Economy Likely To Falter, Not Fall

Gail Fosler is executive vice president and chief economist of The Conference Board. The Wall Street Journal has twice named Fosler as America's most accurate economic forecaster, and her commentary is extensively reported in global media. A nonprofit, nonpartisan business organization, The Conference Board was founded nearly 100 years ago, and it produces widely watched economic gauges, such as the Consumer Confidence Index and Leading Economic Indicators.

In an interview with CRN Editorial Research Director John Roberts, Fosler said an economic slowdown is upcoming -- though not likely as big as some other economists have predicted -- and that businesses today are looking at IT spending as just one of a range of options for their investment dollars.

CRN: What's your forecast for economic growth over the next 12 months?

FOSLER: We are looking at a 1995-style [economic] slowdown, with growth slowing to about the 2 percent to 2.5 percent range.

CRN: So you don't foresee a full-blown recession?

FOSLER: That's right. But the critical factor here is the ability of what we think are some pretty overinflated financial markets -- largely outside the United States -- and commodity markets to find their natural level in an orderly fashion. The question is whether all of this going to adjust in an orderly fashion over the next couple of years, or are there going to be adjustments that create financial and/or credit risk.

CRN: What trends do you see for interest rates and inflation?

FOSLER: I think it's hard for the Federal Reserve to stop raising rates when oil prices are as high as they are. But if commodities come off their highs, then the Fed might stop. But as you know, there is a lot of commodity inflation, and with oil at $75 a barrel, how can the Fed stop raising interest rates?

CRN: How much of this pressure is coming from outside the U.S. -- from China and India, for example?

FOSLER: If you look at the press, they will say that China's demand for oil is up 15 percent in the first half of this year. That's true, but their demand for oil didn't rise in all of 2005. On the other hand, in 2004, their oil imports more than doubled. So if you look over all of the data, the trajectories that these countries were on in 2004 were simply not maintained in 2005 and 2006. So you can't blame commodity price inflation entirely on forces outside this country.

CRN: Aside from commodity markets, what other risks do you see for the U.S. economy, particularly the housing market?

FOSLER: The housing market is slowing, as everyone knows. But the interesting aspect here is that I don't see this having a major effect on consumers in the sense that a lot of people will have to sell their houses, creating a housing implosion. What is typically the case is that a decline in the housing market is a reflection of some underlying economic phenomenon. In 1987, the housing market in New York City was white hot but collapsed soon after. This was a reflection of the '87 stock market crash, which created a massive consolidation in the financial services sector. That sector, in turn, had been a source of tremendous employment growth in the city.

That said, I think so far the economy has been settling but not sinking. And as long as that continues, people will be able to adjust. There are some debt structures out there that are disturbing. People are taking terrible risks with adjustable rate mortgages, where you can get the sudden shock of big debt obligations. We should also be aware that a huge financial-services sector has grown up around the housing boom, and that is at risk as well. It's not just the home builders; it's the ancillary services, the mortgage services, the real estate service and the various types of debt services that also could suffer. We have to be mindful about that, because bank balance sheets are heavy with real estate assets.

CRN: The Conference Board's Consumer Confidence Index has remained so strong in the face of, for example, $3 a gallon for gasoline. How do you explain this strength?

FOSLER: The strength is fundamentally rooted in the job market. The index is made up of two subindexes: one where we ask households about the present situation, and the other where we ask about their expectations. The present-situation subindex has been largely driven by the job market, weakening in May and June and then steadying in July.

Expectations, in contrast, have been on a deteriorating trend for the past couple of years. Typically, in cyclical peaks, people say things are pretty good, and they can't get better. And that is when the expectations numbers give you a forward signal that things may not remain as good as they are today. In addition, the [Conference Board's] index of Leading Economic Indicators has moved into negative territory -- on a six-month rate-of-change basis -- for the first time in this current business cycle. This is not the end of the world, but it is a sign that the cycle is aging. These are some of the signals that help us gauge where we are in the business cycle.

CRN: So it's more a matter of the aging of a business cycle rather than a sharp economic downturn.

FOSLER: Right. And one of the big signals we are looking at is second-quarter corporate profits. This is another one these so-called long lead indicators about trends in the economy. Corporate profits have been just phenomenal, and it's hard to talk about a recession in that context.

CRN: How much of this corporate cash will go into new investment in business technology vs., for example, stock buybacks or acquisitions? And if consumer spending slows, can business technology investment pick up the slack?

FOSLER: Companies have been spending a lot of money on stock buybacks and acquisitions, but investment rates are not all that high. As to technology investment picking up the slack, I think that the answer is no. The world has been on what I would call a diversified investment boom -- unlike the 1990s, where investment was almost all in the technology sector. A lot of manufacturing investment has been going on globally, along with a lot of infrastructure investment. So you have a much more diversified investment environment, especially with what has been happening in China and India, and technology doesn't begin to have a claim on the investment dollar today that it did 10 years ago.

CRN: So technology is now one sector out of many that is competing for the business investment dollar, and that makes technology a tougher sell.

FOSLER: That's right.

CRN: In your speech at the Conference Board's Sustainability Forum in January, you said knowledge is a "unique forum for the divide between advanced and emerging markets," and in China and India, for example, the idea that knowledge could be a "private" good is incomprehensible, given the cultural histories of these countries. That's very interesting in light of the growing concerns about intellectual property protection. Can this divide be overcome so that these countries take the idea of intellectual property protection more seriously?

FOSLER: Only with difficulty. We are co-organizing a major conference in China with the National Bureau of Statistics on innovation. We're going to do an innovation survey of Chinese companies, and we may learn a lot about their attitudes about intellectual property. But we have been coming at these things from very different value structures and, up to now, we have been able to ignore this. However, with all the multinational investment and globalization going on, we are eventually going to have to sit down and say, 'Maybe there is some value to these differences. Maybe we should do things a little your way.' We have to be respectful and get down below the how and into the what.

Complicating matters is the fact that some companies view intellectual property as "closed" and some view it as "open." On the one hand, you have strong intellectual property advocates like Microsoft. But on the other hand, you have other companies like Philips that think the transfer of technology is so ubiquitous in the ability to design that rather than spending a lot of time trying to protect innovation, we are just going to try to out-innovate, out-brand and out-market our competition. So things like the know-how, the marketing and all the rest become a part of the debate as to how important intellectual property is.