(FORTUNE Magazine) – WHO WILL LEAD the way, business or the consumer? Each spurs the other, of course -- that's how it goes in the circular world of economics. But look to business to start the recovery rolling, not the upsurge of consumer confidence that many economists count on. Though a quick end to the war could send spirits soaring and touch off a brief buying spree, people can't live on good feelings. Even swelling optimism would not mean much until incomes start to climb again. When the process starts, though, don't expect the kind of robust rebound typical of the past. Because this recession will have been mild and shallow, the recovery will be more subdued than most. And consumers, besides suffering some temporary body blows, may well be in the early stages of a sea change in their spending patterns. Demographers and other experts who plumb the consumer psyche see signs that war and recession have accelerated a nascent trend toward prudence. It will take only a small shift in the final demand for goods to set the recovery in motion (see inventory chart). FORTUNE expects the change to show in the next quarter. Real GNP will grow at nearly a 3% rate late this year and early next -- about average for the Nineties, we predict. This recession began when business, already in a troubled mood, swiftly cut employment and production in response to the invasion of Kuwait, the surge in oil prices, and souring consumer confidence. The result was a rapid drawdown of inventories, which were already lean. In past recessions, by contrast, inventory typically piled up rapidly as economic activity slowed, forcing deep bouts of liquidation. This recovery will begin just as quickly. Business will not be adding to inventories over the next few months -- but it won't have to. Simply slowing the rate of liquidation will lift production, bringing an end to the cutbacks in employment that have depressed incomes. In the fourth quarter, business reduced inventory at a $20 billion annual rate (in 1982 dollars). Based on early numbers for sales and production, that rate may have accelerated to $30 billion this quarter. In FORTUNE's most recent quarterly survey of 180 top financial officers on their inventory plans, businesses reported that on average they would like 3% less inventory relative to sales than they had at the end of 1990. But they expect sales to rise better than 3% over the coming four quarters. This suggests that the continued cutting is a precaution in case sales don't pick up as anticipated. But as sales level out and in some cases improve -- thanks in part to stronger exports -- business will slow the liquidation. The turn will probably come very soon. FORTUNE augmented its recent survey by talking with 20 major CEOs, and many were poised to swing. Says William O. Bourke of Reynolds Metals: ''With inventories lean in our company, in our industry, and, I think, in most industries, the recovery will begin rather quickly.'' Frank Greenberg of Burlington Industries agrees that inventories are very low and adds, ''Apparel sales are better today than they were at the end of the year.'' John F. Woodhouse of Sysco reports that his food wholesaling business slipped immediately after hostilities, but ''now it's coming back to where one would expect it to be.'' If steadiness in sales prompts business to cut liquidation in half next quarter -- a typical cyclical response -- that alone would add 1.5 percentage points to the growth rate of GNP and wipe out most of the decline in the first quarter. Exports and housing will provide critical momentum. Despite slowing growth among many trading partners of the U.S., the weak dollar will help lift exports at a brisk clip. The dollar will also trim imports, spurring output of competing domestic goods. In the housing market, a plethora of unrented apartments will remain for several years. But single-family starts will probably head up again in the next two or three months. Mortgage rates, down nearly a percentage point since October, have made new houses significantly more affordable. Anecdotal evidence suggests that home buying just might be reviving already. Shortly after the war started, real estate agents around the country were surprised by a surge of browsers and buyers, reports Glenn Crellin, research director of the National Association of Realtors. He says members in some markets are convinced they have turned the corner. Capital spending will not provide any immediate lift for the economy -- but as long as business does not slash such spending sharply, neither will it undercut the revival in other sectors. Most orders for new equipment have slipped since last winter -- the major exceptions were aircraft and power- generating turbines -- but the declines were small. Contracts for commercial construction are showing signs of leveling out, and those for manufacturing buildings have edged up. Some of the CEOs FORTUNE surveyed are indeed trimming capital spending, $ notably those with high debt or battered profits. But few are cutting much. Many, looking well beyond the recession, are holding outlays steady. Says William W. Goessel of Harnischfeger Industries, a manufacturer of papermaking and mining equipment: ''We plan to continue the very aggressive capital spending we've had the last three years.'' Adds Richard J. Mahoney of Monsanto: ''We are following a long-term strategy. We haven't slowed down our capital and R&D programs appreciably.'' Even beleaguered Detroit continues to invest heavily. Says William Fife of machine-tool maker Giddings & Lewis: ''We've seen quite a lot of activity in Ford and GM.'' ONE THING that won't do much for the recovery is government spending. There seems little chance that the federal budget will turn stimulative, especially if the war ends in less than the three months or so most experts have been expecting. Replacement of ordnance will not provide enough firepower this year or next to offset last fall's budget discipline. If matters go according to the Administration's budget proposal, the government will reduce its net largess to the public by $25 billion to $30 billion over the next two fiscal years, equivalent to half a percent of GNP. These numbers are calculated from the so-called cyclically adjusted budget that economists use to judge the economic impact of fiscal policy. This budget is free of such effects as the tax revenues lost during a recession. In a major change from the past, restrictions enacted last fall will keep Congress from jacking up total spending or lowering taxes without making up the difference elsewhere. So the President's budget overall seems a reasonable approximation of what will happen in fiscal 1991 and 1992. Revenues don't seem out of line with FORTUNE's estimates, and even a longer or deeper recession than we expect would not affect the budget's basic drag on the economy. The notion of a restrictive budget might seem to fly in the face of the official deficit numbers, which rise from $220 billion in fiscal 1990 to $318 billion in 1991 and $281 billion in 1992. But these are misleading, reflecting in part the difference between the official budget and the cyclically adjusted version. Along with the revenues lost to the recession, they include $55 billion of extra borrowing for the S&L bailout in 1991 and $30 billion in 1992. Most economists exclude that money when analyzing the effects of the budget because it doesn't add to the income of those receiving it -- all along they assumed their deposits were guaranteed. And the government's borrowing should have little impact on interest rates, because the money returned to depositors will likely be reinvested immediately. The Federal Reserve has done about all it's going to do. Over the past two years short-term interest rates have fallen three percentage points -- a bit more than they ordinarily do in a recession. And bond yields have dipped a point, about as much as usual. January's poor retail sales and industrial production numbers may be echoed in February, leading to some further small declines in rates in the next few weeks. Though the lower rates have had little noticeable effect so far, look for them to start helping in the near future. Consumers will begin contributing as incomes rise again this spring. Confidence plunged further and faster after Iraq's invasion of Kuwait than it did even in the severe 1981-82 recession. Recently it was near its lowest reading on record (see confidence chart). After the shooting started, sales at many businesses stopped cold. Says Avon Products CEO James Preston: ''It was like somebody just all of a sudden turned the lights off.'' Nationally, retail sales in January dropped a sharp 0.9%. Though consumer confidence surveys have been providing mixed signals about where such sentiment is heading, the end of the war could lift it swiftly. But even if the conflict drags on, such experts as Richard Curtin, who directs the University of Michigan surveys, think confidence has already bottomed out. Survey respondents are encouraged because interest rates have fallen and inflation seems under control. It would take an unexpectedly severe setback to knock confidence down again. Fabian Linden, director of the Conference Board confidence surveys, draws similar conclusions and adds that the effects of the war tend to overstate the cautious mood of the consumer. The survey predictions are best when people respond to their own economic situation -- primarily, the outlook for employment and inflation. Based on how consumers regard these, says Linden, ''they are going through a slightly difficult economic moment, not a profound trauma.'' Companies anticipate a spurt in demand once war worries are allayed. ''You'll see a tremendous rush of people who've put off travel plans,'' says Michael Ribero, senior vice president of marketing at Hilton Hotels. Tandy Corp. marketing vice president Lowell Duncan foresees a ''short-term upsurge'' in Radio Shack sales, and Avon's Preston anticipates a ''good buying spree'' if the war is short. But -- and this may be the big news -- no extended spree seems in store once the nation gets beyond the valley of war and recession and the peak of satisfying pent-up demand. Most experts on consumer behavior expect that in the decade ahead people will be more frugal than they were in the 1980s. The shocks have not started any new trends, but they have coincided with -- and perhaps hastened -- several important ones: -- The search for the right price. The slump has ''knocked some sense'' into people who were overspending and overleveraged, says Linda Morris, a retail analyst at PNC Financial Corp. in Philadelphia. Once the cycle is over, she predicts, they will be more conservative than before. Avon's Preston glimpses this consumer of the future in today's price-sensitive shopper, who waits till the last minute to make a decision. Bargain hunting is intensifying as many people adjust to the fact that their real incomes have gone nowhere during the past year. A key change in consumer psychology, says Michigan's Curtin, is the curtailment of inflationary expectations. In the 1970s companies could easily raise prices because consumers didn't resist -- in fact, people often bought sooner rather than later to beat further price hikes. During the Eighties the old fears faded. Instead, consumers got in the habit of waiting for automakers to offer rebates or airlines to push new discount fares. Even the surge in oil prices after Kuwait's mauling didn't raise long-term inflation fears, according to the Michigan research. The message: Consumers in coming years will continue to wait for the best prices before buying and thus will continue to put pressure on sellers' profit margins. -- The death of conspicuous consumption. Late in the 1980s the exuberance that marked the recovery from the last recession began to evaporate, says Madelyn Hochstein, president of DYG Inc., a marketing and social research firm in Elmsford, New York. Her surveys showed that as income growth slowed, many parents started worrying that their kids would not do as well as the older generation. The October 1987 stock market crash flashed an early signal that all was not well. Now, says Hochstein, ''we have megasignals,'' such as the S& L crisis and extensive layoffs, that economic security can no longer be taken for granted. Hochstein finds that even the supposedly wealthy beneficiaries of the Reagan years no longer feel well-off. Most people in the top fifth of income earners worry about the security of their middle-management jobs, increasingly at risk in companies trying to reduce overhead. Even if they feel safe, they are anxious about their house payments and the ever-escalating cost of their kids' college education. Hochstein calls them the ''phantom affluent.'' On paper they may have the income to spend freely, but they will remain cautious nonetheless. This ''erosion of the psychology of affluence,'' as Hochstein calls it, means the putative rich will eat out less, vacation closer to home, and buy fewer clothes. But because they scale down their quantitative demand, they will insist on quality and pay a premium for performance and durability. The flip side of this prediction is that conspicuous consumption will fall. Consumers are paying less heed to fashion and more to health and safety, says Edgar Wachenheim III, chairman of Greenhaven Associates, a New York City money management firm (he's structured his portfolio accordingly). Those who've got it may also not want to flaunt it. Who needs dirty looks from folks who feel the Eighties left them behind -- or more soak-the-rich legislation from Congress? PNC's Morris believes that the lust to measure success by paycheck size will decline. Baby-boomers moving into the thick of their family- formation years will overcome the urge to work 70 hours a week and focus instead on family and other quality-of-life pursuits.

-- The baby-bust bust. While most marketers are scrutinizing the great army of baby-boomers, demographer Richard Hokenson of Donaldson Lufkin & Jenrette is raining on the parade by focusing on the baby busters. As fewer Americans turn 25, he says, fewer new households will be formed in the years ahead, trimming purchases of all the furniture, appliances, telephones, and other equipment that new households buy. This damper on consumer spending began in the late 1980s and is making the recession worse, Hokenson believes. Hard times typically depress household formation, but in past downturns the number of households still grew along with the population of young people. Now household growth is slowing -- indeed, when the numbers are in, the past year may mark the first annual decline this century. FORTUNE believes enough household formation will occur in the coming year to allow a modest recovery in new-home construction, but the demographics do mean fewer starts in this decade than in the past one. If the free-spending 1980s consumer is indeed dead, to be replaced by a more sober 1990s model, would the economy suffer? With consumption accounting for two-thirds of GNP, a slowdown would point to reduced growth. But less spending also means more saving -- funds for plant and equipment to boost productivity and international competitiveness. Thriving capital goods and export industries could then raise incomes enough to offset the chastened-shopper effect, allowing the economy to grow at a heartening pace. The discredited yuppie credo of the Eighties, ''you can have it all,'' would take on a new meaning in the Nineties: more consumption and more saving.

CHART: NOT AVAILABLE CREDIT: CHARTS BY LINDA ECKSTEIN CAPTION: CHANGES IN INVENTORIES LOTS OF LEVERAGE Just slowing the drawdown of inventory will require business to raise output. That will strengthen employment and lift incomes again.

CHART: NOT AVAILABLE CREDIT: CHARTS BY LINDA ECKSTEIN CAPTION: CONSUMER CONFIDENCE DOWN, NOT DESPERATE The plunge was scary, but experts say the war is exaggerating its import. They also think confidence has reached its bottom.