Slower growth ahead for 2005

The U.S. economy will carry some heavy burdens in 2005. Among the obstacles will be slower gross domestic product growth, rising interest rates, a falling U.S. dollar, rising inflation, a record national debt, a record national trading deficit, record consumer debt, rising costs for energy and raw materials, continued rising health care costs, stagnant wages, a looming Social Security crisis, an uncertain war in Iraq and the ever-present fear of another terrorist attack.
So, given all of those obstacles, one might think Michael Knetter, economist and dean of the University of Wisconsin School of Business, would be a bear about the U.S. economy in 2005.
However, Knetter notes that some of those macro-economic factors are two-edged swords that also could help specific U.S. industries and companies. In fact, he believes that manufacturing and agriculture – two long-time staples of the Wisconsin economy that have been battered for years – are poised for growth in 2005.
In general, Knetter is predicting slower national economic growth this year, but growth nonetheless. He tempers his optimism with the uncertainties of Iraq, terrorism, Social Security and the national debt.
Knetter, who was scheduled to speak at the Northern Trust Economic Trends 2005 breakfast on Jan. 21, recently discussed his outlook with Small Business Times executive editor Steve Jagler. The following are excerpts from that interview.
SBT: Let’s start by breaking down some of things, item by item. The gross domestic product – the common wisdom on the street is that it will be slower in 2005 than it was in 2004. Does that ring true with you?
Knetter: "Yes. In 2004, I think we’re going to come in at about 4.4 percent. That’s my guess. And I would say that in 2005, we’re looking at about 4 percent. So, we’ll have a little bit of deceleration in the growth rate, but still positive growth. I would say, if predictions are borne out, we will view 2005 as a good growth year."
SBT: Given all the negative factors, what will drive that growth?
Knetter: "One is our own consumers who want to buy things. Another is foreign consumers who will see attractive pricing for U.S.-produced goods and services, because of the weaker dollar. That, to me, is what the demand side is. The supply side is just, you know, that will be driven by additions to the labor force, investments that are being made and improvements in technology, and continued implementation of new technology in a lot of workplaces. To get any level of growth, there has got to be a demand side to it and a supply side, and I think they’re both there."
SBT: Your mention the falling U.S. dollar. That has impacts, both negative and positive, doesn’t it? I guess the positive is that goods produced by American companies can be sold at cheaper prices overseas.
Knetter: "Yes. Foreign tourists and foreign consumers of U.S. products will perceive a sale in their own currencies on dollar-denominated goods and services."
SBT: What would be the most significant downside to a falling U.S. dollar?
Knetter: "For our consumers, the flip side is foreign products to us will start to look more expensive, unless the foreign producers reduce the prices in their own currencies."
SBT: China has the cheaper labor. Is there any indication that China is getting any closer to becoming more of a consumer economy, where its people are able to purchase products made in the United States?
Knetter: "They’re still a very poor country. We have to remember that. A lot of the things that we’re producing, the typical Chinese household cannot yet afford. I don’t think it’s fair to say they’re not a consumer society. It’s just that what they can consume is pretty cheap stuff. Per capita income for them is still very low.
"I also think people get carried away with this notion that labor’s so cheap in China that pretty soon they’re going to be producing everything for everybody. If you just step back for a second and remember, this is a country of people who still, on average, have a very low standard of living. The notion that they’re able to produce enough to meet all of their needs and our needs is preposterous. They can’t do that. If they could do that, they’d be rich. And they’re not. They’ll continue to move up the value chain in production. And they have been. They’re producing more and more sophisticated things and getting richer and richer, and as they do that, their consumers will be able to buy more and better things. Eventually, they’ll be able to buy more at some point, but that’s going to take a while."
SBT: Let’s discuss the U.S. interest rate climate. By any assessment, the prevailing notion is that it’s not a question of if the Federal Reserve Bank will raise interest rates in 2005, but rather a question of how many times it will raise rates and how quickly it will raise rates. Is that perception correct?
Knetter: "I think that’s right, because the balance of risks, with the weaker dollar, is moving toward inflation as a bigger risk than unemployment. The Fed doesn’t need to stimulate the demand side so much with weaker credit. In fact, they need to be a little vigilant about inflation and over-stimulation and probably prevent the dollar from sliding too much, too fast. That means raising interest rates."
SBT: What about wages? They have been slow to grow in recent years, which is good from a human resources standpoint for businesses, but the downside is that it limits consumer buying power.
Knetter: "Wages is a very narrow measure of income in the economy. With wages, we’re talking about an hourly employee. And there are a lot of those. I think it’s true that wages are not likely to go up that much. Salaries probably will go up quite a bit. Yesterday, I read where the Ferrari dealerships are busier again because Wall Street is giving out big bonuses. So, salaried, white-collar employees – their compensation is continuing to rise, but blue collar compensation is under pressure. I think both of those are manifestations of global competition. Worldwide, there’s a scarcity of white-collar workers and a surplus of blue-collar workers. There are a lot of substitutes for our blue-collar workers, and their wages are under pressure."
SBT: Does that imply a shrinkage or a shifting of the middle class in the United States?
Knetter: "Yes, if you think of the middle class as blue-collar. But I think there is a white-collar version of the middle class now, too. There’s a little bit of a barbelling going on in the income distribution, where there’s a bigger chunk of people making pretty higher levels of income than we used to have, and at the lower end, blue-collar work isn’t being rewarded at the same rate. Education levels are an incredibly important driver of where people fall on the income distribution. Twenty years ago, people with a high school degree, if you could get a job in an auto plant, you could make a lot of money. That’s not an option anymore. So, today, education really is the name of the game."
SBT: The one exception to that seems to be in the skilled trades. Plumbers and electricians in their 50s and 60s are working overtime, and people in those kinds of industries tell me that they don’t see the next generation coming up behind them to meet the demand for those services, even though they pay very well.
Knetter: "They’re doing pretty well. But you know what’s going to happen, right? It’s going to get more and more expensive to get somebody to do that type of work, and that will draw more people into it. It’s just people responding to market prices. There will be electricians. They may be more expensive for a while, but that will increase the supply of electricians."
SBT: I guess we’re seeing the same thing happening in the health care industry. Small Business Times recently ran a cover story about people who are waiting two or three years just to get into training programs for careers in health care, because those good-paying jobs are so much in demand.
Knetter: "Right. And that’s how it will happen. A little bit herky jerky, and you will have shortages for a while, but it will sort itself out."
SBT: Supply and demand, I guess.
Knetter: "Exactly. The key is making sure you’ve got the educational system capacity to deal with it."
SBT: What do you see the unemployment rate doing in 2005?
Knetter: "I think it will be down, maybe by a half of a percentage point."
SBT: With the rising interest rates, is now the last chance for homeowners with adjustable rate mortgages to lock in fixed rate mortgages?
Knetter: "Well, (laughs) the last thing an economist ever wants to do is be an interest rate forecaster. I don’t consider myself one of those. Let’s just say, I’m glad I locked in when I did."
SBT: Looking at some things with a tighter focus, what industry sectors are poised for growth in 2005?
Knetter: "I would look for anything where American companies are competing in a global marketplace. So, manufactured goods, for sure. I think the weakness of the dollar is going to help firms that have most of their costs based in U.S. dollars. It’s going to make them more competitive.
"I think we’re still charging out ahead when it comes to information technology and its use in the workplace. I would expect companies in that will continue to do well, and their products will become more affordable in the foreign workplace. That’s another sector I would expect to do well."
SBT: What about the war in Iraq?
Knetter: "Economically, oil is a big wildcard that has a pretty big effect on the world economy. And I think how the U.S. is perceived by other countries and how much we have to spend on this mission in Iraq, those are the other big things in play here.
"The one thing you mentioned at the beginning in the litany of bad things about the U.S. economy that really needs to be addressed is our fiscal policy. We have a pretty large deficit right now, and we’re not showing any indication that we’re willing to raise taxes to pay for big increases in defense spending that we’re incurring to fight this war in Iraq.
"You have our government in there running these huge deficits every year and promising people these future Social Security payments that I don’t believe, under current policy, we’re going to meet. That’s a problem that we need to start facing up to. That, to me is a big risk. The war in Iraq poses big risks to oil prices and to our national reputation."
SBT: President George W. Bush’s economic agenda has been to cut taxes to stimulate the economy and increase the revenues coming into the federal government. That isn’t happening, at least not yet, is it? Is that because the war in Iraq has consumed or exceeded whatever additional revenue that has been generated?
Knetter: "Well, I just don’t think that the tax rates were that high. I just think that rates were moderate enough to begin with, that we weren’t likely to get a big effect from that change. I think when (former President Ronald) Reagan did it, marginal tax rates were a lot higher. A lot of people were at over a 50 percent tax rate. The fiscal deficit is something I am quite concerned about."
SBT: Turning to our own backyard. You mentioned that U.S. manufacturers competing in the global marketplace are poised to do better in 2005. That would certainly bode well for Wisconsin.
Knetter: "Well, I should add to that. Agriculture. Very tradable. Getting to our backyard, I would say Wisconsin is a state that is poised to do pretty well because of the weaker dollar. A lot of our agricultural markets should benefit because of that."
SBT: In listening to you, I think people might find it strange that two real strengths in Wisconsin’s economy in 2005 will be manufacturing and farming. Who would’ve thunk it?
Knetter: "I just think that because they’re highly tradable, the week dollar positions them well for 2005. While they’ve been beat up pretty bad in the last five or 10 years, I actually think they’ll do quite well. Foreign cheeses are going to get very expensive."
SBT: With the falling U.S. dollar and the drops in prices to buy U.S. goods, is that likely to take some of the steam out of the march to outsource jobs overseas?
Knetter: "Absolutely. You know, it makes it more costly to pay the foreign workers, because the dollar doesn’t buy as many units of the foreign currency as it used to. That’s going to reduce the incentive to outsource."
January 21, 2005, Small Business Times, Milwaukee, WI