A Threat to Global Growth

How the next OPEC-spurred downturn will hit countries big and small

As they awaited this week's two pointedly paired economic gatherings --the OPEC oil ministers' price-setting meeting in Geneva and the summit of the leaders of the seven top industrial democracies in Tokyo--the men who guide the Western economies were fairly exhausting their vocabularies of gloom.

U.S. Treasury Secretary Michael Blumenthal saw "some very nasty storm clouds" developing quickly as a result of the oil cartel's seeming insatiability for higher prices, while West German Chancellor Helmut Schmidt intoned about "great danger" ahead for all concerned, including the oil producers. The best hope that France's President Valery Giscard d'Estaing could offer anyone was that the industrial world could look forward to a prolonged period of "sober growth."

Such gloom is justified; another substantial hike in oil prices could well nudge the Western world into recession. But for a number of reasons a new downturn might not be as severe as the one that struck in 1973-74. Then, the first round of OPEC price hikes helped kick off a global recession that quickly became the longest and deepest that the U.S., for one, had experienced since the 1930s. Moreover, when the oil price explosion occurred, the industrialized nations were all lined up at the crest of a simultaneous boom. They all skidded into recession together, and many smaller countries slid down with them. Largely to pay their bloated oil bills, the less developed countries (LDCs) borrowed heavily from public institutions like the International Monetary Fund and from private banks in developed nations, notably the U.S. Since 1973, the foreign debt of the non-OPEC LDCs has doubled to more than $200 billion; today they must spend at least 12% of their export revenues to service their debts.

Japan and the Western European countries were slow to bounce back from the recession and suffered through a lingering period of sluggish production and relatively high unemployment. By contrast, the U.S. economy rebounded fairly smartly: production picked up, and joblessness fell from its 1975 peak of 8.9% to the current 5.8%. But the U.S.'s solo recovery brought problems. Prosperity sucked in imports, but American exporters found little demand for their goods abroad. Then, too, the nation's dependence on ever more costly foreign fuel increased, lifting the U.S. oil import bill to boggling heights--$40 billion last year, perhaps $50 billion this year. The result was a three-year string of stinging trade deficits, including a record $28.5 billion in 1978. The devastating drop in the value of the dollar overseas, which largely reflected the poor trade situation, helped fan domestic inflation by making imports more expensive.

The Administration insists that the U.S.'s present 13% inflation rate can be tamed by gently slowing the economy. Its program is to: 1) cling to the tattered wage-price guidelines*; 2) hold the fiscal 1980 budget deficit to $29 billion, down from $32 billion in 1979; and 3) encourage the Federal Reserve Board to continue to keep a firm rein on the money supply. But most non-Government economists believe that inflation will be curbed only by the recession that they predict will begin this summer.

The most convincing evidence that a downturn is coming is that spending by consumers, which has been the chief engine of the nation's 50-month-old recovery, is slowing substantially. The nation's output of goods and services grew by a paltry .8% in the first quarter. For April and May, industrial production actually declined, though only slightly, for the first time since January 1978. The standard forecast now is for a shallow slump lasting no more than two to three quarters.

But a continuing climb in oil prices could make that slowdown longer and deeper.

Somewhat surprisingly, the other industrial nations, which once counted on the U.S. to be the world economy's "locomotive," would now welcome a mild American recession. After a long period of sluggishness, the six other leading economies--Japan, West Germany, France, Britain, Italy and Canada--are showing hesitant signs of revival. An index of leading indicators for the six advanced 8% during the latest twelve-month period, vs. 1% for the U.S. But the gains have not been without cost, notably a rise in prices. According to the Organization for Economic Cooperation and Development, which monitors trends in the leading non-Communist industrial states, inflation among its 24 member states rose 1.1% in April, the steepest monthly jump in two years.

A U.S. downturn would slow U.S. inflation and narrow the American trade deficit. It would reduce U.S. oil consumption and thus reduce upward price pressure on crude oil and other commodities.

That would enable other countries, notably West Germany and Japan, to continue their moderately expansive policies and keep the world recovery going, instead of being forced to restrain inflation by curbing growth.

The big difference between now and 1974 is that instead of declining in unison, thus severely crippling trade, production and growth, the major nations are all at different points in the economic cycle, making a deep world downturn less likely. A sampler of conditions of the key industrial nations:

West Germany. The Germans' economy is, as usual, in better shape than any of their European neighbors'. The big worry, also as usual, is rising inflation: though prices increased a mere 2.6% in 1978, inflation so far this year has been running at an annual rate of 7.4%, a figure that might be cheered elsewhere but is regarded with concern in this inflation-phobic nation. German exports are surging and now account for fully 12% of total world trade--the same as the U.S.

Italy. Industrial production, the most reliable gauge of business trends, was up 7.3% in the first four months of the year.

In addition, the April balance of payments showed a healthy $1.1 billion surplus. Yet many forecasters are beginning to take a dim view of 1979's second half, largely because of the gathering oil crisis.

Rising fuel prices can only aggravate the root problems: unchecked wage increases, large budget deficits and excessive monetary expansion.

Britain. Despite the efforts of Margaret Thatcher's new Conservative government to rein in double-digit inflation by trimming spending, the country's economic outlook remains bleak. Though Britain's North Sea oil supplies have eased its dependence on-OPEC, British exports are still not strong enough to pay for its imports.

Japan. After its longest postwar recession, the country is again moving ahead, with its growth running at an annual rate of 7.4% in the first quarter of this year, up from 6.8% in the final three months of 1978. At the same time, the growth of exports, a main source of irritation between Japan and its trading partners, has slowed. The official growth goal for the year is 6.3%, but, given the need to curb oil consumption, actual economic expansion could be limited to 5% or less.

France. Rising energy prices have forced President Giscard to scale back his nation's growth projection from 3.7% for the year to 3.4%, and expectations are that it will go even lower by year's end. Yet Giscard has so far taken only mild measures to conserve oil: lower home heating levels, stricter speed limits and vague ideas on producing a more economical car. Inflation remains a serious concern. Last year, seeking to buck up the investment rate by improving profit margins, the French removed the price controls maintained on many goods. But that kicked living costs up sharply--and is a big reason why 1979 inflation is expected to climb above the officially projected 10%.

Canada. The U.S.'s biggest trading partner is having its share of economic problems. Its new Conservative Prime Minister, Joe Clark, is committed to cutting inflation from its present annual rate of 11.7% to 5% and joblessness from 7.9% to 5.5% by 1985. Clark has vowed to use tax cuts and other incentives to boost Can ada's growth from its present level.

If advanced nations are worried about the rise in oil prices, the LDCs and the world banking system have even more cause for concern. In the aftermath of the fourfold price rise of 1973, U.S. banks led the way in trying to "recycle" the dollars that flowed into the oil-producing states and were then invested in the West or parked for short periods in the major institutions of industrialized nations. Much of this money was loaned to the hard-pressed developing countries to help them pay their ever heavier oil bills. The international banking system came through that operation in much better shape than many of the pessimists believed possible, though the amounts involved were huge:

U.S. banks alone have $48.7 billion in loans outstanding to needy LDCs.

Though bankers agree that they are nearing the point where additional loans to LDCs could be an unacceptable risk, relatively well-off countries such as Mexico, with its new-found oil riches, and Brazil will continue to find a welcome. Middle-income states such as South Korea, the Philippines and Taiwan will also find lending officers receptive. But the traditional weaklings, such as Dahomey, Upper Volta, Turkey, Zaire, Egypt and others, will face a real struggle trying to get additional loans. Says one White House economist: "For the weaker LDCS the choice will be either lowering their living standard or cutting their development programs. Neither choice is any good."

As the Federal Reserve reported last week, fully 24% of all U.S. foreign bank loans--mostly commercial--have now been made to non-oil-producing LDCs.

Even so, many American bankers argue that there is no cause for alarm. Nonetheless, critics want banks to take a harder look at LDC loans. They contend that loose lending practices to developing countries encourage those states to avoid the fiscal and monetary discipline needed for broad-based economic development.

Many Congressmen also worry that the banks could be caught with their liquidity down in the event of a world recession and a string of defaults. In that event, Washington would be forced to provide aid to LDCS simply to preserve the stability of the U.S. banking system, a move that would be inflationary, disruptive of financial markets and a restraint on growth. Says House Banking Committee Chairman Henry S. Reuss, a longtime critic of banks' overseas lending policies: "The ability of the financial system to pyramid inflationary loans to developing countries is limited, and those limits are being approached."

Banks are not alone in nearing their limits. Unless the OPEC nations come to realize that the world cannot indefinitely absorb rapidly rising oil prices without tipping into recession, the economic outlook for oil users--and thus for their suppliers--will remain uncertain. In such a climate, any return to robust global prosperity is impossible.

* A federal appeals court in Washington last week reversed a decision by a lower court and ruled that the Administration did indeed have the right to withhold Government contracts from firms that break the guidelines.

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