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PepsiCo Serves Up a Good Lesson for Policy

High hopes were expressed in Congress last week that a balanced-budget amendment would pass this session. But we’d better hope that it doesn’t.

In the short term, a push to balance the budget would hurt an economy that is slower than a lot of people think--as major companies such as PepsiCo indicate by their actions.

And in the long term, a balanced-budget amendment would be like a rerun of Prohibition, a riot of unintended consequences ending in frustration.

But rather than abstract debates about the economy, politicians, business people and all of us might look to PepsiCo for clues to the economy’s underlying currents and for lessons on managing the public finances.

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The giant company, with more than $30 billion in annual sales of soft drinks, snacks and restaurant food, announced last week that it is spinning off the Pizza Hut, Taco Bell and Kentucky Fried Chicken chains to shareholders.

The restaurants account for more than one-third of PepsiCo’s sales but don’t bring in sufficient profit for Pepsi Co to keep them. So Wall Street cheered when Chairman Roger Enrico said Thursday that PepsiCo would put the chains in a separate company and concentrate on improving its Pepsi-Cola and Frito-Lay businesses. PepsiCo stock had been lagging, but it rose 10% in very heavy trading on the news.

The restaurants represent promises unfulfilled. When they were acquired--Pizza Hut and Taco Bell in the late 1970s, KFC in 1986--Pepsi management was hailed for smart moves. The company would ride the growing trend of eating outside the home, went the thinking; the fast-food eateries could push Pepsi soft drinks.

But growth wasn’t as strong as predicted. And the “synergy” backfired when rival Coca-Cola used Pepsi’s restaurant ownership against it in marketing to other fast-food chains.

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Pepsi went into restaurants in the first place, Enrico explained to investment analysts last week, “because it didn’t see future growth in its soft drink and snack” businesses and thought diversification into restaurants would provide expansion.

But now, after almost two decades, the company recognizes “that restaurants are quite different from soft drink and snack businesses,” Enrico said.

In fact, the restaurants not only didn’t meet expectations, they siphoned attention from Pepsi and potato chips. “The restaurants demanded a lot of capital and management effort. They became a distraction,” says analyst Douglas Christopher of Crowell Weedon, a Los Angeles investment firm.

And lately, fierce competition in fast food drove profit from Pepsi’s chains, to a point at which they were struggling to earn their cost of capital, a minimum requirement for any business. So they had to go.

In contrast to prevailing wisdom in the 1970s and ‘80s, business today is being forced to make choices, not to hold on to operations on the chance of a good year now and then.

Purchase, N.Y.-based PepsiCo will now focus on its core products (soft drinks and snacks), in which it has belatedly discovered great promise in global markets. And the restaurants also may do better in a trimmed-down, focused company managed by restaurant people.

What does PepsiCo tell us about the broader economy?

For the short term, that business is not as strong as some experts think. There are too many restaurants, with too few customers, making too little profit. “The same goes for all retailing--too many stores, too few sales,” says investment strategist Charles Clough of Merrill Lynch.

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And amid signs of a slowing economy, that it would be unwise to accelerate the push toward a balanced budget, especially as the deficit is disappearing without much push. In fiscal 1996, which ended Sept. 30, the federal deficit was $107.3 billion, only 1.5% of the economy’s output of goods and services. And the fiscal 1997 deficit is likely to be even lower. A budget in balance by 2002, the goal of both parties, is a cinch. The worry is about the years and decades after that.

For the long term, the PepsiCo example is even more instructive. Promises unfulfilled in restaurants finally had to be faced and corrected. So in our national life, promises made in the 1960s for Medicare, expanded Social Security and other entitlements are proving difficult to redeem in the 1990s.

“The economic growth we counted on to pay for all those promises has failed to materialize,” says economist Barry Bosworth of the Brookings Institution, a Washington think tank. “That’s why we have such arguments over taxes and government programs--we’re scrapping over scarce resources, and Americans don’t do that very well.”

How to correct that? Not with a constitutional amendment banning deficit spending. First, such amendments don’t work. States that have balanced-budget requirements continually get around them with subterfuge--transferring state operations to separate agencies and balance sheets, borrowing at high interest to cover budget shortfalls, as California has done.

Second, a balanced-budget amendment could be counterproductive. “It could force tax increases in recessionary times, making bad situations worse,” says economist James Doti, president of Chapman University in Orange.

The key to the present U.S. situation is to understand the problem and deal with it. The future difficulty for public finance is the rising costs of Medicare and the prospect of a large Social Security bill for the baby boom generation.

But the problem won’t really hit until 2010, when the first baby boomers reach 65. There is time to make decisions about programs, benefit levels, taxation, financing and future retirement ages.

Also, there is time to invest in continued economic growth. “It’s logical to expect that productivity gains and technological advances will help our economy in the 21st century as they do now,” says economist David Levy of the Jerome Levy Economic Institute in Chappaqua, N.Y.

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To be sure, tough decisions are harder to make in Washington than in corporate boardrooms. The PepsiCo shareholders who are Roger Enrico’s primary constituents applaud when the company gets its act together--whatever the hardship involved for employees of the restaurant divisions.

But the voter constituents of presidents, senators and representatives howl bloody murder when even slight adjustments are proposed to Medicare and other entitlements. So voter patience and economic understanding is needed as government tries to get the country’s balance sheet in order.

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James Flanigan can be contacted by e-mail at jim.flanigan@latimes.com


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