Don’t Bank on Economic Predictions : They’re Uncertain Because the World Is Uncertain
We are entering the 38th month of the ninth economic recovery since World War II. Only three have lasted longer, and this may be the strangest. Unemployment remains high, and the economy’s output--the gross national product--has grown relatively slowly. Yet, in another way, America is booming,. Personal consumption has risen faster than in previous recoveries. What explains the apparent contradiction? Just this: Imports have met about a quarter of the increase in consumer and business demand.
Four years ago almost no one predicted the import flood. Remember that as you ponder the new year. It’s the season for economic forecasts, and this year may be especially baffling. Economist Robert Eggert, who has compared forecasts for 17 years, has never seen such wide disagreement. Optimists believe that declining interest rates, the booming stock market and the dropping dollar will sustain a strong economy. Pessimists think that debt-burdened consumers will slow spending, pulling down business investment. Some economists see a recession.
Why can’t economists be more certain?
The simple answer is that the world won’t hold still. Many economists once thought that, with computers, they could solve the future. But they found that even computers can’t cope with the complexity of modern economies. Governments alter policies, and markets change. In particular, global markets have become more important. These changes disrupt established patterns of business and personal spending.
The result is that, for all their alleged sophistication, most economic forecasts are at best educated guesswork. For 1986 the uncertainty is especially acute. Eggert regularly collects 50 forecasts for his “Blue Chip Economic Indicators,” and here is what his consensus--the average of all 50--shows for 1986:
--Economic growth will be better than in 1985, with “real” (inflation-adjusted) GNP rising 3.1% against 1985’s estimated 2.4%. But growth will only absorb the expansion of the labor force, leaving unemployment stuck at about 7%. Inflation will be 3.6%, as against 1985’s 3.3%.
--Housing starts will equal 1985’s 1.7 million units, but automobile sales will decline--from 1985’s estimated 11.1 million to 10.6 million. Domestic producers will account for all the drop; imports will increase from 2.8 million to 2.9 million. New business investment will increase 3%, about half the 1985 rise. Inventory rebuilding also will help the economy; in 1985, business barely increased its inventories.
--Just as a widening trade deficit siphoned demand from the economy, a lower dollar will shrink the trade deficit and improve the economy. American goods will become more competitive, and more U.S. demand will be satisfied by U.S. production. By 1986’s fourth quarter, the deficit will be (at an annual rate) nearly 15% below the record level of 1985’s third quarter.
Can you trust this forecast? Not really. Although Eggert’s “consensus” has often been accurate, it has frequently bombed. For 1982 it failed to predict the worst postwar recession. And it has consistently misjudged inflation, underestimating it in the 1970s and overestimating it since 1982.
The economy’s current puzzle is that it has ample room to grow, but it’s unclear how it will grow. The prospective rise in consumer spending appears weak, and recent surveys of business investment show small declines in 1986. By itself, a dropping federal budget deficit would also dampen economic growth. Without a narrowing trade deficit, most forecasts would show little or no growth for 1986.
The good news is that a burst of economic growth could feed on itself. Rising inflationary pressures or shortages often stopped previous recoveries. These problems are now notably absent. Unemployment remains high, while factory utilization (about 80%) is low. This means that higher consumer and investment demand, if met by U.S. production, should translate into more employment and profits--not higher inflation. In turn, higher incomes would spur more spending.
Economists deserve some sympathy for their inability to make reliable forecasts. The practical problems are huge. One is information. They don’t always know what they need to know. For example, are consumers overextended or not? The answer is vital, because it shapes consumer spending, which is about two-thirds of all spending. And, by one measure, the answer seems clear: The ratio of consumer debt to disposable income is a record 18.9%; the previous high was 17.7% in 1979.
But wait--there are conflicting signals. More people than ever use credit cards as plastic cash. But even though their charges are repaid each month, they’re counted as debt. Moreover, the size of the 25-to-44-year-old age group, traditionally big borrowers, is rising. These factors inflate the debt statistics without necessarily adding to individuals’ debt burden. Economists at the investment firm of Goldman Sachs conclude that “U.S. consumers are not seriously overburdened by debt.”
The forecasters’ true bane, though, is change, not skimpy statistics. Most American economists were taught that our economy is largely self-contained. It’s difficult to cope with new global realities. Since spring, our interest rates have dropped; so has the dollar’s exchange rate. Might these changes spur greater growth abroad and thereby increase U.S. exports? (Foreign growth could increase because U.S. interest rates influence foreign rates, and a lower dollar cuts foreign inflation.) Few forecasts consider the possibility.
Economics is a behavioral discipline. It attempts to understand and predict business and consumer behavior. But its powers of prophecy are sharply limited by chance, the diversity of a global economy and the constant flux of modern institutions and habits. Like generals fighting the last war, economists are always trying to explain yesterday’s surprise.