Russia Thinks America Is Bluffing
To Deter a Ukraine Invasion, Washington’s Threats Need to Be Tougher
The performance of the world economy in 1983 is difficult to characterize. For the industrialized market economies-members of the Organization for Economic Cooperation and Development-it was the year of the long-awaited recovery after the second oil shock of 1979-80. World trade began to revive after two years of stagnation and decline. There was continuing good news about inflation in the OECD area. Business and especially consumer confidence improved. A major rupture in the world financial system was averted through effective, concerted crisis management led by the International Monetary Fund, whose role was further enhanced by an infusion of new resources. The heavily-indebted developing countries demonstrated considerable progress in external adjustment: indeed the largest Latin American debtors accomplished an amazing turnaround in trade performance.
It was also a year when the seemingly inexorable rise in unemployment continued in Europe. The state of global indebtedness was (as usual) hard to assess statistically, but by year-end the sharp slowdown in international bank lending looked ominous in the light of the estimated needs of the major debtor countries, already showing signs of the political and social strain of adjustment. It was a year of new and renewed protectionism. In 1983 (like 1981 and 1982) the debate about deficits in the United States raged on and was unresolved. Interest rates, which had stopped falling by the spring, were gingerly nudged up, and wobbled irresolutely thereafter.
The word "interdependence" reemerged with new emphasis in 1983 discourse. Prime Minister Robert Muldoon of New Zealand summed it up at the spring OECD ministerial meeting when he said that 1983 was the year that interdependence "leapt out of the textbooks and . . . arrived on ministers' desks everywhere." The word was used to mean several things, not always clearly distinguished by the user. It embraced the neutral, descriptive term of increasing economic linkage among countries, both within the OECD and non-OECD world, through trade and financial flows. It covered, as well, a somewhat different notion, i.e., the complex interrelationship among the major forces shaping the present and foreseeable world economic system: debt affecting trade and vice versa; exchange rates affecting trade and vice versa; exchange rates affecting debt and vice versa. These two different (though related) meanings of interdependence have different policy implications in both domestic and international dimensions. But, at bottom, interdependence conveyed a sense of amplified risk, both upside and downside. The opportunities for joint gains everywhere and in everything are enhanced by interdependence but vulnerability-everywhere and in everything-is also increased. In 1983 there was this sense of amplified risk and, even more, of amplified uncertainty.
How should one characterize this mixture of good news, bad news and no news? The atmosphere was one of attentisme: 1983 was a year of marking time.
It was a year of marking time in another sense: a year of anniversaries. October was the tenth anniversary of the Arab oil embargo and the first of the two OPEC shocks that dominated the deteriorating economic performance of the 1970s. The post-1980 decline in oil and energy prices (in part a consequence of OPEC-induced recessions, in part a consequence of OPEC-induced improved energy efficiency) was a significant factor in the onset of the recovery.
Other anniversaries were important too. August 1983 was the first anniversary of the great Wall Street bull market, which by year end, however, had failed to surpass the record of its only rival (since 1884, when Charles Henry Dow launched The Index), the Bull of 1932-33. In June, Paul Volcker was reappointed to a second term as Chairman of the Federal Reserve Board, and October marked the fourth anniversary of the arduous American quest for credibility in the war against inflation, which had been launched by the recently-appointed Governor Volcker in 1979 and entered a new and delicate phase in 1983. Having successfully weathered the danger of perverse market reaction to the easing and move to a more flexible and pragmatic stance in the fall of 1982, what might be described as an exercise in monetary fine-tuning was launched in the spring of 1983. So far, applause has drowned out the boos and catcalls. The North American recovery (initiated in good part by the 1982 easing of monetary policy with an assist from Wall Street) may have slowed but didn't abort.
Another auspicious anniversary-the centenary of the Metropolitan Opera Company-provoked a search for a musical analogue for the year. The dramatic events of 1982 were obviously Wagnerian, but the sounds of 1983-the lilting American recovery played against a dark rumbling overseas and to the south-remained musically elusive. And yet, the lyrics of a catchy little tune nagged this observer while reading the financial press and official pronouncements on the state of the world economy. They go like this:1
Whenever I feel afraid
I hold my head erect
And whistle a happy tune,
So no one will suspect
While shivering in my shoes
I strike a careless pose
And whistle a happy tune,
And no one ever knows
The result of this deception
Is very strange to tell
For when I fool the people I fear,
I fool myself as well. . . .
The most important development of 1983 was the OECD recovery. Since the end of 1980 forecasters had been predicting such an upturn.2 Thus, its actual arrival was initially greeted by some with a certain skepticism or, at least, a sense of déjà prévu.
The major forces which led to the recovery were: the disinflationary process itself, stimulating consumer spending and a turnaround in inventories; the easing of monetary policy initiated in the United States and then matched by most other OECD countries (least in Japan); and the expansionary thrust of U.S. fiscal policy with its present and prospective budget deficits. The pace and nature of the upturn, however, differed markedly among the major "blocks" of the OECD-North America, Europe and Japan-and were also affected by developments in the non-OECD world and by "systemic" factors such as the international financial and trading systems.
Thus it was estimated at the end of the year3 that the aggregate of the gross national products of the OECD countries had grown in 1983 by just over two percent. For the United States and Canada, however, the rate appeared to have been between 3 and 3.5 percent, in contrast to an average for Europe of one percent.4 Japan, the only major OECD economy where activity has been maintained since the second oil shock, appeared to have continued growing at over three percent, above the OECD average but well below Japan's own historical standards.
This divergence was amplified when one considered the unemployment picture. In North America the growth pick-up has led to some cyclical re-absorption of labor: unemployment rates, while still high by postwar standards, have been reduced-in the United States from an end-1982 peak of nearly 11 percent to 8.2 percent, with a similar trend in Canada where rates, however, remain higher. In sharp contrast, European unemployment rates have continued their steady rise and by the end of the year appeared to have climbed another full point (two million persons) above the 1982 level, reaching approximately 18.5 million or nearly 11 percent of the labor force-more than triple the rate in 1973. Of this total, in many European countries between one-third and one-half are long-term, hard-core unemployed, who have been without work for a year or longer (the comparable figures for North America are between five and eight percent).5 After no employment growth in 1980 and a cumulative decline of 2.25 percent in 1981 and 1982, European employment is continuing to fall, though at a moderating pace.6 Finally, while Japanese unemployment edged upward (from 2.4 percent to 2.7 percent between 1982 and 1983), it is strikingly low by international standards and would remain so even if adjusted for the uniquely Japanese practice of labor hoarding in large enterprises.
The pattern of divergence did not apply on the inflation front; there the deceleration, unexpectedly rapid in 1982 and into mid-1983, appeared to have moderated somewhat for the rest of the year throughout the OECD. The pace of disinflation slowed because of some pickup in commodity prices (excluding oil, which fell during 1983 about 15 percent in dollar terms from its 1982 level) and some rebuilding of profit margins-and because the dramatic descent, from the 14-percent peak in the first half of 1980 to an overall rate of 3.5 percent in the first quarter of 1983, left little room for future big gains.7
Moderate wages and cyclical (and, especially in the United States, secular) gains in productivity are now the essential sources for further disinflationary momentum, as well as for successful consolidation of progress that has already been made. While the decline in inflation during the recession was common to all OECD countries, rates still vary substantially-from the lows of Japan (1.5 percent), Germany (three percent) and Switzerland (3.3 percent) to nearly 15 percent in Italy and the robust double digits of the high-inflation Mediterranean countries. A modest acceleration in the United States in the last months of 1983 still left the annual rate below four percent, well under the 5.8 percent of 1982.
It seems, then, that the elusive recovery is on its way, reasonably so in North America and Japan, barely so in Europe. The big bang in disinflation is over but the gains appear, by and large, successfully consolidated.
Why the pattern of divergence? The recession, after all, had a common "cause"-the second oil shock and the synchronized policy response undertaken by the major OECD countries to prevent the external price pulse from embedding itself into the already high underlying rate of inflation. On its own terms-fighting inflation first-that policy was unexpectedly successful. Inflation peaked earlier, and at a lower rate, than after the first oil shock and decelerated far more rapidly than expected. However, output also fell more than expected: in effect, nominal GNP (gross national product, the combination of prices and output) was weaker than expected or intended. Further, the transition to renewed growth, for which lower inflation and the avoidance of another severe profit squeeze (as in the mid-decade shock) were considered essential prerequisites, proved longer than had been hoped for when the "inflation first" policy was launched.
Be that as it may, the lower inflation itself was considered by some as both necessary and possibly sufficient to produce renewed growth.8 Indeed, consumer response to lower inflation has been an important factor in the European upturn. But divergent recovery patterns are not simply the result of differing inflation rates: a number of European countries have achieved lower inflation rates than has the United States. More important, no doubt, are the greater structural rigidities in European markets, especially in contributing to the far larger structural component of European (than North American) unemployment. While these structural phenomena surely affect European growth potential or longer-term growth trends, it is harder to assess their role in a short-term recovery from a growth performance which has been, throughout the OECD, well below "potential." It is therefore necessary to probe a little deeper into the forces shaping the recovery both in Europe and the United States (as well as Japan) to understand the differences. The persistence of divergent growth is dangerous to the functioning of the industrialized market economies as a whole, leading, as it may, to increasing threats to the open trading system as well as heightened political and social strain.
Since the second oil shock the U.S. economy has gone through a series of short, hard-to-predict cycles, as though it were bouncing between a floor constructed of a thrusting growth dynamism and an expansive fiscal policy, and a ceiling set by a strong anti-inflationary monetary policy. The proximate force propelling this recovery was the lifting of that monetary ceiling in the summer of 1982, with the subsequent steep decline in nominal interest rates and the dazzling stock market rally. American consumers, who had earlier been cautious and fearful of rising unemployment, were in a highly liquid position which was improved by the personal tax cuts and the increase in wealth from equity holdings (more than sufficient to offset the wealth loss from declining housing prices during the recession). Household net worth increased by more than $1 trillion since mid-1982. Pent-up demand for housing, autos and durables was "released" as the drop in short-term interest rates fed into mortgage and consumer credit rates. Responding to the revival of consumer confidence, business triggered the upturn by slowing the run-down of inventories and re-hiring layoffs. The gain in employment has been widespread and surprisingly rapid by past standards. Investment has also been above average, stimulated by an atypically rapid and vigorous rebound in profits-the result of lower inflation, low wage settlements and the 1981 corporate tax changes.
At one level, it is quite plausible to describe the U.S. recovery as a not unusual policy-led upturn. But, in fact, the recovery is unusual in several respects. First, interest rates, especially long-term 'real' rates (the inverted commas acknowledge the difficulty of definition), are at unprecedentedly high levels for this stage of a recovery. (As growth picks up they would normally be expected to rise.) It is an understatement to say that there is no agreement as to the cause of the high long-term rates (or even as to their level) but one would have to take a very extreme position indeed to discount the effect of market fears of a persistent "structural deficit" (the gap between spending commitments and tax revenue that remains even at high employment levels) of near $200 billion-perhaps two to three percent of GNP.9
Such high real rates are evidently a major impediment to revival in other countries (and a serious burden for the heavily indebted developing countries). Yet the U.S. economy, so far, appears to be less interest-sensitive than other economies, perhaps for tax-related reasons, or because of the far greater importance of equity markets than in most other countries, the improved profit flow emanating from the recovery and modest wage behavior. There may be more elusive reasons-underlying bullishness, confidence, flexibility, dynamism-which are impossible to quantify but undoubtedly important. The macroeconomic consequences of a growing defense sector, likely rather interest-insensitive, may be still another factor.
The recovery is most unusual in another respect. One consequence of the high real U.S. interest rates (though other factors were also at play) has been the deterioration in competitiveness occasioned by the continuing appreciation of the dollar. So this recovery is also unique in beginning with an unparalleled trade deficit, the recession having been seriously exacerbated by the loss on the external side rather than the usual pattern of external offset to weakening domestic demand. On the assumption of unchanged exchange rates (and given the more robust U.S. recovery than elsewhere) the 1983 trade deficit was probably around $70 billion. (This, of course, was of considerable benefit to the rest of the OECD as the United States sucked in European, Canadian and Japanese exports.)
Even this may cut both ways, however. The appreciating dollar has played an important role in lowering U.S. inflation-a plus factor in the recovery. Further, the remarkable capital inflow which pushed up the dollar served to counterbalance some of the domestically generated pressure on interest rates. Eventual negative effects will depend on when, how and how far the dollar falls-and on the U.S. domestic policy response to its fall and ensuing inflation.
What is at issue is the resolution of the clash between the present stance of monetary policy-now delicately tuned to accommodate a nominal income pickup of nine to ten percent (no easy task in the face of ongoing financial deregulation and innovation contaminating the targets)-and a fiscal stance, in the form of present and prospective budget deficits, which has helped initiate the growth pickup but also threatens its longer-run sustainability either for domestic or external reasons or both. Any marked change in the severe American affliction of fiscal catatonia before the election in 1984 seems improbable.
Some of the weakness in Europe is a consequence of the unusual features of the U.S. recovery. High real interest rates, in part at least a result of the expansive U.S. fiscal stance, seem to be a far greater impediment to European than North American growth. The option of "de-linking" from U.S. rates-easing monetary policy and risking further depreciation vis-à-vis the dollar-has been rejected because of the inflation implications.
The appreciation of the dollar, as well, is seen by the Europeans as a major factor in their sluggish recovery. The rising dollar adds to the cost of imported oil (priced in dollars) and, to a lesser extent, other commodities. Further, in addition to constraining monetary policy, the misalignment and volatility of European exchange rates vis-à-vis the dollar add to uncertainty, thus engendering a "wait and see" attitude on the part of investors. It is also argued that uncertainty about further protectionist measures-provoked by the deterioration in American competitiveness-has a similarly negative effect on investment planning.
While these negative influences are important, they provide only a partial explanation of the weakness of the European outlook. The more vigorous U.S. recovery and the deterioration in American competitiveness do serve to stimulate European net exports (and help offset the shrinking opportunities in the debt-constrained Third World). The United States may no longer be as powerful a locomotive for the rest of the OECD, but it's still a locomotive. Nor is it by any means obvious that a tightening of U.S. fiscal policy and a fall in the dollar (so often proposed as the conditions essential to renewed and sustained European expansion) would provide, in themselves, a significant stimulus to European growth. The outcome would depend on the impact of the deficit reduction on U.S. growth, the response of U.S. interest rates, the stance of European monetary policy and the effects of declining European competitiveness on their net exports. Further, a fall in the dollar would likely produce renewed strains within the European Monetary System.
There would be pluses and minuses in this complex scenario but, on balance, the result seems unlikely radically to transform the present European outlook. This is not to say that a resolution of the U.S. fiscal-monetary clash or a realignment of exchange rates is not desirable (for the United States, the OECD and the developing countries) but only that the major forces affecting the European recovery are primarily to be found within Europe.
Just as this is not a standard recovery in the United States, so is it somewhat unusual in Europe. Far weaker than past cyclical upswings, it so far lacks the vigorous export boost which has typically added strength early in the recovery, and depends to a surprising degree on reduced household savings fuelling consumption. Apparently the unexpectedly rapid decline in the rate of inflation has improved consumer confidence, and has also enhanced their real wealth. (This is particularly marked in the United Kingdom, where the household savings rate has dropped an astonishing six percentage points over the past two and a half years, but is also evident in most European countries.) Oddly enough, though American consumers showed great caution and concern as unemployment rose in 1982, and Canadians continued to resist running down savings even as the recovery proceeded and unemployment declined, the marked and continuing deterioration in labor market conditions in Europe has had no discernible effect on consumer behavior.
A recovery which is heavily dependent on a reduction in household savings is unlikely to be either rapid, robust or sustainable. Further, the policy environment in Europe does not add to the forces stimulating growth. The easing of monetary policy in 1982 ended and was modestly reversed in 1983-all in line with U.S. developments. The stimulus provided by the initial decline in interest rates to consumer spending in housing and durables was significant. But the decade or more of deterioration in the profitability of enterprise in Europe and the general climate of uncertainty and lack of confidence or underlying bullishness10 present formidable hurdles to investment at the present level of long-term real interest rates. While profit shares are improving in many European countries (in part as a consequence of the moderation in labor costs during the recession) the weakness of the recovery thus far suggests that the improvement may only be sufficient to arrest the secular decline in profitability.
It is fiscal policy, however, which presents the most striking contrast with North America (the Canadian fiscal position being less expansive than that of the United States but less restrictive than that of most European countries). Deeply concerned with the large deficits which had emerged in the 1970s-a consequence of greatly expanded social expenditure and declining revenues stemming from slow growth-most European governments have sought not only to reduce the deficit but to shift the composition of both expenditure and taxation in order to reduce consumption and increase investment. Some countries have also tried to shrink the total size of government in order to improve the flexibility and efficiency of markets (seeking, in effect, though seldom in stated purpose, "supply-side" benefits). The distinction between actual and structural (or high employment) deficits, so important in the North American debate about fiscal policy, carries less weight in many European policy circles, the Germans and the Dutch being paradigmatic examples. Largely ignored as well was the impact of simultaneous tightening among the closely linked European economies, amplified through induced reduction in trade and hence activity.
The results have been disheartening-akin to running up the down escalator-for two reasons. The first is the concurrent fall in revenues and rise in unemployment compensation associated with weakening activity. The second is the higher payment needed to service outstanding debt, largely associated with the high interest rates of the past several years. Worse, deficit reduction has more often been achieved by cuts in public investment than in public consumption (the Italians-who should know-have a wise saying: "public consumption has a thousand fathers in parliament, public investment is an orphan"), or by tax increases, with adverse supply-side consequences. Ironically, the commitment to deficit reduction, proclaimed as essential to restoring business confidence, created an expectational climate which has both reduced the already constrained room to maneuver in the fiscal area and added to uncertainty and pessimism.
There has undoubtedly been no option other than a determined and continuing fiscal tightening for the high-inflation and high-structural-deficit countries of Europe, and there is a need in many European economies to reform and restructure expenditure (especially social security expenditure). But a number of the lower inflation countries are at present in approximate structural balance, their actual deficits mainly reflecting the effects of the prolonged recession. Yet further moves to tighten in Europe as a whole were undertaken in 1982 and 1983, with announced plans for the future in the same direction. Moreover, there has been less progress (Britain being an exception to some degree) in tackling the non-budgetary aspects of government-the nexus of economic regulation both within countries and within the Community-including the elaborate subsidization and tax expenditure programs and the anti-competitive practices in both product and labor markets, sustained by government action and inaction.
In sum, then, the weak recovery in Europe is largely a result of the weak dynamic forces shaping it: the post-oil-shock disinflationary process and the relatively slow growth of external markets other than the United States. External constraints on monetary policy, a restrictive fiscal stance and a failure to grapple with non-budgetary aspects of government instrusiveness either domestically or at the community level are powerful countervailing negative forces. The "experiment" in "self-levitation"-the view that low inflation and reduced government are both necessary and sufficient conditions for restoring sustainable growth through the self-equilibrating properties of a market economy-could not have been conducted under less advantageous conditions.
The danger that inherited structural rigidities will be exacerbated by a prolonged period of stagnation has been termed the "slow growth trap." The trap has many hooks: cyclical unemployment, through skill erosion and lack of job experience, becomes hardcore structural unemployment; deficits become structural; bailouts, subsidies and proliferating neoprotectionist measures reduce efficiency, productivity and flexibility; reduced investment increases potential capacity bottlenecks; low growth expectations come to dominate entrepreneurial behavior. To escape ensnarement in this trap, business fixed investment must "take over" as the engine of growth in Europe. The recent improvement in profits and turnaround in confidence are hopeful signs. But for the present the appropriate judgment on self-levitation must be the Scottish "not proven."
Finally, to complete the profile of the 1983 recovery, a look at Japan. Japanese growth had been largely maintained during 1980 and 1981 by strong exports, while adaptation to the oil price rise and to structural changes in production and demand proceeded with astonishing rapidity, as did the remarkable deceleration of prices (now below the inflation rate of the 1960s). But export volumes began to taper off by the end of 1981 and continued to drop through 1983. How much of this was due to the general weakening of world trade and how much to increased protectionism (voluntary or otherwise) is hard to gauge. But given the greatly enhanced competitiveness of Japanese exports due to the rapid development of new products, the substantial depreciation of the yen during 1982 (and again in 1983 vis-à-vis the dollar), and the extreme modesty of wage developments, it seems likely that protectionism of one kind or another has been a significant factor.
If export restraint continues, Japan will have to shift more to domestic growth; indeed, limited efforts in that direction have been taken and are planned. However, Japan's room for maneuver in both monetary and fiscal policy is seriously constricted. Unlike most European countries, the Japanese did not tighten monetary policy in early 1981 (in response to the rise in U.S. interest rates at the turn of the year) and the subsequent yen depreciation, which kindled and exacerbated protectionist pressures, has prevented any significant easing in response to the fall in U.S. rates. Given the low rate of inflation, real interest rates are very high and serve to inhibit investment, especially in the dynamic small-enterprise sector. Until sustained appreciation of the yen is assured, the scope for a significant easing of monetary policy remains very limited. (The full details of the recent U.S.-Japanese agreement on measures to strengthen the yen remain to be spelled out by the joint study group set up on the occasion of President Reagan's November visit, but seem to involve an effort at increasing internationalization of the yen.)
Fiscal policy is even more constricted. The Japanese structural deficit is presently estimated at perhaps three to four percent of GNP, larger than that of the United States (although much higher household savings in Japan make the situation less immediately threatening). The possibilities for cutting expenditure over the medium term are limited both by the continuing need to upgrade the still-inferior social infrastructure and by demographic changes which will increase social security expenditure (and reduce household savings). The Japanese tax base is far and away the smallest in the OECD and has proven, so far, politically very difficult to either extend or restructure. As the stock of public debt rises and deficits persist, the upward pressure on interest rates will mount, adding to the deficit itself-the syndrome familiar in Europe. But, unlike the Europeans, the Japanese are quintessential pragmatists in fiscal policy (fine tuning public works expenditure over the fiscal year is a fine art) and have sought to maintain domestic demand during the present period of weakened growth and rising protectionism. Nonetheless the economic predicament is real and can only increase over time.
Finally, there is a deeper dilemma inherent in the present situation, a dilemma which seriously adds to the strains within the OECD area as a whole. The proliferation of protectionist measures against Japan over the past few years has had a pernicious effect on the structural adaptability of the importing countries (see below). Mounting protectionism has, moreover, led to higher export prices for Japanese products as Japanese producers have responded to these restraints both by moving upstream in exports and, because of floor price mechanisms, increasing profit margins-thus possibly accelerating technological change (through increased research and development expenditure) and stimulating further "targeting." The vicious circle thus widens. Because the Japanese have adapted so quickly to the voluntary restrictions, the value of Japanese exports in these sectors has been affected far less than the volume. Yet some of the present weakness in investment in Japan is no doubt related to the present trading environment and to fears of further protectionism, which are impeding the desired shift in growth from external to domestic demand. Modest additional measures to further open the Japanese market to imports were taken in 1982 and 1983, but sluggish domestic growth and the weak yen have so far limited their impact. A marked increase in direct investment abroad is also a welcome development (although there is growing concern about a competitive scramble for such investment which could induce further distortions in the multilateral trading system). There are, unfortunately, few signs of more foreign investment in Japan, which would be equally desirable.
Some of the present Japanese dilemma stems from the American policy clash. But, as in the case of Europe, that is only part of the story. Japan needs to get its tax system in order and resolve its fiscal problem-politically to accept over the coming years the fiscal implications of a mature industrial society-and more vigorously to open up its markets, including the still highly regulated financial markets.
The nature and pattern of the OECD recession and recovery has been influenced by and is influencing the world trading and financial systems. The unexpectedly rapid disinflation, manifested domestically in declining output and rising unemployment, operated systemically to spawn new and renewed protectionist measures, exchange-rate volatility and misalignment, and serious debt and balance-of-payment problems in many non-OECD countries.
Since the end of the 1970s there has been, within the OECD, a slow erosion of the open trading system mainly in the form of the "new protectionism": voluntary export restraints negotiated on a bilateral basis and various types of subsidies. (With the major and important exception of the renewal of the Multi Fibre Agreement in 1981, the principal direct impact of these measures has been to increase protection among the developed market economies themselves.)
The erosion has indeed been slow. Underlying protectionist pressures, with rising unemployment and exchange rate misalignment, have been powerful; yet the system has proved remarkably resilient so far. Studies of the recent stagnation and (in 1982) actual decline in overall world trade reveal no significant causal factor other than the recession itself.
The dangers of continuing slow erosion, however, should not be underestimated. Traditional economic analysis has concentrated on the "static" efficiency costs of trade barriers. What is more important at the present time is increased awareness of the more elusive and inherently less quantifiable "dynamic" costs of the new protectionism: the reinforcement and extension of structural rigidities which further impede the capacity of the industrialized economies to adapt to ongoing shifts in comparative advantage and changing technology, and further undermine the effectiveness of macroeconomic policy. Given the divergent pattern of the present recovery and the greater flexibility of the U.S. and Japanese economies, the risks of further deterioration in the trading system may be especially high for Europe (although it would be unwise to underestimate the threat to the system which could arise if the necessary long-term adjustment of the U.S. steel industry is impeded by further politically motivated protection). In any case, a perpetuation of divergent growth patterns among the major blocks of the OECD will itself greatly intensify protectionist pressures.
As for developments in 1983, the year began auspiciously enough with a press release from GATT (the General Agreement on Tariffs and Trade) on January 3 to mark its 35th anniversary and the halfway point in the phasing-in of the Tokyo Round tariff cuts. But the flavor of the year was probably better captured by a Financial Times leader on February 15 entitled "The Drift to Managed Trade."
The occasion was a three-year trade agreement between the European Economic Community and Japan to limit Japanese exports of a wide range of products into the Community. The most important of the products were VTRs (video recorders) for which (a new twist to the new protectionism) European manufacturers were guaranteed a minimum price and a minimum production run. The agreement-the first negotiated at the level of the Community rather than individual countries-neatly sidestepped GATT as well as both national and Community competition-policy provisions, despite its cartel-like nature.
The agreement is intended to provide the time and conditions which would permit European producers to improve their competitiveness vis-à-vis Japan-an infant industry rationale for an important "sunrise" sector. But it is not clear how the big European producers are to "achieve the economies of scale and profitability which will enable them gradually to close the efficiency gap between themselves and the Japanese." One way would be through market competition, which the voluntary export agreement effectively limits. The other possibility is a European industrial strategy-as yet to be defined, let alone launched and implemented. It is important to point out, moreover, that Phillips and Grundig were in the VTR business well before the Japanese but were unable to establish a foothold in the European market.
The EEC-Japanese agreement was the most elaborate but by no means the only example of protectionism in 1983. For the most part such measures continued the trend toward "managed trade" in industries already affected by the new protectionism. Thus, in February, the Japanese renewed their voluntary export restraint on autos into the U.S. market for a third year and, in November, for a fourth year. In both instances Canada was not far behind in seeking relief from potential trade diversion. The battle over steel between the United States and the EEC, and within the EEC, continued. Europe tightened steel quotas from Third World countries. Australia unveiled, in August, a five-year protection and development plan for its steel industry. Canada and the United States undertook further measures to stem the flow of clothing imports. And so on.
It's likely that the sum of the additional protectionist measures which took place in 1983, if one could quantify their impact, did not significantly increase the portion of world trade which is now "managed"-an oft-quoted estimate (including agriculture) is 30 to 40 percent. But, despite official pronouncements to the contrary, no new initiatives either to stem or reverse the drift were successfully launched (with the welcome exception of the OECD agreement on an automatic system to reduce the subsidy element in export credits). It remains an open-and valid-question whether creeping protectionism can just continue to creep or whether slow erosion, on reaching some invisible and unpredictable threshold, will abruptly transform the world trading system.
As has already been pointed out, the main direct impact of the new protectionism has been on the developed countries. But by impeding the process of structural adjustment, no longer confined to labor-intensive consumer goods, the erosion of the open trading system will certainly affect the growth opportunities of the developing countries-and, of course, their ability to service debt and import the new capital essential to their long-term development.
A development in the steel industry at the end of 1983 provides a cautionary tale. In November, U.S. steelmakers, having won restrictions on Japanese and European imports, filed a countervailing-duty action against state steelmakers in Mexico, Argentina and Brazil charging that the three governments are subsidizing exports. Given the need for foreign currency to service the enormous debts of these Latin American countries, combined with falling steel demand and excess capacity throughout the industrialized world, the complaint seems plausible enough. But, as The Wall Street Journal commented, "the trade actions are unlikely to be cheered by the International Monetary Fund, which has been working to alleviate the debt burdens of Mexico, Argentina and Brazil."11 Similar trade actions are likely to multiply throughout the industrialized countries as the difficult and painful realignment of the world steel industry is impeded and prolonged, as the strains on the world monetary system persist and as the slow erosion of the open trading system continues. The cautionary tale of the steel industry captures the essence of "interdependence."
The characterization of 1983 as a year of "marking time" is especially appropriate to the international debt situation. Seemingly endless negotiations, discussions, haggling and dickering finally culminated, in late November, in the ratification, after bitter debate, by the U. S. Congress of the International Monetary Fund's quota increase (decided in February by the IMF's Interim Committee); the resumption of normal lending by the Fund (suspended in September); and agreement on a complex loan package for Brazil, the world's largest debtor (to whom the Fund had stopped lending in May). A rupture of the international monetary system had once again been averted and by year-end optimists could detect signs that the case-by-case approach to rescheduling, the preferred game plan of the main actors, was slowly evolving in the direction of a more coherent strategy. But the essential preconditions for a longer-term resolution of international financial strains were by no means firmly established.
The origins of the debt problem must be traced to the dramatically changed economic environment after the second oil crisis. Apart from the fact that there was some highly imprudent lending and borrowing, especially toward the end of the 1970s, and certainly domestic policies in some of the developing countries left much to be desired, the more fundamental explanation of the vast indebtedness of a number of the non-oil developing countries lies in the second oil shock and the unexpectedly rapid disinflationary process triggered by the synchronized "inflation first" policy response of the OECD countries to that shock. Shrinking markets, plunging commodity prices, a rising dollar (in which most of the debts were denominated) and an unprecedented turnaround from negative to high real interest rates made debt servicing nigh-impossible for a number of developing countries.12
Indeed, disinflation was so much faster and greater than intended in part because the extent and nature of both real and financial linkages between the OECD and non-OECD economies had been underestimated. Of course, the linkages operate in both directions. The impact of the developing countries on the industrialized economies, while quantitatively less significant than the reverse feedback, grew in importance over the 1970s. During much of that decade the non-OECD regions absorbed a rapid growth in exports from the OECD. As recently as 1981 these exports were growing at an annual rate of nine percent in real terms (whereas intra-OECD trade peaked in 1979 and then turned negative) and thus helped to maintain OECD activity in the face of weak domestic spending. The non-OECD countries were able to purchase these goods partly because of their oil revenues, but also in large part because of their heightened ability and willingness to borrow in an inflationary environment and, finally, because they could expand their own exports to the OECD. The situation now and for the foreseeable future is the obverse. The capacity of the non-OECD countries to import from the industrialized countries will be largely constrained by their ability to sell to them; indeed, their imports for a time must lag behind their export receipts if they are to cope with their excess indebtedness.
Of equal or greater importance are the financial linkages, since it is the banks of the industrialized countries who are heavily exposed to LDC (less-developed country) debt and it is that exposure, dramatically increased since the late 1970s, which represents the threat to the stability of the international financial system. The non-oil developing countries now have total external indebtedness (medium and long-term) of more than $575 billion, of which well over half is owed to OECD banks, most of it at variable interest rates, and over $100 billion to U.S. banks alone. There is, in addition, a substantial amount of short-term debt owed to private creditors. Further, the country concentration is very high: Latin American borrowers account for nearly half the total debt.13
The concentration of the debt problem in Latin America is evidenced also by the marked geographic differences in debt servicing capabilities. The IMF estimated, as of end-1982, that debt was equivalent to 246 percent of annual export earnings of the non-oil developing countries of the Western Hemisphere but only 81 percent for the Asian region.14 While information for 1983 is not yet available, projections by Morgan Guaranty Trust15 illustrate the variation among selected major LDC borrowers:
Average Debt in 1983
as Percent of Exports
of Goods and Services
As the table shows, with the exception of the Philippines the debt-export ratios are very much higher for the major Latin American borrowers. Further, a far larger proportion of Latin American debt is owed to banks and the short-term share (over one-fifth at the end of 1982) is much higher than in any other region. While it would be wrong to underestimate the difficulties in other developing countries (and, indeed, these will be especially severe in the lower-income countries with little exposure to private financial markets and little prospect of increasing development aid), it is nonetheless the concentration of risk in a few large debtor countries which poses the more serious threat to the stability of the international financial system.
The response to this threat has been a case-by-case rescheduling (and provision of new funds) managed by the IMF and involving the debtor countries, the central banks of the industrialized countries through the Bank for International Settlements (BIS), and the commercial bank creditors. (Official debt has been handled through the so-called Paris Club.) The approach, a combination of financing and "adjustment" (a mild euphemism for sometimes brutal retrenchment by the debtor country), was novel in several respects. The BIS "bridging loans" provided the debtor country with the time for the complex and difficult negotiations with the Fund and the private banks. There were very large numbers of private banks involved and yet, remarkably, they have managed to undertake joint action-albeit with a certain amount of arm-twisting by the Fund and some central banks. Indeed, the most novel feature of the approach has been "the reversal of the traditional relation between the IMF and the banks."16 Rather than using its "imprimatur" as an inducement to the banks' cooperation, the Fund stipulated that provision of its facility was contingent on satisfactory bank participation.
Judged by its success in averting a rupture in the world financial system, this case-by-case emergency operation has been extraordinarily effective. In terms of debtor adjustment, by mid-1983 the Latin American borrowers had moved to substantial surplus on their trade accounts-mainly, however, through cuts in merchandise imports. Tight fiscal, monetary and income policies and major devaluations have enabled them to meet external adjustment targets, but declining growth and rising inflation have worsened domestic performance, especially in Brazil. In that country it is by no means certain that the domestic targets set by the Fund in the new agreement can be met. Mexico, on the other hand, is regarded as well on the way to both external and domestic adjustment.
Since the onset of the "debt crisis" there have been a number of suggestions for more comprehensive plans, which are based on the premise that, in the absence of an internationally coordinated "global" solution, the scale and nature of developing country debt represents a permanent threat to the world monetary system. Although details vary, the basic approach involves a basically uniform long-term stretchout of the debt and a reduction in interest payments. These schemes have been firmly rejected at official levels, not only because they are considered politically unfeasible but also because they could well provoke the crisis they are designed to contain, by cutting off the flow of new lending to developing countries.
Given the wide differences in the economic and political circumstances of debtor countries, the case-by-case approach seems preferable. But expressions of concern were mounting as the year wore on. An emergency technique appropriate to a crisis atmosphere is likely to become less and less effective if repeated "encores" are demanded. Nor is it clear at the present time whether the "unspontaneous" lending by the commercial banks will be adequately augmented by the reduced but sustained flow of new funds essential to the viability of the debtor countries' external positions over the next several years. As of mid-year, the BIS reported some slight pick-up in voluntary lending to the non-oil developing countries, after a virtual cessation earlier in the year. But the situation appeared fragile, and in the final quarter of the year, data on international borrowing showed further retrenchment.17
There were, however, some signs of a more helpful evolution in the basic approach. Under the auspices of the BIS, a committee report clarified some worrisome ambiguities in the regulation of international banking-though deliberately not in the even more worrisome area of lender-of-last-resort responsibilities. (On the other hand, part of the price for congressional endorsement of the IMF quota increase was a significant tightening of requirements for U.S. banks which could inhibit new international lending.) Growing criticism of the arrangement fees and increased lending margins claimed by the banks involved in the restructuring operations led to a modest reduction in fees and margins for Brazil, which may presage further change in this direction. Indeed, proposals for reductions in rates, to be tied to debtor country performance in meeting Fund targets, emanated from the banking community itself.18 Further, there appeared to be a growing recognition that a longer stretch-out and grace period could well be required in particular cases (and that regulatory authorities would have to accommodate such a development). The risk, however, in pursuing both lower rates and longer terms is that they might increase the reluctance of some banks to provide new lending.
Other developments in 1983 may also serve to strengthen the cooperative multiparty strategy. The most important, of course, was the increase in the Fund's quota and the enlargement of the size and scope of the General Arrangements to Borrow (GAB) from major industrial countries. Further, the creation of the Institute of International Finance, to improve the flow of information on international debt to the private banks, could facilitate the participation especially of the regional and smaller banks and more generally bring better order and discipline to international lending. Finally, having launched some experimental co-financing techniques early in the year, the World Bank in November announced plans to embark on new borrowing ventures (to tap the short-term market) and was reported to be exploring the establishment of a new affiliate to work with commercial banks in lending for development purposes as well as a new multilateral investment-insurance scheme.19
In sum, over the short run, the most critical and uncertain feature of the case-by-case financing cum adjustment approach is the provision of adequate commercial banking flows. But assuming that the short-term liquidity problem can be solved, the longer-run condition for sustaining the indebtedness of the developing countries must involve a restructuring of their domestic economies to increase savings and expand exports (the lesson of the economically dynamic Asian newly industrializing countries and, recently, of India). This, it almost goes without saying, will require a maintenance of the open trading system. And to reestablish growth and satisfactory debt-servicing capacity the developing countries will also need an improvement in the quality of capital flows-a shift from short-term balance-of-payments financing to longer-term development funds and, desirably, more equity capital-all involving a much enhanced role for the World Bank.
Finally-and this brings us full circle-there can be no question of a longer-term solution to the global debt problem or the more pervasive systemic strains in the absence of durable, more balanced growth in the OECD countries.
The Williamsburg Declaration on Economic Recovery, issued on May 30 at the close of the ninth annual economic summit conference of the seven largest industrialized countries in the OECD (the United States, Japan, Germany, France, the United Kingdom, Italy and Canada), focused on "the challenge of ensuring that the recovery materializes and endures." To meet this challenge, the heads of state emphasized the importance of both domestic policy and international coordination of policies.
As to the former (domestic policies in the major industrialized countries) the Declaration provided a strong endorsement of the new classical economics. The way to promote recovery is "to reduce structural budget deficits." Though "structural" was a code word to emphasize the special importance of this commitment by the United States, it was nonetheless meant to apply to all the summit seven, without differentiation. However, the Williamsburg prescription is, in fact, being followed only by the European summiteers.
The divergent pattern of the 1983 recovery has already been described. The more vigorous U.S. recovery has been attributed, in part, to a modest easing of monetary policy in 1982 and to the substantial fiscal stimulus of 1982 and 1983-a cumulative swing of 1.5 percent of GNP in the cyclically adjusted budget.20 But this assessment is clearly a matter of judgment and, given the state of doctrinal dispute within the economics discipline, it is not a judgment which would be unanimously endorsed-nor would its empirical verification be easy. Moreover, and in this there would be a greater degree of unanimity, it could all end in tears because in the long run, if inflationary expectations have not been decisively destroyed, a return to high levels of employment may bring with it a resurgence of inflationary wage and price behavior.
In other words, in the long run there may be no trade-off between growth and inflation. But there does seem to be such a trade-off in the "policy run," when governments must make policy choices and assess their economic (and political) impact.21 Of course the question of the sustainability of the U.S. recovery remains open. Whether action now to ensure that the structural deficit does not materialize in the future (along the lines of the contingency tax proposal) would reduce long-term real interest rates sufficiently and sufficiently promptly to offset the impact of the fiscal contraction is also an open question and unlikely to be answered until after the next election. And that may be too late because the more immediate threat posed by the monetary-fiscal clash in the United States could well be an unmanageable slide in the dollar which would force a tightening of monetary policy and, through a reversal of the capital inflows that have helped fund the present deficit, push up interest rates even higher.
Since the Europeans are, unlike the Americans, faithfully following the Williamsburg prescription, the issue of the role of fiscal policy in ensuring recovery is perhaps more relevant for them.
Again, as a matter of judgment, given the weakness of the European growth outlook it doesn't appear to be the case that cutting deficits in recessions promotes recovery-at least not in the "policy run" (and the political cost has, so far, been surprisingly light). But, of course, new classicists don't think in terms of the policy run-for them, only the long run is relevant. So the question has to be put another way: is fiscal tightening in Europe shackling the natural, self-equilibrating properties of the economy? The implication of the question, it must be emphasized, is not an advocacy of short-term fiscal stimuli but of a less extreme restrictive stance in the present conjuncture. For Germany, the dominant economy in Europe, the cumulative estimated discretionary swing in the direction of restriction represented 3.2 percent of GNP in 1982 and 1983 with a further 1.2 percent at present planned for 1984. That could be a pretty heavy shackle for even the liveliest self-levitater.
If the dynamic sources of growth were more powerful, the fiscal stance might not be so important. Cutting deficits, after all, is intended eventually to improve confidence and produce beneficial supply-side effects. Typically, in post-war recoveries, exports have played an important role as an engine of German growth not only by directly affecting output but through their favorable influence on entrepreneurial expectations, thus inducing both capacity-expanding and cost-cutting investment. But, given the present world outlook, exports will not be a major source of growth for the present. The problem is exacerbated by the uncertainty generated by exchange rate instability and rising protectionist pressures both within and outside the Common Market. So far from being a factor strengthening confidence and improving investment, the relatively greater dependency of European (than of American or Japanese) firms on export markets has acted to reinforce the declining growth expectations of many European enterprises.
Perhaps too in this period, more than is usually the case, the role of fiscal policy in sustaining domestic demand is especially important because of the external constraint on monetary policy. An approach that moderates medium-term fiscal deficit targets in the light of the impact of fiscal stance on activity (and vice versa) seems warranted, especially in Germany and some of the other low-inflation continental European countries. (Among the major European countries only in the United Kingdom is the fiscal position neutral or slightly expansionary.) A more vigorous and assured recovery is an essential precondition for tackling the more deep-seated structural problems in Europe. In its absence, it may be impossible to avoid measures which worsen them.22
While fiscal policy was highlighted in the Williamsburg Declaration, the other major domestic policy instrument-monetary policy-was also mentioned. But specificity as to either calibration or implementation was avoided: the adjective "appropriate" was used. Perhaps this reflected the experience of 1981 and 1982, especially but not only in the United States, when the relationship between the monetary targets of the central banks and the final objectives of policy proved exceptionally unpredictable. This has led, as has already been mentioned, to a more flexible and pragmatic approach to the implementation of monetary policy involving the monitoring of several monetary aggregates as well as other indicators of monetary conditions. Rapid financial innovation has affected and is affecting the behavior of different monetary aggregates. Innovations or other factors which reduce or increase the demand for "money" (it's not so easy to define these days) can make a given money rule more expansionary or contractionary than intended. So, in effect, the move to more flexible implementation implied an effort to take into account changes in money demand or its obverse, the velocity of circulation. The hope is that this more pragmatic approach will not undermine the credibility of the commitment to reduce inflation. The unanswered question is whether inflationary expectations are simply quiescent or finally quelled. As long as the question remains, so will the need for caution in monetary policy.
The change in the conduct of monetary policy is one of the reasons for a renewed interest in approaching macroeconomic policy objectives within an interpretive framework of nominal GNP23 (arithmetically equal to MV, the monetary target and velocity). This would not provide a substitute for setting monetary targets, but would serve to emphasize that final objectives of policy include growth as well as inflation-and that these are influenced by fiscal as well as monetary policy and the degree of congruence between them (the "mix"). In the recent recession, as inflation declined more rapidly than expected, there was a temptation, as one British economist described it, to "pocket the gains and run," leaving no growing room for the real economy. While macroeconomic policy cannot determine in any direct fashion the "split" in nominal GNP between growth and inflation, the concept itself is useful in conveying to private sector decision-makers that jobs and growth will depend on their behavior as well as on government policy. Far from being arcane, such a message may carry greater weight in subduing inflationary expectations than reiteration of a determined adherence to a mysterious M-whatever. Given the confusion over M's during the past few years one can sympathize with the economist reported to have said: "If it's egg salad production that the Fed is watching, then we'll be looking at egg salad production."24 Quite. But it might not provide much guidance for the next bargaining round in the steel industry.
Turning from domestic policy to international cooperation or coordination, the summit communiqué emphasized, as did the Versailles Summit the previous year, the need for "convergence" of economic performance. The institutional vehicle for achieving convergence is the Group of Five (G-5) finance ministers (Britain, France, Germany, Japan and the United States) meeting in conjunction with the Managing Director of the IMF. The Versailles Summit, which established this new procedure of "multilateral surveillance," had stressed the importance of achieving stability of exchange rates through better coordination of monetary policies, but the Williamsburg Declaration went much further in spelling out the policies "that will be kept under review" to include not only monetary, fiscal and exchange rate policies but also "policies toward productivity and employment" embracing a comprehensive range of structural policies.
It's too early to judge what impact, if any, the new procedure has had. The problems of exchange-rate misalignment and volatility have not perceptibly receded over the past two years nor does the present recovery hold much promise of near-term convergence in growth performance. The differences in inflation rates among the major industrialized countries have narrowed marginally and-barring major exchange rate changes-seem likely to narrow further in 1984.
So, while a forum for multilateral policy coordination has been established, the difficulties in achieving such coordination remain formidable. The initial focus of attention on monetary policy and exchange rates was, in retrospect, unfortunate. Anthony Solomon, in a review of summitry efforts in this respect since Rambouillet, analyzes the economic, political and institutional obstacles to achieving coordination of domestic monetary policies.25 The far broader range of policies spelled out in the Williamsburg Declaration is, therefore, a welcome development.26 Still, if it has proved impossible to agree on guidelines for the coordination of one policy instrument, why would a more elaborate array of policies present a more promising basis for achieving progress toward the goal of convergence? The answer surely has to be that in itself it won't. But, by including the full range of policies that influence both growth and inflation as well as structural adaptability, the narrow definition of convergence implied at Versailles-inflation and exchange rates-has been broadened to include all the strategic variables that govern the dynamics of economic performance. The nominal GNP framework, which embraces this broader definition of performance, might provide a useful basis for a more meaningful discussion of convergence.
By focusing on medium-term convergence of nominal GNP, the importance of both inflation and growth would be recognized. Low-inflation countries, having "earned" growing room, should be encouraged to ensure that the room was occupied. High-inflation countries would have no option but to reduce inflation to gain "space" for growth and jobs. Since nominal GNP is influenced by both monetary and fiscal policy, the objective of convergence would necessarily involve a consideration of both policies and the compatibility between them, both domestically and internationally. And since the "split" between growth and inflation in any given nominal GNP is determined by supply-side factors (as well as the behavior of market actors), this broad framework for international discussion might serve to point up the dangerous international implications of policies which impede adaptation to structural change.
An agreement on such guidelines for discussion could make a contribution to furthering international cooperation, but alone would not overcome the more deep-seated problems that impede coordination. The extent and nature of economic and financial linkage within the OECD area, and between the OECD and the rest of the world economy, severely limit the scope for effective domestic economic management. When, as was the case in the early 1970s and again after the second oil shock, there is a synchronization of macro policy within the OECD, the effects (in the first case, highly inflationary, in the second strenuously deflationary) are far greater than any individual country, even the largest, anticipates or intends. In theory it would be possible to take these effects into account in calibrating policy stance, and in that sense "coordination" might not be necessary but simply better information, perhaps through cooperative discussion in a multilateral institution. In practice, of course, the process of domestic policy making reflects domestic preoccupations and what is regarded as an erosion of national sovereignty is increasingly resented or, where a country is powerful enough, simply ignored.
Daniel Bell has written about a mismatch of scale: governments today are too small to deal with large problems and too big to deal with small problems. More to the point in the present context, there is also, because of the powerful and pervasive economic linkages in the world, a mismatch between policy instruments and objectives. Further, there is a mismatch which extends beyond national governments. The interrelationship between systems-the world trading and financial systems-has increasingly blurred the boundaries which represent the mandates of the postwar multilateral institutions. While major institutional restructuring is neither feasible or desirable, much more systematic consultation and cooperative procedures than now exist have to be established. These two aspects of interdependence-linkage and interrelationship-thus demand a degree of cooperation and coordination both among national governments and among institutions which far outstrips present political reality.
The best hope for progress in dealing with the problems of interdependence lies in the growing awareness of the economic and political consequences of failure. Coleridge's aphorism, "Fear gives sudden instincts of skill," captures the essence of the emergency response to the global debt crisis. But the aphorism may be particularly appropriate because the global debt problem is so visible and its dimensions and implications so visibly mind-boggling. The dangers of the slow erosion of the world trading system and the reinforcement of deep-seated structural rigidities are correspondingly greater precisely because they are less transparent and less easily comprehended. In 1983, while we may not have moved much closer to that invisible threshold of systemic transformation, we did not take any decisive steps away from it-we only marked time.
1 "I Whistle A Happy Tune," from Rodgers and Hammerstein's The King and I.
2 This is not as bad as it sounds! An examination of forecasting errors for the period 1979 to 1982 suggests that they were far smaller than was the case after the first oil shock of 1973-74 (OPEC I). At that time forecasters made the largest errors in postwar forecasting experience. By the time OPEC II occurred there was a much better understanding of the nature of such a massive exogenous shock. What was not clearly understood (not surprisingly) was the effect of a prolonged period of monetary tightness when pursued simultaneously by the major OECD countries under the circumstances which existed at the onset of the 1980s (the condition, for example, of many of the non-oil LDCs with respect to balance of payments and indebtedness). Both forecasting episodes are, perhaps, examples of a more general phenomenon: "statistical models are likely to become more unreliable when extrapolated to make predictions for conditions far outside the range experienced in the sample." (C.A. Sims, "Policy Analysis with Econometric Models," Brookings Papers on Economic Activity, No. 1, Washington: Brookings Institution, 1982, p. 122.) The implications of this problem go well beyond technicalities of forecasting; indeed, the extreme uncertainties of prediction underlie much of the current policy debate.
3 Although the reader may assume that by early 1984 an economist "knows" what 1983 looked like in terms of major economic indicators-growth, inflation, unemployment, trade, etc.-such, alas, is not the case because of the long and varying lag in the production of economic data. Further, it is often the case that the most difficult period to forecast is the recent past. The projections used here are from the OECD Outlook, Dec. 1983 (No. 34), Paris: OECD, 1983. They are based on the usual technical assumptions of unchanged policy, exchange rates and oil prices.
4 The estimated rates of the European "big four" were: Germany, 1.2 percent; France, 0.2 percent; Britain, 2.5 percent; Italy, minus 1.4 percent; smaller European countries average, 1.4 percent. A modest acceleration to an overall 1.5 percent growth rate is forecast for 1984. Only in the United Kingdom, where the recession began earlier and has been deeper than in Continental Europe, is the growth rate likely to be sufficient to stem the rise in unemployment and restore output to its pre-recession (1979) level.
5 For further detail, see OECD, Employment Outlook, Paris: OECD, September 1983.
6 The stagnation of employment in Europe is not a problem which arose in this recession. Over the decade of the 1970s, while employment grew by nearly one-third in the United States and even more than that in Canada, European growth was barely three percent (much of it in the public sector). Another way of underlining the contrast is to note that for every ten new entrants to the rapidly growing U.S. labor force, there were nine new jobs: for every ten new entrants to the slower-growing European labor force only about three new jobs became available. In the 1980s, the number of new entrants to the European labor force is growing more rapidly than in the 1970s (for demographic reasons), which makes the job problem worse.
7 Perhaps as much as 40 percent of this deceleration was due to the direct and indirect effects of plummetting non-oil commodity prices and, therefore, desirably transitory-considering the implications for the producers, especially in the developing countries. For some individual OECD countries-notably the United States and the United Kingdom-a significant portion of the decline in inflation was also due to exchange rate appreciation, again, in part, transitory.
8 This view of "self-levitating" growth is strongly held by the new classical economists in Europe and has shaped policy stance in many European countries, especially since the second oil shock. In addition to monetary targetry (or exchange rate targeting in some countries) it emphasizes a fiscal policy of reduced budget deficits, supply-side measures to improve the flexibility of markets, and real wage reduction.
9 There is widespread disagreement on the quantitative impact of the structural deficit on interest rates both within the economics profession and within the Administration. On the former, the present state of the debate is best summed up in the title of a Wall Street Journal article (October 24, 1983), "Are Big Deficits Bad? Yes and No and Maybe," an account of a discussion "by several dozen of the country's most eminent economists." On the latter, see "The Reaganites Civil War Over Deficits," by Richard I. Kirkland Jr., Fortune, October 17, 1983.
11 The Wall Street Journal, November 11, 1983.
14 IMF Annual Report, 1983, p. 30.
15 World Financial Markets, September 1983, p. 12.
17 OECD Financial Statistics Monthly, Paris: OECD, December 1983. Moreover, except for the United States, there was a sharp slowdown by year end in export credit insurance from the industrialized countries to the developing countries and signs that such credits were being used selectively for trade promotion purposes.
18 See Business Week, December 5, 1983, for a report on such a proposal by Robert V. Roosa.
19 A proposal for the creation of a facility in the Fund to insure bank loans against political risks was made by Johannes Witteveen, former Managing Director of the IMF, on the occasion of the 1983 Per Jacobsson Lecture in September.
20 All estimates are from OECD Outlook, December 1983.
21 See David T. Coe and Gerald Holtham, "Output Responsiveness and Inflation," OECD Economics and Statistics Department, Working Papers, No. 6, Paris: OECD, 1983.
22 In December, the incapacity of the Community summit to reach agreement on the budget in the face of impending bankruptcy underlines the extreme gravity of the situation. A failure to tackle the thorny question of reform of the common agricultural policy threatens a renewed flare-up with the United States over a number of agricultural commodities.
23 The OECD Ministerial Communiqué, for example, makes mention of a nominal income framework in considering medium-term macro policy settings, as did the Group of 30 at their May meeting in London. See Financial Times, May 11, 1983. For a full discussion from a long-time exponent see Samuel Brittan, The Role and Limits of Government, London: Temple Smith, 1983, Part II.
24 Business Week, October 3, 1983, quoting W. Lee Hoskins of Pittsburgh National Bank.
25 George de Menil and Anthony M. Solomon, Economic Summitry, New York: Council on Foreign Relations, 1983. Mr. Solomon notes that there is now a discernible convergence of views "among the financial authorities of the major countries, and something like a pragmatic consensus might emerge." (p. 73, emphasis added). Recent statements from the Bank of England support this view. See Financial Times, November 17, 1983.