January 1996 € Volume 6 € No. 1

Sluggish Growth Continues in 1996

By Michael K. Evans

APICS consulting economist Michael K. Evans forecasts a 1.5 percent growth rate for the U.S. economy through 1996, fostered by static capital spending levels, sluggish growth in U.S. exports and continued weakness in consumer spending.
The main reasons the growth rate fell more than 2 percent in 1995 include the following:
  1. The capital goods boom came to an end.
  2. Export growth was cut in half, from 14 percent to 7 percent.
  3. Excess inventory stocks led to cutbacks in production and manufacturing employment.
  4. The lagged effect of higher interest rates reduced housing starts. Even though they rebounded in the summer, starts fell from 1.45 million to 1.35 million for the year.
  5. These factors resulted in an average decline in employment in the goods-producing sector of about 12,000 per month in 1995, compared with an average monthly gain of 58,000 in 1994. Other employment rose an average of only 136,000 per month in 1995, compared with 236,000 in 1994.
  6. As a result of the slowdown in employment growth, consumption of durable goods rose only about 2 percent, compared to 7 percent the previous year, while consumption of nondurables was up 1 percent instead of the 3 percent rise seen in 1994.
Economic growth in 1996 will probably be just as sluggish as it was in 1995. The causes are mainly the same: relatively tight monetary policy, slower growth in exports, little growth in capital spending outside the high-tech area and anemic gains in discretionary consumer spending.

As this article went to press, the Commerce Department was changing its methodology for measuring real growth, and the brief shutdown of the government threw a monkey wrench into the schedule for releasing these revised estimates, which therefore were unavailable. Nonetheless, it does seem likely that when the revised figures are finally issued, they will show that real gross domestic product (GDP) rose only 1.5 percent from the fourth quarter of 1994 (1994.4) through the fourth quarter of 1995 (1995.4), down from 3.8 percent the previous year. That's the sort of performance we expect for 1996 as well.

Inventory stocks will probably return to normal levels by the end of 1995, so inventory investment should stabilize instead of declining further in 1996. However, it will take more than inventory investment to boost real growth back to average or better levels, and none of the other sectors seems capable of providing that jump start next year.

Capital spending: flat except for high-tech equipment
The trend in new orders for capital goods has been flat since March. Excluding defense and aircraft, new orders for capital goods rose from an average monthly level of $35.3 billion in 1994.4 to $37.5 billion in 1995.1, and have remained at that level for the past two quarters. Shipments have shown a similar pattern.

The initial slowdown in new orders stemmed from the rise in interest rates in 1994. That increase has now abated; however, it has been replaced by sluggish growth and declining rates of capacity utilization, particularly in commodity industries. Orders and shipments of high-tech equipment continue to rise at rapid rates, but orders and shipments of other equipment have declined since peaking early in the year.

For at least the last half-century, investment booms have never lasted more than three years, even though periods of expansion have occasionally lasted almost an entire decade. There is no mystery for this development. After three years of double-digit expansion, enough new capacity has come on line that further plans for expansion in most industries are put on hold. Also, although it doesn't need to happen this way, three years of accelerated growth from an investment boom generally puts upward pressure on inflation and interest rates, which reduces capital spending even if excess capacity isn't an issue.

Exports: worldwide growth turns more sluggish
Most forecasters are more bullish about the world economy than we are. Their forecast for 1996 shows real growth in Germany (and continental Europe) remaining at 1995 levels, a pickup in Japan from 0.8 percent to 2.0 percent, little change in Canada, and a major recovery in Mexico and Latin America. We don't agree with these bullish forecasts.

Growth in Germany is already being hampered by new taxes, many of them designed to reduce construction, and by investments outside the country by German industrial leaders. The improvement in the Japanese economy is mere wishful thinking. The Bank of Japan has reduced the discount rate to 0.5 percent, and the government recently passed the seventh consecutive fiscal stimulus package, yet none of these traditional stimulatory moves has so far had any positive response.

The outlook for the Canadian economy essentially follows that of the U.S. economy, so it's not surprising to find our forecast for Canada is about one percent below most forecasts, since that also is our forecast for the United States. The near-split in that country, and the likelihood that major changes in the treatment of Quebec will have to be made in any case, do not create an environment that encourages either domestic or international investors.

It now appears that real GDP for Mexico will decline 4 percent this year, but even that figure, which is on a yearly average basis, understates the true devastation in that economy; second quarter real GDP fell 10.5 percent, with third-quarter real GDP down an additional 9.6 percent. Most forecasts predict a 2 percent gain next year in Mexican GDP, but that is wishful thinking; real GDP will continue to decline in 1996, especially with the recent drop in the peso which necessitates a more stringent monetary policy.

Brazil and Argentina also remain mired in recession. The latest data for industrial production in Brazil and Argentina show a decline of almost 10 percent from recent peak levels. Until the downward pressure on the Mexican peso abates, tight monetary policies will remain in force for these two countries as well, thus inhibiting recovery of real growth.

Thus worldwide real growth (excluding the U.S.) is in the process of declining from its peak level of 4.5 percent last year to about 2.5 percent next year. That reduction will inhibit the growth in exports from rebounding in 1996.

Consumer spending remains weak
Most of the time, consumer spending has a neutral effect on the economy; consumers spend their paychecks, with little or no money put aside for saving (other than mandated plans, such as pension or retirement plans). If income rises faster, so does consumption; if it rises slowly, consumption follows suit.

The major exception to this rule-of-thumb occurs when cost or availability of credit conditions changes dramatically. Since the early 1980s, this link has worked mainly through mortgage refinancing. When mortgage rates decline, many homeowners with adjustable rate mortgages (ARMs) refinance, providing them with smaller monthly payments and hence more money to spend on other goods and services. When interest rates rise, those with ARMs find themselves saddled with a bigger mortgage payment the following year, so their spending on other items is correspondingly reduced.

Interest rates rose during most of 1994, but the impact on consumer spending was not immediately felt because employment grew rapidly, and there is usually a lag of a year or so between the time interest rates rise and monthly payments increase. In 1995, though, the rise in rates caught up with homeowners, and while some were able to refinance at lower rates in the first half of the year, that source of funding dried up in the second half, so discretionary spending became quite anemic.

The Fed could cut rates sharply in early 1996, in which case consumer spending would, after a short lag, snap back to life. We don't think that will happen, because the unemployment rate is still relatively low and at least some members of the Fed are concerned that inflationary pressures are not yet totally extinguished. On balance that means that consumer spending will be sluggish unless capital spending or exports step up the pace, neither of which is expected to happen.

The other possibility is that meaningful deficit reduction will occur, thereby sending bond yields sharply lower just as bond yields fell sharply in 1993 after the Clinton tax hike. Deficit reduction also would stimulate the economy. However, from what we have seen so far of the budget proposals, they are front-loaded with tax cuts, some of them retroactive; and back-loaded with spending cuts that probably will never be implemented.

Thus our overall forecast for real growth in 1996 calls for continued 1.5 percent growth unless the Fed eases interest rates significantly early in the year, or the budget agreement reduces interest rates. We think the chances of either of these occurring is very unlikely.
Michael K. Evans of Evans Economics, Inc., Boca Raton, Fla., serves as a consulting economist for APICS and prepares the APICS Business Outlook Index, which appears monthly in APICS-The Performance Advantage.
Michael Evans writes the APICS Business Outlook Index which appears on a monthly basis in APICS-The Performance Advantage (see page 8) on a one-month's delay-primarily because of publication deadlines. The current month's report is available via fax immediately upon release to all companies who participate in the survey. APICS members and others from companies that are interested in participating in the Index are urged to call Evans at (407) 338-5300. Participants will receive, free of charge, advance information and data that will be significant to organizations as they plan for the months ahead in a competitive business environment. Interested parties also may contact Barbara Gleason, senior communications manager, at APICS headquarters, (800) 444-2742 or (703) 237-9344, ext. 271.

Following is the 1996 APICS Outlook Index Release Schedule:

JANUARYMonday, January 29, 1996
FEBRUARYThursday, February 29, 1996
MARCHFriday, March 29, 1996
APRILMonday, April 29, 1996
MAYWednesday, May 29, 1996
JUNEFriday, June 28, 1996
JULYMonday, July 29, 1996
AUGUSTThursday, August 29, 1996
SEPTEMBERMonday, September 30, 1996
OCTOBERTuesday, October 29, 1996
NOVEMBERFriday, November 29, 1996
DECEMBERMonday, December 30, 1996

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