Can Consumers Sustain Growth?

Since mid-1984, real gross national product has been increasing at a 3% annual rate--just about the long-term trend. It is very modest, however, compared to the 7% average annual growth rate in the opening stages in this expansion--from late 1982 through the first half of 1984. An occasional quarter during this slow-growth period has been robust but, on balance, it has been a monotonous and sluggish performance.

In the most recent quarters, however, the growth pattern has changed. In the early part of the slow-growth period, the consumer was the driving force in the economy. In 1986 alone, consumer spending grew 5.4% in real terms, and durable goods spending surged 11.5%.

But in the first six months of this year, consumers slowed down: Consumer spending grew at an annual rate of only 0.9%, and durables purchases fell at an annual rate of 5.2%. Consumption contributed only 14% to the rise in GNP in the most recent quarter.

But, just as the consumer faltered, a new source of economic growth emerged, spearheaded by a foreign sector rebound. A combination of the weak dollar, cost control by U.S. business and restructuring at many U.S. companies have finally halted the worsening of our trade deficit. In inflation-adjusted terms, imports have leveled off while exports have risen, posting a particularly impressive gain in the latest quarter, despite some recent setbacks. A wide variety of exports, including industrial supplies and materials, capital goods and even agricultural products, have shown strength.

I remain convinced that, in a world of surpluses, further reductions in our trade deficit are likely to be painfully slow. Nevertheless, even the end of the decline in the trade balance would be a boost to the economy--the removal of a negative force becomes a positive factor.

The economy, then, is in a period of consumer slowdown but, at the same time, it is experiencing an end, and possibly a reversal, of the decline of the trade balance, especially due to export strength. Overall, GNP growth is likely to remain modest--perhaps in the 2% to 2.5% range--but the economy is now much better balanced.

Earlier, robust consumer spending did not translate into strength in manufacturing, because virtually all the increase in goods consumed in this country came from abroad. Until last fall, U.S. industrial production grew very slowly--less than 1% per year over two years.

This weakness, of course, was a direct counterpart of the strength in imports, which gave rise to a unique situation: The ratio of industrial production to GNP actually declined during a business expansion. Normally, the ratio falls in recessions, when consumers postpone purchases of durable goods, forcing businesses to cut inventories and capital spending. In this recovery, however, for the first time in the postwar period, the ratio declined even as consumption growth remained strong.

Starting in the second half of last year, the flattening in imports and growth in exports have spurred a rise in U.S. industrial production that has matched the growth in the overall economy. Now, American goods consumption and production are growing in step, and the ratio of industrial production to GNP has flattened.

The switch to a more balanced growth in goods and consumption has important geographic ramifications. Earlier, the U.S. economy was described as bicoastal: Consumer spending spurred growth on the East and West coasts, while a vast depression belt consisting of weak manufacturing and collapsed agriculture and energy sectors lay in between. Now, activity on the coasts has cooled off, with slower consumer spending growth. But the pickup in manufacturing, as well as the modest revival in the agricultural and energy sectors, have breathed some life into the heartland.

But is a better balanced economy sustainable? Consumers, even at slower rates of consumption, are still sinking deeper and deeper into hock and drawing down their remaining assets, including the equity in their homes. The reason for this is that while spending growth slowed, purchasing power actually fell in the first half of 1987.

Nominal income growth has long been extremely weak; recently, however, an uptick in inflation has turned modest gains into losses in real terms. In the first quarter, hourly compensation in the non-farm sector rose at 1.1% rate in nominal terms, but fell at a 3.9% rate when adjusted for inflation. In the second quarter, the nominal growth rate of 2.9% translated into a 1.9% rate of decline for purchasing power.

The revival in manufacturing, as indicated earlier, has largely been the result of uncompromising cost-control efforts by U.S. business. This is the most exciting development in my business career: It will, I believe, restore our international competitiveness and push operating earnings up at a compounded rate of 9% to 10% during the next decade. But the obverse of cost control is a squeeze on incomes.

The effects of cost control on middle-income households have been, and will probably continue to be, devastating. Households with pretax incomes in the $20,000 to $60,000 range in 1985 dollars--the core of the American middle-class--saw their share of total households fall from 53% in 1973 to 49% in 1985, and will probably drop to 38% by 1995.

Thus far, consumers have been supplementing the shortfall in their incomes by borrowing. Sooner or later, however, they’ll have to pull in their horns. In the past three years, consumers have been able to carry the economy virtually single-handedly. Can manufacturing do the same when they stop? Consumer spending accounts for roughly two-thirds of the economy. Moreover, as indicated earlier, further solid gains for U.S. manufacturing at the expense of foreign producers won’t be easy.

Moreover, the United States has been the only locomotive in this recovery. Many foreign economies, including those of most Western European nations and Japan, rely on their sales in this country to generate growth. If U.S. consumers sharply reduced their spending, our trading partners would themselves plunge into a recession, throttling the nascent revival in our exports.