Several challenges still lie ahead. First, the economy is showing signs that it may be nearing full resource utilization. The unemployment rate has dropped below 6 percent and the growth rate of the labor force is slowing to 1 to 1.5 percent, from 2 to 3 percent during the 1970's. Competition for labor could therefore start an acceleration in pay growth.

Second, capacity utilization rates in nondurable goods industries, such as chemicals and paper, are at record high levels while Government estimates of surplus capacity in the durable goods sector are probably overstated because of factory closings and lower manufacturing investment during the early 1980's.

The sharp appreciation of the dollar exchange rate during Donald Regan's stewardship as Treasury Secretary severely damaged the competitive position of American industry and caused the growth rate of the country's manufacturing capital stock to turn negative for the first time since World War II. It is true that total investment rose, but a large share of the spending was for tax shelter-driven construction of office buildings, shopping centers and hotels that add little to productivity.

If the economy is too close to full resource utilization, further rapid contraction of the trade deficit could start a resurgence of inflation unless there is sufficient slack in domestic spending to offset it. The risk of resurgent inflation is apparent from examining the supply-side components of economic growth.

Once an economy achieves full resource utilization rate, its potential noninflationary growth rate is equal to labor force expansion plus productivity gains. By that formula, the economy's potential noninflationary growth rate appears to be 2.5 percent. If one assumes that the trade balance must improve at a rate equal to 1.0 percent of G.N.P. during each of the next four years to produce a trade surplus for servicing the country's large external debt by 1992, domestic spending will be able to expand at only 1.5 percent annual rate or zero in per-capita terms.