AfPRIMOFORRFIEflSE DATE;?
DEVELOPED COUNTRIES: GROWTH, INFLATION, AND TRADE
Selected Articles from the Economic Intelligence Weekly
5
OF CONTENTS
TADVERVIEW ON 1
GROWTH
Inventories in 5
Interdependence and Economic11
Cautious Policy Response to16
The Capacity22
INFLATION
inflation: Patterns, Trends, and
26
Inflation in the European Community,
Japan, and31
TRADE AND MONETARY
Slump in Export Volume37
une
EC Perceptions of Recent OS Trade42
Slide of Sterling45
Shifting Trade Patterns in the48
(Not previously published)
y
TABLE OP CONTENTS (cont'd)
GOVERNMENT POLICY AND THE BUSINESS CYCLE
Italy: isky Reflation52
(C)
Economic Prospects
for the Small61
SYH Id
DEVELOPED COUNTRIES: INVENTORIES IN PERSPECTIVE
Inventory-building was reduced sharply in5 in four of the major foreign countries, as well as in the United States, halting the rapid accumulation of surplus stocks that occurred last year.* In all of the countries examined, except the United Kingdom, cumulative surplus stocks appear to have peaked after the turn of the year. In Japan, Canada, and the United States, they hit record or near-record levels. Moreover, because surplus stocks of this magnitude are unusual at this stage of the business cycle, we expect stockbuilding to play an abnormally weak-and perhapsegative-role in recovery over the next few quarters.
Recent Trends
In, companies attempted to bring their excess inventories into line with sagging sales. In three of the major developed countries, they reduced stockbuilding substantially, while in two others they actually cut inventories.
In Japan, stockbuilding in the first quarter amounted to only one-fourth of stock additions in fourthtocks probably declined in the second quarter.
In Canada, stocks accumulated in the first quarter at about one-third4 rate.
In West Germany, stocks declined slightly in the first quarter, as they had in
In the United States, manufacturing and trade inventories fell in four of the first five monthsliding downecord pace in May; total stocks, including raw materials, dropped
byillion in the first quarter andillion in the second.
the United Kingdom, stockbuilding continued at about the same low rate as in fourth
CONHOENTIM
The decline in stockbuildingajor factor in the first-quarter deterioration in real GNP (seasonallyn the United States, the stock drawdown accounted for the entirerop in GNP. In Japan, even though final demand rose slightly in the first quarter, GNP fell because ofadjustments.
Percent
Change Attributable To
Quartet Change in GNP
InvMitonei
Final Demand
Japan
United Kingdom United Slates Wen Germany
1
1
Cumulative surplus stocks are the largest in Japan, having reachedf GNP in the first quarter. Jaoan typically experiences wide swings in stock/demand relationships because of the reluctance of business firms to lay off workers. In West. Germany and Canada, surplus stocks as shares of GNP are roughly half those in Japan. The United Kingdompecial case, with no surplus stock accumulations at present. Low rates of stockbuildingarge stock draw-clown in4 during the coal miners' strike,urprising firmness in final demand until recently have moderated accumulations.
Implications for Recovery
In sharp contrast with most earlier posticession periods, when inventory rebuildingtrong boost to expansion, stock changes are expected toeutral force at best for several months to come. ey factor determining the role of stocks in upswings is the timing of the inventory cycle peak in relation to the business cycle. Usually, recovery beginsime when inventories already have neared their low.
On those rare occasions when the inventory cycle peak and the business cycle trough have overlapped-as now appears to be the case in the United States and Japan-stockbuilding hasweak or negative for the first few quarters of the recovery period. In West Germany and Canada, the inventory overhang may actually delay the onset of recovery until late in the year.
fiPPROVEQ FDR RELEASE DATE:?
, . DEVELOPED COUNTRIES: INTERDEPENDENCE AND ECONOMIC GROWTH
If fears of renewed inflation or payments problems cause the industrial nations to rely on the United States or any other single country for export-led growth, recovery will be long and slow. Except in the case of Canada, the exports of the Big Seven are too dispersed and theirin final demand too small for economic prosperity to hinge onby one trading partner.
Induced Growth*
Despite strong linkages among many OECD economics, only Canada among the Big Seven is strongly affected by economic growthingle trading partner. Its exports accountf GNP,f foreign sales going to the United States. We calculate that Canadian GNP rises by about one-thirdercent for everyncrease in US GNP. This estimate takes into account the direct and indirect effects of US growth through enhanced demand for Canadian products in the United States and in third countries.
The induced impact of growth in any other major country
is at most one-fifth of the initial rise in GNP in the "lead" country.
France: West Germany, the United States, and the United Kingdom induce the most growth, in all cases less% for eachncreaso in their own GNP.
West Germany: Prance, the United States, and the United Kindgom each inducen GNP growth.
% rise in West German outputifthercent to GNP growth.
CUffliiiLNIiAL
United Kingdom: The United States induces the greatest increase in GNP% for, followed by West Germany and France.
Japan: % increase in US GNP% to economic output; no other OECD country adds more.
United States: Because of its small foreign sector, the United States io barely affected by isolated changes in foreign GNP.
The spillover effects of GNP growth in the Big Seven are much more important in themaller OECD countries, particularly those in closely integrated Western Europe. Expansion in West Germany and Britain has the most marked impact. % increase in the GNP of either of these nations induces an average rise of. mora than one-fifthercent in the output of the smaller countries; ew cases the impact is as large as one-halfercent. Because of their dependence on foreign trade, tho Benelux countries are the most sensitive to developments in the Big Seven.
Coordinated Recovery
Simultaneous expansion among the larger economies would have important spillover effects on growth in the OECD area. We estimate% increase in the combined national output of the three major countries with strong oaymentsest Germany, Japan, and the Unitedould induce as much as one-thirdercent growth in the OECDhole. The impact would% for the Small% for the six major foreign countries;% for the United States. The psychological effects of aapproach, which cannot be quantified, wouldan additional boost to growth.
Regional Groupings
Our analysis of theconomics shows that spillover affects from growth are much stronger within Western Eurone than within the North America-Pacific area or between these two regions.
CONflOEilM
Initialise in CNP In
Europe
America-Pacific
spillover in: Western Europe North America-
Pacific All OECD
Implications
Our analysis suggests that continued European reliance on the United States or on West Germany to lead economic recovery would resultackluster revival. on growth in the OECD from expansion in these countries is small (about one-tenthercent for eachncrease in either German or US output). igh proportion of the impact of an acceleration in US growth is through slow-acting secondary and tertiary effects. Simultaneous expansion among tho larger countries, on thn other hand, would substantiallyutput, especially in western Europe. Tn Japan, domestic demand appears to be the key tooncertedxpansion in all other OECD countries would add1 to Japanese GNP.
TJMfflBBiWL.
QuiiiiOtKHfll
Developed Countries: Effects of Growth in the Big Seven on One Another
United States
UniK* Sibibi
West Giiwcr Frame
Umllfl Hmjdnm
Italy
I]
Japan
=)
1 J
ucid Hi tack CiMtr*% kufamiMNP rn tho laid couirtrfj
b
Kingdom
D
Germany
France
Italy
Simultaneous Expansion ie
United States, Japan, and
West Germany
2 i * .5 * cut
0 .1 .1 -3 A J> J
a-71
Developed Countries: Effects of Growth in the Big Seven on Selected Smeller Countries*
[*ifi CgumtynenmeM lo CNP In thi Itafl couni'r
United
States
SwiUtrUnd
Drnnurk
Ireland
Nii
Aiillfil
Japan
Kingdom
F
Geiraany
France
Italy
2 .1 I i -I .1
PlftMl
Ml
COHFIOENTlftl
DEVELOPED COUNTRIES: THE CAPACITY OVERHANG
Byxcess plant capacity in major developed countries reached the highest level in at leastears. With the large overhang, business firms are holding the line on capital outlays until capacity utilization rates improve. We conclude that fixed investment will provide only moderate push to economic recovery until well
Capacity Galore
Capacity utilization rates in the major countries stoodelow normal by Despite some subsequent increase in output, the amount of excess capacity remains substantially greater than at the low point of any previous postwar recessions.
In Japan, industry is nowelow capacity despite anncrease in production since February.
In France and Italy, where production fell through midyear, industry iselow capacity.
In West Germany, industry is operatingelow capacity.
In the United Kingdom, output has droppedelow capacity, and the economy is continuing its downward slide.
In Canada, where industrial production has fallen less rapidly, idle capacity nonetheless amounts.
Basic industries, operating near capacityonths ago, have been hit hard. Byteel firms were operating atelow capacity, with Japan and the United States accounting for most of the slack. Capacity utilization in the nonferrous metal, paper, and chemical industries is also down sharply, reflectingrop in output during the last yearalf. Most consumer industries are operating well below potential, although.the gap has narrowed somewhat in recent months. Auto production,elow capacity inelow capacity by mid-
--
-
Impact on Investment
1 The capacity overhangey factor depressing capital spending. In most major countries, plant andoutlays in constant prices, continued their downward trend through Capital spending by Japanese firms fellnnual rate in first5 compared with the secondollowingrop last year. West German, British, and US outlays also fell, while Canadian spending flattened.
Leading indicators point to little or no improvement in business spending in the months ahead. Only in the United states have machinery and equipment ordersthe most important investment indicatorturned around substantially. An upturn in West German orders in the first half was spurred bynvestment rebate program, which expired in June; orders subsequently have fallen back. Surveys of investment plans suggest that Italian and French orders have also fallen in recent months.
In roost countries, orders for nonresidential construction are also stagnating or declining. In Japan, these orders tenhe second quarter with no improvement since then. Canadian orders have remained level after turning up slightly in In West Germany, construction orders have failed to respond to the investment rebate, stayingelow0 average.
Implications for Recovery
In previous recovery periods, fixed investment accounted
for one-fourth of the growth in CNP during the first year of
expansion. Although normally lagging the upturn by one or
two quarters, these outlaystrong push once
recovery began. This time, fixed investment is likely to
mark time until capacity utilization rates improve substantially.
Given the sluggish pace of final demand and exceptionally low
operating rates, an upturn in fixed investment is likely to
be far more moderate and probably more delayed than in the past.
DEVELOPED COUNTRIES: Investment Indicators
. Stssonil'y Adjuttad. Conitant PiIch
Machinery and Equipment Orders'
CONFIDENTIAL
CONFIDENTIAL
" lUUHDEHTllbr
INFLATION! PATTERNS, TRENDS, AND PROSPECTS
Policymakers have found their flexibility severely limited by the raoid price increases of the past few years. In spiteubstantial moderation in price pressures in firstS, inflationothersome oroblcm over the nextonths. The diversity of inflation factors, together with differences in government policy, means that rates will vary widely from country to country.
Byholesale prices in major countries on averagebove the level ofhen the orice spiral began. Consumer prices were. Inflation will persist at least through the middle of next year because of: (a) labor catchup wage raises; (b) an increase in the OPEC oil price which we expect to be about (c) ain other raw material prices; andradualin economic activity, stimulated by reflationary moves.
Patterns of Inflation
The price SDiral has gone through srveral distinct phases. Tho initial phase beganhen manyadopted expansionary monetary policies to spur growth. The resulting simultaneous surge in demand in developed countries led to soaring raw material priceswith high food costs, they accounted for about half the rise in overall prices. In that year, increased profits also contributed to the price bulge; shortages of many oroducts and strong overall demand allowed firms to widen orofit" margins.
Sinceigher oil costs have contributed heavily to inflation. Byonsumer andprices in the major countries were increasing atrates, respectively. Higher oil costso the rate of inflation in the first half4 andn the second half. The Arab oil embargo in3 caused commodity prices to climb raDidly, primarily because of speculative.buying to hedge against Byon-oil commodity orices began to decline sharply as demand-pull inflation dissipated.
Afteroaring labor costs took over the lead role in the inflation process. Anxious to regain previous
-CONFIDENTIAL-
losses in real income,or pay hikes. as recession worsened. These labor costsecord pace, however, firms were forced to crease by cutting profit margi with declining commodity price through Measured in the developed countries was pared with an average
n the major countries held out Labor productivity declined two factors pushed up unit
With aggregate demand sagging absorb much of the costsharply. This, together s, helped slow inflation rates by consumer prices, inflation
n firstom-
Phase of Inflation
In recent months, continuing cost pressures appear to have prevented further progress in slowing inflation. price rises remain stuckhile wholesale prices are gathering steameriod* of relative stability in Government efforts to take the starch out of wage demands by letting the economic slide run its course are having only mixed success- At the same time, an increasing number of business firms are raising prices to avoid further erosion of profit margins. US and Japanese steel firms, for example, have already announced price hikes, even though demand for their products remains weak. Higher prices for grain and other commodities are alsohreat.
Labor Costs
While high unemployment has checked extreme wage demands, wage rates are still rising unusually fast for this phase of the business cycle. rowing number of workers have won contracts with escalator arrangements. Other workers have also come to expect "catchup" wage increases. Recognizing political realities, governments have not opposed workers' attempts to maintain real wages. In the first halfourly wage rates in the major countries had risenannualven faster than the rise inprices. At present, Japan is the only major foreign country where the rise in productivity is keeping oace with gains in money wages.
Other Factors
Food prices continue torominent role ininflation. oor Soviet grain crop and reduced harvest expectations elsewhere are beginning to affect
international commodity markets. The London Economist index
fornternationally traded foodstuffs has
since June, aftern the provious six months.
The impact on consumer prices will bo felt later this year.
The sharp decline in industrial raw material prices which
helped offset rising labor costs earlier this year has also halted.
Because most of the fat appears to have been squeezed out of profit margins, many companies are no longer absorbing cost increases as they did over the pastonths. In Japan, for example, unit profits by the start5 had dropoedelow3 peak, to their lowest level"inears. The profit, squeeze in West Germanv has also been severe. To cover recent cost increases, producers in some highly concentrated industries, including automobiles and aluminum, areound of price hikes. Weak demand, high inventories, and large excess capacity nonetheless make it difficult for many industries to fully pass forward cost increases.
Prospects for Inflation
We estimate that consumer prices in tho major foreign countries will increase on average at annual rates ofn second5 andn first These rates, although down substantially4 andre more than double the average annual increase%. Wholesale prices will be more stable, increasing perhapsetweennd Among major foreign countries, Japan and West Germany will have the lowestprice inflation rates.
Balance5
Several factors already in train willore rapid improvement in inflation during tho remaindert least part of the first-half rise in labor costs and more recent increases in agricultural commodity prices will not be folt at the retail level until later this year. ThePEC oil price rise we expect in October will raise wholesale prices by% and consumer prices by nearly as much if fully passed forward.
First6
Aside from higher food and energy costs, the pace of economic recovery in large measure will determine the rate of inflation during the first In countries such
as the United Kingdom, where recovery will be slow and halting, productivity gains will be small and inflation consequently high. In countries with better recovery prospects, notably Japan, productivity gains shouldfor wage increases. Industrial raw material costs will probably show some increase bylthough largeof most commodities will restrain their prices.
As demand gains strength, business attempts to raise profit margins willore important element in price increases. Firms will attempt to recoup past losses to the extent possible without endangering their market shares.
Because economic slack is so large, governments could
probably stimulate demand more rapidly than at oresent with-
out adding appreciably to near-term inflation. *Mosthavearticularly tight lid on the money supply growth toepetition ofxperience. Since the startS the money supply in the major countries grew on average at an 8ft annual rate, comparedhen all countries were operating closer to capacitv. Policymakers remain concerned that rapid growth in moneywould eventually spark another round of demand-cull inflation.
tm) 11
DEVELOPED COUNTRIES: Contributions to Changes in Wholesale Prices'
Ull
m
-ii
afproveq for rfifase date:?
INFLATION IN THE EUROPEAN COMMUNITY, JAPAN, AND CANADA
Although the causes of the current inflationboundaries, striking differences in thetiming of the price surge among the developedemerged since saried3 fromnn Japan and Italy. Whereas inflation hasin most major countries, the united Kingdomintoange this year,esurgencein Italy and
ational variations in inflation patterns mainly reflect airrerences in governement policy and in the attitudes and strength of organized labor. In West Germany, theearly imposed stringent deflationary measures, and labor has not .sabotaged this hardnosed aoproachainful rise in unemployment. At the other extreme, London has vacillated on anti-inflationary policy in the face of strong labor pressure. Britain's Conservatives were knocked out of office last year on the issue of statutory wageand the unions subsequently kicked over the traces of voluntary restraint.
Strong traditions of labor discipline and closeties with the business community have failed to protect Japan from the inflationary virus.
Inflation took off inhen an increase in government spending hit an economy already operating near capacity. Accustomed to rapid increases in real incomes. Japanese workers responded to inflation bynnual wage increases3illip to the wage-price spiral. ain in laborhelped offset wage and other cost increases; inas output slipped and employers felt dutybound to retain workers, productivity barely rose. Tokyo gradually stepped on the monetary and fiscal brakes through4 and made extensive use of moral suasion against wage and Drice hikes. Consumer prices, nevertheless,ast year, double3 rate.
DOHriflFNTIti'
As international price pressures eased and recession took some of the steam out of union wage demands, inflation slowed starting in first For the yearhole, consumer prices Drobably will be up. Tokyo is taking advantage of the lull to stimulate the economy without fanfare, with further expansionary measures planned this fall. Slack in the economy precludes major bottlenecks, and infaltion probably will be held somewhatext year.
West Germany
Historic fear and hatred of inflation have made firm deflationary policies politically feasible.
The then Economics and Finance Minister Helmut Schmidt put through strong deflationary measuresonths before other governments acted. His programurcharge-on personal und corporate taxes,ax on investments,harp rise in the discount rate. onn relaxed its fiscal stance slightly to offset thr drain on purchasing power from the oil price hike; monetary policy remained extremely tight. Weak domestic demand, reinforcedudden jump in the savings rate, prevented firms from passing on increased wage costs. Appreciation of the mark, esult of success in restraining domestic inflation, dampened the impact of rising prices for raw materials, food, and oil. esult, the Increase inprices at3 and4 was the smallest among the major developed countries.
In firstonsumer prices roue atnnual rate, wage increasesnd the high savings rate persisted. At the same time, import prices fell and the wholesale price index remained flat, suggesting that the rise in consumer prices could slow further by yearend. The Schmidt government's cautious approach to economic revival, coupled with wage settlementsuggests little if any worsening on the prica front
France
Gaullist fiscal orthodoxy and technocratic dirigisme have helped offset pressure on prices from domestic demand, rising import costs, and wage push by the left-dominated labor movement.
Buoyant demand, fed by large increases in thoupply, pulled consumer prices up3 as thetrained against capacity limits. Rising prices for food and imported raw materialsrowing role over the year, with the oil price hike adding its impactabor responded to the accelerating rise in consumer prices by pushing wage rates3 andontributing to the inflationary momentum. Theprice index4
Paris can claim that efforts to deflate demand through balanced budgeting and restraint of monetary growth,with tighter regulation of profit margins and prices, have gradually slowed price increases since the4 peak. ecline in the cost of imported raw materials helped, and rising unemployment influenced labor to trim its wage demands. Despite all these factors, prices rose at an annual rate ofn the first half5 and are likely to rise nearly as fast in the comingonths. The prices of Prcnch raw material imports apparentlyin May, and the government hasmall deficit6 to stimulate production and omployment. Partly offsetting the inflationary forces are monetary stringencyarge overhang of idle labor and industrial capacity.
United Kingdom
Erratic economic policies have combined with the actions of an unruly labor force to give Britain the worst inflation in the developed world.
Fiscal policy has flip-flopped several times since thes London's attention has fluctuated between the Scylla of stagnation and unemployment and the Charybdis of inflation and balance-of-payments deficits. Inhe Wilson government cut value-added taxes, gaining pre-eloct price relief but worsening inflation later by widening the budget deficit. Fiscal policy again was tightened last April, although the budqet was not brought close to balance. Money supply has been permitted to grow at an annual rate in excessince Wilson regained power infter the debacle of former Prime Minister Heath'swage controls, Wilsonystem of voluntary restraint less abhorrent to workers. lie maintained price controls, which apparently helped hold inflationlthough prices accelerated after controls were eased late in the year.
In firsthe unions pushed wages up more (annualnd inflation accelerated. Recognizing the failure of his "socialilsoneiling on wage incroases, backed up by sanctions against employers. Prospects are fairly good that the wage-price spiral will slacken in the next few months. Unomoloy-ment has reduced labor's stridency, and weak demand militates against big price hikes. We still expect the momentum of past cost increases to result in consumer price inflationnnual rate in second Prospects are bleaketurn to single-digit inflation in the coming year.
Italy
A powerful labor movement eager for social improvementsovernment torn by party dissensions have made Italy particularly vulnerable to inflation.
In exchangeruce with labor, Rome adopted sharply expansionary economic policies3 to pull the country outengthy recession. Unions held down their strikes but still managed toage hikes out of employers fearful of renewed disruptions. Consumer pricesnd inflation accelerated as the upswing in demand continued through Depreciation of the lira and the higher oil costs aggravated inflation early in the year,ummer increase in value-added taxes contributedecond-half bulge in consumer prices.
As domestic austerity cut into demand in first5 inflation moderated. Consumer prices willor the yearhole, still an improvement over The salutary effect of reduced demand pressure is being partly offset by (a) declining labor productivity and (bj Drice-indexed wage adjustments for organized labor. Further progress in reducing inflation appears unlikely. Contractsillion workers are about to expire, and wages are likely to show substantial increases later in the year. Meanwhile, under strong pressure from the Loft, Rome is embarkingold program of expansion that will boost6 budget deficit% of GNP.
Canada
Inflation has followed similar paths in Canada and the United States, with Canada expected to moveittle faster in the next few quarters.
Canada, as elsewhere, inflation accelerated early
:nd consumer prices were up nearlyor theyear. Because of Canada's roleajor grain exporter, rising ccrcinodity prices were especially important in generating added income and fueling inflationary expectations. nflation, contributing to the fall of the Trudaau government, which had rebuffed opposition demandseflationary budget and an incomes policy. After winning reelection at midyear, Trudeaulightly expansionary policy. While rising import prices and escalating wage settlements were key inflationary elements, Ottawa used fiscal juggling to staveurge in domestic oil prices, taxing oil exports and subsidizing oil sold to Canada.
Developed Coon Dies: Price Index Changes
Percent1
Japan Germany France Kingdom Italy Canada
0
trial pnees
0
9.0
Consumer prices
ie. aaasonany
rotiruirai'm
0
90
92
7
14
0
0
Inflation dipped earlyhen rose in the summer,annual rate) for the half year. Fiscal policy continued midly expansionary; monetary policy wavered erratically. Recently, Ottawa lifted ceilings on oil and natural gas prices, and food prices are moving up again. Wage settlements haveo far this year. With Ottawa unwilling to clamp down because ofouble-digit increase in the consumer price index is in prospect for the nextonths.
Belgium, Denmark, Ireland, Luxembourg, and Netherlands
The small EC countries are all heavily dependent on trade and extremely sensitive to international price
The inflationary wave Inundated the small EC countries, starting Most of these countries are ruled by coalition governments whose survival depends on labor-oriented parties which oppose austerity measures. Government policy thus has tended to reinforce inflationary pressures from abroad. Widespread use of indexing has also prolonged and strengthened the inflation, especially in Belgium. Last year, Ireland experienced the worst inflation; Denmark was close behind. In the Netherlands, price increases were kepty the strength of the guilder, which has been enhanced by natural gas exports.
Ireland, strongly influenced by events in the United Kingdom, has experienced an acceleration in inflationhis year. Otherwise, the small countries are posting records that at worst arear with last year's. The comingonths should see further improvement.
DEVELOPED COUNTRIES: SLUMP IN EXPORT VOLUME SLOWS
The decline in the export volume of the major developed countries slowed to an annual rate of onlyn March and April, compared withn September-Novembern December-February.* The slowing of the trade contractiontho more moderate rate of decline in output in the Big Seven as they approach the bottom of the recession. harp pickup in trade volume is unlikely until economic activity begins to expand in several of the largerecline in sales to non-oil LDCs and smaller industrial countries is expected to more than offset gains in shipments to OPEC states. Consequently, hopes for export-led recovery generally are dim in the large industrial countries.
Mixed Performance
The export decline for theroup began to moderate late in the first quarter, after the steepest part of the recession had passed. Trends among the individual countries, however, have varied considerably.
Rates of change in trade volume are calculated from three-month moving averages to minimize the effect of anomalicaj*--
West Germany's foreign shipments declinednnual rate from August until March, when they began to rise.
French exports, after falling at an annual ruterom August to February, declined% rate in March-April.
Italian shipments dropoed sharply in SeDtemher and trended gradually downward in succeeding months.
Japanese exports plummetedate from November to February and then stabilized in March.
In Canada and the United States, both imoortant exporters of food and raw materials, foreign sales fell at ratesespectively, from August through February and then dropped more steeply in March and Aoril.
monthly data.
f
: <
OONTIUTHTIAl
In the United Kingdom, export volume increasedock strike in Aprilharp
falloff.
Geographic Patterns
Depressed demand in the Big Seven has been the major factor in the contraction in exports. Trade among themselves accountsf their total exports. Their aggregate imports droppednnual rate from August to February -nearly twice the rate of the falloff in theirndate in March-April. The steepest declines indemand occurred in Italy, which took the strongest measures to cure oil-related payments problems, and in Japan and the United States, where excessive inventories aggravated the slump in final demand.
with demand slack in the Big Seven, producers in these countries have become more dependent on sales elsewhere. Shipments to OPEC grew rapidly4 and continued to rise in Sales to the Communist countries also have continued to rise, thoughower rate this year. Buoyancy in these markets has had little impact on total exnort volume, however, because OPEC and Communist countries together account forf Big Seven exports.
The downward trend in their exports to the smaller developed countries sincerobably accelerated in the first quarter. Sales to the non-oil LDCs held up well until late last year, when payments problems began to bite. In the fourth quarter, the deficit of these countries with OECD nationsroup reached an annual rateillion. The volume of Big Seven exports to the non-oil LDCs declined byn the fourth quarter4 and probably dropped further in5 because of the countries' reduced ability to pay.
Impact on Trade Balances
The trade balances of most of the major developed countries have improved sharply this year, as the recessionteeper drop in imports than in exports. The total trade surplus of the Big Seven swelled8 billion in the first quarterompared withillion in the preceeding quarter. Improvement was most marked in France and Italy, where the balances shifted from large deficits to surpluses.
cownncMTiAi
Prospects
Although the sharp decline in sales volume of theeven seems to be ovor, we do not foresee substantial growth ih exports through tho end of the year. Even if final demand increases moderately in the major countries, the pickup in demand for foreign products probably will be small because of the overhang in inventories.
Exports of the major developed countries to the rest of the world probably will continue to slip in spite of increased shipments to OPEC and Communist countries. The recent decline in sales to non-oil LDCs and the smaller developed countries is likely to accelerate. Much of the imnrovemcnt in thecurrent account balance of the Big Seven has come at the expense of these countries, compounding their oayments problems. Moreover, the smaller developed countries arc generally lagging behind the major industrial countries in the current business cycle and thus can be exnected tolater.
-COWriDCWTIAl..-
CDWriDCH
SLIDE OF STERLING .RESUMES
The pound, after three months ot relative stability, re-sumcd its rapid depreciation in late September and now stands. The Kuwaiti decision to_end sterling payments for' oil was the proximate cause of the latesthehigh rate of British inflation and widespread pessimism about British economic prospects are the underlying cause of the decline. Sterling has tumbled morerade-weighted basis since
UK:TradfrWtightsd and Pries-Adjusts* Eichssge Rates1
-cghllntkaiiHnltiluiMii'chJ(jii
ii irwh -lobitla pn.ti iM.i na),
ift<b< a
"CONriDLfjTIW:
Word that the Kuwaiti government had instructed British Petroleum to make future payments for oil in dollars rather than sterling began to circulate in late September. This news, coupled with oil company sales of sterling for dollars to comply with the new payment instructions, has driven the Brisish% in the past four weeks.
Earlier Declines
The latest decline follows two other slumps in the lastonths, slumps also related to financial decisions by oil producersi
sterling fell aboutn fourth4 following decisions by Saudi Arabia and Kuwait to sharply limit new sterling investment and by Riyadh to stop taking payments in sterling, and
sterling's trade-weighted exchange rate dropped anothern second5 as OPECsold off0 million of theirassests.
Ouuigea in Fortigo Slating Huldinp
MfllioQ Pound!
Held by OfficialOPEC Otherotal Totalnd of period
-COIttliilUlAi
Underlying Causes of Sterling Weakness
Decisions by some oil producers to stopterling and tolow and quiet selloff are symptoms as well as causes of_the pound's weakness. The crux of the problem is Britain's dismal economic performance, particularly the rapid inflation that has eroded the competitiveness of an already weak British industrial sector. In theonths endingholesale prices in the Unitedore than those of its trading partners,exceeding the competitive gain from depreciation.
sterling will continue weak until domestic inflation is brought under control or until forth Sea oil trims the trade deficit. In the interim, the inflation gap with other countri requires that sterling drop further if the competitiveness of British industry is to be maintained. One of London's difficulties is that sterling depreciation itself adds to inflation, because nearly one-third of final demand is met with imports.
The UK strategy so far has been to tempero keep it fromout. The government will find controlling the rate of descent progressively more difficult if oil producers abandon sterling at an even faster rat*.
teetotal* Qun.fr
tnUdutrlal Wbotaaait Prion (Annual Rain)
Kingdom
Statu
.
Ccimany
ITALY: ISKY REFLATION PROGRAM
5 billion reflation program introduced in Augustarked shift in policy and ran counter to the advice of the OECD, the EC Commission, and the Bank of Italy. These bodies had beenoreposture to avoid aggravating inflation and jeopardizing the sharp but tenuous improvement in the balance of payments.
Political expedience was the key factor motivating the center-left government to veer down this economically risky path. The Communists have found an increasingly sympathetic audience for claims that they alone can solve Italy's problems. By preempting many of their spending plans, the Moro government apparently hopes to undercut Communist efforts toarger role in the national political scene.
The Package
The new spending program attempts to stimulate demand while stilling public clamor for improved governmental The measures fall into three major categories:
improvements in public housing, hospitals, ports, airports, and urbanillion);
increased export insurance5nd
aid for small and medium-size businesses, for agriculture, and for economic development of southern5 billion).
The Impact on Growth
This fiscal stimulus shouldirect expansion
of domestic demand equivalent tof GNP, with the bulk
of the impact coming Multiplier and psychological
effects on consumers and investors will amplify this impact,
provided that the government is not forced to abort the
After falling sharply inndustrial output continued to decline through the first eight monthsarticularly sharp dropn May, production
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rebounded in June and July but fell again in August. ontinues to edge up and is expected to averagehisompared with Short-time work in theuarter was double the4 level.
Demand has shown no signs of reviving in recent months. Despite rising real incomes, consumers continue to hold back on spending because of job uncertainties. With capacity utilization at record lows, investment has plummeted, even in the face of easier credit. Export volume,trong prop to production, has been stagnant since last
n Prices
The new program, along with sharp increases in government pensions and wages, will boost the excess of budget appropriations over revenues6illion, the equivalent off GNP. Although the cash deficit may lag because of bureaucratic delays, government spending will stimulate the inflationary process.
Consumer prices rose at an annual rate ofn theday period for which data are available, down fromhe same time last year. The near-term outlook already has been darkenedew hike in oil prices, rising prices on other imports,eakening lira. Most ominously, wagebove last year's level and not yet digested in the price structure-are sure to rise further this fall when labor unions representing moreillion workers negotiate new contracts.
nd on the Balance ot Payments
The antirecession program also will worsen the trade balance, which had been expected to deteriorate in any case. By stimulating both consumption and inflation, the increase in government spending will raise demand for imports of raw materials and consumer goods and negatively affect exports.esult of the new package, the trade balance could worsen to an annual rate5 billion.
Even before the reflationary program was announced, imports seemed sure to pick up as companies completedin their stocks of raw materials, particularly oil.
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At the same time, exports were not expected to growof the slow recovery foreseen in major marketsdwindling sales to the non-oil LDCs. Renewed capitalan apparent reaction to Communist success in theelections, already is hurting the balance ofJ
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PRANCE: STRONG ACTION TO REFLATE
President Giscard d'Estaing in early Septemberide-ranging package of economic measures aimed atan upswing. Fiscal steps1fouble the amount expectedew weeks earlier. They are being supplementedajor easing of credit. Paris has emphasized fast-acting stimuli in hopes of obtaining an immediate impact. The main effect of the programwill be to amplify the recovery already expected in
Rising government concern over unemploymentajor factor determining the size of the proposed program. The number of jobless, which doubled over the past year toshould goillion by December even with the program. Paris has concluded it cannot wait for an upturn in the US and West German economies to pull France out of tho recession.
Something for Everybody
The new measures focus on projects that can be initiated quickly. In October,illion will be disbursed to the aged poor and to families with children. 0 billion will go for construction of highways and other publiche government has specified that these funds must be spent by the ond of
Industry isurprisingly largo share of the benefits. New aid to business0 million, mostly in the form of low cost loans. ax credit has been expanded to cover all purchases of capital goods,ost0 million. Paris hopes that the tax credit, still sot to expireecember, willurst ofspending in the fourth quarter. 2 billion in corporate taxes duo this month havo been deferred until April, easing tho immediate cash-flow problems of many firms.
A grab bag of other expenditures2 billion and0 new public housing units, aid to local governments, and supplementary.credits for various government agencies. Giscard also has promised administrative action to improve export incentives, boost housing construction, and encourage firms to hire moro workers.
On the Monetary side, Paris has reduced bank reserve requirements, setting the stage forillion in new loans. The bank rate has been cut sharply,%hich should pull down other interest rates. To stimulate demand for consumer credit, the government has substantially eased the conditions for installment loans.
The trade unions are urging universal reduction of the workweek fromoours without loss ofncroaae in the minimum monthlyower retirement ago, and the creationobs in the public sector. The Communists have advocated an even more extensive program; they have been criticized in the press for failinq to specify how it would be funded.
Impact
Pinancing the government's program will push this year's budget deficit2 billion, aboutfuge amount by French standards. This is tone-timeeturnalanced budget is planned
The new measures will have small impact on production and employment this year. Unemployment will continue to rise rapidly through the fall as new graduates enter the labor force. Industrial production will remain far below4 peak, although some improvement could occur by yearend.
The government's program no doubt will amplify thein private demand expected to begin early next year. The selling off of accumulated inventories, which contributed heavily to the present recession, should endew months. Business surveys indicate that private investment in plant and equipment will recover strongly next year from the present depressed level.
Political Goals
Giscard is aiming at political as well as economicwith his program. He will probably propose additional measures to the Assembly later this year. Although aware of the risks of alienating some of his conservative supporters, the president also hopes to win support on the left. He has already received plaudits from.leftists of the former Radical Party, now part of the Communist-Socialist alliance.
The divisions within the leftist parties and trade unions will allow Giscard at least to buy tine with his program. The almost-one-year-old public debate between the Communist and Socialists not only diminishes the effectiveness of their Opposition to the government but also diverts public attention from issues they could exploit.
Continued Communist-Socialist competition can be expected toominant theme on the national political scene this fall, especially among the workers. Tha leftist unions,are still recovering from setbacks suffered over the last year when they failed to mobilize the rank and file behind their demands. Union leaders realize that rising unemployment and lack of funds to support major strikes will continue to hold back radicalism among the rank and file.
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WEST GERMANY:. SWITCHBACK IN ECONOMIC POLICY
Bonn plans budget tightening measures6 that lessen West German chancesustained economic upswing. The new budget calls for onlyominal growth in federal expenditures. This translates at best into zero real growthector accounting for nearly one-sixth of GNP. By implication, Bonn is banking on foreign and domestic private demand to promote growth next year.
Release of the budget came on the heelsewly2 billion program designed to prop up construction this winter. The volte-face in Germany policy comes much earlier than warranted by the stage of the business cycle and is curiously juxtaposed with Chancellor Schmidt's call for coordinated economic expansion by tho major industrial countries.
deficit that
will soar to SI6 billion this year, from S4 billionhe deficit represents the equivalent off GNP, compared withn the United States in
urge in expenditures coupled with stagnant revenues is responsible for the rocord red-ink figure. Spending is rising more thanlanned earlier, largely because of heavy subsidization of the unemployment insurance fund. Revenues are less than foreseen by budget officials because the economy has performed considerably worse than
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Initial budget projections had% increase in real GNP thisrop now seems ltUKt3Mnl
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government borrowing drive up interest rates and stifle the hoped-for recovery in private investment.
Schmidt hopes to trimillion from6 deficit by cutbacks on spending for federal government personnel and an increase in employer-employee contributions to the unemployment insurance system. Revenues are expected toutpacing expenditures but lagging the officially forecast rise in nominal GNP by several percentage points. The medium-term budget plan calls for an increase in the value-added tax7 to help shearillion off the deficit
Razor's Edge
Success for Schmidt's strategy hinges on stronger foreign demand and consumer spending, which in turn would revive long-dormant investment. We believe the budget tightening will dampen the economic% torowth rate much more probable6 than the government's sanguine estimates.
A flood of last minute orders for capital goods in June, as businessmen beat tho deadline for the investment rebate, will provide only temporary momanturn to production. Bonn's August
stimulation program-equal% of GNP-will concentrate on construction projects that
WEST GERMANY: Now Industrial Orders
can be quickly initiated and completed. Even though exports are regaining some of the ground lost in the first quarter, they are unlikely toajor impetus until the latter parthen demand for capital goods should finally strengthen.
The risk of slowed or delayed recovery is accentuated by parsimonious spending plans at the state and local levels. These layers of government account forourth of GNP, and they already have pared their increases in expenditures. State outlays in first5 wereear earlier; growth in the similar period4.
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DEVELOPEDPROSPECTS FOR THE SHALL SEVENTEEN
The seventeen small OECD countries* should eke out real economic growth% this year,% increase In comparison, the Big Seven OECDfailed to grow at all4 andecline of more than The better performance of the smaller economies, surprising in view of their heavy dependence on trade, stems from several causesor example, earlymoves in Belgium and the Netherlands, the resort to import controls rather than cuts in demand in Australia and Finland, and the oil boom in Norway. Next year, the Small Seventeen probably willeturn to4 growth rate despite worrisome payments balances and persistent inflation.
how5 Is Shaping Up
Portugal will turn in the worst performance among the smaller countries. Output is expected to drop Severe political instability has been accompanied by worker takeovers at industrial plants and other disruptions in production. GNP also will fall in Finland and Switzerland, as these countries feel the effect of sharp declines in export volume- On the brighter side, the North Sea oil bonanza will lift Norwegian GNP nearlyhis year, while Ankararowth in the facenflationillion dollar current account deficit.
Lower export volume is an important factor in the economic slowdown. Exports are equivalent tof combined GNP, running as highn the Beneluxn Norway and Iceland,r more in Austria, Denmark, Ireland, and Switzerland. f Small Seventeen exports ordinarily going to the Big Seven, the recession in the major developed nations hastrong negative factor in the economic balance sheet.
In value terms, imports have slowed even more than exports. Oil imports have leveled, off while exports to the OPEC countries have gone up. We expect the overall trade deficit to be
* Australia, Austria, Belgium, Denmark, Finland, Greece, Iceland, Ireland, Luxembourg, New Zealand, Norway, Netherlands, Portugal, Spain, Sweden, Switzerland, and Turkey.
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illionomparedillion4fenC account deficit should decline one-fourth,illion toillion,onsiderable drop in tourism.
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Australia, Belgium, Denmark, the Netherlands, and Switzerland all are managing substantial improvement in their trade balances. Spain hopes only to hold its own on current account this year, with increased earnings from servicesurther increase in the trade deficit. Finland, Norway, and Turkey are experiencing substantial slippage in both trade and current account balances.
Government Policies
Governments are trying to steer between (a) cuts in output and employment and (b) stepped-up inflation anddeficits. In recent months, several of the Small Seventeen have loosened policy reins:
Denmark has slashed value-added taxes andore expansionary monetary policy.
Switzerland and Austria have given credit incentives for investment and exports.
Sweden has cut taxes selectively to encouragewhile keeping money tight to maintain capital inflows.
Ire*and has reduced value-added taxes and increased subsidies in an optimistic effort to reduce inflation and unemployment simultaneously.
A few governments have followed expansionary policies during most of the recession period. The Netherlands,urrent account surplusower inflation rate than most countries, falls in this category. Despite serious payments deficits, Ankara and Helsinki have tried to prop up domestic demand to compensate for lost export business. Norway has only recently moved to restrain its oil boom by imposing price controls and mild fiscal
Prospects
We expect real GNP growth in the Small Seventeen to approachext year. This growth rate would not beto reduce unemployment, given the normal increases in the labor force and in labor productivity.
Denmark will do much better than this year, the Swiss decline will be arrested, and Finland should see lumber and paper exports pick up. Portugal will bounce back from its current low if political order is re-established. Norway and Sweden should maintain their reasonably aood arowth
rates
Expansionary fiscal policies are expected to add to disposable incomes and stimulate investment demand in most of tbe Small Seventeen. Further easing of monetary conditions also is likely, in particular benefiting housing construction and investment in plant and equipment. At the same time, we do notobust recovery in key export markets, notably West Germany, France, and Great Britain.
Original document.
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