Outlook '81: A Stagnant Europe

By Charles Alexander

Trying to curb prices, governments hit a new oil slick

Another year of economic stagnation. That is the gloomy picture that TIME'S European Board of Economists sees for 1981. As nations struggle to absorb rapid-fire energy price shocks from the Middle East, unemployment in Europe will climb and torrid inflation will cool only slightly. To rein in rising prices, governments have resorted to traditional tactics, in particular sharply slowing the growth of their money supplies. The result is, however, an international war of high interest rates that threatens to deepen and prolong the economic malaise. Says Hans Mast, executive vice president of Switzerland's Credit Suisse: "There is no mistaking that the world is moving into perhaps its most difficult phase since World War II, and governments cannot do very much about it. After three decades of Keynesianism, old instruments of policy do not work any more."

The most ominous aspect of the current slump is its global reach. Even during the severe 1973-75 recession that racked industrialized nations, growth in developing countries, such as Brazil, South Korea and Singapore, continued to move ahead. The thirst of those countries for imports from machine tools to tractors helped keep production lines working in the U.S., Europe and Japan. That expansion and the ever higher oil bills, though, were paid for by increasing doses of credit from Western banks. As a result, the developing countries have piled up a staggering $450 billion in debts. Now the banks have grown cautious, and the debtor nations face hard times. Warns Jan Tumlir, chief economist for the international organization GATT (General Agreement on Tariffs and Trade): "I expect that for the first time we will have a generalized recession in the sense that the imports of the developing countries will increase only marginally, if at all."

TIME'S economists see a lean period ahead for each of Western Europe's four major economies:

WEST GERMANY. This mighty economic juggernaut has begun to sputter badly. In 1980, West Germany's current account deficit, which includes trade of both goods and services, reached a record $15.4 billion; inflation was 5.2%, an unacceptable level by West German standards. The Bonn government is therefore slowing the growth of spending and curbing the money supply. Herbert Giersch, director of the University of Kiel's Institute for World Economics, expects no growth in his country this year, following a 1% decline in 1980. Though inflation should fall to 3.5% by the end of 1981, unemployment will rise from its present rate of 4.5% to 5.5%.

FRANCE. Because President Valery Giscard d'Estaing faces re-election this spring, the French government is unlikely to be quite as tightfisted as its Bonn counterpart. Jean-Marie Chevalier, professor of economics at the University of Paris Nord, predicts that growth, which was 1.6% in 1980, will decline slightly to between .5% and 1% in 1981. Unemployment, now at 6.9%, could reach 8%. Progress against inflation will be small. After rising by 13.5% in 1980, prices this year will surge another 11% or more.

BRITAIN. Prime Minister Margaret Thatcher shows no signs of wavering in her campaign to restore Britain's economic vigor through a tough policy of controlling the growth of money. Though the British G.N.P. declined by 5.5% in 1980, Economist Samuel Brittan of the Financial Times of London expects four more quarters of recession and another 1% drop in national output in 1981. Unemployment, which is currently 8.7%, Britain's highest since the Great Depression, may hit 11.5% by year's end. Says Brittan: "We have been carrying millions of unemployed on the books of firms up until recently. Now they are being transferred to the unemployment rolls." He predicts that inflation will begin to ease in 1981, going from 15% in 1980 to 9% by the end of this year.

ITALY. With inflation running at a 21% rate in 1980, Italy's key exports, such as textiles and shoes, are rapidly becoming uncompetitive in world markets. Guido Carli, president of the European Community's Union of Industries and former governor of the Bank of Italy, foresees no growth in the Italian economy this year, after a comparatively robust 4% rise in 1980. The slump should slow inflation to about 16% by next December.

TIME'S economists warn that competitive belt-tightening by the major industrialized nations may seriously stall economic recovery. The oil exporters will drain $120 billion from the importing countries next year, and every Western nation seems determined to reduce its deficit in order to keep its currency strong. As governments slow their economies by escalating interest rates, they also choke off the capital investment that is vital for renewed growth. An additional danger is that, as unemployment rises, workers will demand protection from imports. New barriers to world trade would ensure sluggish growth. European industrialists have already been lobbying governments to limit the imports of American textiles and Japanese cars.

The ultimate key to international financial stability, of course, is the price of oil. TIME'S economists are cautiously optimistic about the near-term energy outlook. France's Chevalier, an energy expert, sees no significant increases in world oil prices during 1981 beyond those following the OPEC meeting in Bali two weeks ago. Though the Persian Gulf war knocked out 2.9 million bbl. per day from Iran and Iraq, according to Chevalier's figures, other OPEC members, including Saudi Arabia, Kuwait and the United Arab Emirates, increased output to ease the shortfall. Oil importers are also being helped by increased production in Mexico, the North Sea and other non-OPEC areas. Moreover, conservation and slow growth reduced oil demand by about 2 million bbl. per day over the past year.

Chevalier, however, fears that any petroleum price relief may well be temporary. He agrees with reports by the CIA and others that oil output in the Soviet Union, the world's largest producer, is peaking. Until now, the Soviets, who pump more than 11 million bbl. per day, have been able to satisfy their own needs and those of their Communist allies. But the antiquated condition of Soviet drilling equipment, a situation that has been made worse by the U.S. embargo on high-technology exports to the Soviet Union, has delayed the development of new oil deposits. By 1985, the Communist nations may be forced to import oil from the Middle East, which would provoke new shortages and put intense pressure on prices in the world oil market. Toward the end of the decade, new Soviet oilfields and Chinese discoveries could bring supply and demand into closer balance once again.

The ability of nations to weather economic challenges in 1981 will depend, in large part, on their political leadership. As head of the largest economy and the most powerful country in the West, the U.S. President will play the central role. TIME'S economists view the election of Ronald Reagan with both hope and a degree of skepticism. They applaud his announced energy policy, which includes the decontrol of U.S. crude oil and natural gas prices as quickly as possible. This should spur new energy production and encourage even greater conservation efforts.

TIME'S board is less sanguine about Reagan's brand of "supplyside" economics, which would use large cuts in personal and corporate income taxes to stimulate U.S. business. Says Italy's Carli: "Supplyside economics to my ears means inflation." They likewise doubt Reagan's ability to deliver on campaign promises to cut taxes by 30% over the next three years, increase defense spending and balance the federal budget.

The greatest fear of the European economists is that Reagan's policies will result in more U.S. inflation, which would mean more instability for the dollar. The dollar's wild gyrations during the first three years of the Carter Administration disrupted international trade and made governments uneasy about continuing to hold U.S. currency as their chief reserve asset. Some $800 billion is held overseas, and Europeans are anxious to see the value of these funds protected. One of the few bright bits of financial news for the U.S. in 1980 was the strength of the American currency on international money markets. During the year, the dollar increased in value by about 13% against the West German mark. Says West Germany's Giersch: "We would like to see the dollar again as the leading currency in the world."

TIME'S economists believe that Reagan's most crucial task will be to restore confidence in U.S. foreign policy. They point out that the U.S. in the past decade seems to have lost control totally of events in the Middle East, while several African nations, including Angola, Mozambique and Ethiopia, have slipped under Communist influence. Observes Mast: "There is no doubt about it. The Western world is too weak." The European board members, therefore, praise Reagan's intention to accelerate defense spending. They argue that at stake is the free flow of oil that is ultimately the economic lifeblood of rich and poor countries alike. --By Charles Alexander

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