Europe's Recovery Keeps Rolling

By Christopher Redman/London

In its quest for ways to reduce the U.S. trade deficit, the Reagan Administration has repeatedly urged other countries to grow faster and absorb more American imports. One of the prime targets of the jawboning has been Western Europe, which last year ran up a $26.4 billion trade surplus with the U.S. But if the White House is counting on much help from the Europeans this year, it is likely to be disappointed. That was the consensus of TIME's European Board of Economists, which met in London for its semiannual review of Europe's outlook. Average growth in the gross national products of the major West European nations will be a solid but unspectacular 3% in 1987, predicted Switzerland's Hans Mast, senior economic adviser to the Credit Suisse First Boston investment bank. The expected growth rate will be up slightly from 2.5% in 1986 -- not the kind of acceleration Washington has in mind.

Even that moderate growth is by no means assured. To an uncomfortable ! extent, the expansion is dependent on exports, particularly to the U.S. Now that source of growth is threatened by the decline in the value of the dollar, which makes European products much more expensive in the U.S. So far, such premier exporters as West Germany and France have weathered the dollar's fall, but a further steep drop could be devastating.

The only way for European countries to insulate themselves against that peril, TIME's economists agreed, is to boost domestic demand and become less reliant on exports. The onus will be on West Germany, Europe's most powerful economy, to take the initiative. Last year the Germans resisted pressure to cut interest rates and lift demand by promising that strong growth was already in the pipeline. Further stimulus, German officials argued, would raise the risk of an overheated economy and renewed inflation. But West Germany's 2.75% growth rate in 1986 fell short of expectations as the high-flying mark and falling sales to oil-producing countries undermined export earnings.

Last month's decision by West Germany's central bank to trim the discount rate that it charges to banks from 3.5% to 3% was hailed as a much needed step to take pressure off the mark and boost domestic German consumption. Some of TIME's economists, though, argued that a further relaxation of West German monetary policy is still needed. "The Bundesbank's action was too late and not sufficient," complained Mast.

But it is not at all certain that European governments can quickly generate a sharp rise in domestic consumption merely by pouring more money into their economies. A portion of industrial capacity must be redirected from manufacturing products for export to satisfying local demands, and that takes time. Warned Board Member Guido Carli, former governor of the Bank of Italy: "I have doubts that in the short term it is possible to restructure the economies of countries like Germany and Italy, which for so many years have been export oriented."

Until such restructuring takes place, Europe is unlikely to make substantial progress against its chronic unemployment problem. Though some countries will show a slight improvement this year, the overall European jobless rate could remain stuck at 11%. The prognosis for a swift cure is bleak because manufacturers are continuing to trim their work forces as a way of containing costs and boosting productivity.

In contrast to the unemployment picture, the inflation forecast remains exceptionally bright. Most European countries can expect price rises of no more than 3% to 5% in 1987. But that prediction assumes the continued willingness of unions to accept moderate wage increases. In France, the conservative government of Premier Jacques Chirac has recently had to face strikes by public sector employees that interrupted train and electric service. Though the strikers eventually accepted Chirac's offer of 2% to 3% pay hikes and went back to work, the confrontation was a sharp reminder of latent tensions on the labor front.

For at least the next year, however, continued economic growth throughout Europe is likely to keep labor unrest to a minimum. The outlook for Europe's major economies:

BRITAIN. A 13% decline in the value of the pound against an average of major currencies since December 1985 has given a big boost to Britain. The pound's fall, which was linked to the decrease in value of Britain's oil reserves, has stimulated the country's exports by making its products less expensive overseas. At the same time, British manufacturers have been able to hold down their prices because of modest wage settlements. Inflation last year was only 3.75%, a far cry from the more than 20% reached in 1980.

Board Member Samuel Brittan, economics columnist for London's Financial Times, predicted that growth will rise from 3% in 1986 to 3.5% this year and push the unemployment rate down slightly, from 11.4% to 10.7%. Brittan hopes the pound will stabilize at more or less its current level. Further substantial declines in the currency, he said, could begin to put pressure on the British inflation rate by making imports more expensive.

FRANCE. The government has forecast growth of 2.8% this year, but Jean-Marie Chevalier, professor of economics at the University of Paris Nord, contends that it will be more like 2%. He cites soft consumer demand at home and still softer exports as causes for concern. Traditionally, some 30% of French exports go to the Organization of Petroleum Exporting Countries and other developing nations where lower oil revenues and large debt loads have sharply curtailed purchasing power. As a result, France's export earnings are bound to suffer. Sluggish growth may nudge up unemployment from 10.6% to 11% this year, Chevalier said.

WEST GERMANY. Since inflation has at least momentarily disappeared in West Germany (prices actually fell by 1% in 1986), many economists believe the $ Germans have plenty of latitude to try to boost their 2.75% growth rate. Herbert Giersch, director of the Institute of World Economics at the University of Kiel, suggested that Bonn should bring forward tax cuts now planned for January 1988. Such stimulus is needed, he said, because a rising mark could play havoc with West Germany's export industries. Giersch predicted that the country would be lucky to achieve a 2.5% growth rate in 1987.

A stable mark, however, could have some negative side effects. During 1986 the climb in the mark's value reduced the cost of imported oil and other industrial materials and helped companies afford a 4.5% wage hike for employees. But similar wage demands this year could become a heavy burden if the mark stops rising. Giersch voiced fears that pay increases could cut profits, dampen investment and lift the inflation rate to 3%. He suggested that Bonn should strike a deal with the labor unions, in which the government would cut taxes by 5% in exchange for wage restraint.

ITALY. The Italian economy barreled along with a 4% growth rate last year. But that performance was partly the result of stimulative government spending that left a huge budget deficit amounting to 15% of gross national product. Carli warned that runaway spending was a serious threat to long-term growth. "How long," he asked, "can a country survive with public debt taking an ever expanding share of GNP?" Growth will slow to about 2.2% this year, he predicted.

Despite the nagging debt problem, Italy has made enormous strides. Last year's inflation rate was only 4.3%, in contrast to more than 20% in 1980. Carli and Brittan agreed that Italy's GNP is now close to that of Britain and is probably larger if the thriving Italian underground economy is counted.

Italy and all other European nations face the same imperative: generate more internal investment and growth. Otherwise, Europe will remain hooked on exporting. At present the U.S. is the main engine of world economic growth, but that cannot continue indefinitely because the enormous American trade deficit is unsustainable. Warns Nils Lundgren, vice president of Stockholm's Pkbanken: "Either the dollar has to fall more or there will be more protectionism in the U.S." Both outcomes could undermine European growth. Concludes Mast: "We must stop telling the Americans what to do to help the world economy and start doing something ourselves. We have to grow."

CHART: TEXT NOT AVAILABLE

CREDIT: TIME Chart by Renee Klein

CAPTION: Forecasts by TIME's European Board of Economists

DESCRIPTION: Three charts showing growth, inflation and unemployment for West Germany, France, Britain, Italy, Sweden and Western Europe.