How’s the Economy? Strong, Weak

Rounding the Labor Day turn finds economists no closer to agreement on the state of the U.S. economy than they were at the beginning of the year. For every economist who believes that business is weak, there’s another who thinks that things are strong.

To be sure, few would say that we are on the verge of, or are already in, a recession. However, there is no denying the fact that the economy is giving off mixed signals.

In the final analysis, a lot depends on one’s vantage point. Those who are either based in, or concentrate on, the production sector find mostly doom and gloom. On the other hand, those who follow the consumer have a lot more to be cheerful about.

This split between the production and the consumption side of the economy is nothing new. As a matter of fact, it stretches back over two years, to the middle of 1984. That’s when output of American industry began to flatten even as spending by domestic consumers continued to grow. Differences between output and consumption are not unprecedented. But until two years ago, they tended to be short-lived, mostly to correct inventory imbalances. The current split is different. Not only has it lasted longer than usual, but its origins were external, compared to the domestic nature of previous dichotomies.

I am referring, of course, to our trade deficit, brought on by the earlier strength in the foreign exchange value of the dollar. As you will recall, between July, 1980, and February, 1985, our currency nearly doubled in value, compared to a basket of currencies of the countries with which we do most of our trade. This made goods imported from abroad relatively inexpensive while causing our exports to jump in price.

Additional Pressures on U.S. Producers

Thus, while people continued to buy goods at fairly healthy rates, more and more of what they purchased was manufactured abroad. Plainly, this weakened our industrial sector, setting the stage for today’s economic dichotomy.

Even the 30% drop in the foreign exchange value of the dollar that has occurred over the past 18 months has not helped the nation’s manufacturers all that much. And there are additional pressures weighing on U.S. producers:

- Capital spending is being slashed because of the drop in oil prices, the anticipated impact of tax reform, the low rates of capacity in use and the high level of real interest rates.

- To make matters worse, more than $1 out of every $5 spent on capital goods goes overseas, compared to $1 in $30 back in 1965.

- We’re building almost 2 million fewer cars per year than we did 13 years ago--and they are smaller, so they use less materials.

- The rate of new-home construction is no greater today than it was in 1970--with the average home also of smaller size.

- Depressed conditions down on the farm have caused cutbacks in farmers’ purchases of machinery, cars and trucks, housing and home furnishings.

For the consumer, however, it’s another story. The drop in fuel prices, along with the general slowing of inflation, has bolstered people’s buying power, while the decline in interest rates has made such major purchases as autos and housing more affordable. These developments have boosted consumers’ confidence, as has their employment situation:

- At the moment, employment is at a record--both in terms of actual numbers of people at work as well as when compared to the over-16 population.

- Growth in jobs in the first 44 months of this business expansion was the fastest for any postwar expansion that lasted this long--wartime included.

With buying power rising and confidence up as well, you would expect spending to be climbing--and it is. In real terms, taking out the effects of inflation, consumer outlays in the first half of 1986 jumped by an annual rate of nearly 5%, compared to only a 3% rise in the preceding year.

Employment in Some Areas Shrinking

The question then becomes, how long will this split last, and how will it be resolved?

There is growing concern that the sustained weakness in our goods-producing sector will spill over into the rest of the economy. This is because employment in factories, on farms and in the Oil Patch continues to shrink, impacting more and more families.

This is certainly serious, but it’s not as bad as it looks. For one thing, declines in employment in the goods-producing sector are nothing new; they’ve been under way for quite some time.

The labor market is far less dependent on goods-producing industries today than it used to be. Back in 1950, 40% of workers on non-agricultural payrolls were employed in the goods-producing sector; today, it’s 25%. Manufacturing’s share of non-agricultural payrolls has declined to 20% today from 33% in 1950.

But this does not mean that we are becoming a nation of fast-food chains, lawyers and financial service businesses. The nation’s manufacturing sector accounts for the same share of the gross national product today as it did 35 years ago--25%.

So don’t worry about layoffs in goods-producing industries dragging down the overall economy. There’s enough strength in employment elsewhere--not to mention gains in buying power as aggregate incomes far outpace inflation--to keep the economy out of a recession.

Of course, it would be nice to see domestic production gaining strength. But for this to occur, our foreign trade gap is going to have to narrow.

Economists had been looking for a reduction in our merchandise trade deficit by now, in view of the sizable decline in the trade-weighted value of the dollar since February, 1985. However, about all that can be said is that the deficit has stopped widening.

One reason for the lack of improvement in our trade balance is that most foreign exporters have not raised their U.S. selling prices as much as their currencies have risen against the dollar.

Another is that a growing proportion of our trade is with countries whose currencies have either moved with the dollar--or even gone down against it.

To rectify the former, the dollar will have to fall further against such currencies as the Japanese yen, the West German mark and the other European currencies. This way, it will become prohibitive for exporters based in these countries not to raise their prices enough to dampen U.S. demand.

In addition, the dollar is going to have to start falling against those currencies where it has been stable. These would include the Canadian dollar and the currencies of the “Four Tigers” of the Pacific Basin--Singapore, Hong Kong, South Korea and Taiwan.

One way this might be accomplished is for the other countries to revalue their own currencies upward. Barring that, we could depress ours--either through foreign exchange operations and/or through further declines in our domestic interest rates.

But don’t look for a boom. There’s still tax reform lurking in the background, which will retard capital investment by business for some time to come.