The immediate economic outlook for the leading industrial countries is gloomy indeed. For the first time in my memory, all these countries, the so-called G-7, are either in a recession or very close to one.
Europe would have entered a recession earlier had it not been for German unification, which in economic terms was equivalent to an enormous Keynesian-type shot in the arm through deficit spending. Transfer payments of nearly 150 billion deutschemarks last year to the eastern part of Germany tremendously stimulated purchases of goods and services from western Germany and elsewhere in Europe.Until the middle of last year, Germany was without question the growth locomotive for the rest of Europe. Now, however, eastern Germany has suffered a 50 percent drop in industrial production. I hope it has hit bottom and will begin to move upward. Even so, the slow recovery from such a steep decline will offer only a very small contribution to the short-term prospects for general European growth.
The official estimate for German growth in the coming year is on the order of 1.5 to 2 percent, which I find too optimistic, especially since the recent wage settlement between the German steel companies and the unions for an increase of more than 6 percent is so far out of proportion to productivity increases that it has prompted debate over whether west German industry can remain competitive on the world stage. Such a settlement threatens to entrench poor German growth prospects even further.
Additionally, as a result of public sector borrowing related to German unification, the public sector deficit stands at an historically very high level of 5-6 percent of gross domestic product. Inflation is at 4 percent, historically very high for Germany. Under these circumstances, the Bundesbank had no choice other than to boost short-term interest rates, making them higher than in the United States for the first time in my memory.
Surprisingly, at least for some people, the Bundesbank's action has caused long-term interest rates to decline to nearly 8 percent, more or less what they were before unification. This is due, in my view, to the fact that the short-term moves of the Bundesbank reaffirmed its credibility, bolstering the confidence of the financial community. However, the German government's current wrong mix as far as fiscal and wage policies are concerned is a threat to economic growth, not only for Germany, but for Europe as a whole.
In spite of these concerns, the prospect for economic expansion in Europe is far more encouraging in the medium and longer term. The enlargement of the European Community is one of the most remarkable events in recent European history. An integrated market will come into being with no barriers to trade or capital flows or people. In terms of purchasing power, it will be the largest single market in the world.
This new Europe is, de facto, very close to economic and monetary union if EMU (European Monetary Union) is defined as an area without restrictions on trade, services and capital, and with fixed exchange rates. As a matter of fact, stable exchange rates now prevail over a huge area. Since 1987, there has not been a currency realignment among the countries that constitute the European Monetary System. Even non-EMS countries such as Austria, Switzerland, Norway, Finland and Sweden have for all intents and purposes joined this block of fixed exchange rates.
Another encouraging sign is the fact that inflation has declined in all European countries, except for the moment in Germany. To be sure, this is a matter of concern since the deutschemark is the standard for all of Europe.
But I remain hopeful that this is temporary because of the special public spending demands of unification. Because of generally low inflationary expectations across Europe, I would predict that there is a very good chance for lower long-term interest rates in Europe. In the United States, they have already declined substantially.
Of course, these rosier long-term prospects depend on coming to a final agreement on GATT (General Agreement on Tariffs and Trade) among the leading industrial powers, which, shamefully, has not been possible so far. Europe is certainly responsible to a certain extent for the lack of success so far.
It is time to recognize that the EC agricultural policy of maintaining extremely high farm subsidies is no longer sustainable. First of all, it has just become too expensive. More importantly, it is not sustainable because we have to open our markets not only for developing countries and U.S. products, but also to the products of eastern Europe, and these are mainly agricultural products.
The G-7 industrialized group must find its way not only out of the present gloom, but also has to turn to the problems of Eastern Europe and the former Soviet Union, what, Jacques Attali, the head of the European Bank, fittingly calls "Far Eastern Europe." This, I think, will be the real issue for the EC in the years to come.
1992 New Perspectives Quarterly
Distributed by L.A. Times Syndicate