Reason To Smile - future of US economy

Kiplinger's Personal Finance Magazine, Jan, 2000 by Melynda Dovel Wilcox

ECONOMY | In February, we'll set a NEW RECORD for growth. But then what?

KEEP THOSE CHAMPAGNE flutes handy after New Year's Eve. Just a few short weeks later you'll be able to pour the bubbly again, this time to celebrate the longest economic expansion on record in the U.S.

And what a way to enter the record books, with economic growth running at 3 % to 4% a year for the past several years, along with remarkably low inflation and unemployment. Such a heady performance makes it easy to get carried away by glib predictions that we have entered a "new era," some "new paradigm" in which the economy will grow much faster than in the past without sparking inflation. A more sobering explanation, says Jim Griffin, market strategist for Aeltus Investment Management, in Hartford, Conn., is that the '90s have been a peculiar decade, the likes of which won't necessarily be repeated.

For instance, because of recessions elsewhere around the world, the U.S. has benefited from a strong dollar and cheap products from overseas. Not only have U.S. investors enjoyed a rich helping of stock-market wealth, they've enjoyed it with "whipped cream and a cherry on top," says Griffin.

Yet the rules of the game really have changed. "If it's not a new economy, it's certainly a better one," says Christina Romer, an economics professor at the University of California at Berkeley.

Breaking the pattern

ONE CLEAR improvement: Over the past ten to 15 years we've managed to smooth out the bumps in the economy. "Before the raid '80s, recessions occurred on average about every four and a half to five years," says Romer, an expert in the history of business cycles. "If that pattern had continued, we would have experienced three or four recessions since the early '80s rather than just one." She gives part of the credit to the Fed and other central bankers around the world, who have figured out that keeping inflation low can ward off repeated boom-bust cycles.

Computer technology has also helped firms manage inventories better so they don't build up when the economy slows. And inventory swings have become a bit less influential on the business cycle as the economy has become more service-intensive.

Robert Dauffenbach, director of the Center for Economic and Management Research at the University of Oklahoma, offers still another explanation for the economy's stability: "We're playing an international game. While one economy we're selling to might be down, another one is picking up."

Computers and chips

THE MOST OBVIOUS change in the economy is the role of information technology. "Ten years ago, we knew that manufacturing was on the decline in the U.S., and it was hard to know what we were going to be good at," says Romer. "Now we see it--computers and chips."

Moreover, huge investments in computers dating back to the '70s and '80s are starting to pay off in greater efficiency. Firms can link up electronically with their suppliers and make decisions based on more timely information. Wal-Mart, for example, gives suppliers access to its data warehouse so they can replenish stocks at individual stores.

Fed chairman Alan Greenspan says that all this new technology is speeding up the pace of "creative destruction," in which good businesses drive out bad ones--a brutal yet effective way of making the economy more efficient.

Even so, productivity growth in the '90s is still a far cry from the growth rates we saw in the '60s and early '70s, says Michael Knetter, an economics professor at Dartmouth's Tuck School of Business. It's progress, but not necessarily a new era.

Historically, "we reap the benefits of great inventions and then it's quiet for a while," says Romer. Productivity has always been notoriously difficult to measure, and it won't get any easier as the economy produces ideas and fewer widgets.

The oil card

THE "NEW ECONOMY" could get its first real test in 2000, as investment in technology stalls and inflation picks up steam.

Ironically, the biggest wild card is a familiar one: oil prices. With the help of Mexico and Norway, OPEC is flexing more muscle and has managed to hoist oil prices well above year-ago levels."Few people realize how closely U.S. economic performance has followed oil prices over time," says Knetter.

Consumers continue to fill up their tanks even when the price of gasoline goes up. So an increase in oil prices acts like a tax hike, except that much of the money is sent overseas and consumers have less to spend on other items. "There's nothing about the economy that has made an oil-price shock less likely today," says Harvard economist Greg Mankiw.

Other pressures could push the inflation rate up to nearly 3% in 2000. As economies around the world get stronger, they'll attract more capital, weakening the value of the dollar. And a weaker dollar makes imports more expensive. Health care inflation appears to be heading back up after several years of restrained increases. Costs are expected to rise 8% in 2000, double the average rate of the past few years, according to a recent poll of almost 300 chief financial officers by Duke University and the Financial Executives Institute. "The heyday of keeping health care costs under control may be over," says Duke finance professor John Graham, who directed the survey.