INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00771R000706900001-0
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 34
• Document Creation Date: December 22, 2016
• Document Release Date: October 15, 2010
• Sequence Number: 1
• Publication Date: March 16, 1984
• Content Type: REPORT

er
Directorate of Seer
Intelligence
International
Economic & Energy
Weekly
16 March 1984
Secret-
DI JEEW 84-011
16 March 1984
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iii Synopsis
1 Perspective-Prospects for the EC Summit
Energy
International Finance
Global and Regional Developments
National Developments
15 Japan: Shifting Role of Tax Incentives
19 / ,Argentina: Attempting To Resolve the Debt Crisis
23 /Gray-Market Arms Scams
International
Economic & Energy
Weekly
Yugoslavia: Persistent Inflation Problems
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directed to Directorate of Intelligence
Comments and queries regarding this publication are welcome. They may be
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16 March 1 ?DA
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International
Economic & Energy
Weekly F__]
Synopsis
1 Perspective-Prospects for the EC Summit
EC leaders probably will at best make limited progress toward solving the
Community's budget crisis at their scheduled summit in Brussels on 19-20
March. The most likely outcome of the meeting will be a political commitment
to undertake broadly defined reforms, with the details left to the next EC
summit in June.
15 Japan: Shifting Role of Tax Incentives) 25X1
Japan's use of special tax measures to promote the development of selected
industries has been constrained over the past several years by budgetary
stringency and the increased involvement of interest groups in the formulation
of Japanese tax policy.F____1 25X1
19 Argentina: Attempting To Resolve the Debt Crisis 25X1
Argentina faces a crucial payments deadline on 31 March with US bank
creditors on its overdue interest charges. Although there are several roadblocks
to a solution, we believe the problem could be worked out. Beyond the near-
term crunch, however, upcoming bank rescheduling talks are likely to be
difficult. 25X1
23 Gray-Market Arms Scams) 25X1
The international gray arms market, involving the purchase and movement of
weapons on other than a government-to-government basis, lends itself to a
variety of fraudulent arms deals. Iran-having few reliable military suppli-
ers-has often been the target for many of these scams.
27 Yugoslavia: Persistent Inflation Problems) 25X1
Yugoslavia's lack of success in controlling inflation-over 40 percent last
year-was the major failure of its 1983 economic stabilization program.
Because few steps have been taken to deal with systemic problems, rapid
inflation is likely to persist in 1984, threatening both living standards and last
year's gains in the competitiveness of Yugoslav exports.
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DI IEEW 84-011
16 March 1984
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International
Economic &=Ener y
Weekly
16 March. 1984
Perspective Prospects for the EC Summit
EC leaders probably will at best make limited progress toward solving the
Community's budget crisis at their scheduled summit in Brussels on 19-20
March. The most likely outcome of the meeting will be a political commitment
to undertake. broadly defined reforms; with the details left to the next EC
summit in June. The Ten appear to be nearing compromise on several of the
most controversial issues, which should at least enable them to avoid a fiasco
similar to last December's Athens summit. -The leaders believe that, if they
again fail to begin straightening out the Community's financial morass, the
EC could begin to atrophy. Budget compromises will have to be made by all
members if the Community is to avoid running out of money this fall.
French President Mitterrand-who holds the rotating EC Presidency for the 25X1
first half of 1984-has staked his prestige on the outcome of the summit and
has spent much of the last two months shuttling between Community capitals
trying to.forge a political consensus. The results of his consultations have been
closely guarded, but most EC officials appear cautiously optimistic that there
has been sufficient progress to clear the way for some compromises in Brussels.
Significantly, France-traditionally the most obstructionist EC member-now
appears. more willing to accept changes in the way the Common Agricultural
Policy guarantees minimum farm prices. Most in-the Community welcome
Mitterrand's zeal and have willingly entrusted to him the chore of orchestrat-
ing a breakthrough.F____-] 25X1
Reining in agricultural spending will certainly dominate the complex agenda
at Brussels. The leaders will consider proposals agreed to by Agricultural
Ministers on 13 March to reduce costly milk overproduction by taxing
surpluses, and final approval to cut output-with some exceptions for hard-
pressed members like Ireland-appears likely. They may also move toward
phasing out the, Community's complicated system, of agricultural exchange
rates by eliminating over the next three to five years the compensation West
German farmers get to offset the strong Deutschemark. At British and
German insistence, the heads.of government will discuss more far-reaching
proposals to tie the growth of agricultural spending to the growth in EC
revenues, but the political clout of EC farmers makes any early agreement
unlikely.
Financing the EC budget will also be a major topic of debate, and virtually all
Community members now support boosting revenues by increasing the share
of value-added tax payments passed to the Community. An increase in the
VAT ceiling-from 1.0 percent to 1.4 percent of each members' VAT
proceeds-appears to be the most likely outcome.
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Some compromise that satisfies the
United Kingdom-perhaps a five- to seven-year renewable provision that ties
members' payments to their share of Community GDP-will be necessary, but
it does not appear that enough groundwork has been done to settle this thorny
problem at Brussels.
On other issues, Mitterrand will probably use the chairmanship to air some of
his foreign policy concerns. France has backed recent proposals to strengthen
European defense cooperation through a revitalized Western European Union.
EC foreign ministers have also recommended issuing a statement urging
improved East-West relations and encouraging the Soviet Union to return to
the START and INF talks. France may also press for a firm timetable for
Spanish and Portuguese entry into the EC. The leaders may use these foreign
policy ons to project a united front, despite continued internal problems.
Decisions on the more technical aspects of budget reform probably will be left
for the June EC summit in Paris, which will be an equally crucial test of Com-
munity resolve. Over the intervening months, experts-who were excluded
from Mitterrand's bilateral meetings-will have to hammer out concrete
proposals for implementing whatever political decisions are taken at the March
summit. The Commission has already begun resurrecting earlier proposals for
determining fair budget shares. Agricultural ministers will be asked to deal
with sectoral overproduction, especially in grain and dairy products. Finance
ministers will be charged with drawing up schemes for keeping Community
Whatever actions are taken-either at the Brussels or Paris meetings-are
unlikely to involve radical EC institutional reform. We believe that changes in
the EC will continue to be piecemeal and represent minimal consensus among
the 10 diverse members. The Common Agricultural Policy will remain the
centerpiece of the EC, and costly agricultural overproduction will continue to
plague the Community. As a result, the EC will face continued pressure to ex-
port surplus farm products, and US-EC agricultural trade competition in third
markets is unlikely to abate in the near future.
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16 March 1984
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Energy
Oil Market Remains The oil market remains relatively calm. Spot prices in recent days have
generally weak market
declined to levels recorded in late February-prior to unconfirmed reports of
Iraqi attacks against tankers near Khark Island. Most spot crude prices are at
or below official prices, with Arab Light at $28.65 per barrel, 35 cents per bar-
rel below official prices. Although concerned about an
oil supply disruption, there is no sign that oil companies, refineries, or end
users are making a major effort to increase inventories. Worries about Middle
East oil supplies, however, may be preventing further price erosion in a
mark the fourth consecutive year of falling real oil prices.
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OPEC's official sales price per barrel averaged $29.31 in 1983, about 15
percent below 1982 and over $5 per barrel below the 1981 price. OPEC
experienced its first significant official price drop in March 1983 when the
cartel's benchmark price fell from $34 to $29 per barrel. If nominal oil prices
remain stable throughout the year, as most forecasters now expect, 1984 will
OPEC Average Official Sales Price,1981-83
US $ per barrel
35
I I - i I I 1
28 I II III IV I II ^I IV 1 11 Ill IV
1981 1982 1983
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European Electric
Utilities Reduce
94it Use
Oil Exploration
Re 'mes-in'Sudan
Yalaysia Accelerates
Crude Oil Production
oil-fired capacity.
Net electricity generation for the European Economic Community rose 1.3
percent to 888 billion kWh, the energy equivalent of 6 million b/doe, during
the first nine months of 1983 compared with the same period a year ago.
Despite the increase in electricity generation, oil consumption by European
electric power plants fell by 27 percent to 560,000 b/doe. Increased nuclear
and hydroelectric generation more than made up for the decline in oil-fired
generation, rising 235,000 and 45,000 b/doe, respectively. High utilization
rates in nuclear, coal-fired, and hydroelectric plants, however, leave little room
for additional declines in oil consumption by European utilities in the near
term. We believe oil consumption may even rise as the spreading economic
recovery pushes up peak-load electricity demand and requires use of additional
Chevron will resume limited exploration in Sudan, outside of the volatile south
where the major oilfields are located. The company suspended its operations in
early February following a rebel attack on its main camp. In return for
Chevron's token presence, the government has signed an agreement that
relieves the company of any responsibility to work the southern concession
area. The French oil company Total plans to resume exploration in southern
Sudan in April. Total shut down its operations in February following rebel
account deficit and to slow the rapid growth of foreign borrowing.
Last month Kuala Lumpur announced plans to increase oil production to
470,000 b/d in 1984, a 25-percent.jump in output that would match last year's.
gain. Malaysia is boosting petroleum exports-the country's largest -foreign
exchange earner-in an effort to reduce the anticipated $2.4 billion current
petroleum production is nearing its roughly 480,000-b/d
Gulf Canada Up
or Sale
Secret
16 March 1984
oil reserves and lead to a sharp drop in production by 1990.
ceiling. Although output can be maintained at this level for a few years, doing
so would rapidly deplete Malaysia's approximately 2.6 billion barrels of known
The Canadian private sector already has shown interest in Gulf Canada, but,
according to a press report, it may have difficulty obtaining financing to cover
the estimated US $2.7 billion purchase price. We expect the private sector to
ownership of the oil and gas industry from 34 percent to 39 percent.
Standard Oil of California (Socal), which is in the process of acquiring Gulf
Oil, intends to sell the company's Canadian assets to assist in financing the
purchase, according to press reports. The decision to sell Gulf Canada is also
based on Socal's expectation that Ottawa-through its Foreign Investment
Review Act-would not allow the 60-percent interest in Gulf Canada now held
by Gulf Oil to pass into the hands of another foreign owner. Gulf Canada is
heavily involved in Canada's frontier oil exploration, as well as in conventional
oil production, refining, and marketing. The domestic purchase of the
company-Canada's fourth-largest oil producer-would raise overall domestic
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raise the required funds, but if it cannot, Ottawa may attempt to purchase the
company through state-owned Petro-Canada, a move already being urged by
the economic nationalists in the government. Gulf Canada would be attractive
to Ottawa because it would complement and expand existing Petro-Canada
capabilities. Petro-Canada would then become the largest oil company in
Canada.
Canadian Venture On the basis of disappointing results from two appraisal wells recently
G geld Reserves completed on the Sable Island Venture gasfield, Mobil has announced that
rove Disappointing development could be delayed by as much as two years because reserves in the
Venture structure alone appear insufficient to warrant development. The
company remains optimistic that cumulative gas reserves in surrounding areas
will support a gas development project, however, and cites extremely promising
seismic results on the southern end of the Venture structure and on the
adjoining Olympia field. New development options probably will be examined,
and the company has now'set a "sliding target" date of 1988 for initial
production. As a result, application for a license to export any gas deemed sur-
plus to Canadian requirements probably will be delayed until sufficient
reserves are proved. Although several US buyers have expressed interest in
purchasing gas exported from Sable Island, it is still uncertain whether any gas
could be delivered to the US market at prices competitive with alternative
Canadian Supreme The Canadian Supreme Court has unanimously ruled in favor of Ottawa in the
Court Rules on _ longstanding dispute with Newfoundland over ownership and control of the
/Offshore Dispute offshore area that includes the Hibernia oilfield. The recent ruling is limited to
this particular area, but another case dealing with the broader question of
jurisdiction over all offshore resources is pending before the court. Develop-
ment of the Hibernia field, which is believed to contain as much as 2 billion
barrels of oil, already has been delayed two to three years because of the
federal/provincial dispute. Ottawa probably will encourage the oil companies
involved with the project to move ahead quickly with development plans in
view of the ruling, but we expect Newfoundland Premier Peckford to continue
to resist concluding a revenue-sharing agreement until after the upcoming
Canadian elections. Given the continuing uncertainties on federal and provin-
cial taxes and royalties and the projected $10 billion cost of developing
Hibernia, we expect the oil companies to avoid committing financial resources
to the project until these issues are resolved.
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 UK Oil Production
Forecast
British oil production will range
projections of a year ago-are in line with recent industry forecasts.
from 2.3 to 2.7 million b/d in 1984, including approximately 160,000 b/d of
natural gas liquids (NGLs). Total. UK oil production approximated 2.4 million
.b/d in 1983, and we believe actual 1984 output will be near the high end of the-
forecast range. Production of NGLs-which' increased more than 40 percent
in 1983=is expected to. increase an additional,20 percent in 1984. Although
British oil production is expected to hold roughly steady in 1985, the forecast
indicates that crude production will decline approximately 10 percent per year
from 1986 to 1988; NGL output is`projected to'hold roughly steady over this
period. The British estimates-which are about 10 percent higher than official
UK Oil Production Forecast
1984
1985
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Possible Colombian
/ Debt Servicing
Disruptions
World Bank.
Colombia's deteriorating financial position probably will result in its failure to
make some debt service payments in the next few months. The US Embassy
reports the seasonal drop in coffee earnings is larger than normal, and foreign
exchange controls appear ineffective in holding down imports. Moreover, there
are some indications that capital flight is increasing despite tight foreign ,
..exchange controls. Bogota is having little success in obtaining new foreign
credits. A source of the US Embassy reports.there is resistance among
commercial bankers to provide part of a $370 million loan cofinanced by the
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C Adopts High-
Technology R&D
Program
Global and Regional Developments
The EC research ministers recently agreed to implement the European
Strategic Program of Research and Development in Information Technology
(ESPRIT). Formal adoption had been blocked since last December by the
United Kingdom and West Germany because of budgetary considerations.
Both countries acquiesced after they received guarantees from the Commission
that the program would not increase already planned research spending ' .
through the end of next year. The total program is scheduled to cost $1.3 bil-
lion over the next five years. Only one-half the expense, however, will be
charged to the Community's budget; the other half will be borne by private in-
commercial applications of such research into production.
Although the Community touts the program as the key to improving its
competitive position in information technology vis-a-vis the United States and
Japan, the impact is likely to be considerably less. ESPRIT will only fund
basic research in advanced microelectronics, software technologies, advanced
information processing, office systems, and computer-integrated manufac-
tures. We expect EC countries will continue to experience difficulties bringing
Chile's Copper A petition for import relief filed with the International Trade Commission by
~arnings Threatened US copper producers could further damage Chile's troubled economy. Domes-
tic copper producers in the United States are seeking an import quota of
300,000 to 350,000 metric tons per year of refined and blister copper over the
next three to five years. In 1983, US copper imports reached an estimated
600,000 tons, with Chile-the world's largest copper producer-supplying
almost 40 percent. Since 1979, US copper imports from Chile have nearly
doubled. During the same period the US copper industry, battered by high
production costs and low prices, has been forced to shut down mines and
refineries and to lay off thousands of workers.
Chile depends on copper for 45 percent of its export earnings, with- roughly
one-third of this amount accounted for by sales to the United States. Chile,
whose foreign debt is about $20 billion, could see its copper exports decline by.
100,000 tons per year if US quotas are imposed. Even at current low prices of
between 65 and 70 cents per pound, Chile could lose more than $140 million in
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exporters, such as Zambia and Zaire.
export earnings. Santiago could try to offset some of its loss by increasing
copper sales to Western Europe and Japan, but this would tend to drive copper
prices still lower, lessening the return to Chile and other debt-troubled LDC
Italian Company To The USSR has signed a letter of intent with an Italian firm to build a 10,000-
I uild Plastics Plant metric ton-per-year polycarbonates plant. According to a spokesman from
the Soviet, Union Montedison SpA, the deal is worth $40-50 million. The plant will use
East European
Hard Currency Trade
urpl us Grows
USSR and later improved upon by the Soviets.
polycarbonate technology initially developed jointly by Montedison and the
Eastern Europe more than doubled its hard currency trade surplus to $4 billion
in 1983 as Western reluctance to extend credits forced the region to reduce im-
ports for the third consecutive year. Last year's 3.5-percent fall in nominal.
imports, however, was much less severe than the cuts of nearly 15 percent in
both 1981 and 1982. The first increase in exports since 1980-due largely to
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 goods.
Two consecutive years of large hard currency trade surpluses are beginning to
improve Eastern Europe's standing with. bankers. Easier borrowing conditions
will probably produce some increase in imports from the West. The upswing in
lending, however, will be neither immediate nor large, and Eastern Europe will
probably run another hard currency trade surplus of some $3 billion this year.
To increase imports significantly, Eastern Europe needs economic recovery in
Western Europe to generate large gains in exports. Sustainable export gains,
however, are not likely without improvement in the competitiveness of their
experienced decreases in their trade surpluses.
resales of Middle Eastern oil-helped limit the import reductions. Yugoslavia
reduced its deficit to the lowest level in 10 years and accounted for most of the
improvement in the region's trade balance. Only East Germany, which posted
a large increase in imports, and Bulgaria, which suffered a slump in exports,
East European Hard Currency Trade Billion US $
Exports
Imports
Balance
1982 1983
1982
1983
1982
1983
Total
36.8 37.8
35.0
33.8
1.7
4.0
Bulgaria
3.3 2.9
2.6
2.4
0.6
0.5
Czechosl
ovakia
4.1 4.1
3.6
3.4
0.5
0.8
East Ger
many
7.8 8.0
6.3
6.9
1.5
1.1
4.8
4.1
4.0
0.8
0.9
5.0 5.6
4.6
4.6
0.4
1.0
6.2 6.1
4.7
4:5
1.5
1.6
5.5 6.3
9.1
8.1
-3.5
-1.8
National Developments
Developed Countries
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Israeli Wage Increase Private-sector employers and the Histadrut, the labor union organization that
represents virtually all Israeli workers, have agreed to increase monthly
salaries by 8 percent. The agreement, reached on 6 March, is retroactive to 1 25X1
February. The wage boost attempts to compensate workers for an erosion in
real wages caused by accelerating inflation. The increase will undercut the
government's policy of reducing real wages-and thereby dampening domestic
pressures-in order to improve the balance of payments and to control
inflation. 25X1
Less Developed Countries
,,,Strikes. Temporarily Employees in the public sector have returned to work, but they are threatening
/ End in El Salvador to strike again if their demands are not met. The US Embassy reports that
Guatemala's New
_Budget .
labor-management negotiations continue and that one union is asking for a 25-
percent increase in wages, well above the 10 percent specified by the
government's new wage decree. Although most of the unions currently
involved are affiliated with the leftist labor front, labor leaders claim that
democratic unions also may strike. Democratic labor has endorsed Christian 25X1
:Democratic presidential candidate Duarte, and continuing labor strife at this
stage of the presidential campaign probably would benefit rightist candidates.
If the situation gets worse, the. Army may intervene. This would give the
insurgents. a propaganda windfall. just before the elections on 25 March:
Guatemala's recently.announced budget for 1984 reflects two main objec-
tives-maintaining austerity and protecting the military's position during the
transition to civilian rule. Military outlays will rise over 25 percent, and debt
service payments will nearly double. The Ministries of Economy and Agricul-
ture will absorb the necessary cuts to keep the overall public budget roughly 25X1
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constant in nominal terms. Actual spending probably will decline due to
revenue shortfalls and borrowing constraints reached with the IMF. Although
the military will receive enough money to make further progress against the in-
surgents, fiscal stringencies, combined with soft export markets and investor
wariness, suggest that Central America's largest economy is unlikely to
,1tton Crop Helps This year's raw cotton crop-Chad's major export earner-reached a record
'
had
s Economy
140,000 metric tons and could earn more than $100 million if it can be moved
to foreign markets. Favorable weather and the perseverance of southern
farmers are largely responsible for the bumper crop. Although President
Habre has sent additional forces to the area to ensure the cotton makes it to
market, we expect the dissidents to step up attacks on storage areas and
transportation routes. These moves could lead to increased fighting in the
south as each side tries to protect its interests, perhaps preventing much of the
crop from reaching foreign markets.
Ljberian Private-Sector Monrovia's financial problems and ill-conceived government policies may
(fjrculties cause foreign businessmen to reevaluate the wisdom of doing business in
Liberia. The country's liquidity crisis-largely caused by chronic budget
deficits-threatens the dollar-based banking system. Cash flow shortfalls and
government inability to cooperate with the companies in the iron ore sector,
which accounts for 60 percent of exports and 25 percent of GDP, are
threatening the survival of all three major producers. Despite a recent upturn
in prices, the. rubber industry-Liberia's second-largest exporter-is suffering
similar problems, and producers expect to record sizable losses again this year.
The banking, iron ore, and rubber industries are also worried that official
harassment of insurance companies will inhibit these companies' ability to
underwrite their assets or service their claims. Continued problems in the
private sector could cause companies to pull out, increasing unemployment and
causing social unrest that could undermine the scheduled transition to civilian
New Singapore Budget
mphasizes High
Technology
Prime Minister Lee Kuan Yew is using Singapore's 1984 budget to spur high
technology and expand Singapore's international financial role. The budget,
announced last week, encourages venture capital investment in high technol-
ogy and broadens the eligibility rules for accelerated depreciation of capital
equipment. It permits entrepreneurs to write off up to half of their investment
in new high-technology ventures within the first three years of operation if the
venture incurs losses. Moreover, eligibility for accelerated depreciation will be
extended beyond manufacturing firms to include service-oriented firms, such
as computer services and banks. The strategy reflects Lee's emphasis on
developing new industries both to counter competition from lower cost
neighboring countries in traditional fields, such as textiles, and to stay a step
ahead of protectionist barriers used by industrial countries to shelter their
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Ii i Severe Storm Damage Madagascar's agricultural sector, which accounts for about one-third of GDP
n Madagascar and more than 80 percent of exports, was recently hit hard by cyclones that
left over 13,500 people homeless. The island's rice crop-the main dietary
staple-suffered extensive damage, according to US Embassy reporting, along
with peanut, manioc, sugar cane, and cotton fields in scattered areas. Although
crop losses for coffee, cloves, and vanilla-the country's major foreign
exchange earners-are not known, if they prove significant, the troublesome
current account deficit will seriously deteriorate. Many irrigation networks,
farm-to-market roads, agricultural storage facilities, and communications
systems also have been destroyed, disrupting production and distribution
activities and isolating various parts of the island. The Malagasy Government
is turning to various donors, including the'United States, for emergency
assistance to help repair physical damage, prevent widespread food shortages,
and meet public health requirements.
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Japan: Shifting Role of Tax Incentives
Japan's use of special tax measures to promote the
development of selected industries has been con-
strained over the past several years by budgetary
stringency and the increased involvement of inter-
est groups in the formulation of Japanese tax
policy. Tax incentives-equal to about 6 percent of
corporate tax revenues during 1966-75-have de-
clined to less than 3 percent last year. Through the
1960s, tax benefits were designed mainly to help
basic materials and manufacturing industries be-
come competitive in world markets. Today, tax
incentives are targeted not only at growing export
industries, but also at domestic utilities, depressed
industries, and companies operating in underdevel-
oped areas. These broader national objectives re-
flect, in large part, more vociferous demands from
other sectors of the economy.
Tax incentives in the 1950s and 1960s were de-
signed mainly to spur economic growth at almost
any cost. Special tax measures supported develop-
ment of technologies considered crucial to Japan's
economic development, modernization of industries
to reduce production costs, and promotion of ex-
ports. MITI's foremost objective in the 1950s and
early 1960s was the development of heavy indus-
tries such as steel, electric power, shipbuilding,
chemicals, and petrochemicals. The high-priority
industries enjoyed relatively low tax burdens-
under 4 percent of the value added-in contrast to
the 4.7-percent average for all industries. Industries
producing consumer goods, such as automobiles,
were largely ignored.
Shifting Priorities
Increased calls over the past decade for government
action on a wide range of issues has limited MITI's
ability to pursue industrial policy through tax
incentives. Environmental protection, correction of
regional inequalities in economic development, and
improvement of housing and welfare facilities have
become major objectives. In addition, the higher
cost of oil since 1973 and Japan's heavy depend-
ence on Persian Gulf suppliers have dictated the
diversion of government financial assistance to the
development of alternative energy sources and sup-
pliers. High energy costs also have undermined the
economic viability of energy-intensive, basic mate-
rials industries such as aluminum refining, petro-
chemicals, pulp and paper, chemical fertilizers, and
cement. As a result, MITI must assist these indus-
tries' capacity reduction efforts, which further di-
lutes its ability to aid selected growth industries.
Rapid increases in government spending during the
period of economic expansion have led to large
budget deficits. Since the late 1970s, efforts to
close the gap between revenues and spending have
limited the number of special tax incentives. As a
result, industries' savings from these incentives
have become less important as industries have
expanded.
There are three major categories of tax incentives
benefiting corporations-special depreciation, tax-
free reserves, and tax credits. These measures will
cost the national treasury 258 billion yen ($1.1
billion) in lost revenues in the fiscal year ending this
month, with special depreciation accounting for
about 60 percent of the total. Special depreciation
measures generally favor small business, while
R&D-oriented credits and deductions favor big
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Japan: Tax Burden as a Share of Value Added, by Manufacturing
Industry, 1970 and 19818
Steel
Chemicals
Pulp and paper
Food products
1970
1981
Ceramics, stone, and cement
Electrical machinery
Transportation machinery
General machinery
Oil refining and coal products
Shipbuilding
Textiles
Manufactured metal products
Precision machinery
All industries-1981 average.
Manufacturing-1981 average
All industries- 1970 average
Manufacturing- 1970 average
firms, resulting in a surprisingly uniform tax bur-
den by industry. As a result, the incentive to
channel investment into particular industries is
diluted:
? Special Depreciation. In contrast to special de-
preciation measures of the past, which favored
MITI-designated "important" industries, current
measures serve many purposes, including environ-
mental concerns, small business interests, energy-
saving efforts, and promotion of underdeveloped
areas. The industries MITI would most like to
develop are not the primary beneficiaries. Electri-
cal machinery, for example, which includes the
favored computer, telecommunications equip-
ment, and semiconductor fields, ranks only sev-
enth among the listed industries, behind apparel,
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16 March 1984
printing and publishing, textiles, and shipbuild-
ing, among others.
? Tax-Free Reserves. Tax-free reserves-corporate
earnings upon which taxes are deferred-
continue to benefit some of the growth industries
but are now used to support development of a
wider range of industries. For example, the larg-
est beneficiary is currently the electric power
industry-which plays the central role in Japan's
efforts to develop alternate sources of energy.
? Tax Credits and Deductions. Special credits and
deductions provide benefits to large firms, espe-
cially those involved in research and development.
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,,.Because of the decline in size of all tax. benefits,
however, the, advantages are insignificant com-
pared-with those; offered, in the United States.
.The. biggest tax credit is for. incremental research
and development expenditures, which will cost an
estimated $162 million in FY 1983. A National
Science Foundation_study,estimates that,a similar
US credit produces ..a $2 billion annual tax incen-
tive.
The Politics of Balance
The increasing number of, beneficiaries of tax
incentives reflects ,the widening circle that now
influences tax policy.
The Bureaucracy. Within MITI the various
bureaus act as proponents of their own clients in
the annual formulation of policy guidelines. For
example, the Small and Medium Enterprises Agen-
cy.pushes incentives-for small business, the Basic
Industries Bureau works on behalf of steel and
chemicals, and the Machinery and Information
Industries Bureau promotes the electronics, com-
puter, and machinery industries. As a result, MITI
itself supports tax incentives that benefit a broad
spectrum of industries.
Although MITI may take the initiative in propos-
ing a special tax incentive, revisions of the Special
Tax Measures Law are actually drafted in the Tax
Bureau of the Ministry of Finance (MOF). The
MOF takes into account requests from MITI, other
ministries, and interest groups such as the Japan
Chamber of Commerce. Closing the gap between
revenues and expenditures, however, is the first
priority of the MOF, and political considerations
dictate that the effort be concentrated on the
revenue side. The Finance Ministry has tried to
reduce the size and number of special tax measures
benefiting business because this is one of the easiest
ways to increase revenues.
The Tax Advisory Commission. Tax Bureau offi-
cials submit their list of alternative policies to the
Tax Advisory Commission. The commission is com-
posed of former government officials, academic
experts on public finance, journalists, bankers,
businessmen, union leaders,, agricultural represent-
atives, and local politicians. The commission serves
as an arbiter among diverse interest groups and as
a.builder of consensus on broad questions of tax
policy.
The Taxation Research Council. A small group of
politicians from the ruling Liberal Democratic
Party, dubbed the "tax mafia" by the Japanese
press, plays a key behind-the-scenes role in setting
tax policy. Because many of the politicians involved
are former Finance. Ministry bureaucrats, they
share the concern of that Ministry and the Tax
Advisory Commission for fiscal restraint. As politi-
cians, however, they also recognize the value of tax
incentives for politically popular programs such as
housing, small business, and regional development.
The council collects proposals to revise the tax laws
from interest groups such as the Federation of
Economic Organizations and the Central Associa-
tion of Agricultural Cooperatives. Last fall, ap-
proximately 1,000 items proposed by some 150
organizations were included in a listing put togeth-
er by the council. The listing is given to the Tax
Bureau for item-by-item review. Each item is
marked to indicate acceptance, rejection, or the
need for further consideration. The council then
reviews the bureau's. grading and may call in
Finance Ministry officials to explain a decision. On
some items the council may force the bureaucrats
Interest Groups. Special interest groups lobby dur-
ing public hearings held by the Tax Advisory
Commission each fall and influence. members of the
LDP Taxation Research Council.
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The growing number of special interest groups
influencing tax policy formulation is illustrated by
one measure slated for inclusion in the revisions of
the Special Taxation Measures Law for 1984. The
measure increases initial depreciation for new
machinery by 30 percent in designated high-tech-
nology industries in areas for which an official
development plan has been approved. Because of
political pressures, the list of designated industries
tends to become too long to be truly selective.
Industries earmarked under the current Extraordi-
nary Measures Law for the Promotion of Machin-
ery and Information Industries, for example, in-
clude textile machinery, industrial sewing
machines, farm tractors, and lumber-processing
machinery, in addition to integrated circuits and
communications equipment.
Other Tools of Industrial Policy
The declining effectiveness of tax incentives to
assist particular industries has prompted MITI to
place greater emphasis on alternative approaches.
In recent years MITI has, for example, identified
fine ceramics and biotechnology as fields of vital
importance to future industrial development and
established special offices to find ways to assist
these industries. To promote the computer industry,
MITI is attempting to push legislation through the
Diet which would ensure Japanese manufacturers
access to the operating systems of foreign comput-
ers sold in Japan. Without such access, Japanese
companies will have difficulty wresting market
shares away from foreign competitors.
We do not believe that MITI will be able to
compensate completely for the limitations on the
effectiveness of special tax measures with other
tools. The pressures that lead to the dispersion of
tax subsidies among a wide spectrum of industries
affect other tools as well. For example, broader
political considerations prevent the concentration of
budgetary subsidies-at about $2 billion a year, the
most important of the tools used today-and loans
from official institutions to high-priority industries.
The computer and semiconductor industries, which
MITI has been promoting for over a decade,
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16 March 1984
receive a share of the $5 billion in funding directed
toward the manufacturing industry proportionate
to their share of total output. Moreover, the manu-
facturing industry takes a backseat to agriculture,
forestry, and fisheries-key constituencies of the
LDP-which received 48 percent of the $18 billion
allocated in FY 1983 for industry and technology-
related programs. The transportation and commu-
nications sector receives 21 percent-primarily to
cover the deficit of Japan National Railways.
The same inconsistency between the professed ob-
jectives of industrial policy and the actual distribu-
tion of benefits exists in the case of official financ-
ing. Of the $90 billion that government financial
institutions are authorized to loan out in the fiscal
year beginning this April, 25 percent will be for
housing, 19 percent for small business, and 14
percent for environmental improvement. The diver-
sity of objectives in general also is present in the
lending programs of the Japan Development Bank
and the Small Business Finance Corporation, the
institutions established specifically as instruments
of industrial policy.
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Argentina: Attempting To Resolve
the Debt Crisis
Argentina faces a crucial payments deadline on 31
March with US bank creditors on its overdue
interest charges. Although there are several road-
blocks to a solution, we believe the problem could
be worked out, perhaps on the basis of progress
toward an IMF agreement. If the issue is not
resolved, US banks would face substantial earnings
losses.
Beyond the near-term crunch, upcoming bank re-
scheduling talks are likely to be difficult. The
Argentine Government has stated that it will not
accept rescheduling terms that appear either to
impinge on national sovereignty or inhibit the
growth potential of the economy. We believe there
is considerable room for a breakdown in discussions
with banks, which could lead Argentina to take a
hardline approach and limit ties with Western
countries. We'cannot rule out the possibility that
Argentina will repudiate its debt.
Unless Argentina pays by 31 March all overdue
1983 interest payments-estimated to total from
$600 million to $750 million-many of their loans
will be in arrears longer than 90 days. This will
force US banks-under current US banking regu-
lations-to reclassify about one-half of their $8.4
billion Argentine loan portfolios as nonperforming.
We believe the Alfonsin administration is unlikely
to deplete its foreign exchange reserves-now less
than $1 billion-or sell gold to meet the March
deadline. Doing either would leave it vulnerable to
charges by the Peronist opposition of a sellout to
the international financial community. Argentina
could, however, make a partial payment. The ad-
ministration is hoping to repeat the solution to a
similar problem in December 1983, when bankers
granted Buenos Aires the first $500 million tranche
of a $1.5 billion medium-term loan, ostensibly as a
show of support for the newly elected Alfonsin
government. The Argentines agreed to return the
entire amount of the disbursement plus enough of
their own reserves to cover the first $350 million
payment against a $1.1 billion bridge loan and to
bring interest payments current through 13 Octo-
ber.
Economy Minister Grinspun suggested in January
that a foreign bank consortium disburse the re-
maining $1 billion of the medium-term loan with-
out a firm IMF accord. Argentina would then
return the entire disbursement plus enough of its
reserves to make a second $350 million bridge loan
payment and bring interest payments current
through yearend 1983. Grinspun pointed out that
this plan of action would remove the time pressure
on the banks and free him to concentrate on his
goal of obtaining formal IMF and Paris Club
accords and a comprehensive bank rescheduling by
30 June.
In mid-February, the US Embassy reported that
the committee of foreign lenders was willing to
disburse the remaining $1 billion but only if the
IMF's Managing Director recommends that the
Executive Board approve Argentina's proposal for
an economic adjustment program. On the chance
that such an arrangement could be reached, the
advisory committee would prepare an interim fi-
nancing arrangement.
On the basis of talks to date and the apparent
Argentine tactic of postponing comprehensive plan-
ning to gain maximum negotiating flexibility, it is
not possible for Grinspun to have a firm IMF letter
of intent in time to allow a disbursement of bank
funds by 31 March. For example, Grinspun has yet
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Alfonsin's failure to lay out a comprehensive set of
economic policies during his three months in office
has enabled a hardline group on debt to form
within his Radical Party and encouraged them to
assert their views. We believe this group would
seize upon any confrontation with banks or the
IMF to further enhance its position. If these fervent
nationalists-led by Aldo Ferrer, president of the
Bank of the Province of Buenos Aires-are able to
publicize tough tactics by foreign bankers, we
believe they could create sufficient domestic pres-
sure to force Alfonsin to further stiffen his de-
mands.
the hardliners support a negotiating position that
includes a grace period for both interest and princi-
pal, capitalization of interest arrears, interest rates
below those charged to Brazil and Mexico, and
limitation of debt service to 15 percent of export
earnings. If banks do not meet these terms, the
nationalists are likely to propose debt repudiation
and a limiting of economic ties to many Western
nations.
The extent of support for an ultranationalist ap-
proach within the President's inner circle is still not
clear. Some Argentines believe the tough talk is a
psychological ploy.
Although we agree with the US
Embassy that a hardline approach does not now
reflect official policy, strident rhetoric could lead to
increased demands for a tough political stance by
the Alfonsin government.
Argentina is widely recognized as the major debtor
with the best ability to walk away from its debt. It
is a substantial food exporter to the Soviet Bloc,
ensuring a large foreign earnings base to pay for
necessary imports. It is also nearly self-sufficient in
petroleum. Regional pressures on Alfonsin to as-
sume leadership among Latin American debtors
have already surfaced. Should a breakdown in talks
with lenders strengthen the hand of hardline na-
tionalists, we believe Alfonsin would be receptive to
a more radical approach.
? Confrontation and impasse on negotiations with
the bank advisory committee.
? Campaign by the Argentine Government to build
public support for handling debt negotiation posi-
tion, for example, street demonstrations.
? Movement of ofjicialfunds-including gold-to
safehavens.
? Movement by President Alfonsin to assume a
leadership role among Latin American debtors.
In particular, look for Argentine initiatives at
upcoming conferences such as the IADB meeting
in Uruguay later this month.
? Increasing public statements by hardliners who
refuse to follow Alfonsin's more moderate line on
the foreign debt issue.
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Gray-Market Arms Scams
The international gray arms market, involving the
purchase and movement of weapons on other than a
government-to-government basis, lends itself to a~
variety of fraudulent arms deals. Identifying such
transactions is often difficult but is an important
element in monitoring arms transfers. These fraud-
ulent deals-or scams-frequently involve small,
disreputable brokers, operating under the cover of
several front firms. These individuals usually offer
unrealistically high quantities of virtually unob-
tainable equipment and seek both large advance
downpayments and long delivery schedules. Iran-
having few reliable military suppliers-has often
been the victim of many of these scams.
Because of its secretive nature, the international
gray arms market is used by recognized govern-
ments, established manufacturers, private dealers,
and a variety of terrorist, insurgent, and criminal
groups to buy and sell large -quantities of .weapons
through unofficial-and often illegal-channels.
The weapons most commonly traded on the gray
market are small arms, although
heavy machineguns; recoilless rifles;
mortars; a wide variety of artillery munitions;
telecommunications equipment; and spare parts is
also available. In addition to such equipment,
however, gray-market dealers have sought to bro-
ker the sale of large quantities of such advanced
weapon systems as Exocet missiles and Cobra
.helicopter gunships
Offers for this kind of expensive materiel have
traditionally been made to pariah states-such as
Libya and South Africa-or to embargoed nations
at war-such as Argentina during the Falklands
crisis. Recently, many such offers have been made
to Iran, which has been one of the most active
buyers on the international gray arms market since
the beginning of its .war with Iraq.
Recognizing Scams
Gray-market scams frequently exhibit one or more
discernible characteristics. Although any offer of
large quantities-of hard-to-obtain ordnance from
any source should be viewed with skepticism, the
offer of such equipment by a small, obscure firm or
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dealers probably negotiate on behalf of allegedly 25X1
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potential buyer after an initial deal has fallen
through.
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Similarly, cases of two or more firms operating out
of the same office are suspect. Gray-market swin-
dlers may establish phony intermediaries and front
companies to insulate themselves from a customer
who may seek revenge after realizing that he has
been cheated. Multiple firms at the same address
are even more suspicious when the firms claim a
foreign incorporation that cannot easily be verified
Another good indication that a gray arms negotia-
tion may be a scam is the request by the supplier
for a large downpayment prior to the delivery of
any goods.
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16 March 1984
Another sign of a possible scam is the request for a
large downpayment coupled with a long delivery
schedule-intended, no doubt, to allow the broker
sufficient time to abscond with his money.
Gray-market dealers seeking to 'set up a scam will
frequently attempt to convince the client of the
need to act quickly, either by claiming that his own
option to buy will expire soon or by implying that
possession.
Offers of both hard-to-obtain and readily available
equipment suggest that some dealers may seek to
"bait and switch" by seeking a downpayment for
hard-to-acquire, advanced ordnance in the hope of
supplying other, less sophisticated equipment at a
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Iran: A Target
Although we do not know how much money Iran
has lost as a result of fraudulent gray-market deals,
we believe that the amount had reached several
hundred million dollars by the end of 1982.
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The revolutionary
government had halted practically all official arms
buying activity, and established procurement chan-
nels had been abandoned. As a result of the loss of
traditional contacts with the United States and
Europe, an embargoed Iran entered the interna-
tional gray-arms market, where hundreds of private
dealers and would-be agents offered to broker the
sale of all manner of military equipment for the
new regime.
Although arms dealers worldwide have attempted
to sell arms to Iran, most appear to reside or
operate in West European countries such as Portu-
gal, Spain, West Germany, Austria, and, especial-
ly, Switzerland-the latter presumably because of
its prominence as an international banking center
and its favorable incorporation laws. Some offers
from these dealers appear credible and involve
relatively small quantities of small arms, muni-
tions, and other expendables that are readily avail-
able on the international gray-arms market. Other
offers appear to be frauds, however, with small-
time dealers proffering unrealistically large quanti-
ties of sophisticated and virtually unobtainable
weapon systems at exorbitant prices
Although we expect that gray-market dealers will
continue to offer advanced military equipment to
Iran, we believe that Iranian procurement officers
are becoming sufficiently cautious to discriminate
between credible and improbable offers. We expect
that gray-arms market brokers will continue
supplying conventional small arms and munitions
to Iran as well as to any other client with sufficient
cash to pay for them. They are unlikely, however,
to find another customer as willing and able to
advance large sums of money in return for the
promise of advanced equipment-until the next
international crisis or arms embargo creates a
seller's market for such ordnance.
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Yugoslavia: Persistent
Inflation Problems
Yugoslavia's lack of success in controlling infla-
tion-over 40 percent last year-was the major
failure of its 1983 economic stabilization program.
Despite Belgrade's compliance with tight monetary
Yugoslavia: Monthly Increase in
Cost of Living
targets established with the IMF and a price freeze Percent
in effect through July, prices were rising at an
annual rate of 100 percent by the end of the year.
Although administrative price increases to reduce
subsidies and devaluation of the dinar contributed
to inflationary pressures, the chief factors are
rooted in the Yugoslav system of wage and price
formation and monetary and credit arrangements.
Since few steps have been taken to deal with these
systemic problems, rapid inflation is likely to per-
sist in 1984, threatening both living standards and
last year's gains in the competitiveness of Yugoslav
exports.
Double-digit price rises at both the producer and
the retail level have become the norm in Yugoslavia
since the early 1970s. Some Yugoslav officials have
put the blame on rising world prices of raw materi-
als and energy, especially oil.
the 20-percent inflation recorded in 1979 was due
to higher import prices. Even in the absence of
these external factors, however, Yugoslavia's cost-
of-living index has continued to soar, rising nearly
35 percent annually during 1980-82.
The cost of living last year climbed a record 42
percent. A price freeze helped stabilize industrial
prices and moderate consumer price increases
through the first half of the year. Following the
lifting of the price freeze in August and the
continued depreciation of the dinar-policies de-
manded by the IMF-retail and producer prices
rose sharply. By the end of the year, the cost of
living was rising at an annual rate of 100 percent.
Food prices-heavily weighted in the cost-of-living
index-were a major source of inflation, reflecting
higher import prices, some agricultural production
difficulties, and government attempts to reduce
subsidies. The government also boosted prices of
other consumer essentials, such as energy, rents,
and railway fares, in order to comply with agree-
ments made with the IMF.
Yugoslavia's chronic inflation has resulted from
Belgrade's desire to spur economic growth. Invest-
ment, in particular, played a key role in the late
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1970s; real investment grew at an average 8.8-
percent annual rate in 1975-79. Several factors
accounted for this surging investment, including
easy access to foreign borrowing, lax domestic
monetary policy, and negative real interest rates,
which made borrowing an attractive option for
Yugoslav enterprises. The investment boom ended
in 1981 when Yugoslavia agreed to restrict demand
under an IMF program.
Because Yugoslavia's six independent regions and
two autonomous provinces operate independently,
investment and production frequently are duplicat-
ed, leading to inefficiencies and more costly goods.
In addition, regional governments discourage the
flow of goods to other republics, creating local
monopolies that have no incentive to keep a lid on
prices. Moreover, the government's policy of subsi-
dizing firms that would otherwise go bankrupt-in
part, to keep unemployment down-introduces yet
additional cost pressures.
Embedded in the Yugoslav economic system is a
continuous wage-price spiral that maintains the
momentum of inflation. Workers' self-management
councils have voted wage increases in excess of
productivity gains. As unit labor costs have risen,
management protected profit margins by raising
prices. In 1981-83, these costs rose nearly 30
percent per year.
Tito's decentralization of the economy left Bel-
grade with few viable policy options with which to
fight inflation. Federal government expenditures
are small, and therefore fiscal policy has little
impact. Moreover, most discretionary budgetary
powers are delegated to the individual republics
and provinces where strong vested interests and
power groups ensure continued spending.
Decentralization also has weakened the role of the
central bank and put regional banks essentially
under the control of local enterprises. Monetary
policy often has merely abetted the rapid growth
policies. Although Belgrade met the strict money
supply target agreed to with the IMF last year,
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Yugoslavia: Inflation and Personal
Income Trends, 1976-83
Consumer
prices
Nominal
personal income
enterprises evaded the curbs by extending loans to
one another to maintain overall liquidity-a move
they traditionally take when the money supply is
restricted. In addition, the purchasing power of
large private holdings of foreign exchange has
increased as the dinar has been devalued.
Impact on Balance of Payments
Yugoslavia's creditors are concerned that hard-won
improvements in Belgrade's current account may
be eroded if Yugoslavia fails to control inflation.
Last year Belgrade ran a current account surplus of
nearly $300 million, the first surplus since 1976
and a sharp improvement from the $1.4 billion
deficit recorded in 1982. The government hopes to
increase the surplus to $800 million this year, and
even the more cautious IMF is projecting a surplus
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Belgrade pared nearly $2 billion off its trade deficit
last year, reducing it to $1.8 billion. Imports plum-
meted 16 percent, while exports grew nearly 8
percent, largely due to the redirecting of sales away
Yugoslavia: Trends in Real
Effective Exchange Rates, 1970-828
rency markets. Yugoslav officials project another
healthy cut in the deficit this year, essentially by
boosting exports 20 percent and allowing for a
modest recovery in imports.
If Belgrade tries to fight inflation by allowing the
dinar to appreciate in real terms, the current trade
surplus will be difficult to sustain. As prices of
Yugoslav goods rise-and are not offset by dinar
depreciation-their competitiveness on internation-
al markets will decline, and the goods will be
consumed in the home market. In addition, import
demand will increase because of relatively cheap
prices. The IMF estimates that the dinar effective- I I I
ly appreciated 18 percent in November and Decem-
ber. As a result, a major devaluation is included
among the IMF conditions for a 1984 standby
agreement.
Domestic Implications
Worker morale-and thus productivity-will con-
tinue to be hurt if no progress is made in controlling
inflation. Most Yugoslavs have come to expect
steady improvements in their standard of living, but
workers' real incomes have declined 25 percent
since 1979. The full impact has been greatly miti-
gated by other sources of income, such as moon-
lighting, worker remittances, and generous social
payments and allowances. Evidence is growing,
however, that even these supplemental sources of
income are dwindling and that people are now
drawing down their savings. In addition, import
curbs have produced serious shortages of gasoline,
coffee, sugar, soaps, and other consumer goods.
The net effect has been an estimated real drop in
consumption of 3 percent since 1980.
Although Yugoslav workers increasingly perceive
inflation to be a major threat, consumer reaction
thus far has been restrained. Strike action has
increased, but incidents of more serious unrest have
been few. Worker morale continues to plummet
and is hurting productivity-output per worker has
fallen 3.5 percent annually the past two years.
President Planinc of the Federal Executive Council
has stated that the standard of living can drop no
further without exhausting the patience of the
populace.
Dim Prospects for Inflation
Inflation is likely to accelerate in 1984 despite
Belgrade's determination to slow the pace. This
year's target of only 15 percent will not be met for
a variety of reasons, including:
? IMF insistence that the current price freeze
imposed at the end of 1983 be lifted as a condi-
tion of a new standby arrangement.
? Continuing inflationary pressure generated by
1983 price increases as they work through the
system.
Secret
/6 March 1984
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? Further devaluation of the dinar.
? Growing pressure from workers to reverse the
decline in real wages.
Most important, few steps have been taken. to
correct the systemic deficiencies that boost prices.
Yugoslavia's problems with inflation will be cor-
rected only if Belgrade imposes financial discipline
on Yugoslav enterprises that are now sheltered
from competition and financial accountability. Im-
plementation of such measures, however, remains
politically difficult because of the opposition of
vested regional interests.
External pressure from multilateral and commer-
cial banking institutions may be the only force able
to move Belgrade toward remedial policies. Paro-
chial regional interests are so strong that the
government is likely to continue ineffective controls
designed to lessen the damage caused by inflation
without attacking its sources as long as external
financing is available.
Secret 30
16 March 1984
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