A Realistic Lack of Confidence

TIME'S Board of Economists finds many reasons for executive worry

With production heading higher, unemployment dropping and profits climbing, businessmen by all rights ought to be bullish. Quite the opposite: last week brought two new signs that they are still deeply worried. The stock market, that sometimes distorted mirror of investment hopes and fears, tumbled 22 points, as measured by the Dow Jones industrial average, to a 34-month low of 753. And a McGraw-Hill poll of executives in eleven industrial countries found U.S. businessmen second from the bottom in confidence about the future. Only profit-pinched Belgian managers were more apprehensive.

What is it that so worries American business leaders--and keeps them from committing their companies' money to job-creating research, development and plant-expansion projects? Members of TIME'S Board of Economists, who gathered in Manhattan last week, found the answer in a whole series of concerns--about persistent inflation, rising interest rates, the widespread expectation of an economic slowdown late this year or in 1979, the threats of energy shortages and increasing Government regulation. Their rather chilling conclusion: strongly as the economy is performing now, the longer-term risks are genuine and serious enough to justify the executives' considerable caution.

Says Alan Greenspan, who was chairman of President Ford's Council of Eco nomic Advisers: "There seems to be some belief that you can exorcise this state of business mind by mass psychotherapy. But you can't because the attitudes are not irrational. When you are uncertain about the environment for investment, then you will not commit your money, just as someone will not run in the middle of the street blindfolded." Otto Eckstein, head of Data Resources Inc., a Boston-based, computerized economic-forecasting firm, thinks that executives' caution should not even be described as "lack of confidence," but rather as "business realism."

The caution is potentially damaging. Adjusted for inflation, business spending on new plant and equipment is expected to rise only about 4.5% this year, v. the 7% increase the Administration calculates is necessary to keep the economy expanding. One reason: what Greenspan calls the "hurdle rates" for new investment have risen by two percentage points in the past decade. In other words, a company that once would have built a new plant or installed labor-saving machinery if it could expect, say, a 10% annual profit on investment, will not go ahead now unless it can foresee a 12% return.

Equally ominous, spending on research and development has fallen from 2% of gross national product in the mid-1960s to 1.5% today, partly because research projects often will not yield a return until well into what businessmen see as an uncertain future. Both the rise in hurdle rates and the decline in R. and D. indicate that the hired managers who run corporations today are more fearful of taking risks than the venturesome owner-managers of old.

The risks that businessmen see, according to members of the Board of Economists, are not primarily the fault of Jimmy Carter. True, many executives are convinced that the President has not got a handle on the problems of the economy. But their apprehensions predate Carter's Inauguration, and probably would be strong now even if Gerald Ford were still in office.

The most pressing fears:

Inflation Businessmen have never got over the shock of double-digit inflation rates in 1973-74. Such high rates were once considered impossible; now that they have occurred, nobody feels confident that they will not return. Though the inflation has since come down to about 6% from 11% in 1974, Chicago Banker Beryl Sprinkel, a member of TIME'S board, fears that it will soon move up again--perhaps to 7% by the end of 1978 and 8% by the close of next year. Other board members generally think that prediction is too pessimistic, but can see no prospect of a slowing down soon. Republicans blame huge budget deficits and excessive creation of money by the Federal Reserve Board; Democrats, though also worried about the $60 billion deficit proposed by Carter for fiscal 1979, put more emphasis on the tendency of the wage-price spiral to keep spinning from sheer momentum.

Even a continued 6% inflation rate disrupts business planning. "This country doesn't know how to live with 6% inflation," declares Arthur Okun, who was chairman of the Council of Economic Advisers under President Johnson. He gives this example: many companies are reaping such high sales from plants built in the mid-1960s that they would like to build new plants to cash in on expanding markets. But inflation has so raised the costs of duplicating old factories that companies would have to increase prices by 15% to 25% to make the outlays profitable. Uncertain whether they could make such large price increases stick, the companies shelve their expansion plans.

Recession There is a legitimate question whether Carter's programs can keep the present rapid expansion going past this year--especially in view of the drag imposed by higher Social Security taxes, rising interest rates and the upsetting effects of inflation. Though no member of TIME'S board yet predicts an outright downturn in 1979, David Grove, chief economist of IBM, forecasts a growth of only 2.7% for 1979, v. the 4.5% to 5% generally expected for this year. Moreover, he expects corporate profits, which rose 9.7% in 1977, to show no growth this year and next. The reason, says Grove, is that labor-cost increases will be too great for companies to offset by rising productivity, higher prices or even greater volume, given the likelihood of a slowdown.

In the opinion of Walter Heller, chairman of the Council of Economic Advisers under Presidents Kennedy and Johnson, the fear that demand will not grow fast enough to make new factories profitable is the greatest of all inhibitors to investment. Says he: "Sustained strong markets are mighty good therapy for business confidence." But, he adds, businessmen are no longer as sure as they were during the 1960s that people will buy the products turned out by new or expanded plants, which tight-money policies make expensive to build.

Interest Rates They have jumped sharply; the prime rate on loans to business climbed from 6.25% at the start of 1977 to 8% early this year. Sprinkel foresees a further rise of one percentage point in short-term rates this year. Such an increase would slow investment by making expansion funds costlier.

Greenspan and others raise the specter of "crowding out"--meaning that the Government will have to borrow so much to finance its budget deficits that little loan money will be left for business, and the cost will be unusually high. Also, high interest rates and a scarcity of loan money would have a devastating impact on housing, which is a mainstay of economic expansion. Okun is willing to bet all comers that if the rate on 90-day Treasury bills hits 7.5% (it is a bit over 6.5% now), housing starts will tumble, perhaps by as much as one-third in less than a year, leading the economy into recession.

There are other worries, difficult to dispel. Energy is one: businessmen wonder what kind of fuel a new plant should burn, whether adequate supplies will be available and at what price. Government regulation is another: executives know that they will be faced with new environmental, safety and employment rules, but cannot determine what those rules will be and thus have no way of calculating the cost of compliance. Finally, the stock market is not only a reflection but a cause of business uncertainty. It indicates that investors are putting a low value on business assets and earnings prospects--not a cheering thought to an executive pondering an expansion program. The bear market also inhibits capital investment by making it much cheaper for a company to "expand" by buying the depreciated stock of another company than by building new plants of its own.

Is anything in sight that could rebuild business confidence? Democrats on the board can see several possibilities. Heller believes that congressional passage of any kind of energy program would at least assure businessmen that they know what policy is. He adds that enactment of Carter's tax-cut plans, which would reduce the corporate tax rate from 48% to 44%, would also cheer executives. Okun believes that replacement of Arthur Burns by G. William Miller as chairman of the Federal Reserve Board will greatly lessen the chances that the Administration and the Fed will pursue warring budget and interest-rate policies.

Republicans are less sure, but even they see some hope. Greenspan believes that "two or three years of stability"--meaning economic growth at declining rates of inflation--would restore business confidence. Unfortunately, no Administration has been able to supply that ideal combination. But if one could, it would work wonders: there is a huge backlog of expansion projects that executives do not now dare to undertake but would love to start if conditions seemed right.

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