Heading into the Straightaway

By Frederick Painton

Western Europe is enjoying an economic recovery that, for all its modesty, promises to accelerate this year and endure well into 1987. And, thanks to falling oil and commodity prices, inflation is expected to drop further. That was the encouraging assessment presented by TIME's European Board of Economists at its twice-yearly meeting, which was held this time in Madrid to mark Spain's and Portugal's entrance into the European Community.

Despite a declining dollar on world currency markets, which makes foreign products more expensive in the U.S., Western Europe's trade surplus is expected to rise from last year's $25 billion to $40 billion. If, as expected, the European export boom eventually cools down, the gap can easily be filled at home by rising consumer demand and increased industrial investments. Even the painful level of unemployment will probably decline slightly in the year ahead, partly as a result of an increase in small, new businesses. Nonetheless, some 10.5% of the labor force remains jobless, and this continues to be Western Europe's major economic and political problem.

Some board members warned against what Herbert Giersch, director of the University of Kiel's Institute for World Economics, called a mood of "Europhoria." The good economic news has led investors to push up prices sharply on all the major stock exchanges in Europe in recent months, but Giersch warned that growth will not be enough to solve deep-rooted problems like unemployment. Hans Mast, an executive vice president of Credit Suisse, agreed. Said he: "Unemployment in Europe has many demographic, structural and social causes that cannot be redressed simply." He also pointed out that his upbeat forecast assumed that U.S. economic performance would improve. "Ultimately," Mast said, "Europe cannot prosper unless the rest of the world is prospering."

Mast acknowledged that familiar threats to the recovery still existed: a crash landing of the declining dollar, for example, or a collapse of oil prices could bring turmoil to the international financial system. An American turn to protectionism as a means of dealing with its $145 billion trade deficit poses another risk. So does the vast, unpayable debt being borne by developing countries. But Mast believes that prospects for international crisis management have been greatly improved since U.S. Treasury Secretary James Baker launched his campaign last year for closer cooperation among the world's major industrial countries. Said Mast: "1986 could be a decisive year. Let us hope that it will not turn out be a year of missed opportunities."

The French government has suggested that the industrial nations launch a coordinated program to reduce interest rates as way of spurring growth. That was probably one of the topics discussed last weekend at a closed-door meeting in London finance ministers from the five largest industrial countries. The U.S. has been urging West Germany and Japan to follow policies that would foster more growth, but they have resisted, arguing that inflation remains a threat.

The TIME board members were divided over the issue of whether Europe could stimulate its economies more without risking higher inflation. Mast pointed out that West Germany, Britain and France have already introduced tax cuts. Any stronger measures, he indicated, could bring about more price increases and higher interest rates. Mast was backed by Samuel Brittan, an assistant editor of the Financial Times London, who felt that government action push growth would result in "some of the inflationary dangers that made our flesh creep a few years ago."

But Nils Lundgren, vice president of Stockholm's Pkbanken, believes that West European countries are slowly creating conditions for steady, solid growth. Said Lundgren: "We are more inflation-proof now during the business upswings." Imports are cheaper, wage increases are modest, and governments are reducing budget deficits. At the same time, Lundgren found that Europeans, on the political left as well as the right, have learned to accept the need for free-market solutions, even if it means shutting down loss-making steel mills and shipyards. Jean-Marie Chevalier, professor-of economics at the University of Paris Nord, also noted the growth of a new entrepreneurial spirit that helps growth.

Not all the board members, however, predicted only good times ahead for Europe. Giersch, for one, saw a Continent divided between a majority of employed and a significant minority of jobless; between skilled workers and the unskilled; between regions that are prospering, mainly those located around the Alps, and regions whose resource-based industries are in rapid decline. Export industries have been doing well, Giersch noted, while others, like housing, have suffered. What Europe still lacks, according to Giersch, is a flexible labor force that would be willing in some cases to accept lower pay and move more easily to new jobs. Without that, he said, it will be difficult to achieve more than 3.5% growth per year. Guide Carli, former governor of the Bank of Italy, noted that companies were increasing productivity by using fewer workers.

For the immediate future, the board gave encouraging forecasts for five of the European Community's major economies and Scandinavia. The projections:

BRITAIN. Private consumption, which is expanding faster than exports and investment, should lead to 3% growth this year. Inflation is expected to fall to about 3.8% by the end of the year. Unemployment is 13%, but it is likely to fall slightly. Brittan noted that declining oil prices are reducing British revenues and putting pressure on the pound. He predicted that the government would raise interest rates, if necessary, to maintain the value of the currency.

FRANCE. Chevalier predicts a year of improvement based on a policy consensus between the Socialist government and the conservative opposition, which is currently expected to win parliamentary elections scheduled for March 16. Growth should accelerate slightly from last year's meager 1.4%, to 2.1%, because of what Chevalier called "a gift from abroad"--lower oil prices and a cheaper dollar. Inflation in France will dip from 4.9% to 4% this year, while unemployment will edge up to 11%.

WEST GERMANY. Giersch called 1985, when the economy expanded by 2.3%, a disappointing year. But growth in 1986 is expected to swell to 3%, largely on the basis of a doubling of private consumption, from 1.5% to 3%. Consumers will get the first of two planned tax cuts, and wages are expected to rise by around 4% this year. Giersch expects labor leaders to call for larger increases in 1986. Since an election is coming next year, he said, the government will not be in a mood to resist. Inflation, currently 1.8%, is expected to be 2% in 1986.

ITALY. Carli forecast continued growth at around 2.5% this year. Despite that rather modest expansion, companies have enjoyed hefty profits because they have increased prices and kept capital investments low. But the Italian public debt, now 101.9% of the gross national product, is expected to grow another 5.6% by the end of 1987.

SCANDINAVIA. Lundgren observed that four of the Nordic countries are each going through very different experiences. Sweden, for example, is struggling with wage and price increases that are 2% to 4% higher than those of its major competitors. This year wages may rise by close to 8%. Growth is expected to slow from 2.5% to 1% in 1986. In Denmark, by contrast, inflation and wage in creases are coming down to the rate of its partners in the European Community after years of rapid government spending. Denmark's major problem is a widening trade deficit, which is increasing the country's foreign debt. Norway has been enjoying growth rates of more than 3%, largely because of oil exports, but now is running into trouble. Norwegians have been on a consumer spending spree that is pushing up prices and wages. Finland, according to Lundgren, is the Japan of Western Europe. It had 4% growth last year and is expected to have only slightly less in 1986.

Throughout the session, the board members argued basically about how to use the opportunity offered by the arrival of a more durable recovery to create additional jobs. No one disagreed that West European economies are at last on the move after years of little or no growth. Mast warned, though, that labor unions seemed to be becoming more aggressive and demanding higher pay increases as the outlook brightened. The best hope for reducing Europe's continuing unemployment problem is through structural reforms, such as faster progress toward a genuine European common market and greater labor mobility. That would unleash more competition and create both new companies and new jobs. --By Frederick Painton 1985 estimates by TIME's European Board of Economists... Growth % change in real G.N.P., 4Q over 4Q Inflation % change in C.P.I., Dec. over Dec. Unemployment % of civilian labor force, year-end W. Germany 2.3 1.8 9.2 France 1.4 4.9 10.0 Britain 3.5 5.5 13.0 Italy 2.6 8.6 10.8 Sweden 2.5 5.3 2.9 W. Europe 2.7 5.0 11.3 U.S.[*] 2.4 3.6 (Nov./Nov) 6.9 ... and their 1986 forecasts Growth % change in real G.N.P., 4Q over 4Q Inflation % change in C.P.I., Dec. over Dec. Unemployment % of civilian labor force, year-end W. Germany 3.0 2.0 8.5 France 2.1 4.0 11.0 Britain 3.0 3.8 12.5 Italy 2.5 6.2 11.0 Sweden 1.0 4.8 3.4 W. Europe 3.0 4.3 10.5 U.S.[*] 2.9 4.0 6.8

[*] By TIME's U.S. Board of Economists

TIME Chart by Joe Lertola