Europe's Dour Outlook

By Frederick Painton

A year of convalescence with a mild recovery beginning in the summer

For the third time in a row, Western Europe is entering the new year in recession. While there is a prospect of economic recovery beginning in the latter half of 1982, the long-awaited upswing is likely to be highly vulnerable. It could be snuffed out, for example, by a renewed surge of interest rates in the U.S., another bout of currency gyrations or the surrender by hard-pressed governments to mounting pressures for trade protection. Moreover, a sustained pickup is threatened by the increasingly divergent economic performances and policies of the members of the European Community.

That is the rather dour outlook of the six members of TIME'S European Board of Economists at a year-end meeting held in Rome. The group's concerns about the state of business were compounded by doubts that political leaders will persevere with unpopular, anti-inflationary policies at a time of serious unemployment. For the first time in postwar history, the jobless rate in Western Europe (9%) exceeds that in the U.S. (7.75%). Nonetheless, the TIME economists saw little alternative to continuing current austere policies. Said Herbert Giersch, director of the University of Kiel's Institute for World Economics: "It has taken us ten years to get into this mess, and it will take us that long to repair the damage done by Keynesian remedies in the past."

Despite these worries, Hans Mast, a University of Zurich lecturer and executive vice president for Credit Suisse, saw reason for some optimism. Inflation is slackening almost everywhere, he noted, and towering interest rates have started to come down. This should encourage companies to borrow more in order to build up their low inventories, which would stimulate production. Said Banker Mast: "We are not suffering from a shortage of money to lend. Much of the money we send to the oil producers comes back to the West in the form of bank deposits, and is available on the international market."

Mast and others warned that the health of European business will depend to a large degree upon what happens to the U.S. economy and the Reagan Administration's program of large budget cuts, tight money and major tax reductions. American experts generally believe that the U.S. will remain in recession for the first half of 1982 and then grow at about a 4% annual rate during the second half. "I hope the Reagan gamble will come off," said Mast. He added that if it fails, the world could move into a "stop-go" economic situation that would probably make both inflation and unemployment worse.

The Europeans will be anxiously watching the preparations for this year's American congressional elections for any signs of a shift in economic policy toward less strict monetary controls or a less serious battle against budget deficits. Such a change would affect not only the U.S. but the whole world economy.

Samuel Brittan, assistant editor of London's Financial Times, pointed out that a "new world dollar standard" was already emerging under which governments outside the U.S. increasingly determine their fiscal and monetary policies in order to coordinate them with those coming out of Washington. The unintended result, he said, was that governments everywhere have "passed the buck" to the American Federal Reserve Board to pursue noninflationary policies, while they try to stabilize the movement of their currencies against the dollar.

A rundown on the board's view of the outlook in the four largest nations of the European Community:

West Germany. The prospects for expansion in the Continent's most important economy are poor. While the Bonn government assumes that the gross national product will grow at 1% or even 1.5% in 1982, Giersch predicted an increase of only .5%, with most of that coming in the latter half of the year. During 1981, the West German economy declined by 1%. Unemployment, meanwhile, may rise from its present level of 5.5% to 7% in the course of 1982. On the other hand, Giersch foresaw inflation, which was 6.3% last year, dipping to an astonishingly low 3% in 1982.

The German economist said that growth this year will be held back in part by continued steep interest rates. Even though the cost of money is falling, it will remain relatively high and hinder investment. Giersch is also worried about new labor-union demands for close to 7% wage increases, fearing that these would force firms to cancel or postpone spending plans. Said Giersch: "The wage bargaining in the early spring will be a severe test for West Germany." The number of bankruptcies is already climbing dramatically as a result of a squeeze on profits, and some firms may refuse to accept high settlements and thus challenge the West German system of industry-wide wage bargaining.

France. While admitting that there are great uncertainties because of the Socialist experiment and major nationalizations launched by President Franc,ois Mitterrand, Jean-Marie Chevalier, professor of economics at the University of Paris Nord, was generally upbeat about his country's prospects in 1982. He predicted an increase of 2.5% in G.N.P., up from a mere .5% past year. Inflation, he felt, could be held at 13.5%, a slight drop from the 14% of the past twelve months. Chevalier predicted that France would be the only country in Europe where unemployment would be falling, dropping marginally from 8% to 7.9% of the work force.

To make this achievement possible, the French economist said, the government would be pushing public housing construction, increasing expenditure on research, enlarging subsidies to industries, and redistributing wealth toward lower-income groups by expanded social spending. This would mean larger budget deficits, but Chevalier believes that the government can stop a worse outburst of inflation by industry-wide agreements to limit wage increases and prices.

One major uncertainty that Chevalier foresees is how French exports will perform against competition from the U.S. and West Germany. He believes that the relatively high inflation rate resulting from the expansionary program of the Socialists will make French firms less competitive. Inevitably, he said, the Paris government will take indirect measures like subsidized credit to help domestic producers. Chevalier's other worry is that business leaders, fearful about the Socialist policies, will continue to hold back on new investments and thus slow growth.

Italy. The Italian economy has the most clouded outlook of the major countries in Western Europe. Officially, the G.N.P. is expected to expand by 2% in 1982, as compared with no growth in 1981. But Guido Carli, former governor of the Bank of Italy, pointed out that such a prognosis was based on several dubious assumptions. The first was that the inflation rate would slow from 18% in 1981 to 12% in 1982. The second was that the government could succeed in paring down the monumental 50 trillion lire ($41.3 billion) budget deficit.

Carli was not encouraged by Italy's flourishing underground economy, which some observers regard as a sign of the country's entrepreneurial vigor. Said he: "I do not believe that the orderly development of a society or an economy can go on forever when the so-called moonlighting sector expands faster than the economy as a whole. At some point, the control of society gets out of hand."

Carli assumes that the dramatically divergent inflation rates within the European Community will lead to another series of currency adjustments reflecting the growing strength of the deutsche mark against the French franc and Italian lira. Without such changes, he predicted that increased, if hidden, trade protectionism would be inevitable.

Britain. Samuel Brittan forecast somewhat better times ahead for his country's troubled economy. He predicted a 2% increase in G.N.P., a full percentage point more than the official projection. He pointed out that the recession in Britain has been more severe than in other countries, with manufacturing production down 20%. But he added: "My hunch is that since the U.K. was first into the slump, it will be first out."

There are already signs that British companies are no longer running down their inventories. Growth will be stronger once they start restocking their shelves. Brittan expects that the recovery will be led by construction, autos and other industries that are sensitive to interest-rate levels once the cost of borrowing begins declining from the current 15.5%.

Brittan was also more cheerful than the London government on the outlook for inflation. The official view is that the rate of price increases will slow from 11.5% to 10% during the year, but Brittan anticipated a drop to 9%. He predicts, though, that unemployment will climb from 11% of the work force to 12.5%, with the prospect of a leveling out or dip only sometime in 1983.

While the recovery could be relatively strong, it may pose a policy problem. Said Brittan: "In the past, governments have often made their famous U turns and started to pump purchasing power into the economy just when everybody had given up hope of anything but continuously rising unemployment and falling industrial output. The risks of a return toward more inflationary policies are great."

Although the economic policies that have become known as Thatcherism and Reaganomics are now running into political difficulties in Britain and the U.S., the board members were generally sympathetic toward this type of restrictive program. The panelists said that one of the major problems faced by both governments is that the policies were oversold. Said Brittan: "What went wrong was the claim that there were going to be extremely rapid results as soon as the policies of less government intervention in the economy were installed. Neither Ronald Reagan nor Margaret Thatcher could admit that governments cannot reverse long-term historical trends overnight."

Jean-Marie Chevalier was the only member of TIME'S board who favored traditional Keynesian policies of spurring demand, even at the risk of inflation, in order to stem the unemployment plague. This is the program that has been adopted by Mitterrand in France. Said Chevalier: "The French government thinks that its people have a right to work even if we have to pay a price for that in competitive terms in world trade." One benefit, according to Chevalier, is that the Socialists now can count on labor's support. He claimed that restive trade-union leaders in West Germany are demanding that Bonn follow the French example and create 1 million new jobs. The Frenchman argued that a certain amount of government intervention is necessary to attain long-term goals, such as the restructuring of ailing industries.

In addition to their concerns about the sluggish West European economy, several members of the TIME board were worried about increased protectionism in world trade. Jan Tumlir, head of the economic section for the General Agreement on Tariffs and Trade in Geneva, warned that new forms of trade barriers are being established for both industrial products and raw materials. Said he: "With the exception of tropical products, some sporting goods and a few minor manufactured items, all the major areas of international trade--agriculture, steel, textiles, synthetic fibers and other petrochemical products--are already under cartel systems. The situation is politically dangerous because it is bound to increase tensions between countries." Next week top-level representatives of the U.S., the European Community, Japan and Canada will meet in Florida to discuss growing international-trade problems.

Guido Carli found that the temptation to erect trade barriers was at the heart of "the major crisis of the European Community, which is a crisis of political leadership." He argued that the debate over the Community's budget, which has virtually paralyzed it for three years, was "irrelevant" when compared with the trade issue. He said that all the member nations are "behaving contrary to the logic of the Community" by reverting to nationalist, mercantilist policies. Carli described the members as divided into two camps: the protectionists and the free traders. The protectionists include France and Britain, while the free traders are West Germany and, to a lesser extent, Italy, The Netherlands and Belgium.

Another period of little or no growth during the coming year will put severe pressure on Western European governments. There will be loud and persistent cries to forget about inflation and stimulate growth or to protect local jobs by halting the import of foreign goods. But European history, especially that of the years between the two World Wars, shows that such action would produce pyrrhic victories at best, and is more likely to aggravate current problems. Governments this year will have to show that they now have the political vision and leadership to see beyond narrow national interests in a time of adversity.

--By Frederick Painton

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