The Year Ahead: A Portrait in Pastels

If economists' predictions for the coming year could be symbolically represented by a painting, it would be a portrait in muted pastels--no dazzling rosy hues, no daubs of black. The recovery from the worst slump since the Great Depression will continue at a steady but unspectacular pace. Unemployment and inflation will both come down, slowly and moderately. It will be a year of transition--but will the transition be to a new period of balanced growth or a time of stagnation?

Economists are deeply divided on that question. But there is strikingly little disagreement on what can be expected for the coming year. The pastel predictions come from Government officials and businessmen, university, bank and corporate economists. They agree with all eight members of TIME's Board of Economists, who gathered in Manhattan last week for a day-long examination of the outlook for 1976 (Alan Greenspan, who is on leave from the board while he serves as chairman of the Council of Economic Advisers, attended the meeting as an observer).

With the forecasts of all members averaged out, here are the board's key predictions:

>Production of goods and services, discounted for inflation, will rise about 6.2% for the year. That will make 1976 a year of growth after the longest downturn since 1947-48; real gross national product dropped 2% in 1974 and probably will be down a shade under 3% in 1975. But the growth rate will slow at least a bit by the end of 1976, unless Government policy changes unexpectedly.

> Unemployment will decline to an average rate of 7.7% of the labor force, and perhaps to 7.4% by the end of 1976. That would mark a very slow decline from the last reported rate of 8.3% (for November). Main reason: an expansion in G.N.P. of roughly 6% just is not enough to bring about a faster reduction; economists generally figure that a 4% growth rate is needed merely to prevent an increase in joblessness as new people enter the labor force.

> Inflation will slow to an average rate of 6.6%, as measured by the consumer price index, and a hair less than that by year's end. That would contrast with a 7.6% increase in retail prices in the twelve months ended last October and a horrifying 11% in 1974. On this one point, however, there are some serious disagreements in the predictions. Beryl Sprinkel, executive vice president and economist of Chicago's Harris Trust & Savings Bank, sees the end-of-1976 inflation rate at a low 5%; Robert Nathan, head of his own consulting firm, forecasts a startlingly high 9.5%.

> Corporate profits, which already are staging a vigorous comeback from their recession lows, will go on climbing and could wind up next year 20% to 30% higher than in 1975.

No forecast is ever certain, of course, and the near unanimity of the board's predictions mildly worries some members. It indicates that they are all operating on the same assumptions about how the economy works--which could be wrong in some important respects.

Arthur Okun, senior fellow at Washington's Brookings Institution, stresses that consumers' buying behavior is highly unpredictable. David Grove, senior vice president of IBM, discerns a new emphasis on avoiding risk among businessmen who have been burned by recession and inflation. That could lead to less investment in new plants and equipment than most economists now foresee. A sharp slowdown in spending by state and local governments, whose outlays were once characterized by Joseph Pechman, director of economic studies at Brookings, as "the big growth sector of the economy," introduces a new element of uncertainty into the picture.

Much more important, the forecasts are based on two crucial political assumptions that could quickly be disproved. They are that some of the tax cuts of 1975 will be extended, so that paycheck withholding rates would not go up Jan. 1, and that a bill forcing a 12% rollback in domestic crude-oil prices becomes law. President Ford has consistently vowed to veto any tax bill that is not linked to a ceiling on federal spending for fiscal 1977, which Congress is in no mood to enact; Democrats now think they can muster the votes to override a veto if Ford gives them a chance by acting on the bill before they adjourn for Christmas. Federal Energy Administrator Frank Zarb has urged Ford to sign the oil-price bill, but some other advisers are recommending a veto.

Kamikaze Instincts. Successful vetoes of the tax and oil bills could well mean less growth and more inflation than the forecasts now specify. Failure to extend the tax cut would increase individual income taxes by $13 billion in 1976. The result, says Pechman, would "certainly be a shock that would dampen recovery." Sprinkel argues for a veto of the oil bill, because, he says, the rollback would discourage domestic oil production, increase high-priced imports and "give the OPEC nations that much more leverage on us." But a veto that was upheld would end all controls on domestic oil prices, leaving them free to shoot up. Even if the President removes the $2-per-bbl. on imported oil, Okun contends, instant decontrol would "cost something like $8 billion in additional inflation and boost consumer prices by three-quarters of a percentage point."

Board members agree on another assumption: whatever happens to the tax and oil bills, President Ford will fight hard and generally successfully against further major stimulation of business next year. Though it is part of American mythology that the Administration in power does everything it can to pump up the economy in an election year--and though Richard Nixon did exactly that in 1972--board members expect Ford to resist the temptation and remain true to his conservative, anti-inflationary instincts (Board Member Walter Heller, a professor at the University of Minnesota, calls them "kamikaze instincts").

Is that an appropriate policy? Republicans Sprinkel and Murray L. Weidenbaum, former Assistant Secretary of the Treasury, say yes: they think that the recovery now in prospect is the fastest that the U.S. can afford without kicking up inflation. Democrats Heller, Okun and Pechman insist that there is so much slack in the economy that a more expansionary policy would speed recovery and bring the jobless rate down faster while producing little or no added inflation. Yet Pechman concludes resignedly that in the present political climate, an extension of the 1975 tax cut and a money supply growth within Federal Reserve Board Chairman Arthur Burns' target range of 5% to 7.5% "is the best you can get. Thus the soundest prescription now is 'Steady as she goes!'* There is enough time to increase tax cuts or the growth in money supply later next year if developments warrant."

The recovery that is likely to be produced by "steady as she goes" policies bears no resemblance to anything that could be called a boom. If the forecasts are correct, unemployment a year from now will still be as high as it was at the bottom of some earlier recessions, and the inflation rate will be at a level that would have been regarded as intolerably high in most previous years. Indeed, at almost any time before 1974, predictions of 7.7% unemployment and 6.6% inflation would have seemed a forecast of disaster. That they are now prophecies of significant improvement is a true measure of the savagery of the economic storms that have shaken the U.S. in the past two years, culminating in the slump that made 1975 a year for the history books--the year of the most widespread joblessness since the 1930s.

As the year opened, the recession that began in December 1973 had deepened into a nosedive that for a time fulfilled the worst predictions of the glummest pessimists. In the first three months of 1975, the nation's output of goods and services plunged at an annual rate of 11.4%, the steepest drop in 30 years. Unemployment, which began soaring at the end of 1974, continued bounding up to a peak of 9.2% last May--the highest since before Pearl Harbor. Fear spread that the nation might have started on a downward spiral into depression.

Swollen Inventories. Instead, the worst was over by late spring. The economy's vaunted "built-in stabilizers" began to work. For example, as incomes fell, Government tax collections were automatically reduced while outlays for unemployment compensation and welfare soared, thus causing the Government quite unintentionally to pump more money into the economy. Also, Administration policy turned around completely in January. President Ford late in 1974 called for a 5% surcharge on upper-level incomes; by his 1975 State of the Union speech he was instead advocating big tax reductions. The eventual result was enactment in March of $22 billion in income tax cuts for individuals and businesses, including rebates on 1974 taxes in the form of checks of up to $200 mailed to each taxpayer.

The recession hit bottom in the spring. By May, retail sales began to move up smartly; by June, unemployment began to drop slowly. For the second quarter, real G.N.P. squeezed out a gain at an annual rate of 1.9%. That ballooned to 13.2% in the third quarter, as businessmen at last cleaned out swollen inventories and began filling orders from new production. The sell-off gave the economy a one-shot lift; the rate of production growth is widely expected to drop back to about 5% in the current quarter--an anticipated development and no cause for alarm.

In the last few weeks, moreover, some fears that dogged the early stages of the recovery have dissipated. From June through September, the Federal Reserve, worried about inflation, clamped down harder than even it intended and the nation's money supply grew at a miserly annual rate of 2%. That caused interest rates, which had dropped sharply from their towering peaks of 1974, to rise again, and stirred worry that high interest costs and a shortage of money would choke off the fledgling recovery. But lately the Federal Reserve has eased its stand, and seems likely to get back to Chairman Arthur Burns' target of 5% to 7 1/2% growth. Many economists believe that a more rapid increase would be desirable--Andrew Brimmer, a Harvard professor and former member of the Federal Reserve Board, would like to see an 8 1/2% to 9% expansion--but an increase within Burns' specified range should be enough to fuel at least a modest expansion in production and jobs.

Savage Cuts. Throughout the summer and deep into the fall, the prospect of a default by New York City on its mountainous debt threatened to abort the recovery by wiping out most of the value of billions of dollars of city securities held by banks and individuals across the country, and by making it difficult for other cities and states to raise money in the bond market. Finally, President Ford, who had adamantly refused to "bail out" New York, agreed to $2.3 billion in federal loans this year, after the city had made savage cuts in expenditures and agreed to a big package of city-state tax increases.

So default has probably been averted, but the crisis has worsened a situation that will slow recovery anyway. Spending by state and local governments, discounted for inflation, rose by 6% as late as 1973; this year the increase was below 2%, and in 1976 it is forecast only slightly higher. There are reasons apart from New York's agony: cities and states have been caught by recession-reduced revenues and mounting welfare costs. But the New York crisis has helped to raise interest rates on bonds for some cities to 9.2%, and deepened an anti-borrowing mood among voters and an anti-spending attitude among state and local government officials.

Another drag on the recovery probably will be a less dazzling trade performance. For 1975 the U.S. is expected to ring up a record $10 billion excess of exports over imports, v. a trade deficit of $3.1 billion in 1974. Two reasons: the recession slowed down imports, especially of oil; and American inflation, though high, was lower than in most other major industrial countries, increasing the competitiveness of made-in-U.S. products abroad. Next year the surplus is likely to shrink; as production revives in the U.S., the quickening tempo will pull in more imports.

Where, then, will the growth foreseen for 1976 come from? There are several sources of potential strength. Most major industries, including steel and textiles, already are recording increases in sales and orders. No business took more of a drubbing from the recession than autos. Sales this year will total about 8.7 million, no better than depressed 1974 and far below the record 11.5 million cars of 1973, in large part because consumers resisted $500-a-car price boosts on the 1975 models. But sales have been picking up since the smaller, more fuel-economical '76s rolled into showrooms at prices averaging only $200 a car higher than the '75s. Most forecasts are for 9.5 million autos to be sold next year.

Housing, which has been hammered for several years by soaring prices and towering interest rates, was a disaster in 1975. Starts sank to an annual rate below 1 million in May and are likely to wind up at 1.1 million for the year, a 29-year low. But mortgage money is plentiful again, and 1976 housing starts are expected to reach about 1.5 million. That gain should give a helpful, though not major, nudge to the economy.

The biggest hope for a strong recovery is that consumers will throw off their uncertainties and spend heavily, not only for cars and houses but for household furnishings, carpets, television sets and clothing. After several years of saving an abnormally high proportion of their incomes, consumers have the money for a shopping spree. But the upheavals of recent years have made them wary and difficult to judge. During 1975 consumer spending, after an early surge, flattened out in late summer and early fall. Recently it has been moving up again, and storekeepers expect Christmas sales to spurt about 10% ahead of last year. But the University of Michigan's widely respected survey, released last week, showed the consumer, in the words of Survey Director Jay Schmiedeskamp, to be in an "unusually conservative and skittish mood."

What the consumer does probably depends on inflation more than anything else--and that is the biggest imponderable in the 1976 forecast. During 1975, the clumsy hand of recession, as expected, ended the double-digit inflation of 1974. But the course was highly erratic: the compound annual rate of increase in the consumer price index ranged from a startling 15.4% in July to a mere 2.4% the next month. Food prices rose 7.8% during the twelve months ended in October despite record crops, partly because of the Soviets' buying 10.2 million tons of U.S. grain. The momentum seems to be spent now, though, and economists generally expect no sharp run-up in food prices next year.

Those economists who fear a reacceleration of inflation worry instead about two other factors. Nathan discerns a lessening of price competition among many big businesses and a disposition among their executives to raise prices to recover past cost boosts as soon as sales pick up. Heller disagrees, contending that businessmen who have priced their products to make a profit even at low operating rates will find profits moving up so smartly as sales rise that they will not need further price hikes.

A bigger threat is the possibility of a new wage-price spiral. Only 2.5 million workers were covered by contracts that expired in 1975, but 4.4 million will have major contracts coming up next year, including negotiations in four major industries: autos, trucking, electrical equipment and rubber. Workers' purchasing power has eroded over the past two years because wage boosts have not kept pace with price hikes. Between January 1973 and July 1975, the consumer price index rose 27.1%, but average hourly earnings of workers in nonagricultural jobs increased only 21.6%.

Cautious Policy. Nathan, whose consulting firm advises many unions, reports that "the attitude on the part of labor is pretty sour and pretty frustrated." He fears that unions will push for inflationary wage boosts, and he may be right. Last week the Teamsters Union was talking about demanding as much as a 50% increase for truckers over three years. Mechanics struck United Air Lines; the line canceled all flights through Christmas Eve. Other members of the Board of Economists, while granting that there is danger of a wage-price spiral, think it can be avoided. Some reasons: unemployment will still be high next year; low increases for state, local and Federal Government workers will exert a moderating influence on industrial wages; and rising productivity will enable manufacturers to pay higher wages without boosting prices.

The disagreement over inflation leads to another debate that is muted now but will grow much louder during the election year: Where is the economy headed after 1976? No one would be satisfied permanently with the pattern of high (though declining) unemployment and inflation foreseen for next year. But Sprinkel and Weidenbaum see the year as a bridge to a long-term pattern of balanced, sustainable growth--if moderate fiscal and monetary policies are pursued until what they see as a promising start on wringing inflationary momentum out of the economy is carried through to conclusion. Sprinkel argues that it took ten years of Government mismanagement of the economy to produce a situation in which a 6% rate of price increases represents a lowering of inflation. Another three or four years of cautious policy will be needed, he believes, to get the rate down to an acceptable 1% to 3%.

Democrats on the Board of Economists--Heller, Okun, Pechman, Nathan--argue that inflation could be most effectively restrained by Government pressure on industry and labor to pursue moderate price-wage policies, leaving Washington free to stimulate the economy more through tax cuts, federal spending and faster money-supply growth. But they have no hope of changing President Ford's mind. They expect him to present a budget for fiscal 1977 of $395 billion, or $28 billion less than if no effort were made to hold down spending, and to resist further tax cuts not tied to such a spending ceiling. That, they believe, will just not be enough to promote strong expansion after 1976.

The only member of the Board of Economists to attempt a specific early prediction for 1977 is Grove, who is not associated with any particular political line. He foresees real G.N.P. growth averaging 4.4% for the year, and declining to as little as 3%. That would produce hardly any further cut in unemployment from where it would be at the end of '76. But Grove stresses that this result is not foreordained; it could be changed by a switch in policy.

This debate is a preview of the arguments that will be heard, in more emotional voices, from politicians in 1976. Ultimately it will be settled not by economists but by voters--and the shape of the economy in the years after 1976 will be determined by the policies of whomever they choose to be inaugurated as President in January 1977.

* Ironically a favorite maxim of George Shultz. once President Nixon's economic czar.

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