Business Under Reagan II

The economic turbulence of the last 15 years has increased the premium on successfully planning ahead. On the other hand, the record of most forecasters has been inconsistent at best, and for most it has been poor. Forecasting has failed exactly where it is needed most--in anticipating changes or trend breaks. It works best when it is needed least; where changes are smooth or familiar cycles repeat.

Unless one believes that forecasting techniques are somehow regressing, or that forecasters are not as smart as they used to be, one must at least entertain the notion that forecasting itself is suspect in turbulent times. There are many important uncertainties, none of the forecasters has been endowed with a crystal ball, and the resulting forecasts disguise rather than illuminate the critical uncertainties. Facing such circumstances, Royal Dutch/Shell has scrapped the notion of forecasting in favor of scenarios as a basis for evaluating the future. And unlike most other large firms which tried scenario planning, Shell has made it work successfully. I would like to borrow from their scheme to consider the prospects for the second term of the Reagan Administration.

The Shell scenarios are built from an analysis of "forces driving the system" plus "critical uncertainties." In the present context some of the major forces driving the system, and hence common to all scenarios, would seem to include moderate economic growth (no return to the rapid growth of the 1960's), a continuation of moderate oil prices ($15 to $30 per barrel over the period), increasing economic power for Japan and the gang of four, based on continued success as exporters of manufactures, and continuing slow growth and rising unemployment in most of Western Europe. It would also include the prospect of continuing deterioration of economic performance in most of Africa, and of slow growth in Latin America, as these countries maintain their anti-competitive policies such as overvalued exchange rates and low to negative domestic interest rates.

In this context the U.S. can hardly count upon its NATO allies to do "more"; they may indeed decide to do less, and U.S. pressure on them could well be counterproductive. Pressure on our defense budget will remain high. For domestic political reasons to maintain the entitlements programs also remain high.

On the other hand, recent success monetary policy in reducing inflation suggest that a return to the easy money of the 1970's is unlikely. The outcome of the budget debate will thus have a very strong impact on interest rates, the value of the dollar, and U.S. competitiveness. It will not be the only in-fluency, however. Passage of tax reform legislation could also have a major bearing on competitiveness. At present U.S. tax policy favors sheltered domestic industries, notably housing, shopping centers and office buildings at the expense of other areas, notably manufacturing. The Treasury's tax reform proposals would dramatically reshape this situation. Passage of budget reform would seem to increase the odds for tax reform, a possible "double or nothing" situation.

Budget cuts may also force substantial changes on the welfare programs, particularly though cutbacks in foods stamps and other means tested programs. Charles Murray's recent book Losing Ground points out what a disaster those programs have been in terms of decreasing labor force participation among low income families, declining school attendance, family break-ups, etc. The bottom line, as he notes, is that poverty stopped declining as the programs went into effect, and a new dependent underclass has been unintentionally nurtured. However, budget cuts in this area would seem to require a greater role for the private sector in providing jobs, perhaps subsidized by government. Unless the business community gets involved, and recognizes that a reduced role for government requires an expanded commitment from the private sector, this type of change is not likely to be sustained--if enacted.

Combining these uncertainties we can sketch two crude scenarios for the U.S. for the next four years. One might be called "an outward looking, competitive U.S." while the next four years. One might be called "an outward In the former, a historic budget compromise brings the deficit to about one percent of GNP by 1988; is followed by major tax reform similar to that proposed by Treasury and Bradley Gephart, coupled with a realignment of roles of the public and private sectors in dealing with the working poor. Savings rates could be expected to rise sharply, interest rates to return to historic levels, manufacturing investment to rebound, and the trade deficit to diminish dramatically over the period and rising investment plus a declining dollar--reestablishing U.S. competitiveness once again.

On the other hand, it is not difficult to envision a stalemated U.S. where deficits persist, interest rates remain high, the dollar remains high and manufacturing investment low. Productivity gains will remain low, imports will remain high, growth will remain low, unemployment will range from to 10 percent, and unemployment will be a battleground where competing interests fight for a bigger share of a pie which grows very slowly, and in so doing they will prevent enactment of some of the policy changes needed to get the pie (GNP) growing again.

If these scenarios somehow represent reasonable boundary cases, the future might well lie somewhere between. An outward looking, competitive America obviously will be in a much better position to lead an alliance; likewise it will be in a better position to respond to unexpected external shocks.

At this stage, a Las Vegas gambler with a high technology crystal ball and the latest software might be forgiven for giving about 2 to I odds in favor of the stalemate scenario. But then, a Wall Street analyst convinced that the market was due to rise all but one year the superbow I has correctly foretold the course of the market for the year.

So much for the year.

Bruce Scott is Paul Whiton Cherington Professor Professor of Business Administration at the Harvard Law School.