Slipping A Punch

By GEORGE J. CHURCH

Numerically, the forecast for 1998, as seen by members of TIME's Board of Economists and most other predictors, looks ho-hum. Steady but moderate growth in production, profits and wages. Little change in rates of inflation, unemployment and interest. Not bad, not great. Just kind of O.K.

But when TIME's panelists analyzed the forces shaping the numbers at a special meeting in New York City, they repeatedly talked of trends and events "unprecedented for modern economic times." Those words from Allen Sinai, chief global economist of Primark Decision Economics, referred specifically to the meltdown of Asian economies. But other tendencies are at least equally striking. They include a reappearance of the word deflation in serious discussions of U.S. prices for the first time in decades, as well as the possibility of a string of American budget surpluses unmatched since the Roaring Twenties--and the beginnings of a vigorous debate about whether this warrants a total overhaul of the U.S. tax code. In combination--or conflict--these forces make 1998 look anything but ho-hum and a lot more like the start of a journey into an unexplored world.

A remarkably placid start, to be sure. According to Sinai, the output of American goods and services will rise a lackluster 2.6% in 1998, with consumer prices going up a tiny 1.4%. Corporate profits will increase a hair less than 6.5% (vs. 10% last year). Unemployment will rise to 5% by year-end, while interest rates will drop to just under 5.5% on 30-year Treasury bonds. In sum, says Sinai, the economy will be "downshifting from great times to good times." Not surprisingly, the 1997 combination of output's leaping almost 4% while unemployment shriveled to a 24-year low of 4.6% was just too good to last.

Other board members agreed in general but not always in detail. Robert Brusca, chief economist of Nikko Securities Co. International, one of the world's largest brokerages, sees only a nearly invisible rise in unemployment, to 4.7% at year-end, but an uptick in inflation, to a rate of 2.5%, with interest rates on 30-year Treasury bonds climbing to 6.5%, from below 6% in mid-March. In his view, the tight U.S. labor market will give inflation a nudge that the Federal Reserve will try to combat by raising interest rates. (Sinai, in contrast, predicts the Fed will cut rates slightly to prevent a too steep economic slowdown.)

The big question is how badly these forecasts may be knocked askew by the ongoing Asian economic tempest. Henry Kaufman, one of Wall Street's most respected financial analysts, wryly notes that economists most often "forecast usual events because we all have experience" with them. But the Asian breakdown is far outside that experience. "We've gone over 60 years since we've had this kind of a massive disruption."

If the Asian economies continue to spiral down, tipping Japan into a severe recession and roiling global financial markets, says Brusca, "you could have a real horror story." But in what TIME's board hopes is the more likely scenario, the Asian economies will bottom out close to where they are now, and the result will then be to reduce U.S. output growth as much as three-quarters of a percentage point.

That is not a minor hit. It would mean gross domestic product's increasing considerably less than the robust 3% or so that it might otherwise have managed, unemployment's rising a bit rather than sinking to still further lows, and a distinct slowdown in corporate profits--especially among companies that had been exporting $300 billion or more a year to the Asian region. On the other hand, sagging demand from Asia is contributing to a worldwide deflation (a term rarely heard since the 1930s) in commodity prices, especially oil. And that is helping to douse what little inflationary fire may be left in the U.S. economy.

Overall, there could be no better sign of the economy's internal strength than its ability to roll with a punch as hard as the one from Asia and still squeeze out a fairly good year. Some reasons for that strength: rising productivity, which is at last increasing workers' real wages without pushing up prices, and government policies that Sinai pronounces "eerily" wise. Most important, of course, is the swing from gargantuan budget deficits in the 1980s and early '90s to an expected small surplus this fiscal year, with more to come. Kaufman notes a continuing boom in business investments and a new surge in housing--both "very unusual" for an expansion going into its eighth year. One reason: builders of factories and houses can borrow more easily, because the government no longer is gobbling up so much of the available credit to finance its deficits.

Can this virtuous circle keep spinning? Yes, says Robert Reischauer, a Brookings Institution senior fellow, in line with the Congressional Budget Office he once headed. The CBO forecasts a small surplus of around $8 billion this fiscal year, which ends Sept. 30, rising to perhaps $140 billion in fiscal 2008. Reischauer cautions, however, that the projections assume that the White House and Congress can clamp a tight lid on nonmilitary spending. In recent years, continued rises in civilian outlays have been offset by plummeting defense expenditures, but that drop has left little more to cut.

Another assumption is that the economy will grow steadily, continually pushing up tax revenues. Should there be one or more recessions instead, Reischauer thinks, the budget over the next 10 years or so would swing back and forth between "little surpluses" and offsetting "little deficits." Even that would mark the achievement, albeit more than 35 years late, of a goal once proclaimed by John F. Kennedy: a balanced budget over the business cycle.

Stephen Moore, director of fiscal-policy studies for the Cato Institute, a libertarian think tank, is more exuberant. Government projections, he notes, are based on a 4% yearly increase in tax revenues--but, in fact, revenues have risen an average of 7% for the past five or six years. If that continues, he says, "you start getting very enormous budget surpluses very quickly": $40 billion to $50 billion this year, "well over $150 billion by the year 2001."

Which raises a question that, says Moore, "we've never really dealt with": What to do with the money? He and Reischauer agree that at least some of it should be devoted to shoring up the Social Security system against the flood tide of baby-boomer retirements around 2012, though they disagree on the mechanism.

Moore also advocates an overhaul of the tax code that would bring the top federal income tax rate down to perhaps 20%, from the current 39.6%. He and Reischauer, however, would settle for a return to something like the 1986 tax reform, which killed many special tax breaks in return for a greatly simplified and lower set of rates. Congress has since moved in the opposite direction, enacting so many special credits and additional rates that it has, in Reischauer's words, "visited the complexity of the millionaire on the middle class."

There is a danger that the government will dribble away much of the coming surpluses through more piecemeal and confusing tax "reforms," coupled with increased spending. Indeed, the problem of how to allocate surpluses among spending increases, further tax cuts and national-debt reduction looms as the biggest economic puzzle of the next decade or so. But what a happy kind of ho-hum problem it is!