Government action vs. free market: West's differences run deep

* Should the cut and thrust of the competitive marketplace - or government action in subsidizing exports and smoothing exchange rates - lead the world out of global economic recession?

* Can Western Europe find its way out of an increasingly tight economic squeeze - between the computerized high technology of the US and Japan on the one hand and the new ''smokestack'' industrial strength of South Korea, Taiwan, Brazil, and similar fast-developing nations on the other?

Well-placed officials and economists here see these two basic questions underlying preparations for the summit meeting at Williamsburg May 28 to 30. It is to be attended by the United States, Canada, Britain, France, West Germany, Italy, and Japan.

The preparations include (1)revived French ideas for a new international conference along the lines of the Bretton Woods, N.H., meeting of July 1944; (2 )the controversial US-sponsored meetings of trade and finance ministers here May 10-11; and (3)the meetings of the Organization for Economic Cooperation and Development (OECD) in Paris May 9-10.

The divisions between free-market and government-intervention philosophies were very much on show at the OECD meetings here. They run deep between the center-right Reagan administration, supported by Britain and West Germany, and the Socialist government of French President Francois Mitterrand.

The Reagan team insists on relying as much as possible on the force of the competitive marketplace, free from government subsidies and fiats which it says are wasteful and inefficient in the West as well as in the Soviet bloc.

Subsidized exports, argues Treasury Secretary Donald Regan, are by definition inefficient. Commerce Secretary Malcolm Baldrige told reporters May 10 that developing countries had to move toward ending subsidies if they wanted to trade with the US.

At the same time, Mr. Baldrige said, developed countries had to buy more third-world exports, even at the risk of larger balance-of-payments deficits, to block harmful protectionism. The US, he said, was doing this. He estimated the US balance-of-payments deficit this year at $58 billion, up from $43 billion last year.

The US emphatically does not favor a return to fixed exchange rates. Mr. Baldrige said that intervention on exchange rates by one country over a long period was ''futile.'' He cited a recent IMF study, commissioned by last year's economic summit at Versailles, to prove his point.

The French disagree. President Mitterrand revived May 9 the concept of governments acting through a new type of Bretton Woods conference to restructure the monetary system, stabilize exchange rates, and lead to new links between ''have'' and ''have-not'' countries.

While the scope of the French ideas is not yet precisely known, they appear to have some elements in common with a proposal being pushed through the International Monetary Fund framework by former IMF steering committee chairman Robert Muldoon, prime minister of New Zealand.

Mr. Muldoon said May 10 that he had found widespread support within the IMF and the Commonwealth Finance Committee for a new Bretton Woods type of forum, which might at least hammer out some answers to the developing world's increasing debt burden (now about $550 billion).

Bretton Woods saw the world's first major effort to reorder Western economies in the postwar era. It led to fixed exchange rates pegged to gold and the formation of the IMF.

According to Mr. Muldoon, his plan to revive the forum would be presented at Williamsburg by Japanese Prime Minister Yasuhiro Nakasone, to whom Mr. Muldoon had written and who had replied in favorable terms.

US officials acknowledged later that Mr. Mitterrand had taken them by surprise. They saw his speech as a preview of ideas he would raise in Williamsburg. They agreed with some of the points he raised, including the need for a better dialogue between Northern ''have'' nations and Southern ''have-nots ,'' and more technological training for young people.

In quiet but definite terms, however, US officials differed with the idea that governments could step in effectively. So did West German and British spokesmen.

Relations between Washington and Paris had been deteriorating before the speech. Mr. Mitterrand earlier refused to send trade or finance ministers to the US-organized dinner May 10, seeing it in part as unwelcome preparation for Williamsburg. The French President wants no preplanned agenda and no prewritten communique.

At the heart of his policies, many analysts here say, is frustration at the way high US interest rates (and the size of the structural US budget deficit that generates them) are weakening the franc against the dollar. This is especially so at a time when he is widely seen as trying to stave off another devaluation and more austerity measures.

Meanwhile, Western Europe itself feels increasingly squeezed as it searches for a new place in the world economic order. The US and Japan produce the bulk of the world's new high technology. Korea, Taiwan, and Brazil make steel, textiles, and shoes more cheaply than Europe can.

A senior international economist in Paris puts Europe's plight this way: ''If Asia is becoming the world's factory floor, and the US remains its breadbasket, Europe is becoming the world's boutique.'' His point: A boutique is a fine place to visit, but not such a good place in which to live.

The US and some European economists argue that the most effective answer is for Europe gradually to reduce government (particularly welfare) spending, to stop subsidizing ''smokestack'' industries such as steel and textiles, and to promote industry efficiency based on individual risk-taking.

''Europeans, accustomed to a high standard of living based on government welfare and support for industry, don't want to go through this process,'' an economist observes. ''But it is happening in Britain. The effect of recession and inflation is just now hitting the French hard, and is well under way in West Germany. Europe will have to change one way or another. The questions are how, and when.''