A Timid Recovery for Europe

By John S. DeMott

TIME'S Economists foresee an end to the recession

Strapped by huge budget deficits, high unemployment, spiraling prices and distressing trade imbalances, the economies of Western Europe will show little or no growth this year. But in 1982 they will probably begin perking up. That was the conclusion of the TIME European Board of Economists, which met last week in Munich.

All of Europe's major economies show some signs of improvement, but these are still outweighed by the evidence of weakness. Inflation is on the wane in Great Britain, but unemployment could rise to 12% or 13% by the end of 1981. Last week some 60,000 people gathered in London's Trafalgar Square to climax a monthlong unemployment protest. Public spending is expected to jump sharply in France under newly elected Socialist President Francois Mitterrand, who took the first step in that direction last week when he raised the minimum wage by 10% (to $503 a month) and increased outlays for other social benefits.

West Germany has one of Europe's lowest inflation rates, around 5%, but even that is of concern to bankers, who still have nightmares about the hyperinflation during the Weimar Republic. Despite its record, the economy in Western Europe's long-running growth engine is expected to decline by 2% this year. Guide Carli, a member of the TIME European Board of Economists and former governor of the Bank of Italy, expressed amazement that his country was showing any growth at all under the burden of a $57.5 billion deficit and inflation of about 20%. Said he: "I never believe in miracles, but I believe that it is perhaps a miracle that the economy has survived with a deficit of that size."

One of the immediate obstacles to European expansion comes from high U.S. interest rates. Western governments are being forced to push their cost of borrowing much higher than the level demanded for purely domestic economic reasons. They would prefer to leave the rates lower in order to help encourage local business investment. But the high American rates appeal to savvy investors who buy dollars with their money and drive down the value of local currencies. The only defense is for central bankers to raise interest rates. In the past few months the prime rate in West Germany has increased to 14.25%, while in Italy it has jumped to 22.5%.

Despite this, the value of the dollar continues to climb. Since the beginning of the year, the American currency has increased by 19.2% against the French franc, 16.3% against the British pound and 17.5% against the West German mark. Last week the pound was selling for less than $2 for the first time in more than two years, while the mark was worth only 42-c-, its lowest level in more than four years.

The dollar's renewed strength stands in sharp contrast to its weakness in Europe just two years ago, when all the major European countries except Britain formed the European Monetary System as a means of defense against the then tumbling U.S. currency. The dollar's strength is good for U.S. tourists abroad because it takes fewer dollars to buy French, West German and British goods. But it is not good for countries whose currencies are being battered. They must pay for many of their key imports, especially oil, in U.S. dollars, and now those prices are higher. Weak currencies can also have a nefarious, and often underestimated, impact on domestic inflation by making it easier for local manufacturers to raise their prices.

Although sensitive to the problems that high U.S. interest rates are causing in Europe, board members gave a cheer or two for Paul Volcker, chairman of the U.S. Federal Reserve. TIME'S economists urged him to withstand political pressure and avoid actions that could precipitously lower interest rates and dangerously swell the U.S. money supply. The board's members believed that the dollar's strength would hold for a time, "fluttering about" where it is now, said Samuel Brittan, assistant editor of the Financial Times of London and former economic adviser to the government of Prime Minister Harold Wilson.

Herbert Giersch, director of the University of Kiel's Institute for World Economics, foresees a period of higher interest rates to which the rest of the world will have to become accustomed. Said he: "My assumption is that confidence will be regained and the crisis atmosphere cleared up when the countries learn to live with higher real rates of interest." Added Carli: "I believe that interest rates in the U.S. will remain high and fluctuate widely."

High interest rates, but ones that are more aligned with one another, could result in less wildly varying exchange rates. The uncertainty of the large changes in the value of currencies is what most bothers business. But such a concerted policy is unlikely, since some countries have the habit, according to Brittan, of discussing interest and exchange rates only in private "amongst consenting adults."

The board also saw threats to European growth in the old enemy of protectionism and the continuing spread of barriers to trade. High unemployment in most of the European Community has led to a dangerous impulse toward protectionism, loud declarations in favor of free trade notwithstanding. Said Jan Tumlir, the chief economist of the world trade organization

GATT (General Agreement on Tariffs and Trade): "All governments are afraid of protectionism. They are determined to resist it. They repeat that all the time. But sometimes the pressure for it is overwhelming, and then they give ground." That, he said, means that Europe's economies "cannot recover and sustain a long recovery."

The actual percentage of truly liberal trade among European countries and between them and the rest of the world has declined. After eliminating the products for which commerce is restricted, not much is left for free trade. The export or import of most agricultural products, textiles, synthetic fibers, clothing, shoes, steel and automobiles are now limited in some way. And restraints in one country beget restraints in another. No sooner had Washington pressured the Japanese into limiting the number of cars shipped to the U.S. than the Europeans, who already control their auto imports from Japan, were demanding still tougher restraints.

Tumlir warns that strong international cartels in steel, oil and some other basic commodities are forming or are effectively in place. These are propping up prices, fueling inflation, restricting trade and limiting growth. This does not do Western capitalism's image much good, or help the credibility of Western governments that sometimes quietly encourage the formation of such cartels. Says Brittan: "What kind of picture do we present to the Soviet Union when we preach about competition while at the same time our great industries are unable to stand up to the impact of the import of sandals from Korea?"

Most damaging of all, Tumlir warned, the protectionist illusion puts dangerous strains on the international financial system. The industrialized countries export three times as many goods to the developing countries as they import from them.

By restricting imports of Third World goods, the industrialized nations deny foreign exchange to the developing nations, thereby shrinking their own export markets and destroying more jobs at home than they would save through protectionism. Meantime, investment in new plants is retarded and Third World debtor governments--whose creditworthiness depends on export earnings--must borrow more deeply to pay their debts.

One of the great unknowns now hanging over the European economies is the future of French business after the election of Mitterrand. Board members generally doubted that the new French President would rush to fulfill his socialist program. The harsh reality of trying to run a fragile economy will be very sobering. Said Tumlir: "We are gradually emerging from a silly political season to some better understanding of the political conditions necessary for economic prosperity. Recovery always begins with a hangover." Even Italian Communists, said Giersch, are coming to the conclusion that it is "medium-size private enterprise that is really doing the hard work and innovation, and providing the money for government expenditures."

Jean-Marie Chevalier, a professor of economics at the University of Paris Nord, suggested that Mitterrand's ascendancy will in no way amount to the forced socialization of the French economy. Said Chevalier: "Most of the decisions will be taken very slowly." If all the industries slated for nationalization by Mitterrand during his presidential campaign are in fact taken over, the amount of state control of industry would rise only from about 12% to just 16%.

Nonetheless, any new state control bothered some board members. Tumlir said industries that were nationalized earlier, including the railways, steel and utilities, now operate free of political pressure and have usually been spurred forward by a drive for greater efficiency and productivity. The pending actions, he said, are mainly for "political control" of the economy.

Mitterrand's first economic goals will be to increase the purchasing power of low-income families; cut unemployment among young people; and experiment with budget busters like paying women a wage to stay at home, rear children and stay out of the labor force. But even Chevalier admitted he does not know what lies ahead. Said he: "We do not know what sort of things can change, but the French economy, the French administration and the French people needed some sort of change. They were fed up with the rigidity of the economy."

There was no doubt among board members that France's new policies will have an impact on European economic thinking. This might be another example of what Tumlir saw as the political habit, exhibited in everything from trade policy to exchange rates, of using "a substitution of incantation for analysis." Brittan, though, perceived a benefit for Brit ish Conservatives. Said he: "What happens in France will make a great deal of difference in the development of British politics during the next few years. I think we must record a vote of thanks to the French for giving us three years of experimenting before the next British general election."

The board gave generally good marks to the other major political and economic experiment now being conducted: Reaganomics. They believed that if the Administration's brand of supply-side economics yields good results, it can be expected to show up in Europe in three to five years. But there were disbelievers.

Only a "nasty recession," said Brittan, will bring the reduction in inflation to the 5.5% that Reagan wants by 1984. There was also a feeling that Reagan's policies of high interest rates could cause the U.S.

business community, his biggest supporter last November, to turn against him, just as business has cooled toward Margaret Thatcher's Conservative government in Britain.

The board was somewhat skeptical about the current U.S. economic outlook.

Many American economists now predict a reduction in inflation to around 8% by year's end, and growth in real terms of a modest 2.3%. Said Brittan: "A lot of the relative optimism depends on a quirk in your Consumer Price Index, which can show substantial short-term fluctuations with little change in the underlying rate of inflation." The annual core inflation rate in the U.S., which is closely linked to wage rates, is now about 10%.

With the end of the recession just starting to appear on the horizon, Western Europeans will have to begin thinking about the long-range policies that will give them a solid foundation for future economic growth. It will take strong politicians and firm economic policies to do that. Brittan borrowed a line from Shakespeare's Henry V to sum up Europe's economic mission: "He which hath no stomach to this fight, let him depart."

-- By John S. DeMott

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