World's Major Economies Face a Downside Risk

CONSUMERS should cheer. The average inflation rate among the world's industrial nations has dropped to its lowest rate in at least 34 years. In Japan, prices actually declined slightly last year - something that probably hasn't happened in any major economic power since the Great Depression.

But economic growth is expected to slow down this year in eight of the world's 10 biggest economies, raising worries about wages and job creation (see chart, Page 8).

''The risk for major market economies ... is on the downside, rather than the overheating worries of last year,'' notes J. Paul Horne, Paris economist at Smith Barney Inc., a major investment house. Governments in seven of these nations have put their foot on the accelerator. They want to avoid more unemployment. Central banks in six, the United States, Britain, France, Germany, Japan, and Canada, have cut interest rates in recent months in an effort to step up the economic pace. And, having cut inflation, Russia wants growth urgently.

After the finance ministers of the seven largest industrial democracies met in Paris Jan. 20, French Finance Minister Jean Arthuis said that the second half of 1996 ''should be marked by a clear, significant revival of growth.'' But some economists aren't so sure. For example, Deutsche Bank sees a 1 in 3 chance of a recession in Germany and the US.

Yet nearly all major economies are tightening government tax and spending policies. ''Virtually every industrialized economy is facing the same economic/demographic conundrum: an aging population and rising social-welfare costs that are likely to challenge even the best long-term fiscal planners,'' notes a Merrill Lynch economist in New York.

The following reports assess the outlook for the world's 10 largest economies.

US growth rests on consumers

CORPORATE executives love a challenge. They will get one this year in the United States.

Economic growth is expected to be modest, despite efforts by the Federal Reserve to stimulate activity by lowering interest rates. The nation's 1996 gross domestic product, the output of goods and services, is expected to grow by only 2.2 percent from its 1995 level of $7.1 trillion, according to the consensus forecast of economists surveyed by Blue Chip Economic Indicators, Sedona, Ariz. Behind the lackluster growth is a debt-laden consumer who sees little income growth and limited job prospects.

''The consumer is a big question mark in 1996,'' says Veronika White, an economist at First Fidelity Bancorp.

The Fed should have some leeway to reduce rates, since inflation is expected to remain in check at about 2.8 percent. Robert Dederick, an economist at Chicago's Northern Trust Company, says, ''We are counting on the Fed to move fast enough and strong enough to prevent any problems in the system.''

- Ron Scherer, New York

Japan is optimistic

SUDDENLY, the Japanese economy has some pretty influential friends. One of them is billionaire financier George Soros, who on a recent visit proclaimed that he was ''very optimistic on Japan in the near term.''

''Everyone is looking for growth this year,'' says Tokyo-based Merrill Lynch economist Ronald Bevacqua ''There's nothing that's going to derail the economy this time.'' He refers to the last time people got enthusiastic about the Japanese recovery, about a year ago. Then, the yen suddenly and rapidly gained in value. That hurt Japan's exporting companies, whose goods got more expensive.

Now the US dollar is rising and so are share prices on the Tokyo Stock Exchange. The government has financed big stimulus programs.

The long-term prospects for the Japanese economy are much more uncertain. The financial system, marred by scandals, huge portfolios of nonperforming loans, and bank runs, needs drastic reform. Many observers also say too many sectors are overregulated.

One of 1995's biggest concerns, deflation, is now less worrisome. Mr. Bevacqua says prices fell due to competition from foreign goods and other structural changes, but without risking a deflationary spiral.

Japanese continue to worry about the economy's capacity to add jobs. The restructuring forced by the high yen has left many people jobless. In 1995, the unemployment rate reached 3.4 percent, high by Japanese standards.

- Cameron W. Barr, Tokyo

Germany sags

'Mini-recession. No inflation fears in sight. Unemployment high and rising.'' That's a quick assessment of the German economy from Norbert Walter, chief economist at Deutsche Bank in Frankfurt.

Germany has been aware of lackluster performance for months, but it came as a surprise when recent figures showed the economy actually contracting during the last quarter of 1995. Some forecasters see a ''pause'' continuing this winter, and only 1 to 2 percent growth in 1996.

Unemployment - which rose to a postwar high of 9.9 percent in December - is a critical concern. Government, labor, and industry are working out details of a long-term job-creation plan. On Jan. 30, the government announced a plan of wide-ranging tax reforms and other plans to cut unemployment in half by 2000. Moves include a reduction in social-welfare spending.

Joblessness stems not only from high labor costs, but also from the strong deutsche mark, which has hurt exports and led businesses to invest - and move jobs - overseas.

In formerly communist eastern Germany, unemployment rates are in the double digits, despite extensive subsidized job-training programs. Economic growth has been higher there than in western Germany, but now is slowing to about 4 percent this year.

- Ruth Walker, Bonn

Strikes roil France

THE economic tab for the great transit strike of 1995 is still not yet in, but the political costs of nearly four weeks of gridlock have registered in Paris.

At stake: what Parisians call the pensee unique (single policy), a strategy backed by both conservative and socialist governments since 1983 to support a strong franc at all costs - including double-digit unemployment.

Investment houses have long praised France's determination to maintain a strong currency and cut government deficits to meet standards for a single European currency. But the broad support for December's strike signaled that public patience with austerity policies is wearing thin.

''Any further transformation of the public sector is going to seem like a political bomb, and could delay by years structural reform in the public sector and reform of labor markets,'' says Jean-Dominique LaFay, a University of Paris economist.

As new projections show economic growth slowing to 1.5 percent and unemployment approaching 12 percent this year, new rifts have opened in France's conservative majority. Several top conservative leaders called for easing up on restrictive monetary policies, delaying implementation of a single European currency, and focusing on social needs. On Jan. 30, the government announced a modest plan to boost growth.

- Gail Russell Chaddock, Paris

Italy: Lower rates could help debt reduction

'AT the moment, markets are extremely optimistic about Italy,'' says Luigi Spaventa, a former Italian budget minister. Expectations of further declines in German interest rates are the main reason, Mr. Spaventa says.

''That explains the chase of high yields, which is affecting Italy, Spain, and Sweden, which of course is very healthy for the budget, because structurally we would be all right, were it not for the level of interest rates,'' he says.

Italy must meet the tough standards laid down in the Maastricht Treaty if it wants to enter the European Union's single currency. Its greatest barrier, experts say, is its high interest rates, which jack up payments on government debt.

Business has begun to pick up a bit after the kickback-and-corruption scandals of the early 1990s. Called ''Tangentopoli,'' the scandals centered on public contracts and hit construction especially hard. Firms did not want to run afoul of the country's investigating magistrates.

Italy's inflation will drop from 5.4 percent in 1995 to 4.5 percent in 1996, Mr. Spaventa predicts.

- Richard L. Wentworth, Rome

Britain's output grows, but government pressed

CHANCELLOR of the Exchequer Kenneth Clarke is at loggerheads with members of his own party over how Britain's economy is doing.

In his November budget he forecast growth of up to 3 percent in 1996 and said inflation would hit the government's target of 2.5 percent or less.

But on Jan. 15, the House of Commons Treasury committee - dominated by the ruling Conservatives - accused Mr. Clarke of overoptimism and criticized him for admitting that government finances would stay in the red until 1999-2000. The government hopes to provide a boost through recent interest-rate cuts, Britain's withdrawal from the European Union's current exchange-rate mechanism for linking currencies, and the nation's successful trade with Europe. The trade-based growth strategy is tied to refusing to accept EU employment laws, which Clarke says are too inflexible and discourage investment.

But politically, the government is hurt by tax hikes of 1994 and by failure of the ''feel good factor'' to filter through to the general population. Polls show the Labour opposition 40 percentage points ahead of the Conservatives, and gaining.

- Alexander MacLeod, London

China applies brakes

STANDING on a wintry wind-swept corner, Wang Xueping watched her bus come into view. As of Jan. 1, when the government sharply raised subway and bus fares, the government clerk pays almost $2.50 per month to get to work, double last year's ticket price.

''This is a big increase, but it's not too bad. The government loses a lot of money supporting public transport,'' Ms. Wang says. ''I'm just afraid prices will keep going up and up.''

China got some room to hike prices and reduce some subsidies when retail inflation slowed to 14.8 percent in 1995. China's economy, which has been growing on average more than 10 percent yearly since 1979, has slowed under the government austerity plan, in effect since 1994. Measures included price and credit controls and large food subsidies.

Still, Western analysts say the respite could prove only temporary. The deficit-ridden government continues to prop up decrepit state industries with inflationary subsidies. Food prices could again jump because costs of fertilizer, seeds, and other agricultural inputs have risen. Farmers want a raise in the state purchasing price of grain.

Moreover, analysts say inflation has probably been underreported by government statistics officials under political pressure to meet targets. Says a Western economist: China is ''not yet out of the woods.''

- Sheila Tefft, Beijing

Canada relies on trade

CANADA needs continued strong exports to the United States to get even modest economic growth in 1996. Any sudden economic chill south of the border will send a wintry blast northward.

''We've tied our wagon tightly to the US,'' says Michael Gregory, an economist at Lehman Brothers brokerage in Toronto. ''Our consumer growth is fragile, and so is personal-income growth. The only thing pulling the economy along is growth in exports - and the bulk of those are to the US.''

Modest growth in Canada, he says, masks deep troubles for individual Canadians: high unemployment, record consumer debt levels, low-savings, and the heavy impact of tens of billions in federal and provincial government budget cuts.

Canada's industries are running far below capacity because of stagnant consumer demand. ''Canadian consumers have been stunned by the slack job markets, having run down their savings in anticipation of future income,'' reported the Conference Board of Canada in January. Household debt is at a record 89 percent of after-tax income, it said. Unemployment is about 9.5 percent.

- Mark Clayton, Toronto

Russia makes progress - but too late for Yeltsin?

THE Russian economy is just raising itself from its post-Soviet collapse. It is beginning to grow, with inflation finally under control, according to many economists here.

But progress may be arriving too late.

Russian voters showed their impatience with economic reform in parliamentary elections in December, giving communists the largest share of votes. It is unclear how closely President Boris Yeltsin, who faces a presidential election in June, will stick to his reforms. One encouraging sign to Western observers: Mr. Yeltsin recently appointed free-marketeer Vladimir Kadannikov as his new economic minister.

Richard Layard, an economist at the Russian-European Center for Economic Policy, projects growth in 1996 at 2 to 4 percent, the first actual growth since before the demise of the Soviet Union in 1991. He foresees growth of about 5 percent annually through 2000.

Inflation fell over the course of 1995 from 18 percent in January to 3.2 percent in December.

The defeat of inflation, Mr. Layard expects, will draw out consumer spending of accumulated savings, which in turn will drive growth.

- Marshall Ingwerson, Moscow

Brazil battles inflation

AFTER 18 months of low inflation, some Brazilian economists are beginning to ask if the nation is paying too high a price.

President Fernando Henrique Cardoso's stabilization program, which began in July 1994, has slashed monthly inflation from 50 percent to 1.5 percent or 23 percent annually, the lowest rate since 1973. The yearly rate for 1996 is expected to be as low as 15 percent.

Brazilians now stash their currency in interest-bearing savings accounts rather than under their mattresses and have more money to buy food and consumer goods. Last year, Brazil's 121 major shopping centers grossed $12 billion in sales, a 54 percent increase compared with 1994. Consumers bought a record 1.6 million cars, and 6 million television sets.

So what's the problem?

Afraid that a consumer explosion would raise inflation, the Cardoso administration raised interest rates sky-high to slow down consumer spending.

Companies pay more than 50 percent a year above inflation, causing thousands of small businesses to close their doors.

Critics say high interest rates will reduce growth and add to already-high joblessness. They also say Cardoso's stabilization program has failed to curb a growing budget deficit, which has gone from a small surplus in 1994 to a sizeable 4 percent of GDP in 1995.

''Over the next two years, unemployment in Brazil will become the searing political issue it is in Europe,'' predicts Richard Foster, editor of the business newsletter Brazil Watch.

- Jack Epstein, Rio de Janeiro