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Tennessee Valley feels tremors of Middle East crisis.

At this time last year, the nation was expected to be headed for a "soft landing" with GNP growth for 1990 approaching 2.0 percent and no significant increase in inflation. The Tennessee Valley was expected to follow the nation, but with a "rougher landing." The national slowdown resulting from the Federal Reserve's efforts to control inflation through higher interest rates was disproportionately affecting manufacturing-a sector of more importance to the Valley than to the nation as a whole-bringing even lower, though still positive, growth to the region. By 1991, the nation was expected to recover and the region to again experience faster-than-national growth.

SOFT LANDING ROUGHED UP

BY INVASION OF KUWAIT

The above scenario was on track through most of the first half of 1990. By the end of the second quarter, however, there were signs that the national economy was weakening even further. The scenario might still have come about, but Iraq's invasion of Kuwait in August completely derailed this outcome. The Iraqi invasion caused oil prices to jump in August by $10,to $30 dollars per barrel. Saudi Arabia and the other oil producers quickly increased oil production to make up for the lost Iraq and Kuwait supplies. Nevertheless, oil prices have widely fluctuated between $27 and $40 per barrel depending upon speculation as to the outcome of a war that could greatly limit Middle East supplies.

The sharp increases in oil prices were quickly reflected in higher overall inflation. The Consumer Price Index (CPI) jumped from a 3.7 percent annual rate of increase in the second quarter to 6.4 percent in the third quarter and is expected to edge higher in the fourth. Economic weakness caused by the oil price shock was not as immediately apparent as the increase in inflation, but the signs have been mounting. Housing starts have been dropping, unemployment has been on the rise, and consumer confidence has plunged. Industrial production actually declined in October, and retail sales have been sluggish.

Reports have not been all bad, however. GNP estimates for the third quarter indicate a healthy 1.7 percent increase after the dismal 0.4 percent increase in the second quarter. Factory orders for durable goods increased sharply in October. And, except for energy price increases, inflation does not appear to be a problem.

These events have been reflected in the Tennessee Valley economy. Total regional employment growth was stagnant in the third quarter, and the unemployment rate increased from 5.6 percent in the second quarter to 5.8 percent in the third. Building permits and construction employment have been declining. Already sluggish retail sales slumped in August and September (the latest numbers available as of this writing).

Valley economic weakness is also evident in manufacturing. Regional manufacturing employment began to decline consistently in the second quarter of 1990. Durable manufacturing employment had actually been in decline throughout 1990 due to restrictive Fed policy, but nondurables were holding up relatively well until the second quarter.

As with the U.S., not all reports on the regional economy are bad. Commercial and industrial electrical sales have continued to grow. In spite of the generally poor conditions in the U.S. auto industry, the Saturn plant in Smyrna, Tennessee, began production. Sales of Saturn models have been extremely brisk, and the plant has not been able to produce enough cars to keep up with dealer orders. Overall, the economic situation of the Tennessee Valley at the end of third quarter 1990 can be classified as very weak, but not generally contracting.

1990 COMES TO A BAD END

With the spate of bad reports, it is not surprising that 1990 is not expected to end on a positive note for the U.S.economy. the U.S.auto industry has already announced big cutbacks in production for the end of the year. National surveys of consumers as well as retailers show that not much buying, especially of the big ticket items, is expected for the Christmas season. Surveys also show that business investment plans are generally being put on hold. The positive note is that exports are doing well due to the low dollar. Government expenditures for Operation Desert Storm have also been helping to prop up demand. After skirting negative growth in fourth quarter 1989 and second quarter 1990, there is little doubt about a contraction of the U.S. economy in fourth quarter 1990.

The fourth quarter performance will carry its momentum into 1991 and start the year off on a bad footing. In real terms, oil price shocks have thus far been less than half what they were in 1973 and 1979. There is no reason to expect anything more than a mild contraction of the U.S. economy.

But, the real key to 1991 is the Middle East situation. It is assumed that a resolution to the crisis will occur by spring with no additional disruptions to oil supplies. Oil prices will drop quickly to the lower $20s per barrel as supply-especially with the hoarding that has been occurring as a hedge against war-will be ample.thiswill quickly restore both consumer and business confidence.

The Federal Reserve has been lowering interest rates through the second half of 1990, although cautiously, and is expected to continue dropping rates to offset the declining economy. These efforts will see fruition by providing an extra boost as consumer confidence-and thus spending and investment-is restored. Thus, the second half of 1991 will be a period of recovery. However, pervasive problems with a weak financial system, the Federal budget deficit, and inflationary pressures will keep growth relatively sluggish.

VALLEY ECONOMY FALLS

BEHIND U.S.

On average, 1991 will be a very weak year for the U.S., similar to 1990 except with a bad start as opposed to a bad end. GNP growth for 1991 will be about 1.2 percent. Me regional economy will follow the same pattern as that of the nation, but will be somewhat weaker. Gross Regional Product (GRP) will grow by only about 0.8 percent in 1991. Figure 1 and Table 1 show the expectations for major economic variables for the region and the nation in 1991.

The good news for the region is that manufacturing is expected to perform better in the Valley than in the nation. As seen in Table 1, regional manufacturing employment is expected to decline only 1.0 percent in 1991 as compared to 1.8 percent for the nation. The tennessee Valley will see less of a decline in employment in both durable goods and nondurable goods than will the U.S.

The major reason for the more favorable performance of regional manufacturing is the current export position of the U.S. In the early 1980s, the U.S. saw a very strong dollar as foreign investors took advantage of high U.S. real interest rates and the dollar as a safe haven. The situation is very different today. With tensions between the major powers minimized, other currencies are considered as safe as the dollar. Real interest rates in other countries, especially Japan and Germany, are high; thus, there are good investment opportunities abroad. This has led to the dollar being valued relatively low against other currencies.

This is good for the Valley. The region is much more "export oriented" than the U.S. as a whole. ("Export oriented" refers to the production of not only goods for export, but also goods for domestic consumption that are in strong direct competition with imports.) An analysis of the top 50 export oriented" manufacturing industries shows that the Valley has over twice the amount of employment in these industries as a percentage of the total manufacturing base than does the nation.

Whereas the strong dollar in the early 1980s hurt regional manufacturing greatly and contributed to the region's slow recovery from the 1982 recession as compared to the nation, the low dollar is helping Valley manufacturing today. Other countries, especially Europe and Japan, have not been as affected by the oil price shock and continue to expand. This improves the market for Valley export goods, such as some of the machineries, which are competitively priced given the current low value of the dollar. Also, Valley goods for domestic consumption that compete with imports are also more competitive. For example, the low dollar allows Valley textiles to be more competitive against European imports.

Finally, the low dollar also makes it more cost effective to produce goods for U.S. consumption in U.S. plants rather than producing in plants abroad and importing the goods into the U.S. Valley manufacturing will benefit from this as there are several plants in the Valley that are part of international operations, such as the Nissan plant in Smyrna, Tennessee.

Even with the export boost, overall demand will be lower in 1991, causing a decline in manufacturing employment both in the U.S. and in the region. The decline will be less in the Valley, however, because of the more favorable impact of the low dollar on regional manufacturing. In spite of this, the valley economy will perform more poorly overall in 199 1, as was seen in Table 1. Total employment is expected to grow by 0.4 percent for the nation in 1991, while total regional employment growth will be only half that rate.

This results from the more important role that manufacturing plays in the regional economy as compared to the nation. Manufacturing employment makes up 28.0 percent of total civilian non-agricultural wage and salary employment in the region, but only 18.0 percent in the nation. Thus, the same percentage decline in manufacturing employment in both areas implies a larger percentage decline in total employment for the region.

Further, commercial sector employment in the region is more dependent upon the income generated by manufacturing than is the case for the U.S. as a whole. As seen in Table 1, commercial employment in the nation is expected to grow 1.2 percent in 1991. The Valley's commercial employment is only expected to grow 0.9 percent, however. This also contributes to the lower over all growth for the region as compared to the U.S. in 1991.

UNCERTAINTY IN 1991 DUE

TO MIDDLE EAST SITUATION

As mentioned previously, the scenario depicted above depends upon the assumption of a quick resolution of th(, Middle East situation by spring. This is by no means a certainty.

The impact of the war in the Middle East on the economy primarily depends upon its duration.

If the war lasts only a few months with a quick resumption of oil production thereafter, the effects would be minimal. The economy would be worse during the short time oil supplies were cut off during the war, but would likely recover quickly after post-war oil prices declined.

If the war continues for a long time or if oil fields are seriously damaged causing a lengthy disruption to oil supplies, the U. S. and Valley economies would be thrown into a recession rivaling those of 1975 and 1982.

As the Middle East crisis wages on, the Valley should stiffer through a very weak economy in 1991 but be on the road to recovery, along with the nation, by the end of the year.
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Title Annotation:effects of the Iraq-Kuwait crisis on Tennessee Valley's economy
Author:Gonzalez, Juan E.
Publication:Business Perspectives
Date:Dec 22, 1990
Words:1881
Previous Article:The Bureau's business advisory for 1991.
Next Article:The mid-south economic outlook.
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