8:01 AM Apr 21, 1997


Geneva 21 Apr (Chakravarthi Raghavan) -- Western Europe, with its preoccupation with meeting Maastricht criteria to achieve the European Monetary Union, faces poor prospects for reducing unemployment, the UN's Economic Commission for Europe has warned in its annual Economic Survey of Europe.

While labour market reforms, of institutions and regulations, may well deserve to be examined, the employment gains the United States show not only the built-in flexibility of the labour market, but also the important role of sustained economic growth and demand for goods and services, says the ECE.

The preoccupation of West European economies to fulfil the Maastricht criteria for European Monetary Union (EMU) could mean 1997 GDP growth even weaker than the currently forecast 2.5% and hence not enough to make much difference to current levels of unemployment, the UN's regional economic body whose geographic scope extends to Canada and US, western and eastern Europe, Russia and the Commonwealth of Independent States (CIS) of the former Soviet Union, including its Asian republics.

Prospects for any significant improvement in European unemployment are still rather poor, the ECE warns. The stance of economic policy, ECE notes, is dominated by concerns to meet the Maastricht criteria for general government budget deficits (and thus tight fiscal policies), and relatively tight monetary policies to meet ambitious inflation targets.

"It may therefore still be some time before west European growth can rise again to rates that would bring about a significant reduction in unemployment," ECE says.

For the industrialized countries as a whole, says the ECE, real GDP growth is projected to rise in 1997 by some 2-1/2 percent, about the same as in 1996.

In the heterogenous group of transition economies, eastern Europe (where growth in 1996 decelerated to 4-1/2% from the previous 5%) growth is projected to slow down further to 3-1/2% while it will strengthen in the Baltic states. In Russia where slump in output deepened in 1996, rather than bottoming out, while the government and some outside observers expect a modest upturn, this is widely doubted by economic analysts in the country who seem to see even a standstill as an achievement. In Ukraine, the economy is still in deep depression, while in the CIS (Commonwealth of Independent States of the former Soviet Union), the recovery seen in many last year is expected to continue.

The UN body has given the warning about western Europe (in more plain language, more than a year ago) and the adverse effects on continuing high unemployment in Europe by the over-emphasis on meeting Maastricht criteria - and suggested some delay in the EMU without losing sight of that objective.

But like all 'bearers of bad news' to royal courts in medieval times, the ECE and its economists were hit on the head by the EU's Executive Commission -- whose President as well as the Commissioner for monetary and financial affairs publicly disparaged the ECE as some obscure body.

[Last week came a report from Austria of how the European Commission had contracts with Austrian economists, and public officials, to ensure that they give only its side of the EMU to the public]

Though the ECE projections and warnings were echoed later by many other international organizations and institutions, the EU Executive Commission's heavy-handed attack on the ECE (with some veiled threats of withdrawing support for on-going projects with extra-budgetary funding) had a chilling effect, particularly at a time when the UN and its economic bodies were under threat.

That despite these, the ECE and its economists, in their annual Economic Survey of Europe in 1996-1997, have renewed their concerns about the overall economic policies and their effects on high unemployment, couching it though in more careful language, where the discerning reader has to read between the lines -- perhaps shows that the UN system has not totally lost its intellectual integrity.

The ECE notes that the overall economic performance in Western Europe has been disappointing for most of this decade, specially compared to the optimism that prevailed in the 1980s in anticipation of the positive effects of the single European market which entered into force in 1993.

In fact, says ECE, the annual output growth has been persistently lower than successive medium-term projections (which the OECD has even stopped publishing some time ago) and overtime have been steadily reduced against a background of tight economic policies and depressed consumer and business confidence.

The ECE survey traces these to the interaction of shocks and economic policies (tight monetary policies to meet exchange rate targets of the ERM, severe private sector balance sheet problems originating from the asset deflation of the 1991 recession) and says that the greatest uncertainty currently facing west European economies concerning prospects for starting the EMU.

But in any event, the "stability and growth pact" agreed at the EU Council meeting held in Dublin in December 1996 implies continuing fiscal retrenchment in years to come given the objective of achieving broadly balanced government budgets.

Monetary policy too can be expected to be kept relatively tight in view of the ambitious inflation targets being set -- as illustrated by the German Bundesbank's decision to lower its implicit annual inflation target to 1.5% -- and the need for the new European Central Bank to establish its (anti-inflation) credibility in international financial markets.

"Against this background," cautions the ECE, "the return of west European economies to a medium-term growth path slightly below three percent, as envisaged in most recent projections could once again turn out to be too optimistic."

Most West European governments, whether those trying to ensure they are in the European Monetary Union from inception or even those like UK which are not committed to the EMU, are focusing on continued fiscal retrenchment to achieve broadly balanced government budgets (Maastricht requires overall public deficits to be no more than 3% of GDP) and relatively tight monetary policies to achieve 2% annual inflation rate.

With 1996 growth only 1.9%, and most consensus forecasts already only modest, this focus on the EMU and Maastricht criteria would mean weaker than forecast 1997 GDP growth, the ECE suggests.

The weak output and employment growth in Europe mean there has been little progress in reducing the persistently high rates of unemployment throughout the region -- with average rate in 1996 of 10.3%, slightly higher than in 1995 and about the same as in 1993.

And despite considerable deregulation of European labour markets in recent years, adds the ECE, the weakness of demand and output growth continue to hold back any significant reduction in unemployment -- the major exception being the UK where output has grown relatively strongly since 1993.

In the market economies as a whole, the ECE notes, forecasts of real GDP growth in 1996 have been significantly lowered since mid-1995.

In the US, consensus forecasts for economic growth in 1996 were revised sharply downwards in February 1996 - against a background of perceived weakening of cyclical growth forces. But in striking contrast to Western Europe, since spring 1996 there has been an upward revision of forecasts and the gap between actual outcome and earlier expectations is less pronounced than in western Europe.

In Canada, as in western Europe, economic activity picked up in 1996, but significantly lower than in 1995. In Japan, cyclical growth force still appear to be rather fragile -- with continuing balance sheet adjustment problems in the private sector.

The cyclical upturn in the US, which began in the second quarter of 1991, has continued for the seventh year, and is broadly-based, supported by strong domestic demand and export growth, despite appreciation of the dollar. The US doesn't appear to be in a cyclical downswing, but rather in a period of "balanced growth".

In discussing the future outlook, and the room for manoeuvre (in west Europe) to support economic activity, ECE notes that fiscal policy is focused on meeting the Maastricht convergence criteria. In any case the size of budget deficits and debt in many countries is such that there is hardly any scope for fiscal stimulus.

However, the risk is that striving for a "point landing" on the reference value for budget deficits set in Maastricht Treaty may trigger action for additional fiscal retrenchment.

Such an accentuation of pro-cyclical behaviour is likely to be counter-productive and would further restrain forces for growth in western Europe and probably to a further deterioration of government finances.

Monetary policy, the ECE notes, has been relaxed gradually over the past few years and interest rates, in general, are now quite low. But there is scope for more monetary easing without rekindling inflationary expectations -- as was demonstrated by the loosening of monetary policy in the US in 1991-1992 and in Japan.

But the basic problem is that inflation targets in western Europe now appear to be centred around 1.5% - as illustrated by the Bundesbank's recent lowering of the target. This threatens to be too ambitious, and risks placing further restraints on growth and puts excessive burden of adjustment on the labour market.

A less ambitious inflation target would be compatible with a more satisfactory rate of output growth and allow a much needed reduction in employment.

The economic policy debate over the relatively poor performance of west European economies in recent years has focused rather narrowly on the need to enhance supply side flexibility, especially on the labour markets.

There may well be a strong case for reviewing and changing many of the long-established institutions and regulations governing the labour markets. But concentration on this issue is excessive insofar as it neglects the interaction of supply and demand factors in the growth process, argues the ECE.

The significant employment gains in the US not only illustrate the "built-in flexibility" of the US labour market, but also the important role played by a sustained and robust growth of demand for goods and services.

The notion of labour market flexibility is, moreover, rather vague and detailed studies often find the actual degree of flexibility in the system perceived to be rigid is surprisingly large and increasing over time.

"The importance of faster economic growth in facilitating structural change and greater supply side flexibility, deserves to be brought back into the policy discussion."