Europe: The End of a Miracle

The prescription for curing recession and inflation varies from country to country, but the results are remarkably similar

EUROPE:

THE “ECONOMIC MIRACLE” of Western Europe has been supplanted in recent months by economic decay. Nowhere is this more evident than in West Germany, once “the industrial engine of Europe.” On April 12, the five leading German economic research institutes officially declared their nation to be in the worst recession in its postwar history. They predicted that the gross national product would actually shrink by 1.5 percent this year, a decline that would be accompanied by unprecedented levels of unemployment. In prior years, Germany not only had full employment but had imported 2 million “gastarbeiter”—guest workers—from Turkey, Yugoslavia, and Greece to service its burgeoning industry. By last February, however, more than 1.3 million German workers were unemployed, and the number was expected to increase each month. Housing and industrial construction fell at an accelerating rate in the first quarter of this year, which indicated that there would be no immediate relief. As German exports fell, the balance of payments with other nations disintegrated, and Germany wound up 1980 with a $15 billion deficit, the largest in twenty years. And the once impregnable deutschmark has lost almost a third of its value against the dollar since the beginning of 1980.

The research institutes agreed on the causes as well as the dimensions of the German decline. They concluded that the recession and all its consequences proceeded mainly from the shock of OPEC’s raising the price of crude oil by more than 50 percent during the previous year. Since Germany imports nearly all its oil, the sharply higher oil prices drained from the economy huge amounts of money that could have been used for more productive purposes. The research institutes further agreed that the effects of this oil shock were intensified by the tightmoney policies of the Bundesbank, the German central bank, which made it far more difficult for German businesses to finance the added oil burden. As the economy worsened, with no relief in sight, an uncharacteristically public dispute broke out between Chancellor Helmut Schmidt, who blamed the Bundesbank for stifling the economy with high interest rates, and the Bundesbank, whose president criticized the Chancellor’s plans to spend his way into increased employment.

The oil hypothesis proved a convenient and politically palatable explanation of the sudden weakness of the German economy. But OPEC could not be so easily blamed for similar phenomena occurring elsewhere in Europe. Consider, for example, the crash across the English Channel. The British recession, the most severe since the Great Depression of the 1930s, was, if anything, more serious than Germany’s. By last April, unemployment had risen to 10.4 percent of the work force. More than 2.5 million workers were unemployed, with little prospect of re-employment. An additional 370,000 unemployed workers were enrolled in government retraining programs, and if these workers were included, the unemployment rate would approach 12 percent. Indeed, there were fewer people working in England in April than at any time since World War II. And the number of workers joining the ranks of the unemployed was increasing at the rate of 65,000 a month. Not only did the entire British economy shrink in 1980 by nearly 3 percent— despite double-digit inflation —but manufacturing output declined by some 15 percent. By this spring, entire industries had begun to disappear, and the plight of many industrial cities in the north of England, Wales, and Northern Ireland could only be described as fullblown depression.

Unlike Germany, however, England was not hurt by higher oil prices. Its fields in the North Sea produced an average of 1.6 million barrels a day in 1980, making England a net exporter of oil. The OPEC oil shock, with prices increasing to more than $40 a barrel, substantially improved Britain’s balance of payments, strengthened the pound, and enriched the British Treasury by more than $8 billion in taxes and royalties in 1980, more than the previous two years combined. Why, then, the economic disaster? British economists and politicians of all ideological hues were in remarkable agreement in laying responsibility squarely on the policies of the Thatcher Government. Mrs. Thatcher, an unrelenting advocate of monetarism and a species of “supply-side” economics, sought to combat inflation by slowing the growth of the money supply and by cutting both taxes and government expenditures. In her view, inflation was purely a monetary phenomenon —froth that could be blown off without spilling the glass. The unexpected result of her program, however, was an astounding increase in the money supply and the advent of soaring interest rates. Even economists in the camp of Prime Minister Thatcher more or less agreed that her policies were responsible for the collapse of the British economy. But they argued that it was necessary first to depress the economy sharply in order to drive out its inflation, and suggested that they had gone amiss only in using the wrong measure of money supply.

Back on the Continent, the Netherlands was suffering from a remarkably similar deflation of the economy, again without the burden of high oil bills. By April, the number of unemployed Dutch workers was approaching 400,000, or 8 percent of the entire work force—the largest number on the dole in the postwar history of the Netherlands. In addition, industrial output declined for 1980 by some 1.5 percent. As in Germany and England, the economic pie to be divided was getting smaller. The Netherlands also faced a $4.5 billion trade deficit—the largest in its history and still growing.

Just as England exported oil, the Netherlands exported large quantities of gas from the North Sea. Most of it went by pipeline to Germany and more than paid for imports of refined oil. The cause of the economic crisis in the Netherlands was therefore not the oil price increase. Instead, the consensus diagnosis was called “the Dutch disease”—defined by The Economist of London as the transfer of national wealth from productive to unproductive segments of society. Specifically, the Dutch government had followed a policy of spending the enormous proceeds from the sale of its North Sea gas on social welfare instead of allowing them to be used by business enterprises to modernize plant and machinery. The Netherlands, in other words, used its wealth for consumption rather than production—the reverse of the policy installed by Mrs. Thatcher. And yet the result was remarkably similar.

Neighboring Belgium also found itself in deep recession. In fact, by some measures its economic distress was as painful as any in the entire European Common Market. Until recently, Belgium was seen as the rich industrial core of Europe. By April, however, Belgium had an unemployment rate of 12 percent—the highest in Western Europe. Such industries as steel, textiles, and glass, which had been at the heart of Belgium’s prosperity, were now operating far below capacity. Belgium already had the highest wage costs in the world, supported by powerful unions, and businesses found it impossible to produce goods competitive with those of other Common Market countries. In March, bankruptcies reached a record level. There was widespread concern that the industrial core of Europe had become an economic anachronism.

Confronted with an unprecedented $5 billion balance-of-payments deficit, the Belgian currency fell sharply, and because of this the government also fell, on April 6. Finance Minister Mark Eyskens, whose father had five times been prime minister, was called upon by the king to form a new government. Correspondents of the Financial Times in Brussels attributed the Belgian financial crisis to a “savage and sustained speculative attack on the Belgian franc.” The new government defended its currency by suppressing the supply of money and credit.

Alone in Europe, Italy adopted the policy of pumping money into the banking system to spur economic expansion. It also held that such monetary growth was necessary to provide nationwide pay increases mandated by the “scala mobile,” or indexed wages. The result was runaway inflation, with consumer prices rising by 32.5 percent early this year. Yet despite this permissive attitude toward the money supply (and inflation), the unemployment rate was 8.8 percent.

France was not faring much better. In 1980, for the first time in twenty years, the French standard of living declined. Unemployment, which reached a record 7.4 percent this spring, became the central issue of the French presidential election. Many of the candidates blamed guest workers from Algeria and other former French colonies in Africa, and debated various methods for inducing them to return home. When the French voters made their decision on May 10, they voted in the first socialist president in the history of the Fifth Republic. It was a radical change expressing their profound feelings of economic malaise.

THROUGHOUT EUROPE, THERE has been a curious tendency to nationalize the crash of 1981. In country after country, politicians, economists, and commentators have attributed the unprecedented unemployment, declining industrial output and productivity, collapsing currencies, and uncontrollable inflation to some unique national dilemma. The diagnoses varied from place to place: the Dutch disease, the British adherence to monetarism, the German love affair with a strong currency, the financial incompetence of the Italians. But the assumption prevailed in each country that its economic malaise proceeded directly from the current policy of its own government and could be cured by an opposite policy. Yet it seemed to make little difference in the national unemployment rate whether a government followed an excessively tight monetary policy, as did the British, or an excessively loose one, as did the Italian. Nor did it seem to matter whether a government aimed at stimulating private business, as did the French, or at expanding the public sector, as did the Dutch.

Was this the classic problem of blind men manually examining the various extremities of an elephant? If so, the elephant in this case appears to be a European recession of startling proportions. And if one considers Western Europe as a single economic entity, rather than as a variety of sovereign parts, the shape of this elephant emerges more clearly.

In the early 1970s, the Common Market (officially the European Economic Community, or EEC) held out the prospect of becoming the most powerful industrial entity in the world, fueled by North Sea oil and the coal mines of the Ruhr. By 1973, it had subsumed in a giant customs union the economies of nine nations—West Germany, France, Great Britain, Italy, Belgium, Luxembourg, the Netherlands, Denmark, and Ireland. Its combined population was nearly a quarter of a billion people, and its gross national product approached $800 billion. Its economic growth had been truly remarkable: in the preceding fifteen years, the combined output of these nations had more than quadrupled. Unemployment averaged only 2.5 percent in 1973, and workers had to be imported into the Common Market from poorer nations.

By early this year, economic growth had all but halted. Industrial output was dropping at an annual rate of more than 6 percent. Unemployment had risen throughout the Common Market to nearly 7 percent, while inflation remained at more than 12 percent. The Common Market’s trade deficit with the rest of the world had doubled from the preceding year, and the ecu, which is the nominal currency of the Common Market, had lost 16 percent of its value against the U.S. dollar from the previous year. Several EEC members had begun to resort to covert forms of protectionism against fellow members of a union whose guiding principle was free and open trade.

What had happened to Europe’s miracle? The important economic indicators appeared to show a decline so uniform and ubiquitous that the various actions of individual governments— which themselves were often contradictory—hardly seemed relevant. The real question was whether this downturn was merely a cyclical recession or the beginning of a permanent decline in the fortunes of Western Europe.

Edward M. Bernstein, the Washington economist who was the first research director of the International Monetary Fund and a principal architect of the Bretton Woods monetary system, said recently that the tide of progress was no longer running with Europe. He pointed out that the most powerful force behind the postwar miracle was the sweeping shift in Europe from agriculture to industry. The migration of workers from farms to factories resulted in higher wages, production, and consumption. It was, however, as Bernstein put it, a “once-and-for-all event.” Europe could no longer expect the industrialization of the rural sector to fuel its economic growth. In this view, Europe’s miracle would not automatically resume when the worst of the current decline was over.

Moreover, the balance of international trade is now running heavily against Europe. In 1978, the Common Market exported to the outside world almost as much as it imported, and despite the need of most of its members to fill their energy requirements elsewhere, the EEC ran a deficit of only $3 billion. Then, in 1979, exports began to wane and the deficit rose to $28.5 billion. Finally, in 1980, the deficit jumped to $61 billion, much of which had to be financed by government borrowing at near-record interest rates. To be sure, a major part of the deficit could be blamed on rising oil prices, but cheap oil was a relic of a bygone era. And the future holds no promise of improvement. As North Sea oil and gas rapidly deplete in the 1980s and 1990s and the coal fields of the Ruhr become progressively more expensive to mine, Europe’s energy bill will drastically increase.

The shifting balance of world economic power has to do with considerably more than the cost of imported energy. The structure of extraordinarily high wages and fringe benefits in the EEC, which was built on the expectation that Europe’s miracle would go on forever, has resulted in pricing many European products out of world markets. European shipbuilding is virtually dead (with Japan producing half the ships in world trade); European steel mills find it almost impossible to compete with more modern plants in the Pacific Basin; European textile mills are losing out to Taiwan and Hong Kong; and European chemicals and synthetic fibers have to face cheaper competition from Eastern European plants that are unconcerned with conventional measures of profit and loss. The disappearance of Europe’s competitive edge is especially evident in the automotive industry, where, for example, Germany pays its workers 60 percent more per hour than Japan pays its workers. Indeed, the irreversibility of the high built-in labor costs in the Common Market has compelled economists, such as Lawrence Krause, of the Brookings Institution in Washington, to predict that many EEC core industries may be forced to migrate to cheaper labor zones in Spain, Greece, and Turkey.

More alarming, the Europeans are also losing the high-technology race in product development. The Japanese, once ridiculed as copycats, are rapidly becoming innovators in new technologies. Japan-watchers such as Herbert Passim, professor of sociology at Columbia University, are now confidently predicting that Japan will surpass Europe in creating sophisticated new industries in everything from genetic engineering to main-frame computers. This, and American dominance of defense and space technology, could leave Europe dependent on its declining base of heavy industry.

Finally, Europe has had to adjust to a redrawn geopolitical map of the world. Zaire is no longer the private elephant park of a Belgian king; the Persian Gulf has ceased to be a British-occupied pond (Britain removed most of its military forces from the Strait of Hormuz and the Trucial States only in the 1970s); and Algeria is no longer part of metropolitan France. The colonies cannot be relied on as cheap sources of raw materials or as captive markets. But even worse, former colonies can now compete directly with former motherlands.

As Nathaniel Samuels, a director of Lehman Brothers Kuhn Loeb, suggested recently, new and highly sophisticated industries such as electronics can be set up almost as easily in lessdeveloped countries as in Europe. And the Common Market cannot continue to count on expanded trade with the communist nations of Eastern Europe.

After the Polish uprising (and a lesspublicized Rumanian economic purge early this year), West European businessmen had to make drastic changes in their assumptions about the reliability of their East European trading partners. Because of political unrest and other internal factors, Eastern Europe is being forced to divert resources from the production of export goods to domestic consumption; its trade balance is growing increasingly precarious—and its ability to repay loans is increasingly doubtful. Western banks had little choice in April but to agree to “reschedule”—or defer for years—Poland’s payments on its $25 billion debt. (And in the future the debts of Rumania, Hungary, and Yugoslavia—collectively another $32 billion—may double the problem.)

Western Europe, caught between increased competition from the Pacific Basin and diminishing markets in the Third World and Eastern Europe, appears to have reached the end of its miracle. Some European leaders have found it convenient to blame OPEC or high American interest rates or each other. And the optimists among them, believing that what goes down must come up, wait complacently for the business cycle to lift their economies from trough to peak again. None of them seems willing to appreciate that it is the nature of miracles to come only once.

—Edward Jay Epstein and Jeffrey Steingarten