Economic slowdown around the bend

Economic forecasting was once described as neither an art nor a science, but a hazard - and one not subject to regulation by the Occupational Safety and Health Administration. Given the experience of the last few years - each time the slowdown projected for "next" year turned out to be still over the horizon - estimates of the future performance of the US economy do not inspire overwhelming confidence.

Nevertheless, the fall is customarily the time when decisionmakers in both the public and private sectors begin their annual planning cycle.

That effort usually commences with a crystal ball exercise. So here goes. After expanding at an unusually high 4 percent rate for three years in a row, the American economy will slow down somewhat in 2000. The current outlook is for a growth rate in the neighborhood of 3 percent - which is not too shabby.

In part, the slowdown will reflect a very short-term phenomenon. Some unusual consumer and business stockpiling is likely in the fourth quarter of this year in response to scares about Y2K effects. However, as generally expected, the pileup of inventories will turn out to be unnecessary. Thus, the first quarter of 2000 may be especially subdued as stocks of materials are drawn down rather than replaced.

Nevertheless, the economy is showing some of the manifestations associated with the latter part of a business cycle. Labor costs are rising; profit rates are slowing; new housing starts are down. And the Federal Reserve is raising interest rates, albeit at a modest pace 0.25 percent at a time.

Other hallmarks of an unsustainable trend in the national economy include a stock market widely held to be substantially overvalued, a tightening labor market, and a record trade deficit.

Were it not for the financial crisis in East Asia in 1997-1998 (which resulted in downward price pressures here from imports reflecting their currency depreciation and weak markets), the Fed likely would have raised interest rates substantially in the past year or two. This helps to explain why the expected economic slowdown did not occur here last year or this.

However, all the economies of East Asia are recovering, albeit at different rates. Thus, the downward price pressures from imports should be slowing significantly. Moreover, the attractiveness of local investment should be restored in East Asia, at least partially. This shouldn't result in a massive reflow of funds back to the Orient, but rather a reduced flow of new investment capital from that region.

So, it should take some increases in interest rates to attract the funds required to finance our $300 billion annual current account deficit.

Albeit painful, a rise in interest rates will constitute an effective adjustment mechanism. The slowdown in our economy should translate into lower imports and thus a reduced trade deficit. Higher interest rates in turn will help ensure that we remain an attractive place for foreigners and Americans to invest their funds. An important side effect is less downward pressure on the dollar in currency markets.

Why the preoccupation with attracting foreign investment? Because of a fundamental structural imbalance in the American economy.

The imbalance can be described in several related ways: As a nation, we consume more than we produce; we invest more than we save; we borrow more than we lend; and we import more than we export. As we have seen in the last several years, there are attractive positives that result from these imbalances. We enjoy a high growth rate simultaneous with low inflation and low unemployment.

However, these good things may not last indefinitely, as the expected slowdown next year would attest.

Of course, there are many countries that would be delighted to deal with the economic challenges that face the US. A 3 percent rate of economic expansion would be most welcome in Japan and many parts of Western Europe.

*Murray Weidenbaum is chairman of the Center for the Study of American Business at Washington University in St. Louis.

(c) Copyright 1999. The Christian Science Publishing Society

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