COMMERCE DEPARTMENT CRITIQUE OF OUR NICM ON "THE US IN THE WORLD ECONOMY: ELEMENTS OF STRENGTH"

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP83M00914R001000020006-7
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 21
• Document Creation Date: December 20, 2016
• Sequence Number: 6
• Content Type: MEMO

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THE DIRECTOR OF CENTRAL INTELLIGENCE
MEMORANDUM FOR: Director of Central Intelligence
Deputy Director of Central Intelligence
THROUGH . Chairman, National Intelligence Council
FROM
National Intelligence Officer at Large
:D
DDI/NIC #5729-82
13 July 1982
NIC Analytic Group
SUBJECT . Commerce Department Critique of our NICM on "The US
in the World Economy: Elements of Strength"
1. We are disappointed, though not greatly surprised, at the tone
and content of the Commerce Department critique of our study. The points
they make are neither persuasive nor helpful. Our responses to the more
important issues they raise are attached at Tab A.
2. We have drafted your reply to Lionel Olmer in a positive mode,
in the hope of elevating the exchange to a more fruitful level. Our
discussion with individuals on Olmer's staff gives us some hope that a
more balanced appraisal of the difficult issues involved can be undertaken.
In this regard, we suggested to Commerce that they sponsor an exchange of
views among US high-technology companies, drawing in those who have been
successful in competing with the Japanese, as well as those with a poor
track record. As Hal Malmgren may have told you last week, he is under-
taking such a study, drawing exclusively on corporate financial support.
A suggested reply to Lionel Olmer, for your signature, is attached at Tab B.
Attachments:
Tab A: Responses
Tab B: Memo for DCI Signature
All paragraphs are classified
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DDI/NIC #5729-82
13 July 1982
MEMORANDUM FOR: DCI
DDCI
THROUGH : C/NIC
at-Large
NIC/AG
SUBJECT . Commerce Department Critique of our NICM on "The
US in the World Economy: Elements of Strength"
Distribution:
1 - DCI
1 - DDCI
1 - Ex.Dir.
1 - Ex.Secretariat
1 - ER
1 - C/NIC
1 - VC/NIC
1 - NIO/E
2 - NIO-at- l /NH
NIC/A
2 -
NIO-at-Ll NIC/AGj Isbl
(13 JULY
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UNITED STATES DEPARTMENT OF COMMERCE
The:Under Secretary for International Trade
Woc-.,nyson. 0 C. 2O23O
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EYES ONLY
MEMORANDUM FOR THE DIRECTOR OF CENTRAL INTELLIGENCE
Subject: National intelligencweouncil Memorandum 82-10006 of
May 1982:' The United States in the World Economy:
Elements of Strength
From: Lionel H. Olmer
Because the subject report's conclusions struck me as totally
unwarranted based on my own-assessment of the competitive
position of the United States in the world economy, I asked my
staff to provide a detailed critique. This critique, which I
attach for your review, suggests strongly that the NIC memo is
seriously rlawea, botn from the point of view Vi economic
analysis and, perhaps more importantly- because of the
misimpressions it may create as to the true (and worrisome)
character-of our declining competitiveness in world markets,
especially when.compared with Japan. .S
The preface to the NIC memo identifies three assertions which
it states will be 'challenged' in the paper:
1. that the "United States is steadily losing its
competitive e.dge in worldwide and key export markets'
2. that the 'downward trend in US productivity growth is
a firmly embedded phenomenon'
3. that 'Japan's recent drAmatin high-tPc'hnrtlogy
accomplishments foreshadow the end of US technological
preeminence..'
These assertions are indeed proper issues for analysis.
Unfortunately, in the NIC memo, the points are either not
treated in any substantive sense or, as is the case with
item 1, the arguments presented are invalid due to errors or
omissions of a technical character.
With respect to U.S. ccmletitivaror-S in high technology
industries, the Cabinet Council for Commerce and Trade (CCCT)
has commissioned a working group composed of representatives
from many executive agencies to examine this topic in detail.
The working group, which I chair (and which incidentally has
CONFIDENTIAL "
EYES ONLY s'" ??n ?0
DERIV.,CLASS. BY: Lionel H. O1mer
SOURCE: CIA NICM 82-].0006
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EYES :ONLY
benefited enormously from CIA's support), is now in process of
expanding and refining a draft report which has recently been
reviewed by the,000T.' I have shared the preliminary findings
of the CCCT report (which pinpoint a serious erosion of U.S.
competitiveness) with'eight corporate leaders who have
international reputations for expertise in different fields of
technology.' All have-agreed with the basic thrust of the CCCT
study and I think you will find the attached written comments
from one respondent revealing.
Perhaps the subject of the U.S. position in the world economy
is deserving of a careful and thorough 'competitive assessment'.
Tab A: Analysis of the United States in the World Economy:
Elements of Strength
Tab B: Letter' from Horace G. McDonnell, Jr.
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Analysis of
The United States in the World-Economy:
Elements of Strength
(NICM 82-10006)
The National Intelligence Council has released this paper
representing a startlingly different view of America's competitive
position in global markets. In its preface, the NXCM reports it has
found an 'overall picture that ... is considerably more encouraging
than the gloomy perceptions now gaining wide currency even among
well-informed observers.' The ;following is the result of an
analysis conducted by the International Trade Administration.
Summary of the NICM
According Lu the fiCM, America's international economic performance'
in the 1970's was relatively robust. The Outlook for a O.S.
resurgence in the 1980's is, in the NICM's view, encouraging. The
widely-held views of declining U.S. .comr%atitivencee, 6ec:uldr
di=%Alues in productivity, and a prospective lose of technological
pre-eminence are, in the NICM's view of the world, excessively
pessimistic and are not supported by its analysis.
The NICM's conclusions regarding America's performance in the 1970's
rest on four assertions:
0 U.S. real economic growth matched or exceeded that of most
other industrial nations;
o U.S. productivity losses did not reflect economic weakness
so much as the fact that America experienced rapid-labor
force.growth and emphasized job creation (over capital
accumulation);
0 America's current account registered a cumulative 364?
billion surplus from 1970 to 1981, the largest of any major
country; and
0 America increased its. share in world markets in the 1970's,
when viewed in terms of the-volume of trade.
The paper's optimistic view of the future is based (a) on the
conclusion that the past decade or so has not been as bad as most
observers have thought and (b) that-the following five character-
istics of the 1980's will bestow even greater strength on the U.S.
in world markets:
DERIV. CLASS. BY: Lionel H. Olmer
SOURCE: CIA N!CM 82-10006
DECL. ON: N/A
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o We have great energy resources, and-our high per capita
energy consumption means we-can benefit further-.from energy
conservation;
o Uncertainties regarding future demand have repressed
capital spending which will . surge -once current high
interest rates decline;
o Foreign capital will continue to flow into the U.S.;
o Declining labor supply growth will place the U.S. in a
relatively better position to reduce unemployment andns;
induce American companies to emphasize productivity gains;
and
o U.S. performance in technology frontiers will continue to
be highly credible -- the challenge from Japan and other
countries will not be as overwhelming as has generally come
to be feared and, indeed, will serve to stimulate even
greater U.S. efforts to meet foreign competitition.
Discussion
The assertions concerning America's relative decline "in world
markets, which the NICM sets out to challenge, are closer to the
,truth. The NICM incorrectly assesses past economic trends, asserts
the likelihood of future developments without taking fully into
"%Xount Leadily available damographic and acommit fnrAnnnts,
overlooks key factors which will aLiect U.U. and world economic and
trade prospects, Auto uaca alotn that- ate variously incorrect, or
misleading in their portrayal of the U.S. condition in world markets.
Balance of Payments
The overall conclusion of the NICM relies heavily on points dealing
with the U.S. current account position. However, both the data and
the interpretation thereof are in error.
The NICM states that the overall U.S. trade performance was highly
credible during the 1970's since our cumulative current account
surplus was more than $64 billion (pp. 4 and 27)). In fact; the
billion (19@2
cumulative U.S. surplus, 1970-81, was only $10.6
Economic Re ort of the President, p. 346; March 1982 Survey-of
Current Business, p.
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This is-no minor error. A cumulative surplus of $10.6 billion
places America near the bottom of the countries listed in the NICK
-- not the top. -Thus, one of the paper's major reasons "for con-or
cluding.we did rather well is based--on incorrect data. (The seems to come from using the balance on goods and services, rather
than the current account -- leaving out official transfers.)*
Even ignoring this error, the unqualified reliance on the balance of
goods and services as an indicator of the strength of the U.S.
international economic position is unwarranted. Much later in the
report (p. 102), it is noted that the improvement in our goods and
services balance has been due to advances on the services side of
the ledger. A positive and growing balance on services trade is not
an unequivocal indicator of a robust American economic position.
The surplus in the services account-is more than accounted for by
the surplus in direct investment income and interest income from
abroad. Although these returns can serve as an indicator of
American overseas-based wealth, they. should not be equated with a
favorable current U.S. competitive position in the international
economy.
Returns on those. investments are a credit to the international
mobility of funds, the acumen of American investors,%and the
relatively adverse aspects of the D.S. competitive position. They
-certainly should not be viewed as indications of a lastingly robust
,American economy.
Finally, if a measure of trade share (rather than trade balances) is
the preferred basis for demonstrating a strong U.S. global economic
position as the NICM implies through usage,, why is this not also
true for our performance in services? The NICM discusses services-
only in terms of balances perhaps to avoid having to consider claims
such as those set forth in a recent issue of Industry Week that
America's share of world services income fell from 25 percent in
1968 to 15 percent today. The selective employment in the NICK of
different methods to evaluate the two components of the balance
on-goods and services further distorts the analysis and misleads the
reader.
Even had the data been correctly stated, their simple declaration
would have been.misleading. The small U.S. current account
surplus is due largely to the fact that we changed our
statistical definitions a few years ago to include as a credit
the reinvested earnings of U.S.'companies overseas -- even
though such earnings do not directly flow back to our shores.
For example, the 1981 current account showed a $6.6 billion
surplus..,
That included $19.1 billion in repatriated earnings and $11.5
billion in reinvested earnings. Excluding the `flow' of
reinvested earnings (they contribute to an increase in America's
overseas wealth and thus eventually'to expanded repatriated
earnings, but not in 1981), our current account in 1981 would
have registered a deficit of nearly $5 billion.
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Volume vs. Value
The 'NICK-characterization of a robust U.S. performance also relies
heavily on the improvement in the 'volume' share of O.S. exports in
the 1970's, that is to say, after !adjusting for price and currency
changes, America's share of total and manufactures trade actually
increased-slightly during the decade.* The NICM cites this as
further evidence that our global competitive position actually
improved.-
Correctly pointing out that dramatic changes in currency
exchange rates and oil prices have caused a 'blurred image' of
the D.S. export performance, the NICM proceeds to analyze events
based on estimates of 'volume' shares. However, these 'volume'
shares are not pure measures, but rather proxies. Derivation of
such share data relies on a combination of two separate
techniques:
0 deflation of export values based on export prices in a
given period to produce export 'values' in real terms (it
should be noted here that all of the NICM data and tables
fail to. indicate the base years from which 'volume' share
performances are calculated); and
o a calculation of shares on the assumption of constant
exchange rates (again no indication of base year is given).
Both techniques require a further assumption to be made: namely
constancy in the composition of product 4.nd currency prices in
the base year are maintained throughout the period being
analyzed. However, the use of constant composition base period
assumptions necessarily confronts the same type of problem which
the use of `volume' shares seeks to avoid -- shifts in
composition during the decade due to rising oil prices and the
shift to floating exchange rates. The constant enmpno4fion and
sela%.ed assumptions imbedded in this technique blur the imago as
much as market shares based on current values and exchange
rates. Use of either form of share analysis requires analytical
qualification that is not given in the NICM.
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Even granting that such 'volume' share measures reveal a more
dynamic, U.S.-.economic performance than most observers would credit,
a basic. question remains:: at what price?* ? If- export value shares
rise proportionately with volume shares, an improved competitive
position is obvious. The reverse is not as clear. If volume share
rises but value share remains the same.or declines, as is the U.S.
case, then a serious deterioration in the terms of trade is
implied. Such a development hardly should be described as an
indication of a robust U.S.. performance.
As our share of world trade in value term lianas been railing since
1970 even-though it has been rising in volume terms, it is clear we
are selling more now and getting less for our sales than we used to
--- certainly a classic case of loss of competitive advantage..m
Put another way, we have suffered a severe loss in our terms of
trade. IMF data show that during 1970-81 U.S. import prices rose 44 mot= ~_:
percent more than export prices, meaning we must now export 1.44
units to earn the money to buy what one unit enabled us to purchase
in 1970. There is no cheer to be -found in these data. 111.
* Of course, we do not grant the argument since it is clear that
competitiveness is-not judged by the physical quantity of goods
shipped, but rather on the ability to obtain a good price for
what one sells. It is the value of trade that counts, not
merely volume.. As an extreme example, the best-way to maximize
one's 'volume' share of any market is to give one's goods away
for free.
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Japan.
The NICM declares that U.S. manufactures trade, export* volume
'cl'imbed almost as rapidly" as :Japan's (pp. 3 and 39). The validity
of this statement rests. on using 1971 as the base year. It fails to
note that Japanese export volume boomed from 1970 to 1971 with an
increase in that year alone of nearly 20 percent. By contrast,
America's performance that year fell by one percent. The following
data illustrate this point:
Index of Exports. of Manufactures
(1967 - 100)
i1. S . .
Japan
1970
125.3.:
167.5
1971
124.0
200.1
+
f
r
1980
252.5
432.8
Percent Change
1970 to 1980
101.5
158.4
1971 to-1980
103.6
116.3
SOURCE: international Economic Indicators, March 1982, p. 30.
Thus, by adding only one year to the equation, we see that, rather
doing nearly as well, we did considerably worse even using the
NICM's preferred measure of 'volume' share.
Even so, the NICM proceeds then to denigrate the significance of
Japan's economic potential by observing that Japan's better
performance was due' to a concentration (52% of exports in only five
categories: road motor vehicles, steel, consumer electronics,
industrial machinery, and ships. Further, the NICM asserts, this
concentration will limit the scope of Japan's success in the future.
These five categories are so broad and basic they can hardly be
regarded as "concentrated'. Also, it is not at all clear how the
large share of Japan's exports accounted for by these categories
will restrict, ipso facto, further export growth of those products,
export of other products, or in'any way restrict total production by
the Japanese economy.
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For instance,-using categories-at a comparable level of
disaggregation, U.S. exports are. even more concent.rated.than
Japan's. Five categories account -for 64 percent* of total U.S.
exports-compared with only 52 percent for the five Japanese
categories. The five-U.S. categories are. industrial machinery,
foods (including feeds and beverages), chemicals (excluding
medicals), road motor vehicles, and civilian aircraft and parts.
(These U.S,. categories differ from those cited in the NICK.)
Obviously, there -is nothing unique in this 'concentration' in.
Japan's total exports. The scope is typically broad and is
growing. . The notion,of a relation between the scope of those.
Japanese product categories and a restraint on future Japanese
competitiveness Is specious.
Furthermore, the NICM misses the real point -- the growth potential
of Japan's. economy facilitated its ability to rapidly increase its
share of foreign markets in the .1970's. Indeed, this is in part the
source of concern -- Japan has demonstrated an ability to increase
rapidly its share of a particular import market, whether it is a
relatively small market such as video recorders or a very large and
basic market such as automobiles. Japan's ability to mobilize
industrial capacity is a very high profile issue, as Japan tends to
focus on large markets with the greatest growth potential for its
exports such as those in the United States.
?This concern with the scope of Japan's competitive capability is
even more vital as Japan is making rapid inroads into the U.S..
competitive position -- both in foreign and U.S. markets for high
technology products. As both the United States and Japan must
increasingly rely on their output of high technology goods to pay
for purchases of lower technology goods, this growth of Japan's
exports in high technology goods should be a matter of increasing
U.S. concern. This NICM completely fails to deal with the high tech
issues and their relationship to the U.S. economic position now and
throughout the 1960'x.
+ Again, there appears to be a discrepancy in the NICM's data.
The report asserts the comparable U.S. figure at less than 40
percent.
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The notion that-Japan is a copier and embellisher, not an innovator,
in product. technology is deservedly being relegated to the archives.
The notion that Japan's 64K RAM chip success story "may have been
dramatic as a single accomplishment- but it represents only a speck
on the large canvas of the computer-based knowledge industry" (p. 10)
is precisely the sort of view which,. if it continues, will result in
America's waking up to the realities of global competition only to
find we are too late and that the world has passed us by.*
Productivity
The NICM states that declines in U.S. productivity growth in the
1970's were benign, being due to the fact that the labor force was
increasing rapidly and expansion. in output could be achieved more
economically by adding labor than by increasing capital. The paper
judges that when the growth in the labor-force slows, productivity
will improve.
This judgment is incorrect. For example, the paper correctly notes
that the United States created 19 million more jobs in the 1970's --
but fails to note LI,aL w,ily 900,000 of these were in manufacturing.
Despite the marginal increase in manufacturing employment, U.S.
manufacturing productivity declined from a 3.1 percent annual rate
in 1960-73 to a 1.4 percent annual rate in 1973-79 and to less than
a 0..6 percent annual rate in 1977-80.
Productivity declines are due to insufficient investment in new
equipment. From 1949 to 1974 capital per worker grew 3.3 percent
annually in the United States, but since 1974 it has grown only 0.2
percent annually. Our capital-labor ratio, for example, was eight
times Japan's about 1960. But by 1975 Japan`s capital-labor ratio
had almost caught up to ours.
The NICM'b analysis is further voided by the fact that it made its
judgments only in terms of labor productivity. What is more
troubling is that overall factor productivity (units of output per
units of total input) has been on a secular decline in the United
States. Dennison, Kenderick, and other economists have Aocumentcd
this decline, but have been unable to agree on the basic cause, much
less a cure.
? An article in a recent issue of The Economist (June 19, 1982)
does an especially good job of revealing how and why 'the
betting must be that Japan will overtake' us even in high tech
matters. The authors of the NICM would be well-advised to read
it carefully.;
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Relative Economic. Growth
An 'additional basis for the NICM'm.-claim to cheer in the 1970's is
that the United States did relatively better in its real GNP growth
compared to the -other industrial nations than in earlier decades.
This, however,-is only because other nations did more poorly than
before. While U.S. growth slowed in the 1970's, real growth in the
other industrial nations slowed even more. Thus, in relative terms,
we improved.
but this As cause for gloom -- not cheer. We want other nations to
grow more rapidly, so they will pose better export markets for O.S.
companies and so they will be less tempted to pursue
begger-thy-neighbor policies.
Moreover, the relatively favorable U.S. economic growth was achieved
only at the expense of enormous: federal budget deficits. In macro
economic terms, these deficits. supplied the demand stimulation
necessary to offset the depressing effect of the huge U.S. trade
deficits. Such budget deficits, however, are obviously
unsustainable -- and in retrospect few would applaud as sound U.S.
economic policies in the_ second half of the 1970's. ?.?
ManufactureR Trar?e
The, NICM dismisses manufactures trade as being relatively
unimportant for the United States. Yet two-thirds--of our exports
are manufactures and half our imports are manufactures.
Furthermore, manufactures have proven to be Our principal import
problem -- not oil. U.S. oil imports grew $72 billion from 1970 to
1980. But-during that same time, U.S. imports of manufactures grew
$100 billion. The?NICM barely addressed the causes of that huge
import burden and the loss of competitiveness that is implied by it.
Exchange Rates
The NICM probably correctly points out that the U.S. dollar has
recently been at a high point in its series of cyclical swings, and
that in the next year or so the dollar will likely decline. That
decline will help improve the competitiveness of U.S. exports and
make imports more expensive. To what extent this will improve the
underlying trend -in the U.S. trade balance remains to be seen. In
any case, the NICM asserts that the current extent of non-competi-
tiveness is-more due to the current cyclical position of the U.S.
exchange rates than other factors. Nevertheless, the NICM chart (P.
63) comparing the U.S. trade balance to cyclical shifts in exchange
rates suggests no underlying appreciation in the value of the
dollar, but instead a possible long-term deterioration in the
dollar's value. The NICM fails to take account of this trend in
addition to the cyclical swinafi.
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Factors for -the Future
The NICM based its optimism not -orriy on its view of the 1970's but
also on some factors for the 1.980's. These, however, are mere
assertions, not supported by facts, forecasts, or analyses. This is
difficult to understand in view of the fact that there.has been
considerable public and private research into many of the factors
which will affect growth and competitiveness in the 1980's. Most of
this research provides little ground for optimism. Almost all of it
shows that government and business must work harder to assure a good
future for the United States.
Technology -- As noted earlier, the NICM indicates that Japan will
have difficulty moving to original technologies and will most
probably continue simply to improve on U.S. technologies and stay
confined to certain limited areas. The paper imps H pia th?!t the
United 'States will have little difficulty in staying on top of the
technology heap.
The facts indicate the contrary -- including almost all of the
research that has been conducted by the CIA,'and specifically those
elements of CIA which have analyzed Japan's technology future.
Japan each year graduates twice the number of electrical engineers
as the United States -- even though it has half the total population
?ot the United States. Japan, France, Germany, Sweden and others
have all started technology programs designed to cut into the U.S.
lead. In 1962 the United States accounted for 75% of major country
R&D, but by 1975 we accounted for only 50%. The U.S. share of world
trade in most high technology areas has declined sharply during the
1970's. Other nations have begun offering Special tax breaks for
companies that employ new technologies. These and other indications
show that the United States has a huge problem.
Energy -- The NICM asserts that one of our strengths is the high
energy intensity of the economy, since that means we have a lot of
energy conservation potential ahead.of us. Maybe, but the record
indicates most of the easy conservation steps have already been
taken. An alternative view is that our high energy intensity is
going to leave us very vulnerable to future oil price hikes.
Foreign Investment -- The NICM asserts foreign investment will pour
into the United States. It probably will, but this is not always a
'plus". Much of it will be for the purpose of acquiring U.S.
technology. All of it will have the effect-of increasing the
outward flow of repatriated earnings from the United States -- which
will tend to offset the inflow of repatriated earnings from
U.S.-owned companies overseas, hence putting greater pressure on the
U.S. current account.
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Other Factors -- The NICM did not address factors which.many
economists view as the keys to the next couple of decades. These
include:
0 Slow global economic growth. If the industrial countries
grow 3 percent annually rather than 4 percent, the world
will lose one trillion dollars of production by 1990. That
will make trade liberalization more difficult and will
increase global competition for the more slowly-growing
trade 'pie"..
0 European unemployment. Even the most optimistic assessments
of.European economic prospects indicate that European GNP
growth will not be sufficient to reduce the unacceptably-
high present rates of unemployment to tolerable levels.
Protectionism and political instability in Europe are
all-too-real dangers.
o LDC Debt. The non-oil LDC's have accumulated debt that is
now over $400 billion. Earning the foreign exchange to
keep debt service to reasonable levels looks very difficult
-- particularly given the slow growth expected for
industrial nations. ?
o LDC exports. As LDC's increasingly export manufactured
? goods of moderate and low technological content, they
create rising industrial nation structural unemployment for
less skilled labor. This cannot be offset by increased
demand for the skilled labor which will make the more
sophisticated products the United States and other
industrial nations will sell'to the.LDC's.
 Approved For Release 2007/04/16: CIA-RDP83M00914R001000020006-7
Approved For Release 2007/04/16: CIA-RDP83M00914R001000020006-7