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The 1997 outlook.

Throughout the year, the Bureau of Business and Economic Research monitors economic activity. Based upon that information, we prepare an annual economic outlook edition of Business Perspectives which captures the essence of economic trends that we expect to see in the coming year. In general, we try to highlight the important interaction that exists between economic activity at the national level and the outlook for Memphis and the Mid-South.

Because of the size and complexity of the Memphis area, the Bureau believes that the key determinant of the economic outlook for Memphis in 1997 will be the level of economic activity which can be expected for the nation. Memphis cannot prosper unless we can sell the goods and services we produce in strong national and international markets.

How weak or strong will the nation's economic performance be in 1997? What are the key factors that will influence the performance of the nation's economy? How will those factors impact the economic performance of Memphis and the Mid-South? Will 1997 be the year in which the economic growth bubble is burst for the nation and for Memphis? Or, can we expect another year of rebounding growth like we experienced in 1996?

The economy's performance in 1996 was clearly an improvement over figures for 1995. In fact, it appears that the three quarters of weak economic performance experienced in 1995 and the 2.0 percent Gross Domestic Product (GDP) growth rate for the year may well have been the cyclical downturn many analysts continue to look for in 1997. The much stronger quarterly growth figures for 1996 clearly reflect improving economic conditions. Low inflation rates, declining federal and trade deficits, low unemployment rates, and improvements in nearly every sector and region of the country put to bed the recession fears in 1996. But 1997 is a new year, and the possibility of a recession is once again a topic of discussion.

In the November 1996 issue of U.S. Cyclical Outlook produced by the Economic Cycle Research Institute, Inc., analysts reported:

"... an interesting likelihood of a growth recession, or a sustained period of below-trend growth, starting in the first half of 1997. Historically, most growth recessions degenerate into business cycle recessions, but some do not... clear evidence of an upcoming business cycle recession is yet to emerge."

Consistent with this observation, the consensus forecast for the nation in 1997 is for slightly weaker economic growth, stability in most labor markets, acceptable inflation figures, small changes in interest rates, and no major downturns in economic activity. The Blue Chip consensus 1997 forecasts developed from 52 major forecasts of economic activity are shown in Table 1. The data indicate that a small downturn is forecast. No major concerns seem to exist that would suggest any major economic weaknesses in the economy in 1997. And, clearly no evidence exists which would suggest that a recession will occur in 1997.


But given six years of economic growth and expansion. how long can the economic good times last? Is the business cycle a thing of the past? If not, what factors might signal the beginning of the next recession? And, how will the changes which impact the nation's economy impact Memphis and the Mid-South?

Business cycles

After the major recessions experienced in the early 1980s - January 1980 to July 1980 and again in July 1981 to November 1982 - a period of eight years of economic expansion ensued. Except for the expansion period of February 1961 to December 1969, the uninterrupted economic expansion of the 1980s was the longest and strongest in the last 50 years. The brief but serious recession which started the 1990s (July 1990 to April 1991) was, however, a reminder that economic activity can and will periodically experience significant setbacks from shifts in economic factors.

The factors that are the keys to understanding the business cycle are as follows:

"...Considerable parts of the GDP do not seem to experience the business cycle in any significant degree: government demand ordinarily grows in recession and expansion alike, and personal outlays for services appear to operate largely independently of the general business conditions imposed by the cycle.

"On the other hand, some components of the GDP react very clearly - and some of them explosively - to changes in the cyclical phase of the system.

"...These susceptible components are consumer durables outlays (long-lived and heavily dependent upon installment credit); the outlays of business for plant and equipment (also long-lived and credit-dependent); residential building (again, long-lived and credit-dependent); and changes in business inventories (not long-lived, of course, but highly sensitive to the expectations of businesses with respect to future business volume and prices, and very sensitive to interest rate developments, because the carrying cost of inventory is largely a function of the prevailing short-term interest rate)."(1)

Each of these volatile components of the economy represents an area of potential concern in 1997.

Areas of potential concern

First, consumer expenditures on durable goods are more sensitive to economic conditions than other consumer expenditures because they typically are postponable and acquired on credit. Any factors which influence consumer confidence or credit options influence durable goods expenditures. Consumer expenditures on durable goods are expected to be down slightly during 1997. Expectations of slightly weaker auto and light truck sales could be offset, however, by moderate gains in furniture and home appliance spending if declines in mortgage interest rates and renewed strength in the housing industry occur. Strong job growth could also increase consumer confidence levels and stimulate this component of the economy.

Consumer confidence indicators should be watched closely during 1997. A downturn in consumer confidence could signal a decline in expenditures for consumer durables. Consumer confidence is inversely related to unemployment rates, so any increases in unemployment rates in 1997 would signal weaker consumer confidence. Negative economic news about inflation, interest rates, and overall economic activity could also trigger declines in consumer confidence and expenditures during the year.

Second, business outlays for plant and equipment in 1997 are expected to continue to slide slowly downward from peak growth periods in 1994 and 1995. Dramatic reductions in corporate profits from 15.7 percent in 1993, 14.0 percent in 1994, 10.8 percent in 1995, and 8.9 percent in 1996 to the 3.2 percent forecast for 1997 should challenge businesses interested in modernizing and upgrading equipment and facilities. In spite of the poor picture for corporate profits, given favorable exchange rates, low interest rates, continuing high capital utilization rates, and strong year-end industrial production figures, it is difficult to forecast any dramatic weaknesses in this sector.

Third, housing is another potentially volatile sector that should be fairly stable in 1997, in part because of the stability of mortgage interest rates. From the fourth quarter of 1991 through the second quarter of 1996, housing has been a strong performance sector in the U.S. economy, averaging 7.6 percent real growth over the period.

The U.S. housing sector should find that 1997 will be another good year. The National Association of Home Builders (NAHB) is projecting 1.35 million housing starts each year for the next two years (somewhat slower than other forecasts). With a reasonable overall economic performance and stable or lower interest rates, this goal should be easy to attain. If interest rates should decrease or growth figures be higher than expected, the housing sector could expand more in 1997 than anyone currently forecasts.

The housing expansion of the 1990s has been considerably more balanced than those in the early 1980s and the 1970s. The economy has not experienced the dramatic swings that take construction to between 1.5 and 2.0 million units in one year, but typically lead to a drastic reduction in construction the following year.

Finally, an important indicator of economic health is the monthly inventory-to-sales ratio. When inventories rise relative to sales, it is an indication that business is unable to sell its product. As excess inventories develop, businesses will lay off unneeded workers and invest less in new capital, since new capacity is unwarranted when inventories rise. During the 1990-1991 recession, monthly inventories almost reached 160 percent of sales. Beginning in the second quarter of 1991, business inventories began to fall relative to sales. The fall continued through 1994 when the ratio bottomed at 140 percent. In 1995, inventories again started to rise relative to sales. Other indicators of economic troubles, such as the unemployment rate, began to move in the wrong direction. By November 1995, the ratio had risen to 144 percent.

But, 1996 has been a good year of almost continuous decline in this critical ratio. By August, it had fallen back to 140 percent, an indication that business sales and consumer expenditures are working together. What will 1997 bring? Clearly, the most likely scenario is continued health in the consumer sector and few, if any, problems with excess inventories. As long as businesses are able to manage production and inventories so that they match consumer demand, excess inventories will not be a problem. In addition, if the cost of maintaining inventories declines due to lower short-term interest rates, then business cycle problems should be minimal in 1997.

In summary, 1997 should be a year of sustainable, non-inflationary growth. A business cycle downturn should not be expected in 1997. But, we should all be reminded that:

"The structure of the cycle ... is unalterably present. It would be a mistake to assume that the force of the cycle, always formidable when it gathers strength, will not reappear in time. The pendulum may now and then seem nearly still, but the machinery is there, to be restarted when conditions again favor a return to traditional volatile patterns of free market behavior."(2)

Economic Growth: What Can We Expect?

What is the relevant sustainable level of economic growth for the nation? A September 1996 survey of the National Association of Business Economists reported that 48 percent of the panel thought that the sustainable long-term growth rate was between 2.0 percent and 2.5 percent. Another 49 percent thought that sustainable long-term growth was above 2.5 percent; only 2.0 percent thought it was below 2.0 percent. Given this background, the panel reported growth forecasts of 2.3 percent for both 1996 and 1997. Both years would have below-trend economic performance if these forecasts are accurate.

So, what's holding the economy back? Some of the factors identified by the National Association of Business Economists include the following:

1. Poorly-prepared labor force

2. Restrictive monetary policy

3. Growth in government spending and high federal deficit and debt

4. A tax system that favors consumption and not investments

Are we locked in a period of below-potential growth because of some long-term structural problems such as poorly-educated workers, deteriorating infrastructure, excessive entitlements, growing debt, and a choice of consumption over investment? Many economists would suggest that the answer is yes. The Blue Chip consensus for 1997 is certainly consistent with this rather pessimistic view:

"The consensus is that the economy grows near or slightly below trend over 1997. Real GDP grows between 1.9 percent and 2.1 percent, which hugs the low end of the current estimates of trend growth of 2.0 percent to 2.25 percent."(3)

Also in the forecast

Some of the other economic highlights that are in the forecast for 1997 include:

* The strength of the stock market in 1996 may begin to erode if the poor profit picture and the slow economic growth forecast for 1997 become a reality. The sensitivity of the market to recent suggestions by Alan Greenspan that it is increasingly speculative is evidence that concern continues to exist.

* If the weak economic figures forecast for 1997 become a reality, there will be downward pressure on interest rates. If demand figures stay as low as some analysts expect, interest rate projections like those in Table 2 below may become a reality.

But, more modest reductions (if any) should be forthcoming based upon the consensus forecasts for economic growth in the 2.2 to 2.3 percent range. Even then, interest rate reductions should be good news for interest-rate-sensitive industries such as housing, autos, and durable goods manufacturing. In the face of minimal inflationary pressure, the Federal Reserve Bank may be expected to take a more serious view of its role in stimulating the economy in 1997.

* Inflation fears are currently being driven by the severity of the weather being experienced throughout much of the nation and the associated increases in heating oil and other fuel costs. But initial price increases should be short-lived. Competitive forces will require that most employers find non-price mechanisms for absorbing fuel price increases. And, heating oil price increases are seasonal and subject to change.

* The increase in the Consumer Price Index should be 3.0 percent or less throughout most of 1997, in spite of tight labor markets, high rates of capacity utilization, and large federal deficits.
Table 2

Key Projections, Financial Markets

 Fed Funds 3-Month 30-Year
Interest Rates Target T-Bills Tres. Bond

December 13, 1996 5.25 4.91 6.57
End of 2nd Quarter 1997 5.00 4.85 6.25
End of 4th Quarter 1997 4.25 4.15 6.00

Source: Citibank; Economic Week, Year-End Forecast Issue, Vol. 24,
No. 51, December 16, 1996.

International Outlook

Rebounding economic growth figures seem to reflect stronger international markets for most nations in 1997.

For many years, wide variations have existed in the economic fortunes of individual nations. In 1997, strong Southeast Asia economies should continue to grow, even as the economic fortunes of the U.S. and many other countries begin to wane. Clearly, the ability of Japan, Canada, and most European nations to continue their economic recovery will, however, depend upon the severity of the slowdown experienced in the U.S. economy.

Economic interdependence is the key to world markets, and the U.S. economy is the key determinant of world economic expansion. Mexico will continue to suffer from economic instability because of weaknesses in that country's domestic and international markets. Canada will experience the spillover effect of a slow U.S. economy. And, Japan's recovery will stall in 1997 as international markets remain weak and international competition remains strong. Anti-inflationary policies that remain in effect in most European nations have tended to keep interest rates high and have kept domestic growth rates low. Social and political unrest associated with high unemployment rates should however, pressure European governments to provide more economic stimulus to their economies in 1997. The Citibank forecasts of international economic activity shown in Table 3 provide support for this international scenario.

Mid-South firms seeking opportunities in international markets will be forced to struggle with the diverse fortunes of international markets. While international economic opportunities will exist in 1997, slow growth in international markets will continue to challenge export-based industries in our region.

The Bureau's outlook for 1997

In the last few years, the Bureau of Business and Economic Research has tended to be more optimistic than most forecasters about the nation's economic growth. For example, when most forecasts were developed for 1995, economists were dealing with data from 1994 that indicated a major economic growth period was underway. In fact, economic growth rates reflected in GDP numbers were 2.7 percent in 1992, 2.3 percent in 1993, and 3.5 percent in 1994. No forecasts anticipated the dramatic escalation in interest rates which was forthcoming in late 1994 and early 1995. Actions taken to slow the economy's growth were effective and made early forecasts of economic activity in 1995 overly optimistic. The bureau was not alone in its optimism.

In 1996, the Bureau expected the growth in GDP to be 2.9 percent. based on early evidence of a recovery of economic momentum after substantial government cutbacks, corporate downsizing, weakness in personal income, slow consumer spending, and higher interest rates in 1995. While the Bureau's 1996 forecast was lower than our 1995 forecast, we remained more optimistic than most forecasters.

Our outlook for 1997 is only slightly more optimistic than most forecasts. While GDP is expected to slow in 1997, the BBER believes that it will remain close to a long-term sustainable rate of 2.4 percent. Strong labor markets, higher income, and a modest expansion of consumer spending should continue to support the economy in 1997. Stable to slightly lower interest rates should also prevent any dramatic departure from the economy's current growth path.

Similarly, over the last few years the Bureau's inflation outlook was based on a belief that strong economic growth, high rates of capital utilization, tight labor markets. and years of strong domestic demand would fuel inflationary pressures. The actions of the Federal Reserve Bank in raising interest rates and focusing their attention on controlling inflationary pressure have been successful and have prevented substantial increases in consumer prices.

In 1995, the Bureau expected (we think correctly) a substantial increase in inflation associated with the dramatic expansion of the economy taking place in 1994. Clearly, interest rate increases supported by the Fed stifled the economy in 1995 and headed off the anticipated inflation, The Fed's commitment to fighting inflation convinced the Bureau to lower its CPI estimate in both 1996 and 1997. The success of the Federal Reserve and its public commitment to a low-inflation economy make the Bureau's outlook for increases in the CPI fall to 2.9 percent for 1997.

Interest rate reductions in response to market weaknesses should also be evident in 1997. While no forecasts can anticipate the actions of the Federal Reserve, most indicators would suggest that some slight downward pressure on interest rates will exist in 1997. If the economy slows and inflation remains below 3.0 percent during the year, the declining demand for money and low inflation estimates should result in lower interest rates for most borrowers.

Unemployment rates seem to be stubbornly resistant to further reductions except in the nation's strongest growth markets. As the economy slows in 1997, the Bureau expects unemployment rates to rise slowly but remain below 5.5 percent for the year. Many economists would suggest that this rate is at or slightly below full employment for the nation's economy. The remaining unemployed workers are thought to be either frictionally unemployed - looking for work - or structurally unemployed - lacking the skills to take a job. The focus on job training and education currently receiving so much attention is consistent with the view that the absence of high-quality, well-trained workers is a structural barrier to the economy's growth.

1997 Outlook for Tennessee

For the sixth straight year, the economic outlook for Tennessee is for a continuation of its above-average economic performance. But, slower growth nationally should have a negative impact on our growth figures. The state should continue to close the employment and income gaps that exist between Tennessee and the nation.

Some problems are looming on the horizon that will impact our future. In Governing magazine's recently-published "State and Local Sourcebook for 1997," Tennessee ranked number 50 among states on state and local expenditures per capita on all levels of education.(4) Expenditures on elementary and secondary education in Tennessee ranked forty-ninth on a per capita basis and also on a per cent-of-income (or ability to pay) basis.

Expenditures for higher education were only slightly better; the state ranked number 40 on a per capita basis and number 33 on a percent-of-income basis.

Without a quality workforce, the ability of elected leaders to sustain the economic gains we have experienced is in serious doubt. Industrial recruiters cannot be successful unless quality workers are available to take the jobs. While state government has continuously talked about a commitment to education, it has been unable to produce the financial resources necessary to modernize the education system in Tennessee.

Part of the reason for that shortcoming is that Tennessee is forced to rely on a slow-growth, regressive sales tax as its basic source of tax revenue. In the absence of an income tax and in the absence of alternative tax revenue generators (such as lotteries), the state of Tennessee simply does not have the financial resources necessary to support an adequate system of public education. And conditions may get worse before they can get better.

The growth of tax revenue is not expected to be sufficient to support the increased responsibilities assumed by the state. TennCare, Families First, prisons, education, and other programs and initiatives will all require massive funding increases in 1997. Part of the problem is that Tennessee has been forced to [TABULAR DATA OMITTED] assume responsibility for health and welfare initiatives without adequate levels of support from the federal government. In addition, well-defined commitments to prison construction and improving education have overwhelmed our tax base. Consequently, the new year will be filled with conflicts over how to spend the increasingly scarce state tax dollars.

If 1997 is a year of slower economic growth, then the state's fiscal crisis may generate new interest in tax reform initiatives. While evidence exists that suggests that low state and local taxes have a positive impact on a state's economic growth, improvements in social infrastructure might make higher taxes a good investment in Tennessee's future.

Other challenges can be expected in 1997. Urban areas and rural market centers with diversified economies should continue to grow and prosper because of the continued strength of the trade and service sectors. But rural areas dependent on manufacturing firms may experience hard times as the output of manufacturing firms declines in 1997.

A good year ahead for Memphis

For many years. Memphis has been a city characterized by slow, steady economic expansion. While it has not been a "boomtown." Memphis has been a city characterized by manageable growth. That growth has depended heavily upon the growth of business services; trade, both retail and wholesale; and other non-manufacturing components of the economy.

The Memphis economy should prosper in 1997. Highlights of the year should include:

* Employment gain will be between 8,000 and 12.000 net new jobs during 1997. Most job opportunities are generated from an overall expansion of the area's economy. Industrial recruitment will, however, continue to be an important function during the year.

* Manufacturing will gain some strength because of the continuing development of Birmingham Steel, the expansion of Sharp Manufacturing Company, and the growth of other area manufacturers. Manufacturing jobs currently represent only 12 percent of total employment in the city. Perhaps 1997 will be the year when manufacturing rebounds from its long run of decline in Memphis.

* Financial institutions will continue to grow and prosper in 1997 as the industry continues to consolidate. New competitive pressures will make the delivery of banking services increasingly user-friendly. Credit unions and other non-bank institutions may offer more serious competition to regional banks in the new year.

* The transportation-dependent industries will continue to prosper in 1997 because of the basic infrastructure investments made to support the road, rail, air, and water-dependent industries in this area. The new Federal Express service center in Collierville, the new runway at the airport, the new UPS expansion at the airport, and other distribution-based activities should keep this sector in the news next year.

* The retail sector should experience an exciting year in 1997 as the long-awaited Wolfchase Galleria mall begins operations. Easy access and consumer interest should make the new mall an instant success. The renewed strength of the Poplar Plaza shopping area should complement Oak Court Mall. Finally. Home Depot's entry into East Memphis should help reinvigorate the Eastgate commercial area. Other commercial areas such as Hickory Ridge Mall and Winchester Road have demonstrated the ability to prosper in spite of an increase in competition from new commercial centers.

* The housing sector should maintain its strength in 1997 if interest rates remain favorable and Memphians continue their rapid movement to the suburbs. Construction spending for publicly-supported projects should help offset part of the slowdown anticipated because of the completion of projects in Tunica and East Memphis. Highway construction activities should continue to open up new opportunities for commercial and residential developments.

* International business in Memphis should continue to gain strength if the strong economic recovery of foreign markets continues in 1997. Memphis industries continue to look to foreign markets for growth opportunities, low-cost inputs, and potential projects. Extremely large international transactions in any single year have a tendency to distort the positive natural growth path of this aspect of the economy. The strength of the expansion of international economic activity will determine this sector's growth path.

* The service and retail sectors of the economy will continue to generate the vast majority of job opportunities in Memphis. The potential for growth in non-manufacturing industries may be constrained by the absence of available workers with state-of-the-art job skills.

* Like banking, the medical community will continue to consolidate and grow through the acquisition of existing firms, the expansion of services, and the continued market demand for improvements in health care. Uncertainties regarding TennCare, service and cost constraints from managed care organizations, and the potential for new types of competition will make 1997 a challenging year.

* Tourism should continue to increase in 1997 as local attractions and special events continue to attract visitors to the city. Graceland, the Memphis Motorsports Park. Beale Street, Memphis in May, and other attractions will continue to expand and improve during the year. Tunica will continue to be an unexpected complement to the entertainment industry, in Memphis and the Mid-South.

* Gaming in Tonica should continue to grow in 1997. Casino-based developments such as hotels, golf courses, and housing developments should help Tunica maintain its vitality. But competitive pressure. market constraints, and an absence of other large-scale investment in Tunica may ultimately limit its growth potential. Without developing improved transportation opportunities for long-distance gamblers. the size of the market will continue to be a constraint on Tunica's development.

* Millington has demonstrated the ability to turn a negative into a positive. The movement of additional Naval personnel functions to Millington will create hundreds, if not ultimately thousands, of new jobs in this community. The ability to provide high-quality housing, schools, and commercial opportunities for those employees will determine the community's long-term growth potential.

* Bartlett, Cordova, Collierville, Olive Branch, Southaven, and other suburban residential, commercial, aid industrial areas will continue to grow in 1997. Most demographic and economic growth in the Memphis area will continue to occur outside the Memphis city limits.

* Downtown developments will continue to depend on public/private partnerships. Public investments will create opportunities for private developments to be successful. Expanded housing, the success of Beale Street, the new Mud Island connector. and Convention Center initiatives should help focus the community's attention on the opportunities which exist downtown.
In Population Growth, Memphis Trails Others

Demographic growth drives state and local economic activity. In
percentage growth, Memphis lags behind four other Tennessee metre

 1990-95 1990-95 Rank,
 Population Growth Percent
Metro Area Change Rate Growth

Chattanooga 18,713 4.4% 6
Clarksville 20,038 11.8% 1
Jackson 5,733 7.4% 4
Tri-Cities 18,009 4.1% 7
Knoxville 54,740 9.3% 3
Memphis 61,585 6.1% 5
Nashville 108,810 11.0% 2

Tennessee 378,848 7.8% -

* The Clarksville MSA includes Hopkinsville, Ky.

** Johnson City/Kingsport/Bristol, Tenn.

Source: U.S. Census Bureau.
Taxing Tourists May Have Its Limits

Travel taxes in Memphis may already be too high if the city ever
hopes to grow its convention and tourism-based industry.

Selected cities, ranking by level of overall travel taxes

Metro Area Rank

Chicago 1
Seattle 2
Houston 3
New York 4 (tie)
Dallas 4 (tie)
Reno 6
Washington, D.C. 7

Memphis 13 (tie)
Knoxville 13 (tie)
Nashville 16
Atlanta 47
Cincinnati 48
Boston 49
Honolulu 50

Source: Tax Foundation, Tax Features, July 1996, Vol. 40, No. 6.

1 Albert T. Sommers, with Lucie R. Blau. The U.S. Economy Demystified. Third Edition (New York: Lexington Books, 1991), pp. 97-99.

2 Sommers, with Blau, p. 111.

3 Blue Chip Econometric Detail, Vol. 12, No. 4, Dec. 10, 1996.

4 "State and Local Sourcebook for 1997," Governing, January 1997, p. 44.

5 "Do State and Local Taxes Affect Relative State Growth?," Economic Review, March/April 1996, pp. 18-36.

Dr. John Gnuschke, director, Bureau of Business and Economic Research
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Title Annotation:economic trends
Author:Gnuschke, John
Publication:Business Perspectives
Date:Jan 1, 1997
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