Europe's Outlook Brightens Time's

By Frederick Painton

It took two years for the American economic recovery to cross the Atlantic in strength, but it has finally arrived. Western Europe is entering 1985 on an upswing that promises growth of 2.8% over the next twelve months, the highest level in five years. European exports are strong, while inflation and interest rates are heading downward. Unemployment in Western Europe remains at an average of about 11%, but productivity per worker there is increasing at an annual rate of 3.5%, in contrast to some 2% in the U.S. This business pickup is bringing a long-overdue antidote to the pessimistic view that Western Europe was condemned to an economic decline. Such was the upbeat assessment of TIME's European Board of Economists, which held a meeting last week in the West German Baltic port of Kiel.

Hans Mast, a University of Zurich lecturer and executive vice president of Credit Suisse, pointed out that Western Europe is probably the only part of the industrialized world where the gross national product is expected to increase at a faster rate this year than in 1984. If U.S. growth is slow in the first half of 1985, as Mast and other board members believe it will be, then Europe will become the motor of world economic growth until the American recovery finds its feet again toward the end of the year.

Fueling the European recovery is an extraordinary export boom. Last year Europeans racked up a balance of payments surplus of $8 billion. This year Mast expects it to reach $25 billion. With inflation slowing from 5.8% last year to 5% and government budget deficits remaining moderate, he expects interest rates to dip in the latter half of the year, spurring more investment, particularly in housing. Said Mast: "All told, Europe does not present the picture of a sick economy." Despite recent talk of Euro- sclerosis, said Mast, the old Continent still enjoys leading positions in various industries, including nuclear energy, pharmaceuticals, & telecommunications and heavy electrical equipment. If Europe lags in electronics and computers, it is not a fatal technological gap, as Mast sees it, because "another train always shows up soon after the one you have just missed."

Beyond the generally encouraging economic statistics, all the board members at Kiel detected a shift in the mood of Europe. Said Samuel Brittan, assistant editor of London's Financial Times: "There is at least the beginning of an American sense that human problems are solvable, that even the problems of the labor market might yield to the application of political intelligence and economic analysis." Herbert Giersch, director of the University of Kiel's Institute of World Economics, observed "an improvement of mood, particularly in the business community."

The board members agreed that Europeans are beginning to respond to economic and business challenges from the U.S. and Japan. Old-style corporate management is giving way to methods that favor flexibility, risk taking and new forms of cost control. As ailing industries such as steel, textiles and shipbuilding decline, trade unions, which have often slowed progress in the past by restrictive labor practices, are losing power. At the same time, voters have been showing a marked preference for fewer government controls and more private initiative. As in the U.S., skepticism is growing about the value of heavy government spending on welfare-state benefits.

Much of the strength in the European economy is the result of the high value of the dollar, which has made Europe's exports attractive against U.S. competition at home and abroad and has helped foster the export boom. The dollar's future thus is an important subject for Europeans. Mast believes that the sharp run-up in the value of the dollar since 1980 is likely to come to a halt and perhaps even give way to a decline during the next twelve to 18 months. He thinks that the flow of capital into the U.S. to take advantage of higher American interest rates will slow now that they are coming down. Moreover, he believes that foreign investors will want to diversify their holdings and will thus be expanding dollar accounts more slowly. Said he: "There will be a moment when somebody says--and we are telling people this now--that they should try other investment vehicles." Mast, like others, would like to see the dollar make a "soft landing," which means a slow decline rather than a sudden drop. A collapse could disrupt international money markets and the world economy. But, warned Mast, "the longer the dollar keeps rising, the more a crash landing becomes possible."

Giersch, on the other hand, believes that the dollar will probably stay robust. Said he: "Capital in the world is well prepared to cooperate with flexible labor, but it shies away from rigid labor markets where profits are squeezed as a result of wage pressures. Until we have solved that problem in Europe, the dollar is likely to remain strong." Jan Tumlir, the chief economist for the General Agreement on Tariffs and Trade, believes that sooner or later the dollar is due to decline, but he does not expect it to drop by more than 10% to 15%. World central banks and international monetary organizations would certainly cooperate to avoid any sudden fall.

Assuming no monetary upheaval or political crisis, the board gave encouraging forecasts for the European Community's four major economies:

WEST GERMANY. Herbert Giersch describes himself as a "short-term pessimist and a medium-term optimist," meaning that he foresees West German growth at a 2% annual level in the early part of 1985, shifting to 3% in the latter part of the year. He admits that there is a more optimistic group of forecasters who see a 3% growth for the entire year based on hefty increases in profits and growing investments in 1985. Giersch pointed out that West German budget deficits are low, a tax reduction is anticipated, the money supply is likely to be loosened, and unions are expected to ask for more moderate pay increases than they did in 1984. Inflation this year should remain at last year's remarkably low 2% level.

FRANCE. Jean-Marie Chevalier, a professor of economics at the University of Paris Nord, finds his country's economy slowly improving but with great difficulty. Last year, he observed, was the third year since World War II that real personal disposable income declined in France. The others were 1980 and 1982. The Socialist government of President Francois Mitterrand, he said, is still paying for the illfated attempt to spend its way out of recession during its first year of power, in 1981. The gross national product grew by 1.5% last year, and Chevalier expects it to be just 1.1% in 1985. One reward for this austerity is an anticipated decline in inflation, from last year's 6.9% to about 5.8% by the end of this year. The huge trade deficit, which reached $14 billion in 1982, was brought down to $2.7 billion last year, and is predicted to be only $500 million this year. France's external debt last year increased 12%, to an estimated $80 billion, but it is likely to stabilize there during the coming year. For Chevalier, the worst news in the economy was the failure last month of an attempt by the national employers' federation, the major unions and the government to negotiate a contract that would have resulted primarily in greater flexibility in hiring requirements as part of a program to ease increasing unemployment. After six months of talks, a proposed agreement was rejected by the union rank and file. As a result, Chevalier expects the jobless rate to rise from 8% to 10% by the end of the year. Said Chevalier: "Maybe France is a country where the capacity to adapt is weaker because every agreement must be negotiated at the highest level and then be applied by everybody, rather than operating on a case-by-case basis."

BRITAIN. Samuel Brittan expects an increase in growth from last year's 1.5% to 3.5% in 1985. British coal miners have now been on strike for eleven months, but he says that is having a minor effect on the economy because there have been no fuel shortages and workers are drifting back to the pits. He expects inflation to fall from 4.8% in 1984 to 4.5%. In Brittan's view, the government of Margaret Thatcher is quietly "giving the modest stimulus to the economy that some of its critics are asking for." In fact, bank credit has been growing faster than monetary targets, yet instead of raising interest rates, the government for the past several months has been allowing the British pound to depreciate against the dollar and other strong European currencies like the German mark. But at one point last week the pound slipped to $1.12, and the Bank of England started raising some interest rates. The economic recovery has left untouched the 13% rate of unemployment. Brittan maintains that the government could halt the increase during the year with measures such as youth-training programs, the relaxation of minimum-wage laws and the removal of social security taxes on low-wage workers and young people.

ITALY. Guido Carli, the former governor of the Bank of Italy, was unable to get to the meeting because of the severe snowstorm that hit Rome last week. In a report sent to the session, he predicted 2.7% growth this year, just slightly more than last year. But that growth is likely to be accompanied by a pickup in inflation from 8.5% to 9.3%. That would make Italy the only major country in Europe with rising inflation. Carli was encouraged by the government's success in pushing through parliament a budget that limits the increase in the country's huge deficits. Equally courageous, in Carli's view, was a tightening of tax enforcement specifically aimed at shopkeepers, doctors, lawyers and others who have traditionally evaded taxes more easily than salaried employees. Last year the country boosted exports to the U.S. by 60%, mainly as a result of the strong dollar and the U.S. recovery. What happens to the U.S. economy this year, Carli noted, will have a greater impact on Italy than on some of its European partners.

In concluding the session, Jan Tumlir found something paradoxical in the brightening prospects. He noted that while the world economy is doing better, the danger of protectionism is stronger than ever. This is true in both the U.S. and the European Community. A rush of protectionism could halt growth and push economies back into recession. Said Tumlir: "I am, in general, optimistic. But I cannot get rid of this feeling of worry as to where protectionist developments will lead."

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