OECD sees risk of recession: Report warns of danger from rising public debt and falling demand in US and Japan

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THE INDUSTRIAL world faces the prospect of a slide back into recession if demand in the US and Japan weakens and the European downturn grows worse, the authoritative Organisation for Economic Co-operation and Development warned yesterday.

But the threat to the long-term health of the industrial world posed by rising budget deficits and swelling public debt means that tax increases or public spending cuts should no longer be delayed. 'High levels of public debt, fed by large and increasing budget deficits, call for a strategy of steady reduction.'

The intergovernmental forecasting organisation has sharply downgraded its forecast for 1993 growth in the industrial world to 1.2 per cent. Even if this weak expansion is achieved, the OECD expects the jobless total to climb by 1 million to 35 million this year. 'Unemployment will rise further almost everywhere, and could reach 36 million in the first half of 1994.'

The main threats to the outlook include weaker-than-expected demand in the US and Japan, a cautious approach to cutting interest rates by the Bundesbank, the impact of fiscal tightening on world demand and a breakdown in orderly global trade if the Group of Seven fails to salvage the Uruguay round of talks on the General Agreement on Tariffs and Trade in Tokyo next week.

But with yesterday's long-awaited rate cut by the Bundesbank, at least one risk appeared to moderate. Significantly, the OECD supports Bundesbank caution over lower rates. 'Falling output and wage moderation should make an easing of monetary conditions possible for Germany,' it said in the latest Economic Outlook, 'although its timing and extent must be carefully judged in order not to compromise the restoration of price stability.'

Currency markets could also trip up the recovery. 'Exchange rate pressures have again emerged as forces that could complicate policy,' the Paris-based organisation said. Widening external imbalances, such as the persistent Japanese trade surplus with the US, were fuelling protectionist pressures.

The OECD also said there was concern that real interest rates were too high given weak world demand. But it seems little can be done about this immediate impediment to growth, which reflects a delayed reaction to the anti- inflation thrust of monetary policies since the early 1980s.

On a brighter note, the OECD noted that high real interest rates have beaten back inflation throughout the 24-nation OECD area, where it is now at a 30-year low. This has significantly improved the outlook for the industrial world in the longer run. But Britain gets a special warning: once the economic slack is taken up, inflation may flare up again.

The OECD said that despite adjustment in the past few years, heavy debt burdens could still pose a threat to the pace of the US recovery, hitting demand. These fears have been borne out by the latest statistics.

In Japan, the outlook for a recovery in consumer spending was 'extremely uncertain' while the surging yen might also erode business confidence and delay a recovery in domestic demand.

In Continental Europe, the OECD said it was unclear how much further interest rates would have to fall to spur a recovery.

The OECD warned that if concerns over high underlying inflation prompted the Bundesbank to postpone a policy of rapid rate reductions, 'European recovery will be weakened substantially'.

Another risk stems from a potential weakening in demand as budget deficits are cut with tax rises or cuts in public spending. The resulting decline in long-term rates may be too slight and too slow to act as a counterweight.

But the organisation's secretariat warned member countries against allowing deficits to widen further in response to continued recession. If deficits swell up too rapidly, private sector confidence can be undermined despite promises to reverse the process. By allowing deficits to widen during recession, governments tend to overestimate the 'cyclical' element, and a policy of allowing an automatic rise in benefit spending and fall in tax revenues could lead to a lasting increase in public debt.

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