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Doldrums or depression? The meaning of the latest economic indicators may be unclear, but at best they are signaling a pause in the economic recovery of the major industrialized nations and a new wave of political malaise. The speeches read by financial officials at the October International Monetary Fund-World Bank meetings in Manila extolled the economic improvements expected in 1976. Regrettably, however, most of these set pieces had been written before the August holidays, and when the ministers returned home many were confronted with the stark reality of economic stagnation, persistent inflationary pressure and balance-of-payments deficits. The first question, therefore, is whether the journalists are correct in labeling the current economic scene as a pause in the recovery or whether, in fact, it is the onset of a premature cyclical downturn.
The economic indicators can be read as part of a temporary loss of steam, but they may also augur a more fundamental downward shift in the potential growth rate of the by-and-large wealthy countries which comprise the Organization for Economic Cooperation and Development (OECD). The postwar economic boom may have finally run its course, and relatively high welfare and consumer satisfaction in most European countries, together with the constraints of ecology and limited natural resources, may now dictate a lower GNP growth rate than has been achieved during the past three decades-perhaps even zero growth. In addition, however dimly the social process may be perceived, increased questioning of the altered role of economic man within the state has itself set in motion modes of economic and political behavior which do not always serve to promote stability and confidence.
The self-interest of governments, which rightly regard economic stagnation as a threat to their tenure, argues against recession scenarios. But whether existing governments can reverse the direction of policy toward stimulation in time is by no means clear. Moreover, even a more positive economic policy is likely to be offset to a large extent by the defensive behavior of consumers and business fearing another round of inflation. Finally, the challenge from militant, non-ruling political factions, notably in Italy and Britain, may frustrate official efforts to sustain economic growth.
Looking toward 1977 and beyond, the near-certainty is that growth rates will be moderate at best; the probability is that they will be quite low; and the possibility is that they will turn negative. And, as always, the real cause for concern lies less in the statistical level of economic activity than in the fact that, if the recovery fails, unemployment could rise and upset existing social and political balances in the direction of instability and authoritarian government, either Right or Left.
As a cause of the prospective economic slowdown and political difficulties, the high and possibly rising price of crude petroleum is outstanding but by no means alone. Because the economic alarms following the 1973 oil price hike were in many ways false or at best misleading, one hesitates now to play Cassandra. A failure to warn, however, would be to turn a blind eye to an impressive list of interlinked depressive forces. The difference between 1973, when crude petroleum prices rose by more than 300 percent, and the current period is not so much in the proximate source of the problem as in the nature of its impact.
For 1977, oil prices are already sufficiently high-quite apart from whether the Organization of Petroleum Exporting Countries (OPEC) raises them still further-to depress world production and employment by lowering domestic and net export demand in the oil-consuming countries at a time when the world economic recovery is still very hesitant. And one must now presume that the tolerances in the world's financial structure that permitted the financing of balance-of-payments deficits from 1974 through the current period are now close to exhausted for many major international trading countries-and that as private individuals and corporations opt out of the role of petrodollar recyclers, official and semiofficial bodies will be slow to take their place.
The average per barrel price of Arab light crude moved from $2.50 in 1973 to $10.75 in 1975 and $11.50 in 1976. (Although there has been no large change in 1976 in the posted price of the Arab light crude which other producers use as a benchmark in setting their own prices, the prices of many other crudes have been adjusted down or up to reflect the pattern of market demands.) In practical terms, the outlook for 1977 is that a compromise will be struck, within OPEC, between the Venezuelan and Iranian proposal-for a 25 percent hike-and what appears to be the Saudi Arabian position that the price should be raised by a lesser but as yet unspecified amount-leading to an increase in the 5-15 percent range, possibly 10 percent. We may know in December, at the time this article is published. Of course, as in 1975, the announced increase for Arab light crude may exceed the weighted average of price hikes for all oils; the larger the announced increase in Arab light crude, the greater the potential gap due to differences in the quality of oil shipped and the amount of discounting.
For a first cut at analyzing the situation for 1977, the most useful working assumptions might include:
(1) The average price of a barrel of crude will rise by ten percent, to $12.66.
(2) The average national product elasticity of demand for oil will remain close to unity, i.e., for every percent increase in real GNP there will be an equal percent rise in oil consumption.
(3) Most countries will have to import 100 percent of additional oil demand. The United States, however, should begin to receive oil from Alaska in the fourth quarter of 1977 and Britain will obtain substantial additional benefits from the North Sea. Other countries, including Egypt, Mexico and India, should be able to bring new oil sources on stream in 1977 and improve their individual positions, but not enough to significantly affect world supply and demand patterns.
(4) Governments of oil-consuming countries (industrialized and less developed) have been planning on real growth rates in 1977 which would aggregate about five percent. Exceptions are Italy and Britain, where three percent growth is regarded as more appropriate.
On these assumptions the increased oil bill for importers in 1977 might amount to $20 billion, most of it in payments to OPEC, and more than three-fourths by OECD nations. (The U.S. share is $5-6 billion.) Total exports of oil and other products by OPEC countries might expand from $122 billion in 1976 to $140 billion in 1977.
The OPEC countries have surprised the world-and often themselves-by the speed with which they have been able to increase their imports. Nonetheless, Saudi Arabia, Nigeria and some other OPEC countries have increasingly had to delay domestic projects because of incapacity to absorb them at the pace initially envisaged, while Iran and several other nations have had to trim spending plans in order not to exceed prospective revenue flows. Accordingly, OPEC's imports may increase by only $15 billion so that the aggregate merchandise trade surplus would go up by $3 billion.
Interest and dividend receipts of the OPEC countries should rise significantly in 1977 (by $2.3 billion) as they increasingly invest their growing portfolios in longer term, higher yielding assets. This should be more than offset, however, by rising OPEC payments for transportation, other services and private transfers. Taking official transfers into account, it appears that the OPEC current account surplus in 1977 could amount to about $50 billion, only slightly greater than the average of the preceding two years.
While on the surface this may not appear especially dramatic, it is worrisome, in the first place, because the corresponding payments deficit will be shared unequally by oil-consuming countries and because the 1977 payments imbalance will be in addition to a series of large current account deficits which, as noted, have already strained the fabric of the international trade and payments system. The United States, because of its relatively firm economic recovery and moderate inflation rate, will probably see its current account surplus reduced by about $14 billion in 1976 to near zero. Other countries are less fortunate: Canada appears to have entered into a period of persistent large current account deficits; Japan has been able to approach payments equilibrium only by slowing the level of activity at home while pressing its exports into increasingly inhospitable markets; and France is finding her external deficit especially burdensome in the face of a troubled political scene and domestic economy. Similar payments difficulties abound in most parts of the globe.
Compounding this situation, most oil-consuming countries (excepting the United States) have now put into practice many of the more obvious and less costly means of energy conservation. In addition, many have eroded and in some cases virtually used up their international lines of credit and ability to float bonds abroad, and some have depleted their reserve assets in an effort to sustain economic activity levels. For an increasing number of industrialized and developing nations, therefore, balance-of-payments deficits have become even more of a depressant on growth than normally. By curbing their imports, they have not only constrained their own development but also reduced the exports of others.
Although the impact of the 1973 oil price hike in stoking inflation was all too clear, its effect on growth was less well understood. It was only with great difficulty that the Secretary General of the OECD, Emile van Lennep, and others managed to make clear the extent to which (and the mechanisms by which) the 1973 increase in oil prices depressed world GNP. For most nations the escalation of energy costs which took place in the course of 1973 did not immediately affect GNP by causing tight monetary conditions and financial shortages. Funds tended to reflow to the importing countries where they were needed through a variety of private and public channels. Instead, the depressive impact came from the disruption of income and spending patterns. The insecurities caused by the unstable world petroleum situation led consumers, investors and importers to become more cautious. Moreover, by transferring purchasing power from nations with high consumption levels to OPEC nations where the short-term capacity to spend was more limited, the higher oil price had the same negative impact on GNP as a tax levy. The interplay of higher oil prices with the existing economic excesses of 1973 also led to a race to build inventories and raise prices. When governments finally acted to curb aggregate demand, higher oil prices contributed in no small way to the depth of a recession whose seeds had been sown well before October 1973.
The increase in petroleum prices from the beginning of 1973 to early 1974 amounted to roughly $9.00/barrel; the assumed ten percent increase in 1977 would raise the price by $1.15/barrel. But even if the absolute amount of the 1977 increase is only one-eighth as large as in 1973 and represents but a fraction of one percent of total GNP in consuming nations, it would come at a time when the international economy is walking with feet of clay. The fragility of many national economies, both in Europe and the less-developed world, has already caused many of these countries to cut back development targets. An additional boost in oil prices will incline them to retrench further, and, as they do so, even the strongest world economies will have their growth rates reduced.
The heavy reliance on export sales to non-oil developing countries appears as an especially serious potential problem for Japan, France and Britain. Even the German economy would be adversely affected by a slump in world demand for the capital equipment which comprises roughly half its exports. The United States is also vulnerable, but in view of its improving competitive position in world markets and the small role that international trade plays in its GNP relative to other countries, it might not be as affected as many others.
Because inflation is a dynamic phenomenon, as dependent on the behavior of individuals as on any mechanical economic relationship, it is not possible to know with certainty what effect a ten percent rise in oil prices would have on price levels in importing countries. It almost certainly would directly boost inflation rates by close to 0.5 percent, a significant amount psychologically and perhaps practically-witness the acute attention economic and financial observers and the stock market give to each monthly announcement of the consumer and wholesale price indexes. There is little doubt, moreover, that this would be magnified by sympathetic price increases for other products, albeit limited by the deflationary effect of slower GNP growth. What is clear, however, is that, contrary to the experience of 1973-74, the impact of higher oil prices in 1977 will probably fall less on inflation than on real growth and the balance of payments.
Clearly, the preceding analysis is broad-brush and naïve, since it cannot fully reflect interlinkages of the world economy-the reality that the situation of each nation is materially affected by what goes on elsewhere. One reason why the current European and Japanese economic recoveries were so late in coming was the Alphonse and Gaston behavior of governments; each hoped to have its economy stimulated by export demand and delayed introducing expansive domestic policies. The present danger, suggested by the fact that the official projections of major trading nations show total exports adding up to significantly more than 100 percent of imports, lies in the possibility that many individual governments will independently seek to improve their international payments and inflation positions by restricting imports and domestic demand. Should this occur, national policy targets would probably be only partly fulfilled and at great cost. Whereas theoretically it is possible for oil consumers to improve their payments positions relative to OPEC, if they all act simultaneously to curb aggregate demand, unemployment could soar and production plummet, spelling political and economic instability throughout much of both Western and Eastern Hemispheres.
In sum, the outlook forcibly argues that the assumption of a five percent GNP growth rate in most OECD countries is optimistic, particularly if one assumes a ten percent boost in oil prices. (At lesser GNP growth rates the quantitative impact of high crude prices would become somewhat less acute, but would still constitute a major negative element in the OECD economy.) On an overall basis, one must conclude that the impact of an oil price increase would be extremely serious.1
It would be wrong to place emphasis solely on a prospective increase in crude prices. Other developments totally unrelated or related only tangentially to oil are also casting an ominous shadow over prospects. The first of these, which cannot be dismissed even though it has somewhat technical economic origins, is a weakness in the current recovery phase of the business cycle. It is well illustrated by the case of Germany, Europe's strongest major economy, and one looked to-along with Japan and the United States-as the engine that can pull others up, or down.
Consumers in Germany increased their personal outlays for automobiles and other products in 1976, but largely by reducing their rate of savings. Because wages and the rate of inflation have increased at roughly the same rate of speed, real incomes have hardly risen. This, combined with the lingering high rate of unemployment and traditionally conservative German attitudes toward spending, suggests that consumption will not be buoyant in 1977.
Business too will provide only moderate support for the real growth rate. The stimulus of moving from inventory liquidation to accumulation is past and with relatively few exceptions new plant and equipment spending is not slated to increase very fast. This is especially disappointing to policymakers because even though company profits have not regained the 1972 level, they are a great deal better than in 1975 due to a conscious decision by the Bonn government to stimulate investment by raising the share of national income going to business at the expense of workers. The small increase in investment in prospect for 1977 will not only fail to give the total economy the upward thrust which it usually provides at this stage of the business cycle but, because it is highly capital intensive, will also do little to alleviate the unemployment problem. The cause of this investment drought and its consequences are major issues to which I shall return.
Budget policy is likely to be still another depressant on Germany's growth in 1977. Although government spending still exceeds revenues, the size of deficits is shrinking; in effect, government is now pumping less purchasing power into the economy and may exert even less upward push in 1977.
The export sector is almost universally cited as the leading edge of the German economy in 1977. But even this may be an illusion. True, export orders are booming. But is it not true, given the almost 50 percent emphasis on capital goods, that these orders are more likely to be filled over the course of five years than five months? Moreover, in noting the rapid increase in current export shipments, most analysts seem to overlook the still more rapid increase in imports. Germany's current account surplus-already down to an estimated $2.5-3.0 billion in 1976-should continue to decline in 1977, thereby tending to curb the level of domestic activity.
If Germany's real GNP grows at only two to three percent in 1977 (half of what the Bonn government and four out of five of the major economic institutes have predicted) the impact may be less on Germany than its trade partners. A major assumption of the "Plan Barre" is that France will be able to take advantage of a more than four percent German growth rate and an eight percent rise in the imports of its trade partners, to increase the volume of its exports by ten percent. This target now appears suspiciously high. Plan Barre is comprised of a variety of economic measures delicately chosen to curb inflation without at the same time raising unemployment or plunging France into negative growth. The difficult political compromises that will be required to implement it stand little change of success if France faces an external environment of rising oil prices and stagnant world trade. Even assuming that Giscard d'Estaing is able in the spring of 1977 to reverse the thrust of domestic economic policy by making it more stimulative, the costs of doing so may be rapid inflation, capital flight, large international payments deficits, and a sharply declining exchange rate for the French franc.
The situation of France is particularly interesting because it lies somewhere between that of the stability of Germany and the endemic weakness of Europe's sick men, Italy and Britain. While it may be too easy a generalization to say that Europe is becoming divided into two distinct groups based on their economic strength, recent history certainly does reveal the existence of significant differences in the economic performance, even of nations which are geographically contiguous and supposedly linked by close economic ties.
As conditions vary, so too do economic and social policies. In 1977, policy patterns among nations will continue to diverge, not only because of differences in natural resource endowments (e.g., the abundance of natural gas in Holland) or historical and political trends (the peculiar situation of Italy's Christian Democratic Party, for example), but due to inter-country differences in economic goals. Some countries (Germany and Switzerland) have regarded inflation as their principal problem. Others have been particularly concerned with correcting payments deficits (Italy and France), or have put emphasis on maintaining the pace of industrial activity and employment (Sweden and Denmark), or have been preoccupied with political issues (Portugal and Spain). Also important are the efforts of some nations to promote the economic role of government at the expense of free enterprise and to give income distribution priority over economic growth. The speed with which governments have reacted to emerging economic problems and the time frame in which they have sought to apply their chosen remedies have varied enormously. Finally, differences in the choice of policy instruments have magnified international disparities. Efforts to impose an "incomes policy" in Britain, for example, have yielded results rather different from the more purely fiscal/monetary measures taken by Germany or the French approach of mixing state intervention in the economy with more traditional economic policy measures.
From a European point of view, the pattern of each economy increasingly going its independent way is a source of deep concern, even anxiety; it has been demonstrated that a course once chosen is not readily altered. It is not just that the chances of accomplishing the goals of the European Economic Community-monetary union and policy harmonization-now appear to have receded. The more immediate worry is that concrete achievements of the EEC, including its common agricultural policy, industrial integration, and even the customs union, are endangered by a rising tide of economic nationalism. Indeed, it can no longer be taken for granted that political institutions such as NATO will survive the present strains in recognizable form. When Mr. Callaghan intimated in October 1976 that Britain might not be able to support fully its present commitment to the Army on the Rhine unless its friends provided the financial backing which is its due, he was uncomfortably close to opening a Pandora's Box for the Western Alliance.
Because the nexus between international economic disintegration and the new roles which governments are assuming in domestic economies is generally not well understood, it is usually not given due place among the factors causing the current world economic crisis. At one level, the disparate preferences for policy goals and means of implementation cited earlier make cooperation among states more difficult and lead to patterns of economic behavior that are not readily compatible. More fundamentally, egalitarian demands for the expansion of the public sector, and even changing attitudes to work itself among a younger generation that forms a larger and larger part of the work force-all these social and demographic trends have had a basic impact on the productivity of mixed economic systems. In many European states the urgent demands of the electoral majority make it more and more difficult for governments to maintain the vitality of the mainsprings of economic growth.
All this is perhaps most vivid in its impact on the rate of real investment, which is at best laggard and in some cases declining. To dwell for just a moment on this important question of investment, it must first be recognized that cyclical factors enter in. The economic recovery, because of its modesty, thus far has failed to utilize fully Europe's existing industrial capacity, and it is now accepted by many that the future rate of growth will be less than that achieved in the past three decades.
It is also clear, however, that returns to capital as a share of gross national product have fallen. In effect, entrepreneurship has become less profitable, a shift which could only be justified if the risk of investing had also been reduced, which it has not. If anything, recent social legislation such as laws preventing companies from laying off labor in times of recession, rapid inflation, floating exchange rates and other new features of the economic environment have increased the riskiness of business investment. In addition, the assault on established economic interests, be it in the form of progressive income tax rates, wage and price controls which squeeze company profits, or neo-Marxist efforts to achieve egalitarianism by "debauching the currency," have induced many asset holders to adopt defensive strategies such as holding gold, choosing production processes which use a great deal of capital and little labor quite without regard to the large numbers of unemployed, and diversifying their assets geographically so as to have less stake in the future of Europe.
This phenomenon is probably best exemplified by Italy, a country which enjoyed rapid economic development in the 1950s due to domestic investment and in the 1960s owing to foreign investment. Today, confidence in the outlook for private capital in Italy is virtually nonexistent. Only the government is in a position to make the investments which would complete the modernization of Italy and the social reforms which are needed. But as long as government is committed to enormous non-productive transfer payments, and with the Communist Party unable to fully mobilize the labor unions to raise the productivity of existing capital, the outlook for Italy will remain rather bleak.
A similar prognosis could be applied to Britain, although in this case there are more grounds for optimism. Not only has the government recognized the need for investment, but it appears to have initiated at least some of the political and economic reforms prerequisite to halting a long-term deterioration of Britain's economic system. Is it also true that the old-line interest groups within the Labour Party have responded to the inroads that leftist militants have made on party structure with a move to regain control? Is James Callaghan in a much stronger political position-given the alternatives-than is suggested by the press? Has there been a fundamental change in the attitude of workers as suggested by (1) the fact that 1976 has been the best year in 23 for avoiding strikes, (2) the social contract has been kept despite a fearsome inflation which reduced workers' real incomes even more than had been anticipated, and (3) the hitherto unheard-of behavior of the labor force at Ford which refused to join a handful of door hangers in a wildcat strike that would close the entire plant but rather undertook to hang doors in their absence? If the answers are yes, Britain's future prosperity may be determined by more than its North Sea oil resources.
To recapitulate, the impact of the high and increasing price of petroleum on balance-of-payments deficits, rising international debt burdens, the threatened early aborting of the business cycle upswing, disparate economic performance and policies, and depressed investment-these together add up to a crisis of confidence, notably advanced in Europe. Too many participants in an increasingly interdependent world economy have lost faith in their governments' ability to ensure their future prosperity. And too many governments have doubts-admittedly well founded-about their own ability to deal effectively and simultaneously with inflation, unemployment and payments deficits while maintaining their tenure in office.
For the United States, the implications of Europe's current difficulties are not clearly defined. This is in part because America's size, geographic position, natural resource assets, financial standing, and domestic economic policies provide a degree of insulation from developments abroad. Indeed, the situation of a stable, growing U.S. economy could act as a magnet for capital and human resources, thus benefiting the United States and exacerbating Europe's difficulties. The conditions already exist.
In terms of first-order effects, it is clear that a recession abroad could depress U.S. exports and, as countries and companies abroad sought to maintain production levels, increase U.S. imports. The resulting deterioration in the trade balance would tend to curb the growth of America's GNP; to put the adage of the 1950s in reverse, "If Europe contracts pneumonia the United States cannot avoid catching a cold."
True, there might be a positive immediate benefit from recession abroad in that the combination of global overcapacity in most industries and a strong dollar in foreign exchange markets would lead to a further abatement of U.S. and world inflationary pressures. A downturn might also discourage some of the more outlandish proposals for commodity cartels. Unfortunately, in the process some of the primary commodity producing nations might be deprived of a reasonable return for their exports, and also the new markets they need to diversify their economies. This would only hold back and make worse the problem of accommodation between "have" and "have not" countries.
Turning to more specific consequences, U.S. banks are especially vulnerable to renewed international economic disorder. There are several countries which are acutely in need of having their entire external debt restructured and many more which may eventually become candidates for such treatment. Although heretofore commercial banks have generally not participated in debt rescheduling, recent meetings of private bankers in London and New York to discuss Zaïre's debt indicate that the international banks are now less protected than in the past. Large-scale defaults are not now in prospect, but if banks sustain difficulties with their international portfolios this could have an important effect both on their earnings and their ability to support domestic economic progress.
One wonders whether it is purely accidental that Europe's current problem coincides with a major change in its economic relationship with the United States. For 25 years European industry gained in competitive position owing to smaller absolute dollar increases in wage levels and a faster increase in productivity, largely related to U.S. direct investments abroad. Since the devaluation of the dollar in 1971, however, it is the United States which has been gaining competitive position. European wage rates have caught up with and in some significant cases exceeded the American equivalent.
Still more important, the "investment gap" which caused U.S. companies to go abroad-the superiority of U.S. technology and managerial skills, and the shortage of capital in Europe in the postwar period-has been altered profoundly in the course of time. Moreover, the strategic investment moves necessary to take advantage of European free trade have now been achieved. It should come as no surprise, therefore, that U.S. companies are now more interested in investing at home than abroad; nor that foreign companies such as Volkswagen, Michelin and Sandoz are reacting to their newfound sophistication and capital adequacy, as well as the depressed outlook in Europe, by increasing their commitments to invest in the United States. To the extent that this represents the development of a larger two-way flow of direct investment capital, with global benefits for production efficiency, it is to be welcomed. But, insofar as it will tend to move the locus of production from a depressed Europe where it is badly needed, it will be painful.
If we ask how far European governments would permit such economic trends to proceed before taking decisive action, the danger to the United States and, more generally, the world economy is all too clear. One can take comfort that in 1975, and again in 1976, the OECD countries pledged to eschew restrictive trade practices and also that governments have generally not depressed the exchange rates for their currency as a form of beggar-thy-neighbor policy. Yet one need look no further than Italy's import deposit scheme or the high interest rates now in force in Britain, France and elsewhere, to grasp the potential of balance-of-payments deficits as justification for policies which may harm the fabric of the international trade and payments system directly or indirectly. There are many who have welcomed the breakdown of the Bretton Woods rules but few who would be pleased to see the underlying liberal principles swept away. But that too is among the dangers inherent in current economic trends.
If this gloomy prognosis is near the mark, no prescription for U.S. and European policy can look generally attractive-or be in itself decisive. All realistic alternatives must accept that economic growth rates will be well under what the OECD countries have become accustomed to in the past three decades (and what might still be achieved but for the inescapable balance-of-payments deficits). Moreover, the policy challenge is probably to develop a variety of measures, often independent of each other, which together will add up to a sensible package. And, with the lack of perfect foresight, there must be an element of improvisation and preparedness to plug leaky dikes wherever they may appear.
Future policy will not be built in a vacuum but rather on the existing array of domestic and international measures, many of which have been pursued since before 1973. These include: (1) efforts to prevent OECD and other countries from adopting beggar-thy-neighbor policies-depressive domestic economic policies as well as outright trade restrictions; (2) measures to develop new energy sources, conserve on current consumption and establish emergency procedures for dealing with material and financial crises; (3) financial support for countries which merit it by adopting balanced and internationally constructive economic policies; (4) efforts to press upon OPEC countries the economic and political consequences of their price policy and to convince them to assist directly those countries that have been most severely affected by high oil prices; and (5) a joint striving to substitute cooperation for confrontation in negotiating a better world economic order which will increase the stability of international relationships and help the poor. Although each of these avenues has been followed with some degree of success during the past three years, the task of carrying them forward has become more difficult as the underlying economic problem has grown more acute and complicated. Redoubling the emphasis on existing policies is indisputably necessary but probably not adequate to dissuade national governments from imposing siege economies which could be ruinous to existing, hard-won international economic and political relationships.
In seeking supplementary measures, however, it is easier to define what is unworkable than to invent new solutions. Clearly undesirable would be for the industrial powers to subscribe to the view, advanced to some degree by IMF Managing Director Witteveen at the 1976 Annual Meeting in Manila, that a major effort-essentially deflationary-should be made to adjust to the new terms of trade between oil producing and consuming countries, i.e., that balance-of-payments deficits should be substantially reduced. The difficulty with this solution, as suggested earlier, is that most improvements in payments positions would be made at the expense of other oil-importing countries rather than the OPEC group. Moreover, many governments could not survive the political strains that they would generate if they were to reduce domestic production to narrow international payments gaps.
Equally infeasible is the opposite approach-based on the assumption that the current problem is due mainly to higher oil prices-that real adjustment can be totally avoided if only there is a general fiscal stimulus to curb unemployment, combined with new "recycling" facilities to assure that the international flow of petrodollars helps finance investment at home and imports of would-be debtor nations. This solution is simply too good to be true. It ignores the fact that the Western economies have been built on the assumption of inexpensive energy and cannot adapt to a fourfold increase in oil prices without costly internal adjustments in resource use. Because adjustments must be made in basic structures and over time, merely compensating for higher oil prices by fiscal measures and financing is at best only part of the answer. Proposals for a general economic stimulus also fail to consider the response of domestic economic sectors which would interpret such a policy as inflationary and harmful, even if accompanied by mandatory wage-price restraints. Just as individual nations acting on their own behalf may make a mess of the world economy, consumers, investors and others can frustrate national policy by excessive wage demands, capital flight, scaled-down investment spending, commodity hoarding and other actions which seek to protect their own interests.
The opening for a constructive new policy arises in part because some countries with relatively strong balance-of-payments situations and price stability-Germany, Japan and the United States are conspicuous examples-are not currently making full use of their human and capital resources. If these nations could, without abandoning their efforts to reduce inflation, ensure that their real growth rates in the next several years will not fall below five percent, they would make an enormous contribution to maintaining economic activity elsewhere. In short, the fiscal stimulus appropriate to the current situation is both limited in amount and possible only for several stronger economies. If implemented, however, even a boost of this nature-reducing balance-of-payments surpluses, if not turning them into deficits-would help other nations to avoid the kinds of autarkic strategies that were so disruptive in the 1930s.
Equally important, if global depressive forces are to be minimized, weaker countries should resist restrictive economic policies. If they act together, they should be able to maintain small but positive growth rates, fight domestic inflation, and still permit a great deal of freedom for international trade and capital flows. In mounting a joint effort to design cooperative national economic policies-affecting a wide range of variables, from international trade to domestic inflation-the machinery for coordinating the economic policies of the Western industrial powers is already present within the OECD, the Bank for International Settlements and elsewhere. What is needed for the future is not new institutions but an upgrading of existing bodies so that nations not only discuss economic policies among themselves but change their policies to reflect communal as well as strictly national interests.
Although it will also be useful to arrange get-togethers where heads of state and senior economic and political officials can exchange views, several factors argue against frequent use of this device. In the first place, such gatherings, if they are not large and unwieldy, tend to raise the specter of elitist or hegemonial management. This could dampen international cooperation, which will require not only leadership but a sense of general participation. Few developments would be more unsettling to the international community than the apparent evolution of a "special relationship" between the United States and West Germany, or among some slightly larger group. Second, for the heads of state or government to get together without being able to advance new solutions to outstanding problems could be worse than if they never met.
A test case for international cooperation may be the United Kingdom. If the internal dynamics of the British economy are now improving, as suggested earlier, recognition of this fact should induce the international community (particularly Germany and the United States) to rally behind Mr. Callaghan. This is not to say that Britain should be excused from accepting realities such as the demise of sterling as an international currency or the need at least temporarily to halt the progress of welfare legislation. (An external bond issue denominated in dollars or special drawing rights [SDRs] would be appropriate to the first of these concerns; limits on money supply growth imposed as a condition for an International Monetary Fund credit, to the second.) The detailed prescription for Britain may, in fact, be less important than an international show of confidence in the government. By halting the slide in sterling's foreign exchange rate and easing inflationary pressures, this would at least give breathing space for existing policies to take effect.
The British case underscores the significance of confidence as a prerequisite for avoiding crisis. To obtain confidence and implement needed economic policies, however, will require considerable skill and ingenuity on the part of both public servants and private individuals. To this end, and with the conviction that the IMF and international bodies should play a major role, the Fund might want to gear up the "wise men" procedure it has used in the past to mobilize international support for solutions to major economic problems. Because the persons involved in such an exercise would necessarily be experts, they could produce practical benefits even before the new U.S. Administration has been organized and has developed the working relationships which will permit it to assume its full responsibilities.
The immediate problems of Britain also illustrate the opportunity for greater U.S. leadership than has been displayed since 1971. Almost without exception, foreign officials have the impression that they have been confronted by a Washington which does not understand or is unsympathetic to their desire for more cooperation in narrowing exchange-rate fluctuations and other issues which they regard as important. Although domestic problems may limit what actions a new U.S. Administration can take on others' behalf, setting an international tone which is ecumenical, non-strident, non-dogmatic and non-ideological would open doors for constructive cooperation which have long been closed. To embark on a course of more active U.S. leadership would entail some costs to this country-including satisfying prior obligations to finance the International Development Association and a new commitment to some arrangement like the financial "safety net" which Congress has thus far rejected-but these would be small relative to the size of the U.S. economy and would not, as some fear, return America to its previous role as world guardian.
Taken cumulatively, the actions outlined above represent a useful first step that should render the world economy measurably stronger than it might be in their absence. Moreover, unlike more radical or less subtle policy prescriptions, they do not risk serious adverse side effects.
Economic policymakers must recognize two major facts about the future. First, natural forces operating over time will eventually ease the pressures now emanating from the world petroleum situation. Cartels do not have infinite lives and the combination of new energy sources, energy conservation and growing OPEC demand for imports will one day narrow the difference between the price of energy and the cost of production. Second, demographic, geopolitical and other changes will require imaginative new approaches to the traditional economic goal of growth with social justice. Neither the stock remedies of the neo-Keynesians and monetarists, nor the seductively comprehensive answers of the econometricians, will be able to substitute for thoughtful and practical attention to political-economic issues as they develop.
1 This view is similar to that of Henry Wallich, a Member of the Board of Governors of the Federal Reserve System, who has said that a significant oil price rise would bring recovery to a grinding halt (Newsweek, November 15, 1976, p. 85). Professor Richard N. Cooper of Yale, in contrast, reportedly perceives the difficulties as well within the scope of counteracting public policy (The New York Times, November 3, 1976, p. 65).