1998 BUSINESS OUTLOOK FORECAST: ECONOMIC EXPANSION TO CONTINUE

INDIANAPOLIS -- It's a familiar story. The longest economic expansion since the end of World War II will continue into yet another, eighth year, as real growth in gross domestic product has been a consistent trend, with a few minor exceptions.

That is the view of professors in the E.W. Kelley School of Business at Indiana University, who presented an economic forecast as part of the Business Outlook and Public Policy Forum's first 1997 presentation, scheduled today (Nov. 6) in Indianapolis.

The IU panel made a similar presentation today in Bloomington. The two presentations were the first in a statewide tour that will include 10 cities over the next three weeks. In addition to the annual forecast, IU faculty in business, public and environmental affairs, and economics joined state public policy experts in discussing how current trends are affecting Indiana.

"We expect another good year in 1998," said Willard Witte, IU associate professor of economics. "Economic growth will probably decelerate from its rate the past two years, but given capacity constraints, some slowdown is desirable."

In the forecast, IU professors said that inflation nationally is expected to worsen slightly from its present, historically low level. Real GDP is projected to rise between 2.5 percent and 3 percent during 1998, with inflation rising back toward 3 percent. Employment will rise about 1.5 million, which would be considerably less than the rate of recent years, but enough to hold the national unemployment rate at around 5 percent.

The story will be similar in Indiana, although economic expansion will be dampened somewhat by manufacturing trends, said Morton J. Marcus, director of the Indiana Business Research Center at IU.

"Indiana's economy is expected to roll on with another year of substantial employment and income gains in 1998," Marcus said. "Manufacturing will continue to dominate the Hoosier economy, but its hold will again be weakened as firms seek efficiencies by downsizing or relocations.

"Over the past year, manufacturing employment fell slightly and that decline is expected to continue in 1998. Workers can look for moderate gains in their paychecks, even after adjustment for inflation," Marcus added.

The U.S. economy has grown at a rate in excess of 2.5 percent for most of the past six years. Since the last recession ended 80 months ago in 1991, output growth has averaged 2.9 percent per year. Statistics through the third quarter of 1997 indicate that real GDP will rise by about 3.5 percent this year. At the same time, inflation has steadily declined -- the prices of all goods and services rose by only 2.2 percent in the past year.

Since 1991, the economy has added, on average, more than 2 million jobs each year, even with a slow start in 1992 and a lull in 1995. Over the past four quarters, 2.7 million jobs have been created, which Witte called "a remarkable performance for a recovery now in its seventh year."

The rising employment has outstripped labor force growth by over 300,000 per year, producing the steady drop in unemployment from 7.8 percent in June 1992 to below 5 percent for the past three months.

"This combination of rising output, low inflation, and low unemployment represents the best economic performance in the past three decades," Witte said. "Indeed, in some ways it is too good to continue. By any standard measure, the economy is now at or very close to 'full' employment.

"Over the past three decades, the growth of the economy has averaged about 2.3 percent. We have been above that long-run benchmark for much of the past six years, including the past two," Witte added. "Consistently in the past, unemployment below the mid-5 percent range has caused pressure on wages which ultimately pushed prices up."

In addition, capacity utilization, one measure of the economy by the Federal Reserve, is now at nearly 85 percent, a traditional danger level.

"Even so, we are sanguine about the outlook for the next year," Witte noted. "The expansion has rested on three strong supports: consumption spending by households, business investment spending, and exports to foreign markets. Each of these should continue to propel the economy forward into 1998."

The rapid increases in employment have been producing solid increases in household real income, as well as high levels of consumer confidence. After a brief lull during the past spring and early summer, consumer purchases, especially of the durable goods -- which are important for the Indiana economy -- have recovered their momentum.

Business purchases of new equipment were up 12.7 percent in the past year, even better than their average increase of 11 percent over the last five years. "There is no sign that this investment surge is slowing," Witte said. "Indeed, it seems to be broadening, shifting from dominance by electronics and telecommunications equipment to include healthy growth of transportation and industrial equipment." Investment in structures was up by 4.5 percent in the past year.

Exports have been averaging double-digit increases the past three years, with an increase of 13.6 percent the past year. "While continued growth at this rate seems unlikely, demand abroad for our goods and services, especially from our trade partners in this hemisphere, should remain healthy," he noted.

It remains a possibility that the tight labor market will produce a surge in wages. Labor costs have increased slowly over the last six months, but they have been partly offset by productivity improvement.

The IU economists said that advances in productivity will be crucial to continued economic progress. Without this, higher wages will translate into either higher prices and certain monetary reaction by the Federal Reserve, or into lower profits, which would endanger the investment boom at the heart of the economic expansion.

On the other hand, if recent capital investments produce a significant rise in productivity, as some prognosticators expect, it would allow for faster growth with low inflation. The IU forecast is between these two extremes.

Another risk to the forecast is instability in financial markets. U.S. financial markets recently observed the 10-year anniversary of history's biggest one-day drop in the Dow Jones Industrial Average. Within a week of that date, the stock market experienced a major sell-off, dropping over 550 points, and has since rebounded somewhat. Clearly, further decline in equity prices is possible.

But in many ways, the situation now is different from 1987, IU economists point out. Interest rates are substantially lower, as is inflation. The government budget, which then had a large deficit, is now essentially in balance. "Further, it should be remembered that the 1987 crash had virtually no effect on the real economy," Witte said.

Problems could also arise in the international realm. The upcoming transition in Europe to a common currency -- scheduled to debut at the end of 1998 -- could have unforeseen effects. The currency turmoil in the Far East is troubling, and there was a hint of a trade war with Japan in mid-October.

The annual forecast of economic conditions is prepared by a group of IU economists and business professors who specialize in analyzing national and state business conditions. The starting point for the forecast is the Indiana Econometric Model, which combines state statistics and a national forecast to develop projections for the coming year.

The panel -- previously known as the IU Business Outlook Panel -- was founded in 1972 by the IU School of Business as a service to bring current economic information to the state's business communities.

Other panelists at the Indianapolis presentation were Dan Dalton, dean of the Kelley School of Business; Robert J. Kirk, IU professor of economics from the Indianapolis campus; Mark Rosentraub, IU associate dean and professor of public and environmental affairs; and Graham Toft, president of the Indiana Economic Development Council.

The panel also will appear in Columbus on Nov. 7; Anderson, Nov. 11; Fort Wayne and Richmond, Nov. 12; Evansville and New Albany, Nov. 13; Schererville, Nov. 14; and Kokomo, Nov. 20. This year's tour is being sponsored by the IU School of Business, the IU Alumni Association, IU campuses and local chambers of commerce.

For more information, contact George Vlahakis, Office of Communications and Marketing, 812-855-0846 or 812-855-3911, gvlahaki@indiana.edu