DOLLAR COSTING OF FOREIGN DEFENSE ACTIVITIES: A PRIMER ON METHODOLOGY AND USE OF THE DATA

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP89T01451R000400470001-0
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 38
• Document Creation Date: December 23, 2016
• Document Release Date: October 16, 2012
• Sequence Number: 1
• Publication Date: July 1, 1988
• Content Type: REPORT

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asE'wE Directorate of 1 Defense Confidential
Intelligence IF Intelligence
Agency
Dollar Costing of Foreign
Defense Activities: A Primer on
Methodology and Use of the Data
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Intelligence (~~- :~~1 Intelligence 25X1
Dollar Costing of Foreign
Defense Activities: A Primer on
Methodology and Use of the Data
Analysis, CIA
This report was prepared by Central
Intelligence Agency, and Defense
Intelligence Agency. Comments and queries are
welcome and may be directed to the Chief, Defense
and Economic Issues Group, Office of Soviet
Confidential
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July 1988
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Summary
Information available
as of I July 1988
was used in this report.
Dollar Costing of Foreign
Defense Activities: A Primer on
Methodology and Use of the Data
strengths, and the operating and training levels of the forces.
Dollar valuations of the defense activities of different countries provide a
useful summary comparison of the scale of these activities. Physical
measures such as order of battle, although important, cannot be aggregat-
ed without some common unit of measurement. Dollar costs are often used
for this purpose because they take into account both quantitative and
qualitative differences. They reflect the number and mix of weapons
procured, the technical characteristics of military hardware, manpower
developed and applied to expenditures in national currencies.
The dollar value of the defense activities of a foreign country is calculated
by estimating the cost of each activity in the prices and wages prevailing in
the United States. For Warsaw Pact countries, each activity is directly
costed in US prices and wages. For example, the dollar cost assigned to a
year's production of T-80 tanks in the Soviet Union would be found by esti-
mating the cost to produce the same tanks, at Soviet production rates,
using US material and labor costs and US manufacturing practices-and,
therefore, US manufacturing efficiencies. The dollar cost of maintaining
the Soviet Union's large inventory of tanks for a year would be found by
applying US prices and wages to the Soviets' maintenance practices. For
non-US NATO countries, personnel costs are directly calculated at US
rates; for the remaining activities, appropriate conversion factors are
Dollar costs of defense activities are estimated in five major resource
categories: procurement, construction, military pay and allowances, opera-
tions and maintenance (O&M), and research, development, testing, and
evaluation (RDT&E). For the Warsaw Pact, thousands of individual
estimates are made for each resource category, such as annual production
numbers for each weapon system for every year, detailed breakdowns of
the number and rank structure of military personnel, and estimates of
military construction activities.
There are no direct measures of the accuracy of aggregate dollar costs of
foreign defense activities. Such dollar costs are a theoretical construct for
which no objective "truth" exists. There are some subjective and indirect
objective measures of accuracy, however. For the Warsaw Pact, the levels
and trends depicted by dollar costs roughly reflect our observations of
forces in the field. Moreover, although applications of the methodology
have been revised over the years, and the data are changed annually to in-
corporate new information, no radical changes in the aggregate results
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(. onnaent1al
Dollar valuations of another country's defense activities estimate the cost, using
prevailing US prices and wages, to produce and man a military force of the same
size, armed with the same weapons, and operated in the same manner as that of
the foreign country. They provide a common denominator to summarize the
diverse activities associated with military programs, allowing portrayal of the
relative magnitudes and general trends in these programs in terms that take
account of both quantitative and qualitative differences.
Dollar valuations, however, should not be used in isolation. They should be
considered together with order of battle, production levels, and other information
relevant to the issues being addressed. Dollar valuations should not be used as
measures of (a) actual foreign defense spending, (b) the impact of defense on a for-
eign economy, or (c) a foreign leader's perception of his defense activities.
Valuations in indigenous currencies are appropriate for these purposes.
Finally, dollar valuations should not be used to compare military capabilities.
Such assessments must take account of accumulated stocks of military weapons,
equipment, and supplies; military doctrine and battle scenarios; the tactical
proficiency, readiness, and morale of forces; the effectiveness of weapons; logistic
factors; and a host of other considerations.
have occurred. Further, the changes reveal no underlying upward or
downward bias in the estimates. On balance, we believe the overall
estimating error amounts to no more than 10 percent for any one year.
But some significant weaknesses in the estimates for Warsaw Pact
countries remain. While we have high confidence in the estimates for some
resource categories, such as procurement, others are more uncertain. The
dollar estimates of Soviet RDT&E are particularly uncertain, with no
immediate prospects for improvement. Lags in data collection are also
troubling, resulting in greater uncertainty in the estimates for recent years
than for earlier ones. This weakness is particularly acute for O&M and
RDT&E activities. A number of years might pass before any change in
their trend would be detected.
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The dollar value comparisons, especially of US and Soviet defense
activities, are used by US policymakers and the Congress. When properly
used in conjunction with detailed information about force capabilities and
requirements, the comparisons provide summary indications not otherwise
available. However, perhaps because dollar costs are used in many ways in
the analysis of US programs, dollar cost data on foreign military programs
seem to convey to many readers information beyond the limited uses for
which they are applicable. Most questions relating to Warsaw Pact-
NATO military issues are best answered using other measures. Although
misuse of dollar comparisons cannot be prevented, the guidelines in the
inset are intended to promote an accurate understanding of their proper
use.
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Proper and Improper Uses of Dollar Costs
1
Estimating Dollar Costs
Product-Group Cost-Estimating Relationships (CERs)
5
US Analogue
6
General Factors
6
Comparability of Coverage
7
Consistency of Results
7
B.
Estimating Dollar Costs of Soviet Defense Procurement
E.
Estimating Dollar Costs of Other NATO Countries'
Defense Activities
G.
Analysis of the Range of Error in the Dollar Estimates of Soviet
Defense Activities
31
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Dollar Costing of Foreign
Defense Activities: A Primer on
Methodology and Use of the Data
more detailed and complex (see inset).
Introduction
Monetary measures have been used for centuries in
the analysis of foreign and domestic trade. In this
century it has become common to see the entire
collection of goods and services provided within a
country summarized in a single value, GNP, which is
then translated into dollars for comparison with the
GNP of other countries. These international compari-
sons of GNP are also broken down to provide compar-
isons of major categories of interest, such as industrial
output and consumption. The dollar valuations of
defense activities of foreign countries have been devel-
oped within this tradition and are based on the same
economic theory and practice used in international
economic comparisons, although their development is
ions.
Physical measures of defense activities include data
on the quantity of weapons and equipment produced
and delivered to military units, the inventories of
major weapon systems, and military manpower levels.
Such measures are useful in portraying the mix of
weapons and the relative sizes of various forces and
their components. They cannot, however, be used to
produce summary measures of diverse kinds of de-
fense programs and military units such as tank divi-
sions, tactical aircraft regiments, and infantry battal-
dollar" can buy
To aggregate such diverse activities, some value must
be assigned that captures the relative worth of each-
in terms of its physical and operational characteris-
tics, resource costs, or some other quality. Because
prices are a useful way to combine otherwise incom-
mensurable quantities and because trends in defense
activities are often related to overall developments in
the economy, it has become the practice to develop
aggregate measures based on the costs of resources
devoted to various defense activities. These costs can
be calculated in any currency, but dollars are the
frame of reference for US policymakers and military
force planners who are familiar with what a "defense
Proper and Improper Uses of Dollar Costs
The primary purpose of valuing foreign defense activi-
ties in US dollar terms is to compare them with
corresponding US defense activities.' Dollar costs
provide an appreciation of the size, quality, and trend
of these activities. The comparisons provide the best
available indicator of this sort. The dollar costs are
calculated using prevailing US wages and prices. For
example, in weapons procurement they represent the
cost in the United States to manufacture the weapons,
using the foreign designs, material specifications, and
production rates and schedules, but with US manu-
facturing practices and efficiencies.
Dollar valuations of foreign programs, in conjunction
with US defense program data, capture differences in
the technical characteristics of military hardware, in
the number and mix of weapons procured, in man-
power strengths, and in the operations and training of
the forces being compared. They can be used to
portray the relative magnitudes of similar programs
and compare trends.
The utility of dollar costs as a common denominator
of defense activities is particularly evident when
dealing with more complex international compari-
sons-for example, the total defense effort of the
seven Warsaw Pact nations. Each of these countries
has an indigenous currency, which, for a variety of
political and economic reasons, is not directly convert-
ible into any other currency. Therefore, any attempt
to aggregate these disparate efforts must be made
using some common denominator. Appendix D dis-
cusses in detail the dollar costing of the defense
activities of the non-Soviet Warsaw Pact countries
A similar situation exists in the non-US NATO
arena. Each of the 15 countries involved uses a
annual dollar outlays for these activities. See appendix H.
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Measuring Soviet Defense Activities
Dollar costs of Soviet defense activities were first
developed within the Intelligence Community in the
late 1950s. In the early 1960s, CIA began annual
publication of the dollar value of Soviet defense
activities. This material has been widely used within
the US Government, particularly by the Legislative
Branch, by the Secretary of Defense and the Chair-
man of the Joint Chiefs of Staff in their annual
reports to Congress, and, on occasion, by the Presi-
dent in his State of the Union address. In 1965, the
Director of Central Intelligence (DCI) and the Secre-
tary of Defense agreed to coordinate their work
"... relating to the cost and resource impact of
foreign military and space programs; and because of
the increasing importance of these economic stud-
ies ... agree/d/ that they should be centrally directed,
monitored, and evaluated. " In a series of communica-
tions between CIA and the Department of Defense, in
which the greater availability of resources at CIA
was acknowledged, CIA was assigned primary re-
sponsibility for such analysis. a In the early 1970s,
the DCI established the Military-Economic Advisory
Panel,
medium of exchange that can, for some purposes, be
readily converted into other currencies. However, the
simple use of exchange rates-especially the highly
volatile rates of the past few years-has led to sharp
year-to-year changes in the dollar value of defense
programs that distort comparisons. More important,
exchange rates are driven by a host of factors unrelat-
ed to the relative costs of providing defense activities.
If the objective is to compare the size of foreign
military programs with corresponding US programs,
consisting of experts from academe and business, to
review all relevant Intelligence Community work,
advise him on its quality, and suggest areas for
improvement. At about the same time, the joint
Military Costing Review Board was established to
coordinate CIA and DIA work in this field.
The estimates have at times been controversial, with
critics charging they are too high, too low, and often
used inappropriately. In 1982 the Deputy Director for
Intelligence, CIA, established a panel of outside
experts to examine the methodologies employed in
preparing the estimates, usage of the estimates, and
the wishes of policymakers regarding their continued
production. The panel held numerous hearings and
took testimony from all interested parties, including
many critics. It concluded that the methodologies
were essentially sound, that the estimates could be
properly used to inform decisionmakers, and that
their continued production was essential
then the best measure is dollars (see table 1).z Dollar
valuations of foreign defense activities have the fol-
lowing important limitations, however. If these are
ignored or misinterpreted, the valuations provide mea-
sures and comparisons that are not valid:
? Dollar valuations do not measure actual foreign
defense spending, the impact of defense on the
economy, or the foreign perception of defense activi-
ties. The foreign country does not spend US dollars.
I Both countries' programs could be measured in terms of the
foreign currency, but that is not generally satisfactory because:
detailed cost information in indigenous terms is not usually avail-
able, particularly for Warsaw Pact countries; US data are already
available in dollars; and, finally, US policymakers, the primary
consumers of such data, prefer measures that are in familiar and
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Table 1
Measures To Use in Addressing Military-Economic Questions a
How much is the United States spending on defense?
What is the trend in the size of Warsaw Pact defense programs?
How do Soviet defense economic activities compare with US activities?
How do non-US NATO defense activities compare with US activities?
How much are the Soviets spending on defense?
What is the impact of defense on the Soviet economy?
What are the trends in Soviet defense spending over time?
What share of Hungarian GNP goes to defense?
How do the East Germans allocate defense resources?
Issues of defense burden are properly analyzed with
estimates of defense expenditures in the domestic
currency.
? They do not reflect the foreign country's view of the
distribution of its defense effort. The price struc-
tures in two countries are often very different. For
example, the costs of Soviet defense activities are
distributed quite differently among the resource
categories when measured in dollars than when
measured in rubles. The effects of different price
structures are significant; for example, Soviet mili-
tary procurement in rubles accounts for about one-
half of total defense costs, but measured in dollars it
accounts for only about one-fourth.
? They do not measure the overall capabilities of
military forces. One of the strongest temptations in
using the dollar value estimates is to interpret them
in terms of military capabilities-either foreign
Dollar costs
Dollar costs
Dollar costs
Dollar costs
Indigenous prices
Indigenous prices
Indigenous prices
Indigenous prices
Indigenous prices
capabilities relative to those of the United States, or
changes in foreign capabilities over time. These
estimates are not intended to and cannot support
such interpretations. Because dollar valuations only
measure the annual production of defense goods
and services, they capture only a small part of a
country's military stockpile. Moreover, assessments
of capability must take into account military doc-
trine and battle scenarios; the tactical proficiency,
readiness, and morale of forces; the effectiveness of
weapons; logistic factors; and a host of other consid-
erations. Dollar valuations of defense activities do
not provide a reliable measure of these disparate
factors.
A final note of caution regarding the use of dollar cost
data centers on the need to make costs in a given year
comparable with those of another year. The usual
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tonnaential
practice to assure comparability is to "standardize"
the costs to a base year. Such standardization removes
the inflationary effects of changes in price levels. In
other words, it eliminates the changes in costs over
time that have nothing to do with the quantity or
quality of the goods or services. These standardized
costs are usually called "constant" costs. A number of
conceptual and methodological decisions have been
made in standardizing the dollar costs; the more
important of these decisions are discussed in appendix
In summary, dollar costs are well suited for compari-
sons of the relative sizes and trends of different
countries' defense activities. They provide a common
summary measure that is needed for any comparison
of the diverse and dissimilar activities of two or more
countries. The dollar cost measures are in terms
familiar to US policymakers and reflect:
? The size of armed forces.
? The quantities and qualities of weapons procured.
? Operating and maintenance practices.
Other measures are available and more appropriate
for addressing issues other than the comparative sizes
of and trends in defense activities. Measures in indige-
nous prices are more appropriate for examining issues
such as:
? How much a country is spending on its defense.
? The share of national output going to defense.
? The relative share of resources going to the various
components of defense.
? Internal perceptions of spending trends.
Moreover, monetary measures, whether in dollars or
indigenous prices, are inappropriate for the analysis of
components of a foreign military program, so that the
final results are both internally consistent and compa-
rable.
The Intelligence Community, after considering a vari-
ety of options, has chosen to use a concept that, in
effect, estimates the cost-at prevailing US prices,
wages, and efficiencies-to develop, deploy, and
maintain a military force of the same size and with
the same weapons as the foreign country and to
operate that force as that country does. For procure-
ment, this means the cost of building the same design
as that of the foreign system at the foreign production
rate, but using US prices and wages and US industri-
al practices and, therefore, US efficiencies at that
rate. It is assumed that the requisite production base
is in place, complete with a trained work force,
qualified suppliers, and all other ingredients necessary
to replicate the foreign output at US manufacturing
efficiencies. This concept is termed "comparable
dollars."
Other concepts are available that, if applied, would
produce different estimates (see appendix A). For
example, at one extreme, US manufacturers could be
asked to design systems from scratch to carry out a
particular mission, and then estimate the dollar cost
of doing so. The resulting costs would then be used for
the actual systems chosen by the foreign country for
the mission. At the other extreme, the starting point
would be to take the foreign country's detailed work
plans for producing a weapon system and then apply
US prices for each labor hour, piece of material, and
so forth, used by the foreign manufacturer.
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relative force or weapon capabilities.
Estimating Dollar Costs
Having decided to provide a summary measure of
foreign defense activities in US dollar terms (that is,
the hypothetical costs of the goods and services if they
had been purchased in the United States), it is
essential to establish an appropriate conceptual
framework that will take into account the many
differences between a foreign way of doing things and
the US way. Such a framework is also necessary to
ensure the consistent application of measurement
methods to the available information on the various
Within the comparable dollar concept, six different
methods are used to develop the dollar cost of procur-
ing a particular foreign weapon system or to value the
other activities that constitute defense. The actual
method used depends on the availability of data.
(Confidence in price estimates is highest for those
components that are nearly identical to US compo-
nents.) Appendix B shows the degree to which each of
the methods is used in estimating Soviet procurement.
The following five methods are described in descend-
ing order of preference. Examples of actual applica-
tions of some of these methods are given in table 2
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Table 2
Examples of Dollar Cost Methods
Applied to Soviet Weapons
Product-specific indus- Small arms (rifles and HP White
trial cost estimates machineguns) Laboratory
General CERs Naval destroyers Gibbs and Cox,
Inc.
1980 Cost estimates are based on detailed examination
of hardware.
CERs are based on a detailed exploitation of both
hardware and equipment manuals.
1982 This is a computer model that estimates dollar costs
of Soviet destroyers based on estimates of the
weight of nine major subsystems. Values are based
on "Sovietized" versions of two US destroyers
(redesign of US ships to reflect Soviet naval design
practices) and adjusted to reflect individual Soviet
ship characteristics.
ferent.
US Price List. This method is used when the foreign
good or service is judged identical, or nearly so, to a
US good or service. For example, US prices are
applied directly to military manpower billets, POL
(petroleum, oil, and lubricants), food, and similar
consumables.3 It can seldom be used for weapon
systems procurement because foreign designs are dif-
Product-Specific Industrial Cost Estimates. This
method is used when we have hands-on access to a
foreign good or detailed design specifications. For
example, about 40 percent of the procurement costs of
Soviet land arms are generated by this method. A US
manufacturer of similar items is asked to make a
detailed engineering cost estimate for producing the
good. He is able to make a fairly accurate estimate
because, by the time we obtain the good or its detailed
' The judgment is made that, on a billet-for-billet basis, any
qualitative differences between a US serviceman and a foreign
serviceman stem from their equipment and training rather than
specifications, the US manufacturer has had consider-
able experience in producing items like it. The prac-
tice is akin to asking General Motors to estimate the
cost of producing a particular five-year-old Fiat de-
sign.
Product-Group Cost-Estimating Relationships
(CERs). The costs of weapon systems within a particu-
lar product group, such as major surface combatants
or tactical aircraft, can be approximated reasonably
well by associating costs with various major charac-
teristics of the systems. This technique, also called
parametric costing, uses actual historical costs for
weapons and regression analysis to develop the appro-
priate factors relating these costs to the system's
characteristics. When adapting this technique for
foreign systems, the resulting cost factors need to
reflect the foreign design characteristics-for exam-
ple, a typical pound of Soviet avionics has a different
composition and is less costly to produce than a
typical pound of US avionics. This step is taken in one
of two ways. The preferred way-resulting in a
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detailed CER-is to develop the factors from prod-
uct-specific industrial cost estimates of foreign sys-
tems within a particular product group. For example,
about 85 percent of Soviet aircraft procurement costs
are based on detailed CERs. The second way-
resulting in a general CER-is to adjust the factors
developed from US systems in a product group to
reflect known design differences. For example, about
80 percent of Soviet ship procurement costs are based
on general CERs.
US Analogue. When the data do not permit any of the
above methods to be used, the cost of the most similar
US good or service is taken if the differences are not
too great. For example, most stand-alone electronics
procurement costs are based on US analogues. If the
US good is too dissimilar, the US price is adjusted to
compensate for the differences. Half of Soviet nuclear
weapons procurement costs are derived from adjusted
analogues
General Factors. Many defense activities are individ-
ually too small to warrant the time or effort to develop
costs by any of the above methods. For example, all
military organizations use a variety of small items
such as furniture and office equipment and supplies.
Costs of these items for a foreign military unit are
estimated by finding the ratio of such costs in a
similar organization in the US military to the number
of personnel and applying that ratio to the number of
personnel in the foreign unit. Maintenance costs are
usually estimated by applying factors to the procure-
ment cost of the item being maintained.
At times, none of the above methods are used.
Instead, the value of a foreign country's activities is
first estimated (or provided in the case of the non-US
NATO countries) in its own currency and then con-
verted to US dollars using either currency exchange
rates or special measures called purchasing power
parities (PPPs). PPPs are used for Warsaw Pact
RDT&E (see appendixes C and D) and the costs of
non-US NATO defense other than personnel (see
appendix E). Conversions using currency exchange
rates are not used within the Intelligence Community
for valuing Pact defense activities, although at least
one critic has argued that the dollar value of Soviet
defense activities can be calculated by applying a
ruble-dollar exchange rate to the estimate of their
value in rubles. Because of the substantial differences
in price structure between the United States and the
USSR and the controlled, artificial nature of the
ruble-dollar exchange rate, this approach has little
merit considering the available alternatives. Exchange
rates have often been used, however, to value NATO
defense spending in dollars.
Confidence in the Estimates
A definitive assessment of the overall confidence one
should have in the estimates is difficult. We are
dealing with an analytical construct for which there is
no objective truth. A substantial effort goes into the
development of the estimates, however, and they
make use of a broad range of military and economic
inputs.
Although there is general Community
agreement on most of these data, the data are still
subject to errors, which are then reflected in the dollar
estimates based upon them. This paper does not
explicitly assess our confidence in these physical data,
as such assessments are provided in other documents.
For example, the annual Interagency Intelligence
Memorandum on weapons production' indicates a
broad range of uncertainties (from "high" to "low") in
the production estimates of individual weapon sys-
tems. When dollar costs are used to aggregate the
individual systems, however, approximately 80 per-
cent of the total dollar cost is accounted for by
systems assigned "high" and "high-moderate" confi-
dence.
Dealing with technologies that cannot or have not
been produced in the country whose currency is used
for valuation is a problem. The USSR has not and
probably could not produce some items in the US
arsenal; the United States has not manufactured a
submarine with a titanium hull as the Soviets have. In
such cases, it is assumed that the technology can be
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produced and costs are increased by a subjective.
amount. Although subject to large errors, such judg-
ments form only a small portion of the overall esti-
mate. Finally, the results and, in a sense, the "accura-
cy" of the estimates are affected by the prices used in
making the valuation because the relative efficiencies
of economic sectors vary among countries (see inset on
the "index number problem").
Any discussion of confidence must be framed in terms
of how well the estimates serve the stated purpose of
providing a summary measure of the comparative size
of two or more countries' defense activities over time.
Several standards should be met for such
comparisons:
? Comparable coverage for each side.
? Consistency of results.
? Quality control in the calculations and reproducibil-
ity of the measures.
? Robustness of the estimates as new information and
methodologies are incorporated.
Comparability of Coverage. With one exception, the
US accounting scheme has been chosen as the stan-
dard for categorizing defense activities and costs (see
inset on next page). The exception is that costs for
both US and foreign defense activities are presented
for calendar instead of fiscal years. Cost estimates
represent actual outlays with total costs usually bro-
ken down by one of two schemes-by resource catego-
ry or by military mission. The resource scheme fol-
lows the standard Department of Defense definitions
of RDT&E, procurement, construction, military per-
sonnel, and operations and maintenance. The mission
breakouts are by the definitions contained in the
Defense Planning and Programming Categories
(DPPC). Considerable care has been taken to ensure
that foreign military activities are placed in the proper
categories.'
Consistency of Results. The individual estimates have
been reviewed repeatedly to ensure consistency of
results. Many of these reviews have been prompted by
intuitive judgments that the estimated dollar costs of
' In the early 1970s there was some confusion in the estimates as to
the proper split of the costs of spare parts between the procurement
and operations and maintenance categories, but this was corrected
in the mid-1970s. Since then, no substantial errors in coverage have
A frequently heard criticism of dollar cost estimates,
based on the so-called index number problem, is that
comparisons in US prices distort the size of a foreign
military program. It is true that shifting the price
base can dramatically change the picture of a coun-
try's defense activities. For example, the share of
total Soviet defense attributable to procurement is
twice as large measured in ruble prices as it is in
-dollar prices. This change does not mean that any one
view-based on any one country's prices-is wrong.
Rather, any difference in results reflects the fact that
in another country certain economic activities are
relatively more expensive (that is, use more scarce 25X1
resources) than the same levels of activity in the
United States; others are relatively less expensive
To determine whether a change in currency causes a
major change in the comparison of US and Soviet
defense activities, we have estimated the cost of US
defense activities in rubles, and compared the ratio of
Soviet to US defense activities measured in rubles
with the ratio in dollars. For each major resource
category, such as procurement, the ratios differ by
only a few percentage points. However, procuring a
weapon system is relatively more expensive in ruble
prices than in dollar prices. As the United States
increased the share of its defense outlays for procure-
ment during the 1980s, the ratios for total defense
activities diverged. During the 1970s the two ratios
differed by only a few percentage points. By the mid-
1980s the ratio of Soviet to US activities measured in
rubles was about 15 percent lower than the ratio
measured in dollars. (Appendix F discusses the index
number problem in more detail.)
individual Soviet systems are too low. The argument,
often called the procurement paradox, is that, al-
though the Soviets are able to procure many more
weapons and equipment than the United States, in
total they have only a slightly greater dollar value;
therefore, the individual dollar values must be too low
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The defense activities covered by dollar valuations
are usually defined in Intelligence Community publi-
cations to include the foreign counterparts of the
following US activities:
? National security activities funded by the Depart-
ment of Defense.
? Defense-related nuclear programs funded by the
Department of Energy.
? Selective Service activities.
? The defense-related activities of the Coast Guard.
? Pensions.
In addition, they include border security forces in
foreign countries that have a wartime mission of
border defense; premilitary training performed by
civilian schools; and pay for reservists funded by
civilian enterprises.
They exclude:
? Civilian space activities that in the United States
would be performed by the National Aeronautics
and Space Administration.
? Military assistance to foreign nations (except for
the costs of uniformed personnel) and military
sales.
Civil defense programs.
Internal security or uniformed labor troops who do
not have wartime defense missions.
? The cost of increasing and maintaining stockpiles of
strategic reserves such as fuel, spare parts, and raw
materials.
? Industrial mobilization preparations.
? Dual-use infrastructure such as communications
lines, reinforced bridges, and wider roads.
(see inset). But repeated examinations have confirmed
that the. individual costs are not understated when the
detailed characteristics of the Soviet items are consid-
ered. This issue was recently explained in considerable
detail by the CIA, using examples of specific weapon
system comparisons
A wide variety offactors influence the cost of produc-
ing a specific weapon system. These factors explain
what has been called the procurement paradox: that
is, the riddle of how the Soviet Union and its Warsaw
Pact allies can procure substantially larger numbers
of weapons than the United States and its NATO
allies, but these weapons can have an'equivalent or
even smaller dollar value.
First, the Warsaw Pact achieves an economic advan-
tage by opting for long, high-volume production runs.
Short-run political uncertainties probably do not
affect production decisions. In addition, the Soviet
Union dominates the Warsaw Pact. It accounts for
nearly 90 percent of the dollar value of weapons
procurement within the Pact.
Furthermore, Warsaw Pact weapon designs have
generally been simpler and less costly to produce
than those of NATO countries. Pact designs usually:
? Are less sophisticated.
? Are designed for a short mission life with few
redundant subsystems.
? Lack mission flexibility.
? Use commercial-grade components.
? Have poor habitability.
? Are maintainable by low-skilled personnel in the
field or else require factory repair.
Quality Control. The production of dollar cost esti-
mates is institutionalized in both CIA and DIA. The
joint Military Costing Review Board and the DCI's
Military-Economic Advisory Panel periodically re-
view the cost methodologies and the resulting esti-
mates. All data processing is done by computer with
numerous quality control checks built into the soft-
ware. Each annual estimate is carefully compared
with previous estimates, and changes are reviewed
and explained. No estimate is released until it has
been presented to and approved by senior intelligence
officials.
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Robustness of the Estimates. We believe that errors in
our dollar valuation of the total defense activities of
the Soviet Union amount to less than 10 percent for
any year from 1970 to 1986.' This belief is based on
various statistical techniques and our past experience,
including the monitoring of our annual revisions.
(Appendix G discusses this evidence.) The margin of
error can be much wider for some individual items
and categories than for the total because, with the
large number of components involved, errors at lower
levels of aggregation tend to partially offset each
other. We also believe that our estimates of the dollar
valuations of the other Warsaw Pact countries and of
non-US NATO countries are of comparable accuracy.
Every year we revise the estimate of the dollar value
of Soviet defense activities using new information on
costs, production quantities, operating practices, and
order of battle. Our estimates for any one year can be
expected to improve over time as we learn more about
the quantities and characteristics of the weapon sys-
tems and facilities produced in that year. The changes
resulting from these annual revisions provide a meth-
od of assessing how well we estimate the dollar costs
of Soviet defense activities. If estimates for a given
year changed sharply with every review-indicating
that improved data, different analysts, and new meth-
odologies produced very different results-we would
have little confidence that we had an accurate esti-
mate of military activities in that year. In fact, the
estimates have fluctuated only by a small amount,
and no bias has been detected.
Figure 1 illustrates the range of variation in the cost
estimates. It shows the largest percentage difference
between the average estimate for a given year of total
Soviet defense costs and all of the other estimates that
have been made for the same year. For example, the
estimate for 1971 has been revised 13 times since
1973. Some revisions increased the 1971 estimate;
some decreased it; but at no time did the 1971
estimate differ from the average estimate by more
than 7 percent. The results show that inclusion of new
' Projections of the dollar valuations of future Soviet defense
activities are less certain.
information on deployments, weapons characteristics,
and operating practices does not lead to large changes
in the total dollar cost estimates. In some instances,
our understanding of the deployment or design and
performance characteristics of individual items has
changed significantly. The effects of these changes on
total costs, however, have tended to be offsetting.
Figure 2 illustrates the lack of trend in revisions,
indicating that the introduction of new information
and techniques did not reveal a bias in the results.
Each graph tracks the estimates made over time for
Soviet defense activities in a given year. For example,
"Estimates for 1970" tracks the revisions made each
year to the original estimate of dollar costs for Soviet
defense activities in 1970.
Prospects for Improvement in the Estimates for the
Soviet Union. Although analyses of past dollar cost
estimates suggest that they are reasonably reliable,
the degree of confidence is always lower for recent
years and for short-term trends. Subsequent refine-
ments and improvements in the basic dollar costing
methodology will not change this, because the largest
gaps and uncertainties in our knowledge of Soviet
military activities are always for the most current
period. There are inevitable lags in collecting infor-
mation on recent systems and their characteristics.
Until the technical characteristics of weapon systems
are reasonably well known, estimates of their costs
remain uncertain. Detecting changing patterns in
RDT&E or in operating or maintenance practices also
usually requires several years of data accumulation.
As time passes and more intelligence is collected,
these gaps are at least partially filled, and the uncer-
tainties diminish.
Some specific efforts would, however, reduce uncer-
tainties and improve our confidence:
? The annual Interagency Intelligence Memorandum
on Soviet weapons production has already contribut-
ed significantly. As the agencies continue this work,
with particular emphasis on expanding the number
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Figure 1
Variations in Estimates of the Dollar Costs of
Soviet Defense Activities
1970 71 72 73 74 75 76 77 78 79 80 81 82 83
84
11 10 9 8 7 6 5 4 3 2
I
of weapon systems included and refining the meth-
odologies used to estimate production quantities,
the procurement component of the cost estimate
will become even more accurate and instill a higher
degree of confidence.
? A better estimate of the exports of Soviet weapons
would also improve estimates of procurement. These
exports must be subtracted from the estimates of
total production to arrive at an estimate of the total
number of weapons being procured by the Soviet
forces.
? About one-third of the dollar value of Soviet pro-
curement is now estimated using less desirable cost
methods. The overall quality of the procurement
estimate will improve as this share is reduced. The
estimates of the costs of advanced electronics will
particularly benefit.
? To improve the comparability of the estimated
dollar costs to US outlays, additional work is re-
quired on the phasing of both recurring and nonre-
curring Soviet weapon system costs.
Finally, there is the possibility the Soviets may pro-
vide data that will aid our estimates. Recently, senior
Soviet officials, including General Secretary Gorba-
chev, have acknowledged that the announced Soviet
defense budget does not include major components of
defense spending. They indicated that, after price
reforms in 1989-90, during which they say Soviet
defense spending is to be made comparable to US
outlays, the full Soviet defense budget will be re-
leased. Any outlay data could be helpful. Depending
on the types and amounts of such information provid-
ed, the dollar cost estimates could benefit, particularly
from disclosures about those components for which
ruble data are most lacking, such as weapon prices.
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Figure 2
Dollar Costs of Soviet Defense Activities
Estimates for 1970 Estimates for 1974
Billion 1979 US $ Billion 1979 US $
50 50
I I I 1 I I I I l I 1 1 1 l 1 1 I I 1 I 1 I I I I 1 I I I
0 1972 75 80 85 87 0 1972 75 80 85 87
Year estimate was made Year estimate was made
Estimates for 1978 Estimates for 1982
Billion 1979 US $ Billion 1979 US $
200 200
50 50
I I I I I I I I I I I I I I I I I I I I I I I I I I
0 1972 75 80 85 87 0 1972 75 80 85 87
Year estimate was made Year estimate was made
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Appendix A
Alternative Concepts of
Dollar Costs of
Foreign Weapon Systems
There are no actual dollar prices for most components
of foreign defense activities because the United States
does not design, produce, man, operate, or maintain a
foreign country's military forces, and foreign coun-
tries do not use US prices. Therefore, we estimate the
hypothetical costs of the goods and services if they
were to be purchased in the United States. Over the
years four different concepts have evolved for develop-
ing appropriate dollar costs for weapon systems that
have never been produced in the United States. They
are summarized in table 3.
The Intelligence Community has selected "compara-
ble dollar costs" as its preferred choice. This concept
and the methods used to implement it are explained in
detail in the text. In brief, the concept calls for
estimating the cost of replicating a set of foreign
weapon systems using US prices and wages, US
industrial practices, and US manufacturing efficien-
cies.' For some items, the necessary data are not
available to apply this concept. In those instances
alternative 2, described below, is used.
The four concepts-comparable dollars and alterna-
tives 1, 2, and 3-differ in the degree to which they
"Americanize" the foreign activities.' For this pur-
pose, a given foreign activity can be described in
terms of:
8 The one exception is the case in which the Soviet design uses parts
that are obsolete in the United States and for which cheaper
replacements have been developed-for example, vacuum tubes.
For such a case, alternative 2 is used to avoid overvaluing the Soviet
product.
' A foreign country an the United States have different industrial
bases and experiences. For example, a US aircraft manufacturer
could not today manufacture a Soviet aircraft. The manufacturer
would first have to develop plans, identify suppliers who could begin
producing subcomponents, train its labor force, retool its assembly
line, and so forth. Most US manufacturers could not even produce
on the large scale that the Soviets do without first constructing
additional plant floorspace. But the purpose of valuing foreign
goods in dollar terms is to gain an appreciation of the size of the
foreign production output rather than the effort involved in trans-
forming US industry to produce those goods. Therefore, all of the
concepts assume that the requisite production base is in place,
complete with a trained work force, qualified suppliers, and all
? Its mission, purpose, or objective. For example,
defend the homeland against bomber attack.
? The mechanism or means chosen to carry out the
mission. For example, acquire, operate, and main-
tain an air defense force of 100 intercepter regi-
ments and 50 surface-to-air (SAM) battalions.
? The specific system or unit designs selected to
provide the means. For example, in 1985 procure 10
SA-10 SAM launchers with associated missiles,
electronics, and support equipment.
? The organization and technologies employed in
producing the specific designs. For example, the
SA-10 missiles will be manufactured in a particular
plant using the production technology and labor
force in place in 1985.
At one end of the spectrum, alternative 1, each
foreign activity is broadly defined as to how it contrib-
utes to fulfilling mission requirements. An estimate is
then made of how the United States would carry out
that activity-from choice of mission means through
the procurement of the requisite personnel and hard-
ware. For example, if US planners had been tasked
with carrying out the Soviet air defense mission as
effectively as the Soviets, they might have chosen a
different doctrine or mix of weapon systems than did
the Soviets. Once the mission means was decided,
they might have designed a different SAM system.
After the missile was designed, it would have been
produced in a US plant. In essence, this concept calls
for measuring the costs the United States would incur
if it had another country's military requirements and
were about as effective as that country in meeting
them. This concept is difficult to apply, however,
because its first step-specifying the means US plan-
ners would. choose to carry out the mission-is quite
subjective. Nevertheless, this concept is appropriate if
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Table 3
Alternative Concepts for Valuing Foreign Programs
in US Dollars
Comparable
Dollar Costs
Ways to fulfill military
mission
Production technology
and organization
For US policymakers,
the most appropriate
monetary measure for
comparing US defense
activities with those of
another country.
Requires developing
costing methodologies
for foreign designs.
Once the mission and US cost-estimating
the means to accomplish methodologies are well
it are specified, it is rela- developed for US de-
tively easy to cost be- signs.
cause most components
will have already been
procured in the United
States.
The choice of means is Must design many new
highly subjective. Judg- US weapon systems for
ment of the degree to foreign choice of force
which the foreign coun- mix.
try has been successful
in meeting its mission
objectives is required.
Measures the cost of a
foreign country's defense
activities, if its price and
wage structure were
identical to that of the
United States.
Large amounts of for-
eign data required. It is
not clear the answer is of
any interest.
one wishes a summary measure of the relative magni-
tude of two or more countries' overall defense pos-
tures.
Alternative 2 is the same as alternative 1 except that
it accepts the foreign choice of mission means. It then
uses US designs and production efficiencies. The
concept measures the cost the United States would
incur if it were to procure, operate, and maintain
military forces with the same general kinds and
amounts of weapons, equipment, and personnel as
those of the foreign country. Because the application
of this concept requires the redesign of foreign weap-
ons to meet US standards and specifications, it is
costly to apply. Moreover, the application of US
design standards and specifications (for example, re-
dundant subsystems for reliability, habitability fea-
tures, military specifications for soldering of electron-
ics) to a foreign force generally results in a force of
higher quality and, hence, higher cost. The concept,
however, is appropriate if one wishes a measure of the
costs the United States would have incurred if it had
procured the foreign force mix instead of the US force
mix.
Alternative 3 uses all foreign designs and efficiencies
but at US prices for material inputs and US wages for
labor hours. For example, the dollar cost of producing
an SA-10 missile would be calculated by applying US
cost factors to all of the physical resources actually
used by the Soviets when they produce the missile.
Applying this concept requires detailed data on the
manufacturing practices of the foreign country. For
the foreseeable future, the Intelligence Community
will lack the data to apply this concept to Warsaw
Pact countries. If practical difficulties could be over-
come, alternative 3 would provide a measure of the
cost of a foreign country's defense activities if its price
and wage structure were identical to that of the
United States.
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Appendix. B
Estimating Dollar Costs of
Soviet Defense Procurement
Figure 3 and table 4 show the distribution of all
procurement costs for Soviet weapon systems and
equipment by type and the method used in estimating
them (the methods are defined in "Estimating Dollar
Costs"). The share for a particular method is the ratio
of the dollar value of all programs based on it to the
dollar value of all procurement in the CIA's data base
(covering the period 1965 through 1996). Almost two-
fifths of the procurement costs are based on the
highest quality methods (product-specific industrial
cost estimates and detailed CERs) and only one-sixth
are based on unadjusted US analogues or general
factors.
Each year the joint CIA-DIA Military Costing Re-
view Board reviews the status of the dollar cost
estimates for Soviet weapon systems and recommends
where external research funds should be applied to
improve the estimates. The Intelligence Community
let $5 million in contracts for this purpose during
fiscal 1982-87. Some contracts result in improved
CERs for a class of weapons, others in improved costs
for a major subsystem. On occasion two different
contractors are asked to estimate independently the
costs for the same system to provide a check on the
quality of the estimates. Table 5 shows, by major
weapon category, the date of the latest cost study and
indicates those areas in which work is expected to be
completed in 1988 but is not yet incorporated into
Community estimates. The studies may address one
or more systems or major components thereof.
A final. methodological note concerns the practice of
using constant costs both to remove the effects of
changes in price level and to assure that costs in a
given year are comparable with those of other years.
The constant dollar costs chosen for all foreign goods
and services are based on the average prices and
wages prevailing in the United States in the base year.
If the good or service is identical to a US good or
service, then the average price or wage for that good is
used. For example, fuel consumed by Soviet forces
would be valued by applying the average prices of the
same fuels in the United States; the valuation of a
Soviet military person is taken as the average pay and
allowances for a US military person with the same job
description or billet. If an identical good or service is
not available in the United States, then it is valued by
estimating what the good or item would cost if it were
available. Such estimates are usually based on a
detailed analysis of the physical elements that would
be needed to produce the good or service and then
summing the individual component prices plus an
average profit. In all cases, prices and wages are taken
as unaffected by the additional demands that would
be placed on the markets for labor or industrial
materials if the foreign items were actually to be
procured in the United States. The fixing of a base
year not only fixes the average price level for valua-
tions but also fixes the levels of manufacturing tech-
nology and general productivity to those of the base
year.
From the foregoing description, one might infer that
two identical products would be assigned the same
dollar value. However, as desirable as this might be, it
is not always possible to do so consistently. The
difficulty arises for goods whose cost to manufacture
is systematically reduced over time because of "prod-
uct-specific learning." Product-specific learning refers
to the fact that, as a good continues to be manufac-
tured in the same facility, the managers and workers
of the facility find cheaper ways to produce the
product. The degree of cost reduction experienced as
more items of a good are produced is termed a
"learning curve." This learning is achieved through a
wide variety of mechanisms, including better organi-
zation of the assembly process, better handling of
supplies, minor design changes to speed assembly, and
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Figure 3
Relative Use of Different Costing Methods in
Estimating Dollar Costs of Soviet Procurement
Percent
0
Product-specific industrial cost
Detailed CER
General CER
Adjusted US analogue
US analogue
Other
10 15 20 25 30 35
Table 4
Distribution of Soviet Procurement Estimates
by Type and Method
Aircraft Ammu- Elec- Land Missiles Nuclear Ships Other Total
nition tronics Arms Weapons
Product-specific
industrial cost
Better quality b 95 21 2 75 59 82 32 68
Lesser quality ~ 5 79 98 25 41 100 18 68 32
a Because of rounding, data may not add to totals shown.
b The sum of the shares for industrial cost, detailed CER, and
general CER.
The sum of the shares for adjusted US analogue, US analogue,
and other.
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so forth.1? Thus, even though the prices of inputs-
material and labor-are held constant to a base year,
fewer inputs are required over time as learning takes
place. There is no completely satisfactory way, then,
to assign a base-year price that remains constant over
time. Two approaches to the problem are usually
taken.
One approach, favored by CIA, is to assign to a good
produced in any given year the cost that the good
would have had in the base year had it been at the
same point on the learning curve in the base year as it
was in the given year. The effect is to use the prices
and wages of the base year for the resources required
to produce the good, but to apply those costs to the
amount of resources implied by the amount of learn-
ing realized in the given year. Figure 4 illustrates the
reduction in constant resource costs that can occur.
This method results in the same kind of costs as those
that are obtained by applying standard price indexes
to US defense outlays expressed in current dollars.
The prices of resources used to produce the final
goods are thus constant. The principal objection to
this method is that the same good does not have the
same price from year to year.
The second approach, favored by DIA, uses for any
given system the average unit cost of the production
run in the base year. This price is applied to all units
produced. For systems that end production before the
base year, the base-year price is taken as the average
cost assigned by the first approach to the last year of
production; this price is selected because no further
learning is possible after completion of production.
For systems that start production after the base year,
the price used is the average cost assigned by the first
approach to the first year of production. This method
not only maintains the price of the material and labor
10 Product-specific learning should not be confused with general
industrial productivity. General productivity comes with the evolu-
tion of manufacturing technology and equipment. The bulk of these
savings will occur between production runs when plants are being
retooled. The constant prices are all based on the general productiv-
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Figure 4
An Illustration of the Difference Between the
Two Approaches to Constant Costs
Second approach a
First approach b
I The second approach assigns the value (1,000) in year four,
the base year, for all years.
bThe first approach assigns the price shown by the curve for
each year. (The price changes as learning occurs.)
inputs at a constant level, but also retains the product-
specific productivity for that product in the base year.
This method results in a constant cost series compara-
ble to the series used by the Department of Commer-
ce's Bureau of Economic Analysis for use in Depart-
ment of Defense budget documents. A final good thus
has the same price from year to year. The principal
objection to this method is that the price relationship
between two goods that appear to be similar and are
produced at identical rates is determined primarily by
when each began production. This effect is particular-
ly significant when the base year occurs near the
beginning of a system's production run.
Compared with the first approach, the second ap-
proach results in somewhat higher growth rates (see
figure 4) because:
? For the years before the base year, the second
approach assigns prices that are lower than the first
approach because the prices are not affected by a
learning curve.
? For the years after the base year, the first approach
assigns prices that are lower than the second ap-
proach because the prices move down a learning
curve.
Despite the theoretical differences in the two ap-
proaches, the practical effects are slight. Estimates
using each approach show similar magnitudes and
general trends for the procurement of a common set of
weapon systems.
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Appendix C
The Special Problem of the
Dollar Costs of Soviet RDT&E
Costing research, development, testing, and evalua-
tion activities in dollars presents a serious problem,
largely because of difficulties in defining the prod-
uct." At one extreme, the product could be taken as
the Soviet military RDT&E establishment. Dollar
prices and wages could then be applied to each cost
element in that establishment. This would result in a
huge estimate because the Soviets generally employ
far more personnel and use more materials and
facilities than the United States to achieve similar
advances. At the other extreme, the product could be
the final results of the Soviet RDT&E establish-
ment-the knowledge and designs that allow ad-
vances in weapon systems. The cost in the United
States to perform the RDT&E required to produce
the Soviet weapons would be relatively small, howev-
er, because the Soviets generally lag the United States
by some years, and minimal US RDT&E would be
required to produce many Soviet designs. As a result,
the method now used to estimate the dollar cost of
Soviet RDT&E tries to take into account differences
in the productivity of the RDT&E process in the two
countries.
In the 1970s we attempted to estimate what RDT&E
cost was incurred in the United States to make
advances in knowledge similar to those the Soviets
made when they developed new weapon systems. This
approach was quite difficult to implement and after
several years was abandoned as impractical. Even if it
had been feasible, it would not have covered the costs
of basic research and other activities that are not
directly related to a final product. We now use a more
general method.
First, Soviet facilities involved in military RDT&E
are identified and all-source data on resource costs-
including wages, materials, equipment, training, oper-
ating, and capital costs-are used to calculate total
expenditures in rubles for these activities. Although
data gaps make this ruble cost estimate more uncer-
tain than ruble cost estimates for other components,
the error in rubles probably is within plus or minus 15
to 20 percent.
This ruble estimate is converted to dollars by using a
ruble-dollar ratio that reflects relative Soviet and US
efficiencies in producing Soviet weapon systems. Use
of this conversion factor assumes that the Soviets have
about the same difficulty performing RDT&E com-
pared with the United States as they do procuring
weapons. Despite substantial past and continuing
efforts to refine and improve our estimative method-
ology for Soviet RDT&E, it remains the weakest
component of the aggregate dollar cost of Soviet
defense activities.
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Appendix D
Estimating Dollar Costs of
NSWP Defense Activities
Dollar costs for non-Soviet Warsaw Pact countries are
estimated in almost the same way as those for the
Soviet Union. Dollar values of Pact defense activities
are developed by identifying and listing distinct com-
ponents of the forces such as individual classes of
surface ships, ground forces divisions (divided into
categories on the basis of type and readiness level),
and air regiments (categorized by aircraft type for
each service). The listing also contains for each com-
ponent an estimate of order of battle, manning levels,
equipment inventories, and new equipment purchases.
US prices and wage rates are then applied to these
detailed estimates of activities.
Procurement
Because most NSWP weapons and equipment are
imported from the Soviet Union, the average unit
dollar costs derived for the relevant Soviet production
runs are used for NSWP items. For indigenous
production, the methods used for the USSR are
applied. Because most NSWP equipment is one or
more design generations behind the latest Soviet
equipment, we have had an opportunity to thoroughly
research these cost estimates and we consider them
quite reliable. Our estimate of procurement of support
equipment-which accounts for roughly one-half of
total procurement in the NSWP-is more uncertain
than our estimate of procurement of major weapon
systems because support equipment is difficult to
monitor on an item-specific basis."
Operations and Maintenance
We calculate Soviet maintenance costs as a ratio of
the procurement cost of a particular weapon; the ratio
is based on operating rates and costs of spare parts.
Except for land arms, for which operating rates are
adjusted for known differences in levels of readiness,
we assume that NSWP and Soviet O&M practices
'Z Support equipment includes electronics, vehicles, engineering
equipment, naval supplies and equipage, organizational equipment,
are the same. This is a good assumption for mainte-
nance practices because NSWP equipment is Soviet
designed or produced, but a weaker assumption for
operating practices because NSWP training and exer-
cise rates differ from those in the Soviet Union.
Although we know that NSWP operating rates have
declined since the mid-1970s, we presently are unable
to estimate the extent of the decline and, therefore,
still base costs on the mid-1970s' levels. Civilian pay is
calculated by multiplying the number of civilian
defense workers by the average pay of their US
counterparts.
Military Personnel
The dollar values of pay for Soviet personnel are
based on the estimated rank of the person the United
States would assign to carry out similar functions.
Because we do not have detailed data on NSWP rank
and billet structure, we are only able to apply US pay
rates to categories of personnel rather than to each
individual billet as is done for the Soviet personnel
estimates. The categories in each branch of service
are officers, warrant officers, career enlisted men,
conscript sergeants, conscript privates, and cadets.
Research, Development, Testing, and Evaluation
These costs are first estimated in domestic currencies
for the countries for which we have sufficient data to
do so-Poland, Czechoslovakia, and East Germany.
We then convert these expenditures into dollars at the
same rate of conversion as implied by the other
military expenditures. RDT&E costs for the other
NSWP countries, for which we do not have RDT&E
data, are assumed to be in the same ratio to total
military outlays in dollar terms as for the former
countries."
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ment Printing Office, 1985), pp. 475-495.
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Confidence in the NSWP Dollar Cost Estimates
In general, we believe the estimate of the total dollar
cost of NSWP defense activities represents a reason-
able measure of their aggregate level. Among individ-
ual NSWPcountries, however, the confidence in the
estimate varies.
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Appendix F
The So-Called Index
Number Problem
The "index number problem" is a term that covers
two different concepts-the effects of picking a par-
ticular set of prices and the artificial inefficiencies
assigned to a country when valuing its output in
another country's prices. This appendix addresses
both concepts as they apply to comparisons of US and
Soviet defense activities.
Choice of Prices
Dollar prices are not the only economic measure that
could be applied to measuring resources devoted to
defense activities. One could also use ruble prices,
Swiss francs, or a host of other value systems. For the
reasons outlined in the text, we believe dollars " to be
the most suitable for a US audience, but the reader
should be aware that a different economic valuation
would change the comparisons somewhat.
Statistics describing Soviet defense activities can
change dramatically when the currency base is shift-
ed. For example, procurement is about 25 percent of
the total costs of defense when defense is valued in
dollars; in rubles, the corresponding figure is almost
50 percent. This does not mean one estimate is in
error. Nor does it mean that dollar costs underesti-
mate "true" Soviet procurement. It merely reflects
the fact that in terms of Soviet economic relation-
ships, defense procurement is relatively more expen-
sive (uses more scarce resources) than the same level
of activity in the United States. Both statements of
shares are correct within their own context.
" Even when dollars are chosen, the question of which base year to
choose remains. We usually choose the latest year for which
detailed price information is available and, hence, the results are
the closest possible to today's values and presumably to our readers'
economic frame of reference. For example, the joint CIA/DIA
testimony to the Joint Economic Committee of Congress in the
spring of 1988 used a base year of 1986. Had an earlier year been
chosen, growth rates for both the United States and the USSR
probably would have been greater because both are now buying
more technologically advanced systems whose prices relative to
other goods are decreasing over time. Similarly, ratio comparisons
of Soviet to US defense activities probably would be somewhat
The same factors that change the value of Soviet
activities when moving from one currency to another
would also affect the value of US activities when
measured in another currency besides dollars. Thus,
the structure of US defense activities, as measured by
shares of total outlays devoted to each resource
category, is different when measured in rubles. Com-
parisons of the ratio of valuations of US and Soviet
defense activities in rubles and in dollars do not
change as much as shares within a country do,
however. We have estimated the costs of US defense
activities in rubles." Although this estimate is sub-
stantially less accurate than our measure of Soviet
activities in dollars, it indicates the potential magni-
tude of change in the comparisons. It turns out that
the relationships between the two countries change
little whether the activities are measured in dollars or
rubles. For example, the ratio of total Soviet defense
activities to US activities over the past two decades
decreases by about 10 percent when measured in
rubles instead of dollars (see figure 6).
Artificial Inefficiencies
Two types of distortion theoretically could affect our
estimates of the dollar cost of Soviet defense activi-
ties. Our methodologies estimate the costs in dollars
of buying the particular assortment of goods and
services the Soviets bought. The Soviets, however, did
not decide on their particular mix in the framework of
dollar costs. To the extent that their choices were
" Applying the "dollar" methodology in reverse to estimate the
costs of US defense activities in rubles would require access to
Soviet cost factors to calculate how much it would cost the Soviets
to produce each US weapon system. We are unable to do this.
Instead, we apply the same techniques used in most international
comparisons. These techniques involve estimating currency (or
purchasing power parity) ratios for various product groups and then
converting, in this case, dollar outlays to equivalent ruble outlays
within each group and summing to arrive at a total. For military
pay and allowances, we apply ruble pay rates directly to US
manpower. For all other defense activities we develop value-
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Figure 6
Ruble and Dollar Comparisons of
Soviet and US Defense Activities
Cumulative 1973-87 ratios:
Dollars: 1.21
Rubles: 1.07
I I I I I I I I I I I I
0 1973 78 83 87
influenced by costs, they were influenced by ruble
prices." Thus, the Soviets might well have chosen a
different array of goods and services if they had been
working in the context of the US economy with its
different relative prices." By the same token, if the
Soviet activities were being performed by the United
"Soviet prices are administratively set and may not reflect the
relative scarcity of resources. However, when goods are priced in a
constant resource ruble price base, they are reasonable approxima-
tions of true economic cost.
20 A similar problem exists when comparing the activities of a single
country from one time period to another. For example, the relative
prices for defense goods in the United States were different in 1980
than they were in 1970. Hence applying 1980 prices to both imparts
States, the mix also might have been different-not
only because of different resource costs, but also
because US decisionmakers might place different
military value on various activities than do the Sovi-
ets. Thus, when viewing Soviet activities on the basis
of dollar costs, two apparent inefficiencies may result:
? The Soviets could have procured a different set of
activities having equal military merit in Soviet eyes,
but at a lower total dollar cost (and higher ruble
cost).
? The Soviets could have procured a different set of
activities having an equal military threat in US
eyes, but at a lower total dollar cost (and a different
ruble cost-perhaps higher, perhaps lower).
These inefficiencies are artificial, not real, because
the Soviets do not pay dollar prices. But there is
legitimate concern that comparisons in dollars inflate
the value of Soviet activities by imposing these artifi-
cal inefficiencies on them."
The degree of inefficiency (paying more dollars than
required for equal military output) that is reflected in
our dollar costs of Soviet defense activities is impossi-
ble to measure precisely because the military merit or
threat of diverse defense activities cannot be mea-
sured precisely in either US or Soviet terms. The
degree of inefficiency, however, is small for the
following reasons:
? The mix of defense activities chosen by either the
United States or the Soviet Union appears to be
driven primarily by national security objectives,
military doctrine, perceptions of threats, existing
forces, and other noneconomic considerations. With
the sole exception of the past few years of the US
buildup of procurement, within each major mission
the dollar value of equipment procured per man is
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similar for both the United States and the USSR.
Yet relative prices for men and equipment differ
.markedly in the two countries. Thus there are
reasons to believe the Soviets would choose about
the same mix of goods and services if they were
paying dollar prices as they did when paying
rubles .12
? The dollar cost assigned to a particular piece of
Soviet hardware is based on US production technol-
ogy and efficiencies (for example, labor/capital
ratios, sophistication of machine tools) applied to
Soviet production rates, so no artificial inefficiencies
are introduced at the production level. The effects
are confined to the basic choice of mix only.
In summary, the Soviets' choices about defense activi-
ties would be substantially the same if they were
somehow confronted with US prices for military
goods and services (but remained Soviets in all other
respects). Therefore, our dollar estimates of Soviet
defense activities contain little distortion because of
these potential inefficiencies and cost ratios (USSR to
United States) provide generally valid measures in US
resource values of the two countries' relative costs of
23 This is not to say they would not buy a different mix if they had
full access to US technology, or if they were in the US geopolitical
position, or if they had the US culture. The statement is limited to
the hypothetical situation in which only the prices of available
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Appendix G
Analysis of the Range of
Error in the Dollar Estimates
of Soviet Defense Activities
Table 6 presents CIA's estimates for the dollar cost of
Soviet defense activities as they were made in each of
the years 1972 through 1987 (no estimate was made
in 1975). The only adjustment made to these historical
estimates is to convert them all into constant 1979
dollars for ease of comparison." Each column of the
table corresponds to the estimate made in that year
for the years indicated by the row labels. By reading
across the columns, it is seen that the annual updates
do not dramatically change the estimated dollar costs
for any given year. A comparison of the changing
estimates for a given year is a rough indication of the
quality of the estimates because each additional year
yields new data and improved methodologies to refine
the old estimates. Moreover, the frequent turnover of
analysts increases the chances that any individual's
blindspots or biases will in time be removed from the
estimates. It can be seen that, although each year's
estimate differs from the others, they are relatively
stable and show no indication of uncovered bias. F_
The relative stability. in the aggregate estimates over
time is partly explained by the fact that, although
there may be a considerable amount of error in
individual cost estimates, these do not necessarily
propagate into large errors in the aggregate estimates.
The reason for this is that errors in components of a
total tend to cancel each other as the components are
summed. For example, suppose that 10 component
estimates of roughly equal magnitude are added
together to form a total, with each of the 10 subject to
an individual error of ? 10 percent. If the errors are
independent of each other, then the error in the total
would be expected to be ? 3 percent.24 As a numerical
illustration of this principle, suppose each of the
individual values were in truth 100, giving a total of
1,000. Suppose, however, the individual estimates
were 91, 107, 98, 105, 102, 98, 90, 99, 97, and 108.
The total would be 995, for a total error of 0.5
percent, even though the average error of the individ-
ual estimates was 4.9 percent. Figure 7 shows the
reduction in overall error as the number of individual
estimates increases for the case in which the individ-
ual estimates are of the same magnitude, with individ-
ual errors of ? 50 percent.
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The bottom part of table 6 indexes the dollar values to
the latest estimate, made in 1987. If one assumes that
this estimate represents the best available, then it
provides a suitable benchmark for the preceding
estimates. Earlier estimates having indexed values
greater than 100 are now seen as having been too high
while values under 100 are seen as having been too
low. Examination of the table indicates that the track
record of the past 16 years is consistent with the claim
that the estimates for the total dollar value of past
Soviet defense activities are subject to no more than
10-percent error for any given year.
2' The year 1979 is chosen as the common base year because it is
about in the middle of the base years actually used in the various
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Table 6
CIA's Historical Estimates of the Dollar Value of
Soviet Defense Activities
Estimate
for Year
1970
1971
1974
1975
1976
1977
1978
1979
1972 1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
Billion 1979 $
136 129
133
No estimate
139
130
122
127
125
129
132
132
127
136
130
128
129
134
No estimate
141
134
125
129
128
133
135
134
129
139
133
131
152
145
139
144
144
148
151
150
144
153
147
145
149
142
148
149
152
156
155
149
156
149
149
146
153
149
159
164
162
156
160
153
152
156
155
161
166
163
156
161
154
154
156
164
168
166
159
164
157
156
169
171
169
162
167
160
160
-
Indexed Values (estimates made in 1987 = 100)
1970
106
101
104
109
102
95
99
98
101
103
103
99
106
102
100
1971
98
102
107
102
95
98
98
101
103
102
98
106
101
100
1972
'
101
108
102
97
100
99
103
104
103
100
106
101
100
1973
106
102
97
101
99
102
104
103
98
106
101
100
1974
105
100
96
99
99
102
104
103
99
105
101
100
1975
100
96
100
100
102
105
104
100
105
100
100
1976
96
101
98
105
108
107
103
105
101
100
1977
102
101
105
108
106
102
105
100
100
1978
1979
Maximum
106
101
104
109
102
97
102
101
106
108
107
104
106
102
Minimum
106
98
101
105
100
95
98
98
101
103
102
98
105
100
Average
106
100
102
107
101
96
100
99
103
106
105
101
105
101
Summary 1972-87 Note: If the population mean is assumed to be 100, then the
Average = 102 standard deviation becomes 3.7 and the ? error becomes 7%.
Minimum = 95
Maximum = 109
Standard deviation = 3.1
? Error (95% C. I.) = 6%
Number of values = 131
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Reduction in Overall Error as
Estimates Are Aggregated
0 10 20 30 40 50 60 70 80 90 100
Number of individual estimates
Note: Each individual estimate has an uncertainty
factor of plus or minus 50 percent.
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Appendix H
Sources of Comparable
US Data
Dollar cost comparisons of foreign defense activities
with US defense activities require appropriate US
data. For such comparisons, US data are derived from
the Five-Year Defense Program (FYDP) of the De-
partment of Defense and from the US budget. The
detailed Total Obligational Authority (TOA) data,
listed in the FYDP by program element, are first
translated into outlays by using Department of De-
fense historical spendout rates. They are then adjust-
ed to match published annual outlays by Department
of Defense resource identification code (RIC). These
outlay data are next converted from fiscal to calendar
year terms and then converted to constant dollars
using detailed price indexes for each type of military
expenditure. Figure 8 shows the difference between
Figure 8
Relationship Between Total Obligational
Authority and Outlays for US Defense Activities
US TOA and outlays by fiscal years since 1970.
Notice that, while TOA has been declining in real
terms since fiscal year 1985, outlays have continued
to rise.
The final US figures thus reflect the years the
expenditures actually take place and have had infla-
tionary effects removed. As such, they no longer
match actual budget authorizations or appropriations,
but they are on the same basis as the estimates for
foreign defense activities.
Outlays
Total
obligational
authority
I I I I I I I I I I I I I I I 1 1
1970 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89
Fiscal year
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