Play It Another Way, Sam

By Frederick Painton

TIME's European economists see growth ahead but worry about U.S. policy

It can hardly be called a boom, but Western Europe's recovery, still somewhat tentative only six months ago, is now taking root and slowly spreading. Healthy profits in many industries are turning out to be the best possible antidote to the fashionable Europessimism that only a few months ago considered the Continent to be in an irreversible economic decline. With the upswing has come a return of business confidence, at least for the next 18 months. Beyond that period, though, the outlook is clouded by the unpredictable course of the surging U.S. economy, because high interest rates plus towering budget and trade deficits make the American expansion appear unsustainable. So instead of relaxing and enjoying the pickup, Europeans are now fearful about a new U.S. downturn and its impact on both themselves and the Third World debtor nations, whose inability or unwillingness to repay loans could bring on an international financial crisis.

That was the assessment of TIME's European Board of Economists, which held its twice-yearly meeting last week in the Italian resort town of Cernobbio, outside Milan. Said Hans Mast, a University of Zurich lecturer and Executive Vice President of Credit Suisse: "Europe's substantial pickup seems to believe recent theories about the inevitable stagnation of the old Continent in contrast with the youthful vigor of the U.S. and Japan. We still seem to possess talents for aggressiveness and innovation in world markets."

Mast predicted an average growth of 3% for Western Europe both this year and next. Said he: "When the expansion in the U.S. economy slows down in the foreseeable future, Europe and Japan are likely to take on more importance as the sustaining force in the world economy." Moreover, European growth is taking place at the same time that the average inflation rate has fallen from 7.1% in 1983 to 5.5% this year. While the recovery was at first pushed forward by private consumption and housing starts, it is currently being driven by exports and private investment.

In just the past six months, Western Europe's foreign trade has expanded by more than 10%, led chiefly by exports to the U.S. Rising profits have helped spur outlays for new plant and equipment, which are expected to grow by 4.4% this year and 5.7% in 1985, according to European Community calculations. Six months ago, Britain led the recovery, followed by West Germany. But now other countries are joining the trend--The Netherlands, Sweden and Switzerland. Even France and Italy, which stayed in recession longest, are showing symptoms of growth.

Despite the spreading upswing, however, Western Europe continues to suffer from high unemployment. The jobless rate is expected to remain at 10% in 1984 and decline next year by a mere half a percentage point. Michael Emerson, Chief Forecaster for the Commission of the European Communities and a guest at last week's meeting, noted that Europe's "non-performance" in creating new jobs was becoming dramatic. Emerson said that the rigidity of the European labor market, where unions are strong enough to make layoffs extremely difficult, have raised real wage costs over the past ten years.

The answer to the unemployment problem is business-labor cooperation to create more flexible and lower real wages that will get people back into a changing job market. But that does not seem to be happening. In fact tensions between the two groups are running high in some places. Britain's violence-ridden coal strike is dragging into its fourth month. West Germany's seven-week metalworkers' strike, which ended earlier this month, was one of the country's most disruptive postwar labor disputes.

As both Mast and Emerson see it, the European pickup rests on a more healthy monetary and financial base than does the stronger U.S. boom. Mast pointed out that the major West European countries, with the notable exception of Italy, are running relatively modest budget deficits of about 3% of gross national product, in contrast with 5% in the U.S. The ten nations of the European Community this year will mark a historical turning point: for the first time in more than two decades, government spending is expected to grow more slowly than the economy as a whole. Said Emerson: "This is no mean feat. It is rather like turning the course of one of the world's strongest-flowing rivers." Moreover, all four major economies can boast strong and improving trade surpluses, compared with the U.S. trade deficit of $130 billion for 1984.

Surveying the Community's four major economies, the board found solid reasons for upbeat forecasts, if the U.S. economy does not derail the recovery:

WEST GERMANY. Herbert Giersch, Director of the University of Kiel's Institute for World Economics, said the year began with such an upswing that he thought the country might have 3% growth. The long metalworkers' strike, though, has forced him to cut back his spring forecast from 2.5% to 2%. It is too soon, he said, to know how the strike's settlement--a 38.5-hour work week--will affect business confidence in the future, but he expects growth to hit a cruising speed of around 2% during the next year. Export performance will continue to propel the economy, while a restrictive monetary policy will keep inflation, now at an annual rate of 2%, from rising more than half a percentage point. Giersch worried, however, about what he called Bonn's reluctance to cut public spending for welfare payments and business subsidies.

BRITAIN. Even if the coal miners' strike continues to the end of September, the effect on British growth will probably be only around half a percentage point, according to Samuel Brittan, Assistant Editor of London's Financial Times. Coal output, which is down by 7%, accounts for about 4% of industrial output. Steel production has dropped by 15%, but hardly any other industries are being affected by the strike.

As a result of the labor troubles, Brittan scaled down his forecast for the year from 3.5% to 2.5%, and predicts 3% growth in 1985. Private investment is expected to rise by more than 10% in real terms this year, and exports will grow by 5% to 7%. Inflation is forecast to remain at around 5% over the next two years, but weak world prices for Britain's North Sea oil may drive down the value of the pound.

Despite the underlying strength of the recovery, which Brittan compared with the "golden age" before the first oil crisis in 1973, the slow upward creep of unemployment--now at 12.5%--has not halted. The problem, according to Brittan, is that labor is taking the fruits of the economic upswing in the form of higher pay rather than in more jobs. The spurt in corporate profits, up 25% last year and expected to continue rising, could gradually encourage employers to hire more workers, Brittan believes.

ITALY. For all its own budget-deficit problems, the Italian economy is expanding much like its northern neighbors at a rate of 3% this year, according to Guido Carli, Former Governor of the Bank of Italy. Exports to the U.S., including such high-tech products as robots, are booming. Next year, growth may drop slightly to 2.6% if the U.S. economy slows as expected. Inflation will crackle along at about a 10% rate this year and next. Unemployment, now running at 9.5%, will near 10% in 1985, as industry continues to shed workers aggressively.

Carli was worried above all by the rise in government spending, which is now about 50% of gross national product. He argued that reducing expenditures for local government, public health and social security is an urgent political necessity. He also believes that an incomes policy to hold down wages is vital but that the government appears to have given the powerful unions a veto in major economic decisions. Said he: "I think that creates a major problem for the functioning of a parliamentary democracy."

FRANCE. The embattled Socialist government of President Francois Mitterrand, while still condemned to practice austerity, has begun to benefit from the spread of the recovery. Instead of the stagnation that had been expected this year, the economy is now growing at a rate of about 1%, with a similar outlook for 1985, according to Jean-Marie Chevalier, Professor of Economics at the University of Paris Nord.

The key to this improvement is the government's success in curbing inflation and holding down wage increases. Inflation has dropped from last year's 9.3% to 7.1% this year, and Chevalier predicts it will fall even further, to 5.5% in 1985. Businessmen are once again investing, encouraged by incentive measures from a government that has rediscovered the virtues of the private enterprise system. Like its neighbors, France is exporting more. But, again, in France unemployment remains a problem. The number of jobless will reach 2.5 million this year, or 10% of the work force, and rise to 11% in 1985.

French industry, said Chevalier, is split between efficient companies, on the one hand, and money losers in need of subsidies, on the other. Yet despite social and political pressures, Paris is determined to weed out the losers as part of its painful and belated drive to modernize the economy.

Throughout the meeting, board members returned repeatedly to what they saw as the dangerous imbalances of the American boom, which are caused by the large U.S. deficits. Jan Tumlir, Chief Economist for the General Agreement on Tariffs and Trade (GATT), compared the American recovery with "one of those elegant ladies of an uncertain age" whose true visage is masked by mountains of makeup. On one level, he said, it appears to be a young boom that could carry on for maybe two years, but rising interest rates also make it look like a dying boom. Said Mast: "The U.S. has one foot down on the budget accelerator and at the same time the other foot on the tight-money brake. Any car driven that way will be ruined in time."

For Brittan, the main question was whether the U.S. would have a "soft landing" or a hard one. The soft landing would bring down the budget deficits and interest rates without causing a severe recession, but Brittan found that unlikely. Said he: "Having waited so long and so late to reduce the deficit, the U.S. Government might well have to reduce spending or increase taxes at a time of business weakness." The result of such action would probably be a sharp recession. Giersch, on the other hand, believed that even a downturn would not shake the world's faith in the fundamental strength of the U.S. economy. Western Europe's cautious recovery has been fueled by the U.S. boom, and now Europeans are anxiously watching the course of the American economy to see what will happen to their own. --By Frederick Painton