and the quality o f our products so as to compete more e ffe c tiv e ly in world markets. One way to achieve these goals is to seek better relations between labor and management, whether by giving workers an equity stake in their organization through employee stock ownership plans, by adopting and adapting some of the collaborative techniques that have worked well in Japanese and European companies, or by other innovative, uniquely American measures. Researchers at the Federal Reserve Bank o f Atlanta have found that companies with outstanding financial performance tend to give employee job satisfaction a high priority among corporate goals. Other research conducted by Bank staff has discovered that gain-sharing measures like employee stock ownership can be effective, often highly remunerative, benefits and significantly reduce turnover, thereby making companies' investment in their employees more worthwhile. If ways can be found to improve our human capital through relations on the job, the productivity advances that should occur from demographic and technological changes will be greatly augmented. As pointed out in a recent report o f the Committee for Economic Development, another way to improve our productivity and product quality and thereby enhance our global competitiveness is to remove government barriers and regulations to the greatest possible extent and to allow free market forces to work in our economy. polite way o f saying, let's get the government o ff our backs. This is a I f we need any evidence -14that this is the right way to go, we need only compare our nation’ s economic performance during the recovery to that o f many developed and developing countries. Too frequently, their economic growth has been constrained and stifled by a large public sector’ s unintended effects on the economy and its ability to adapt to change. welfare Cradle-to-grave systems are limiting economic recovery in Europe and perpetuating high unemployment rates. In LDCs, measures such as price regulations on certain basic goods are distorting their economies, bloating their underground sectors, and generally retarding their development. I f our government w ill retreat from the private sector, if the public sector is diminished, market forces will hone our com petitive edge and, thereby, enhance our position in world markets. Finally, let me add one other environmental factor. I believe that we are now emerging from a period o f deep negativism in our country to a far healthier attitude of hope and positive thinking. During the 1970s, our nation underwent enormous changes such as the shock o f oil price increases following the formation o f OPEC and the implementation o f a new series o f regulations designed to make our products and work places safer and our environment freer o f pollution. Meanwhile, workers were seeking to increase their share o f our national income distribution. In addition, the momentum o f far-reaching social change begun in the 1960s continued into the 1970s. Once barriers to racial and sexual equality began to be removed, as a society we began to address more subtle and harder-to-remove vestiges o f inequality. that in this environment o f profound social, political, It is not surprising and economic change that Americans began questioning and criticizing some o f the fundamental aspects o f our culture. -15The changes that occurred exacted a considerable toll on our economy, although future generations w ill probably look back and thank us for making most o f the decisions that we did. Fortunately, the pains o f this transition are essentially behind us, and along with that, I believe people are becoming more positive about our nation's performance, economically and in other spheres. recognize the improvements. inflationary consequences of Furthermore, workers have come to wage gains that exceed productivity Recent contracts and wage settlements reflect this awareness and a new flexibility on both sides o f the bargaining table. I am grateful that we are moving away from our period o f malaise and that Americans are more upbeat about themselves and more adaptable to the economic realities o f the 1980s, particularly the implications of global competition. Still, we must nourish this renewed faith in our nation's institutions. not become misled by the bad news we often hear and read in the media. We should As an open and free society, we are often our own severest critic; so it is natural that bad news rather than good fills most o f our headlines. A t the same time, we must keep our focus on the substance o f news reports and on the underlying forces at work in our economy and our nation lest we lose the competitive edge that comes with well-founded self confidence. As managers, whether in the public or the private sector, we must constantly strive for greater cooperation with those we supervise so we can all enjoy a higher level o f productivity and economic growth. Policy Implications In assessing and evaluating these forces in our economy, I would o ffer the following prescriptions to ensure that we have sustainable, noninflationary growth through -16the end o f the century: (1) take advantage o f new technology and improve productivity; (2) invest in human capital by well-chosen policies designed to improve the quality o f education and the working environment; (3) provide a good mix o f fiscal and monetary policies; and (4) reduce the federal budget deficit over the next five years. L et me conclude where I began. Nineteen Hundred Eighty-Five will be a year o f good economic growth, with relatively low inflation and unemployment. and always will be dangers, problems, and uncertainties. There are When you add to the economic concerns I have already mentioned, other problems such as the Middle East, Central America, arms control, terrorism—and the list goes on and on—it is obvious we live in a dangerous and difficu lt world. But I am an optimist, and I think we optimists have proven over time to be the realists. I really believe the future holds promise. This country has always been a strong, proud, progress-oriented nation with a deep-seated b elief that today is better than yesterday and tomorrow will be better than today. are at the threshold o f a new world, but we are also at a crossroads. We If we can solve our problems, we have the chance to create an economy and a society that will provide unparalleled prosperity for us, our children, and our grandchildren in the years ahead. We can succeed if we have the wisdom and the will to do it. I believe we can.
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