Special Section

# Ahead: Growth and Danger

TIME's economists see mixed portents across the financial heavens

For months, portents have flashed across the financial heavens, feeding expectations of renewed vigor for the sluggish world economy. The price of oil has been in free fall, lifting a multibillion-dollar burden from industrialized and Third World countries. International interest rates have been dropping steadily, clearing away yet another obstacle to growth. In the U.S., the declining dollar has been named a harbinger of strengthened international competitiveness, meaning that the country's bedraggled manufacturing and farming sectors would once again revive and help refuel the world's foremost engine of economic expansion.

Yet for all those optimistic signs, many of the major economies are showing unmistakable signs of stress and strain. The drop in oil prices in the U.S. has stunned energy-producing regions and hurt a wide range of industries, from real estate to banking. Last week alone brought several seismic shocks: the bankruptcy filing by LTV, a major steel producer; the failure of First National Bank of Oklahoma City, a large oil-patch bank; and the $640 million loss reported by BankAmerica, which is saddled with numerous bad energy loans (see ECONOMY & BUSINESS). The dislocations caused by plunging oil prices have become a drag on the entire U.S. economy. Since January, the level of industrial production has dropped 2%.

The decline of the dollar has at least temporarily derailed the mighty export machines of West Germany and Japan. As the relative value of their currencies has risen, their products have become more expensive in the U.S. Partly for that reason, West Germany's gross national product decreased 1% in the first quarter, and Japan's .5%, its first contraction in eleven years.

Against that backdrop of unexpected economic malaise, TIME last week assembled its U.S., European and Pacific Boards of Economists for a two-day session in New York City. The joint meeting, the first of its kind, brought together 19 distinguished economists from 13 countries plus Hong Kong for an unusually comprehensive examination of the non-Communist world's prospects. A special guest at the meeting was former Secretary of State Henry Kissinger, who discussed how political forces are affecting the economic outlook.

Despite the current troubles, the consensus of TIME's economists was that the industrial nations would soon feel the benefits of cheap oil. Growth is likely to pick up in the second half of the year,

modestly in the U.S. and more robustly in Europe and Asia. But the economists acknowledged several threats to their predictions, including an increase in global trade protectionism, the long-running Latin American debt crisis and the still rising U.S. budget deficit. In the words of Walter Heller, chief economic adviser to Presidents Kennedy and Johnson, the forecast was "at best, one of muted or at least well-tempered optimism."

Specifically, TIME's economists estimated that growth in the U.S. GNP will

growth would jump from zero this year to 6% in 1987. That dramatic hike, he said, would be symbolic of Asians' "uncanny ability to roll with the punches."

But the outlook is quite different for most of the Asian nations that are dependent on commodity exports, for which prices are deeply depressed. In both Indonesia, a major oil exporter, and Malaysia, a supplier of rubber and tin, virtually no growth is expected through 1987. Says Peter Drysdale, executive director of the Australia-Japan Research Center in Can-

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rise from a trough of 2% in the second quarter to 2.5% in the second half of this year. In 1987, however, they expect the rate of expansion to dip again to 2%. Western Europe is likely to have stronger growth: 3% this year and 3.5% in 1987. As usual, Asian nations are expected to be the top performers. Japan, for one, will come roaring out of its doldrums, boosting growth from 1.8% this year to 5.7% in 1987. South Korea's economy will surge a spectacular 9% in 1986 before cooling ever so slightly to 8% next year. The most remarkable comeback story in the region may prove to be the resurgence of the Philippines after the revolutionary triumph of President Corazon Aquino. Bernardo Villegas, senior vice president of the Center for Research and Communication in Manila, forecast that Philippine

berra: "There are going to be considerable stresses on the commodity-exporting part of the Western Pacific economy over the next 18 months or so." He noted that Australia had been severely hurt by low prices for agricultural exports. But after expanding at a barely perceptible .5% this year, the Australian economy will rebound to a 3.8% clip in 1987, Drysdale forecast.

The small upswing in growth is expected to have a mixed impact on the uncomfortable levels of unemployment around the world. In Western Europe, the jobless rate will decline from its current 12.1% to 10.3% by the end of 1987. But no improvement at all is seen for the 13.3% unemployment rate in Britain, which Hans Mast, a senior economic adviser to the Crédit Suisse First Boston investment bank, called the "sick man of Europe." In

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TIME, JULY 28, 1986

the U.S., unemployment will rise slightly, from 7% to 7.3%, by year's end and remain unchanged for 1987. Across the Pacific rim, jobless rates will remain relatively low next year, except in Australia (7.8%) and the Philippines (12%).

The bright spot in the global economic picture remains the squelching of inflation. In the U.S., the consumer price index will rise only 1.5% this year, accelerating slightly to 3.5% in 1987. Western Europe's 1986 inflation rate will be 2.8%, and that figure will stay about the same next year. Inflation will increase only modestly during 1987 in the Pacific region, with the rate of price increases ranging from 1% in Japan to 7% in the Philippines.

World economic performance would be much more sprightly were it not for the sluggishness of the U.S. During 1983 and 1984, the U.S. was a powerful locomotive for global growth, but last year the engine began to run out of steam. At the moment, American industry is operating at only 79% of its capacity, the lowest level since mid-1983.

The U.S. problem, said Heller, is that "we have gotten trapped in a maze of economic lags." Falling world oil prices, for example, reached a new low of $8 on spot markets last week. Cheap oil is putting more money into the pockets of consumers and most businesses, and it will ultimately stimulate sales and investment. But in the short run, the oil-price drop has wreaked havoc among U.S. energy producers, which have cut back on exploration and production, thereby dragging down U.S. output and employment.

Equally frustrating has been the long wait for a positive impact from the falling value of the dollar, which has declined 26% against an average of major currencies since early 1985. The drop—engineered in part by concerted action on the part of the central banks of the U.S., Japan, Britain, West Germany and France—was supposed to make America's goods cheaper in comparison with

foreign alternatives, thereby throttling back the country's imports and spurring its exports. That in turn should have curbed the record U.S. trade deficit ($148.5 billion last year), which has crippled many American industries and produced what Martin Feldstein, a Harvard professor and former chief economic adviser to President Reagan, calls "slow and twisted" growth.

At first, though, the decline in the dollar actually boosted the trade deficit. Reason: American importers had already ordered large quantities of foreign goods, which immediately became more expensive in dollar terms as the U.S. currency declined in worth and thus drove up the nation's import bill. As Americans lose some of their appetite for increasingly expensive foreign goods, im-

porters are expected to cut back sharply on their orders. But that trend has been very slow to develop, and TIME's economists do not foresee a significant lowering of the trade deficit until 1987. One reason for the delay is that the dollar has not diminished in value at all against the currencies of such fast-growing exporters as South Korea and Taiwan. Many American consumers are now buying products from these countries as an alternative to Japanese and other foreign goods.

Perhaps the biggest worry in the U.S. economic picture, TIME's board members agreed, is the virtual standstill of domestic capital investment. Even though the prime rate that U.S. banks charge their best corporate customers has fallen from 10.5% to 8.5% in the past 18 months, business executives now seem reluctant to borrow money to expand. Spending on plant and equipment actually declined 5.4% in the first quarter of 1986, an event that was almost without modern precedent for a U.S. economy that was not wallowing in recession.

One reason for that hesitation, suggested Alan Greenspan, a Manhattan-based consultant who served as chairman of the Council of Economic Advisers under President Ford, is that the sudden drop in world oil prices has created uncertainties similar to the climate of business concern that surrounded the oil-price explosion of the 1970s. Said he: "Until the oil prices stabilize, assuming they do, we are not going to get significant [capital investment] benefits." Greenspan also reiterated a long-standing personal concern that U.S. corporations have borrowed so heavily for expansion in the past that they are unwilling to extend themselves further. "Debt-equity ratios are very high," he said. "The concerns that many corporations have about employing debt inhibit almost all forms of capital investment."

ROLLING ALONG ON THE PACIFIC RIM

<table><thead><tr><th rowspan="2"></th><th colspan="2">Growth</th><th colspan="2">Inflation</th><th colspan="2">Unemployment</th></tr><tr><th>1986</th><th>1987</th><th>1986</th><th>1987</th><th>1986</th><th>1987</th></tr></thead><tbody><tr><td>AUSTRALIA</td><td>0.5</td><td>3.8</td><td>6.5</td><td>4.8</td><td>8.5</td><td>7.8</td></tr><tr><td>HONG KONG</td><td>5.0</td><td>4.0</td><td>4.0</td><td>5.0</td><td>3.2</td><td>3.3</td></tr><tr><td>INDONESIA</td><td>-0.7</td><td>2.0</td><td>5.8</td><td>6.5</td><td>3.0</td><td>3.3</td></tr><tr><td>JAPAN</td><td>1.8</td><td>5.7</td><td>0.2</td><td>1.1</td><td>2.9</td><td>2.7</td></tr><tr><td>MALAYSIA</td><td>-0.3</td><td>0</td><td>1.0</td><td>2.0</td><td>6.5</td><td>6.0</td></tr><tr><td>PHILIPPINES</td><td>0</td><td>6.0</td><td>4.0</td><td>7.0</td><td>15.0</td><td>12.0</td></tr><tr><td>SINGAPORE</td><td>0</td><td>2.0</td><td>1.0</td><td>2.0</td><td>4.0</td><td>3.0</td></tr><tr><td>S. KOREA</td><td>9.0</td><td>8.0</td><td>2.9</td><td>3.5</td><td>3.0</td><td>2.8</td></tr><tr><td>TAIWAN</td><td>7.5</td><td>6.0</td><td>4.0</td><td>4.0</td><td>2.2</td><td>2.4</td></tr><tr><td>THAILAND</td><td>4.6</td><td>5.0</td><td>1.5</td><td>2.6</td><td>4.6</td><td>5.0</td></tr></tbody></table>

Forecasts by TIME's Pacific Board of Economists

GATHERING STRENGTH IN EUROPE

<table><thead><tr><th rowspan="2"></th><th colspan="2">Growth</th><th colspan="2">Inflation</th><th colspan="2">Unemployment</th></tr><tr><th>1986</th><th>1987</th><th>1986</th><th>1987</th><th>1986</th><th>1987</th></tr></thead><tbody><tr><td>BRITAIN</td><td>1.8</td><td>2.6</td><td>2.0</td><td>3.5</td><td>13.3</td><td>18.0</td></tr><tr><td>FRANCE</td><td>2.5</td><td>2.8</td><td>2.6</td><td>2.5</td><td>11.0</td><td>11.0</td></tr><tr><td>ITALY</td><td>2.7</td><td>3.5</td><td>6.1</td><td>4.1</td><td>10.6</td><td>10.2</td></tr><tr><td>SWEDEN</td><td>2.0</td><td>0.8</td><td>3.1</td><td>4.5</td><td>2.8</td><td>3.5</td></tr><tr><td>W.GERMANY</td><td>4.3</td><td>3.3</td><td>0</td><td>3.0</td><td>8.5</td><td>7.5</td></tr><tr><td>EUROPE*</td><td>3.0</td><td>3.5</td><td>2.8</td><td>2.9</td><td>10.8</td><td>10.3</td></tr></tbody></table>

Forecasts by TIME's European Board of Economists

*Belgium, Britain, France, Italy, Netherlands, Spain, Sweden, Switzerland, W.Germany

TIME, JULY 28, 1986

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Special Section

Harvard's Feldstein pointed to another reason for the investment pause: impending U.S. tax reform. As Senate and House representatives began their mammoth tax-bill conference last week, Feldstein pointed out, business, more than any other group, was expected to suffer a big tax bite in any legislation that resulted, regardless of other consequences. The bill, which is expected to abolish corporate America's cherished investment tax credit, may slow the rate of capital spending for another one to two years, Feldstein predicted.

An additional drain on investment is the daunting U.S. budget deficit, which is projected to hit a record $220 billion in fiscal 1986. Government borrowing has absorbed a hefty share of American savings that might otherwise have been available for business capital. Though TIME's economists still expect Congress to begin conquering the deficit, the task has been made more difficult by the Supreme Court's decision to strike down an important provision of the Gramm-Rudman law, which calls for automatic annual cuts in Government spending.

As the U.S. struggles to reduce its twin budget and trade deficits, it will undoubtedly lower its demand for imports. That, said Lester Thurow, a Massachusetts Institute of Technology economist, will be a "deflationary force in the rest of the world." If it is not counterbalanced, said Nils Lundgren, chief economist at Sweden's PKbanken, there would be "the risk of a fairly serious global recession."

To avoid that grim possibility, the members of TIME's U.S. board seemed to agree, West Germany and Japan need to adopt further stimulative measures, such as tax cuts and interest-rate reductions, to increase domestic consumption in their sagging economies. Just that kind of action is strongly favored by Treasury Secretary James Baker and the rest of the Reagan Administration. As Heller put it, "It's now time for foreign governments to do their share in providing fuel for expansion."

It appeared highly questionable to TIME's European economists, though, that those governments would do so. They contended that sufficient growth is already in the pipeline for the coming months. France, for example, is expected to expand at a 2.5% rate this year, and 2.8% in 1987. West Germany will speed up to a 4.25% growth rate for 1986 as a whole, slowing to a more moderate 3.25% next year. Crédit Suisse First Boston's Mast asserted that the Continent's expansion will compare quite favorably with an average 2.5% growth rate among the major West European economies in 1985. Said he: "It is very difficult to see the next twelve months as anything but a boom year for European economies."

Further doses of West European stimulus should come only later, Mast argued, "when and if the repeatedly promised, sizable reduction in the U.S. budget deficit has become a reality." The reason: the prospect of reigniting domestic inflation

in Western Europe "makes governments hesitant to stimulate." Mast's cautious position was buttressed by Herbert Giersch, director of the Institute of World Economics at West Germany's University of Kiel. His country's middling economic performance, he said, "does not mean that great additional measures have to be taken." Pushing West German economic growth up to 5%, he argued, would "strain" the economy.

Bunroku Yoshino, president of the Institute for International Economic Studies in Tokyo, was equally cautious about the

prospects for pump priming in Japan. A more promising approach, he said, would be for the government to dismantle some of the bureaucratic regulations and bottlenecks that impede investment. "The fundamental problem is to deregulate or to reform our economy," Yoshino concluded. "It will take a longer time." But the U.S. is growing impatient. Said Rimmer de Vries, chief international economist of the Morgan Guaranty Trust Co.: "For us, it is incomprehensible that economies with negative inflation, very low rates of growth and huge trade surpluses do not want to expand. That is a total breakdown of international cooperation."

Lagging capital investment is a "serious problem" not only in Japan but elsewhere in the Pacific region, according to Edward Chen, director of the Center of Asian Studies at the University of Hong Kong. Taiwan, with anticipated growth this year of 7.5%, is one of the region's standout economies. Nonetheless, Chen pointed out, the export-oriented island's extraordinary $30 billion worth of foreign exchange reserves is partially a result of a "very sluggish investment climate" that has held back domestic consumption.

TIME's European economists agreed

that capital spending was disturbingly slack in their countries as well. Jean-Marie Chevalier, professor of economics at the University of Paris Nord, reported that a French investment boom was expected early this year. But, said Chevalier, "the business community is less optimistic now." He speculated that the problem might lie with a lack of attractive investment opportunities.

In the developing world, growth continues to be flattened by mountainous debts. For four years, debtor nations have reeled from one payment crisis to the next, bailed out each time by emergency negotiations. The ongoing dilemma has not only forced the debtor countries to impose painful austerity measures but has created serious risks for the American, European and Japanese banks that have loaned money to the Third World. Now plummeting oil prices have added new tension to the situation. Though Brazil and other oil-consuming nations clearly benefit, cheap energy has devastated producers like Mexico, which owes $99 billion to foreign creditors.

The debt crisis was very much on the mind of Henry Kissinger. The former Secretary of State, who now heads Kissinger Associates, a Manhattan-based consulting firm, suggested that the strain of debt-service payments could prove to be too much for the fragile political systems of Latin America to bear. Said he: "The political basis for the present debt solution has, in fact, already evaporated. It is only a question of time before someone says, 'The emperor has no clothes.' "

In particular, Kissinger warned that there could be some form of explicit challenge to the international financial system from Mexico over the debt-repayment issue within the next two years. Said he: "I do not believe it is probable that Mexican President Miguel de la Madrid Hurtado will leave his presidency having done nothing but pay interest to gringo banks for six years, at the cost of increasing unemployment and austerity." To ease the risk of default and, more important, give a positive goal for Mexican-American cooperation that would shift the focus to economic growth, Kissinger prescribed a reduction of Mexico's $9 billion burden of annual interest payments. He also argued that the debt issue should be solved not by negotiations among bankers or officials of the International Monetary Fund but by explicit political discussions between the governments of the U.S. and debtor countries.

Guido Carli, a former governor of Italy's central bank, pointed out that rather than expanding growth opportunities in the developing world, the world's industrial powers have crowded the Third World almost entirely out of world capital markets, forcing those nations to revert increasingly to barter arrangements to obtain needed imports. Carli termed that development an "ominous sign."

TIME's boards heard a more upbeat review of the Latin-debt issue from a

TERRI PARASKE

Kissinger warned of a debt confrontation

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TIME, JULY 28, 1986

guest economist at last week's meeting: Arnaldo Musich, president of the Buenos Aires-based Foundation for Latin American Research. A former Argentine Ambassador to Washington, Musich asserted that although the debt problem is "far from resolved," considerable progress has been made.

Among other things, Musich pointed to heartening signs of positive economic growth in two of Latin America's major economies: Argentina (with a foreign debt of about $51 billion) and Brazil (about $107 billion). He forecast that Argentina's economy would grow 4% this year and Brazil's 3.5%. At the same time, Musich noted, Latin American countries have successfully rescheduled payments on $100 billion of their $370 billion in foreign obligations. Last year the Latin debt total grew only 2%, meaning that for the first time in many years the debt actually declined about 2% in inflation-adjusted terms. Concluded Musich: "The world financial system has shown enough resilience and flexibility to weather the financial storm."

The price, however, has been heavy, and most Latin American countries are worse off today than when the debt crisis arose in 1982. Musich acknowledged Treasury Secretary Baker's October initiative to use increased international aid to spur additional growth in debtor countries. But the Argentine economist warned that the debt burden is not the root cause of the region's economic problems of endemic poverty, inflation and slow growth. Many of those ills are self-inflicted by what Musich called "rigid inward policies," meaning excessive bureaucracy, protectionism and state domination of local economies. Said he: "With or without the debt, Latin American economies would face the necessity of removing these structural impediments."

Narongchai Akrasanee, senior vice president of the Industrial Finance Corp. of Thailand, reported that debt loads are much less onerous in the developing countries of Asia. Only the Philippines, which owes $26 billion, is considered to have a major problem, and that, he said, is "manageable." Oil-producing Indonesia could have future difficulties in servicing its $37 billion debt, but those too, Narongchai asserted, can be handled.

One thing that could cause Asian debts to become threatening would be a continued escalation of global protectionism. The Pacific countries have long kept many foreign goods out of their markets, and in recent years the U.S. and Europe have increasingly responded with moves to limit everything from imported textiles to cars. Suh Sang-Mok, vice president of the Korea Development Institute, asserted that his country, which has a foreign debt of $48 billion, is being squeezed by the trade policies of the industrialized world.

The Asian nations are particularly alarmed by the thunder of trade-war drums in Washington. In May, the

House of Representatives passed an omnibus 458-page trade bill that would require the President to open trade talks with any nation that achieved an "excessive trade surplus" with the U.S. through vaguely defined unfair practices. The aim of the talks would be to reduce the trade imbalance 10% annually in such a case. If no agreement was reached, the White House would have to retaliate, for example, by raising tariffs or tightening import quotas. Clearly aimed at such countries as Japan and South Korea, the House bill is roundly opposed by the Administration, but a similar bill is now on the Senate agenda.

Feldstein termed the House measure "simply awful. It's full of nonsense; it's mischievous." However, he also felt the legislation was little more than a tactical ploy designed to give House Democrats a campaign issue in November's congressional elections. Feldstein predicted that any legislation that emerged from the Senate would be much milder. Nonethe-less, he warned, "if the economy were to become very weak, it may become a real piece of legislation."

Kissinger contended that the free-trading system is in crisis, and could be in the throes of rapid evolution that could lead to a starkly protectionist world of competing regional power blocs, including Western Europe and the Asia-Pacific region under the leadership of Japan. In response, Kissinger observed, the U.S. may be forced to re-examine the free-trade ideals that it has championed since World War II.

Charles Schultze, a senior fellow at the Brookings Institution and chairman of the Council of Economic Advisers under Jimmy Carter, was more sanguine.

"It's too early to give up" on the international trading system, he argued, and the stakes are too high to do so easily. The U.S. would be losing a "tremendous amount" if it retreated to the narrow posture of protectionism.

Samuel Brittan, an economics columnist and assistant editor of London's *Financial Times*, admitted that "the outlook for world trade liberalization is not good," but added, "The surprise is that it is not worse." He noted that the volume of world trade is expected to grow at least 4% to 5% this year. That is a mild increase over 1985, but only half the 1984 rate. Brittan singled out nontariff barriers

to trade, like voluntary quotas, as particular villains in that sluggishness

TIME's economists agreed that world growth has become dangerously unbalanced. The U.S. has been living beyond its means for too long, and the other industrial nations have become too heavily dependent on trade with America for their growth. The crucial challenge that faces governments is to correct that imbalance, and some of the economists doubted that it will be met. Said Thurow: "Everybody is right: the U.S. ought to do something to balance its trade deficit and its federal budget faster than it is, but we are not going to do it for political reasons. The Americans are right that the Japanese and Germans ought to stimulate their economies and grow faster, but they are not going to do it for political reasons." The consensus among the economists, however, was that the world still has time to set aside political considerations and make the economic adjustments necessary for strong, sustained growth.
—By George Russell

*Reported by Gisela Bolte and Jay Branegan/
New York*

TIME's U.S., European and Asian economists mark their conclave with a portrait at the Time & Life Building in Manhattan. Standing, from left: Samuel Brittan, Nils Lundgren, Herbert Giersch, Walter Heller, Rimmer de Vries, Lester Thurow, Suh Sang-Mok, Peter Drysdale, Bernardo Villgas, Arnaldo Musich. Seated: Hans Mast, Jean-Marie Chevalier, Guido Carli, Alan Greenspan, Charles Schultze, Martin Feldstein, Edward Chen, Bunroku Yoshino, Narongchai Akrasanee.

TED THAL

TIME, JULY 28, 1986

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