SOME POLICY IMPLICATIONS OF THE CHANGING GLOBAL ECONOMIC ENVIRONMENT

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00176R001300090001-3
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 12
• Document Creation Date: December 20, 2016
• Document Release Date: April 30, 2007
• Sequence Number: 1
• Publication Date: March 1, 1982
• Content Type: REPORT

Confidential
NIC M 82-10003
March 1982
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Intelligence
Council
Some Policy Implications
of the Changing Global
Economic Environment
National Intelligence Council
Memorandum
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National Security Unauthorized Disclosure
Information Subject to Criminal Sanctions
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 Approved For Release 2007/04130 :CIA-RDP85T00176R001300090001-3
National
Intelligence
Council
Some Policy Implications
of the Changing Global
Economic Environment
National Intelligence Council
Memorandum
Information available as of 4 March 1982
was used in the preparation of this Memorandum.
me igence Counci
This Memorandum was coordinated within the
National Intelligence Council and discussed with the
Directorate of Intelligence. Comments are welcome
and should be addressed to its autho
f the Analytic Grou of e a Iona
Confide ial
Confidential
NIC M 82-10003
March 1982
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Some Policy Implications
of the Changing Global
Economic Environment
Scope Note This paper presents selected propositions concerning circumstances that
could either (1) make US policy choices more difficult, (2) increase frictions
with other countries, or (3) enhance the ability of US officials to achieve
policy objectives. The paper concentrates on the next few years, with a
glimpse at some longer term concerns.
Key Propositions Some major changes under way in global economic conditions may have
important implications for the United States. Specifically:
? The timing and pace of the global economic recovery expected this year
depend more heavily on the economic performance of the United States
than has been the case for any economic recovery during the past 10
years.
? The competitiveness of US manufactures will suffer in 1982 just at the
time the US domestic economy will be near a cyclical low point and trade
frictions with Japan at a high point.
? Tokyo could miscalculate the seriousness of US and European trade
concerns, and so contribute to a significant increase in trade barriers
against Japan and a global upsurge in protectionism.
? Oil prices are falling this year and may continue to fall for several years,
at least in real terms; consequently, the United States and other countries
will have to deal with a new set of energy-related issues.
? The increase in foreign direct investment in the United States provides
the US Government with an increased opportunity to press for the
reduction of foreign government controls on US firms.
? Western Europe's current economic malaise will increasingly aggravate
normal Atlantic Alliance frictions.
? The deteriorating hard currency position of the Soviet Union provides the
United States and its allies with an enhanced source of subtle leverage
against Moscow.
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Some Policy Implications
of the Changing Global
Economic Environment
The timing and pace of the global economic recovery
expected this year depend more heavily on the eco-
nomic performance of the lUnited States than has been
the case for any economic recovery during the past 10
years.
By mid-to-late 1982 the pace of global activity is
expected by most observers to move out of the dol-
drums that characterized 1980 and 1981. How strong
and durable that upturn will be depends to a large
extent on what happens in the United States. The
United States has in place the only major program to
stimulate economic outputs through fiscal and other
means-the midyear tax cut plus earlier investment
incentives. In addition, inflationary pressures seem to
be declining faster in the United States than else-
where. For their part, the West Europeans and the
Japanese are unwilling or unable to provide the engine
of growth they did during the upswings in the 1970s.
Both feel that they can no longer apply massive doses
of fiscal stimulation because of their extraordinarily
large budget deficits. The Europeans also seem to
have lost, at least temporarily, their economic vitality
and self-confidence.
Meanwhile, OPEC, the newly industrializing coun-
tries (NICs), and the Communist countries are no
longer in a position to provide the growth markets
they did in the 1970s. OPEC and the NICs were
especially important because their import markets
expanded at triple and double the pace of the devel-
oped-country markets. These latter two groups face
significant foreign financial stringencies and some
countries within these areas are coping with political
turmoil.
From a psychological point of view, the industrial
world and many LDCs have increasingly, explicitly or
implicitly, turned to the United States for global
economic leadership. Given their mood, the Europe-
ans are much less inclined to be leaders than they
were just a few years ago. Ingrained Japanese atti-
tudes continue to prevent them from playing a role in
global economic affairs that even begins to come close
to their economic prowess. As a consequence, consid-
erable attention abroad can be expected to be focused
on the outcome of the present US administration's
domestic economic policies.
The competitiveness of US manufactures will suffer in
1982 just at the time the US domestic economy will be
near a cyclical low point and trade frictions with
Japan at a high point.
US trade performance since the early 1970s has been
highly cyclical as a result of exchange rate move-
ments. During this period, major changes in the value
of the dollar significantly influenced US trade trends
after about six to 18 months. This lag partially
reflects the time it takes before new contracts reach
the shipment stage. For example, the relatively low
value of the dollar between 1976 and 1978 was largely
responsible for the United States' good performance
in exports of manufactures between 1978 and 1980.
In fact, the US share of OECD exports to the world
was little different in 1980 from what it had been in
the early 1970s.
The situation is changing, however. US price competi-
tiveness is slipping as a result of a strong dollar. By
far the most serious problem is the strength of the
dollar vis-a-vis the yen since mid-1979. The apprecia-
tion of the dollar against the mark and some other
European currencies since late 1980 has also reduced
US competitiveness. As a result, the US share of
OECD exports of manufactures began to slip around
mid-1981, and there is every expectation that the
decline in market shares will persist well into 1982.
Expected slow growth of foreign markets will further
add to US export woes. The poorer export perform-
ance will have a much greater adverse impact on the
US economy than it had just 10 years ago. During
that time, exports as a percentage of total goods
produced have doubled.
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The slipping US trade performance, once it is widely
recognized, will exacerbate the already strong belief
at home that US manufactures are no longer competi-
tive and increase calls for actions to support US
industries against foreign competition and to do more
to open foreign markets.
The comparatively poor US trade performance even-
tually should cause the dollar to depreciate against
the yen and the mark. What is uncertain is the degree
and speed of the currency change. High US interest
rates and political uncertainty in Eastern and West-
ern Europe would help sustain the dollar's value, even
though trade trends call for a depreciating dollar. The
longer these two factors encourage dollar investments
in the United States, the longer it will be before the
United States can recoup its competitive pricing
position in international trade. Meanwhile, the funda-
mental factors influencing price competitiveness will
tend to favor the Japanese and the Germans. Their
inflation rates are expected to run below those in the
United States (as they have for several years), and
these two countries are likely to continue to enjoy
faster growth in productivity in the manufacturing
sector and smaller increases in the labor costs of each
unit of output than the United States. As a result, the
longer the dollar maintains its strength, the larger will
be the cut needed in the dollar's value to restore the
price competitiveness of US goods.
Tokyo could miscalculate the seriousness of US and
European trade concerns, and so contribute to a
significant increase in trade barriers against Japan
and a global upsurge in protectionism.
For the third time in the last 10 years, substantial
pressure is building on Japan to hold down exports
and open its domestic market to more foreign goods.
Since 1980 Japan's exports have been climbing rapid-
ly and its imports have been languishing .This trend
is expected to last well into 1982. As a result, the
country's current account, which fell deeply into
deficit because of the 1979-80 jump in oil prices,
moved back in surplus in mid-1981. This year Japan's
current account, its overall trade balance, and its
bilateral trade balances with the United States and
the EC will all reach surpluses of record proportions.
Other industrial countries understandably believe that
these trends mean Japan is exporting its economic
troubles. Japan has been able to maintain economic
growth in the range of 4 to 5 percent and to avoid
significant unemployment problems even though do-
mestic demand has stagnated.
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Given these major roadblocks, there is a high risk that
the Japanese will not make concessions significant
enough to disarm the rising trade antagonism against
them, thereby unleashing the industrial world's cur-
rent pent-up protectionist sentiment. Some countries
could decide to restrict Japanese exports in a major
way, while others would have to follow suit to prevent
a massive diversion of Japanese goods to their mar-
kets. In the end, the highly effective international
trade arrangements, painstakingly put together in the
post-World War II era, would be severely under-
mined. The newly imposed trade restrictions would be
hard to remove, and, in the future, countries would be
more inclined to take similar restrictive moves to right
trade grievances they have with others.
The opportunity will also be present to make Tokyo
take meaningful steps to reduce its trade barriers.
Public outcries against Japan in both the United
States and the EC will be particularly strong as a
consequence of the high rate of unemployment and
the huge Japanese trade surplus. The Japanese body
politic takes foreign criticism rather seriously, and
Tokyo would feel obliged to try to disarm it. Finally, a
newly established high-level multilateral trade forum
can be used to deal with the problem. The window of
opportunity, however, will be temporary because the
likely appreciation of the yen this year will cut deeply
into Japanese competitiveness and trade surpluses by
1983 or 1984.
Oil prices are falling this year and may continue to fall
for several years, at least in real terms; consequently,
the United States and other countries will have to deal
with a new set of energy-related issues.
After declining nearly one-third since 1979, the de-
mand for OPEC oil will probably begin a trend
upward as global economic growth resumes. The
increase, however, is likely to be slow because of the
continuing conservation momentum and the increas-
ing availability of non-OPEC sources of energy. As a
result, excess OPEC production capacity will remain
large for at least a year or two, even if the Iran-Iraq
war continues, and if there are no major new supply
disruptions. An end to the war would probably in-
crease available OPEC capacity enough to keep the
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oil market soft at least through the mid-1980s. Under
these circumstances, the nominal price of oil will
probably slip somewhat through at least 1982 and
could even fall sharply. In the next few years, the real
price of oil is likely to continue to fall as overall prices
continue to rise while oil prices tend to level off.
The oil market outlook beyond the mid-1980s is
highly uncertain. Diametrically opposed views on
longer term trends are emerging among analysts.
Many expect the oil market to tighten considerably in
the mid-to-late 1980s as economic growth proceeds
and as the declining real price of oil adversely affects
conservation efforts and the development of new
energy sources. These analysts thus see the margin of
available excess capacity squeezed to the point that
fairly small supply disruptions could threaten once
again to set off a sharp price runup. Others predict
little or no increase in OPEC oil demand through
1990 on the basis of more optimistic estimates of
demand and supply responses to earlier price jumps.
Whatever the outcome, the public mood for the next
few years at least will be most impressed by the
declining price trends, and any policy intitiatives in
the energy field will be strongly influenced by this
change in expectations.
Impact on FJjorts To Protect Against Supply Vulner-
abilities. The increasing long-term oil market uncer-
tainties are increasing the difficulties policymakers
face in deciding how much they should now spend on
reducing the risk of an oil price explosion in the mid-
1980s and beyond. If the first view above is correct, it
is easy to justify building strategic reserves to offset
any major supply disruptions. On the other hand, if a
long period of large-scale excess capacity is expected,
the advantages of this policy become less clear, and its
cost becomes more burdensome. These costs would
include the initial outlays to build and stock the
facility and the ongoing spending on maintaining the
effort, especially the interest paid to finance the
inventories.
Impact on Oil-Importing Countries. As real oil prices
decline, some energy production facilities in oil-im-
porting countries will become unprofitable. As the
number of profit-strapped producers increases and
awareness of the new problems grows, the mood of the
body politic could quickly shift from worrying about
shortages to concern about surpluses and protecting
domestic producers. In many industrial countries,
producers would turn to their governments for protec-
tion against "cheap" foreign energy through price
supports and/or budget subsidies.
In these circumstances, a set of national security
arguments similar to those of the 1950s and 1960s
could be injected once again into policy deliberations.
Security issues would be the stalking-horse for eco-
nomic interests of particular groups. Domestic pro-
ducers and others would argue that a tariff on oil
imports is needed to maintain output levels and
conservation efforts in order to prevent a return to a
highly dangerous level of dependency on imported oil.
Consumers (both household and industrial) would
argue that it makes more sense to import low-cost
energy now and save domestic resources for future
needs.
Protection of high-cost domestic energy would dam-
age the US competitive position in some energy-
intensive products and would make the oil input cost
of a broad range of goods and services relatively high.
Because jobs as well as profits would be at stake,
trade frictions among countries could intensify. There
would be growing demands for establishing rules of
the game for energy-related trade protection-no
small task, given the considerable differences among
countries in their energy mix and reliance on domestic
energy sources.
Impact on Relations With Oil-Exporting Countries.
A decline in oil prices would erode both the revenues
and the economic power of the oil-exporting countries.
Most would have to scale down their ambitious
development efforts, some would have to cut ongoing
programs. The poorer and more populous oil-export-
ing countries-Nigeria, Indonesia, Mexico, Iran, Al-
geria, Venezuela, etc.-would be most seriously hurt
by a soft oil market. Unable to diversify their exports
quickly enough to fill the gap in oil revenues, these
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countries would face slower economic growth, and the
expectations of politically powerful groups fora rapid-
ly rising standard of living would be severely
disappointed.
Under these circumstances, some oil-exporting coun-
tries would be susceptible to greater political upheav-
als or radical subversion than is the case at present.
While the interest of industrial countries in the
exporters' energy resources would wane, there would
still be a strong security interest (depending on Soviet
behavior and intentions) and a considerable interest in
these countries' markets. Thus, industrial countries
would find themselves having to balance these con-
cerns with the objectives of minimizing long-term
vulnerability to oil supply interruption and the protec-
tionist demands of domestic energy interests.
The increase in foreign direct investment in the United
States provides the US Government with an increased
opportunity to press for the reduction of foreign
government controls on US firms.
Foreign direct investment in the United States has
risen dramatically in recent years. In the 1960s less
than 3 percent of foreign direct investment by OECD
countries was placed in the United States; in the late
1970s that share had climbed to more than a quarter.
In fact, the United States has now become the
number-one choice for foreign investors. At the same
time, the supremacy of US multinational corporations
at home and abroad is being seriously challenged by
foreign firms. Many of these large foreign firms are
state owned. As such, they often receive from their
governments capital at less than market rates, out-
right subsidies, and other benefits that give these
foreign firms a competitive advantage relative to
privately owned establishments.
Many industrial countries have extensive controls on
foreign investment, even though they agreed under
the 1976 OECD Declaration of Members that they
will treat foreign firms in the same manner in which
they treat their domestic firms (with exceptions such
as defense-related companies). Ottawa has gone fur-
ther, requiring US firms and other foreign firms to
adhere to certain performance requirements as a
condition of entry. For example, one US firm was
required to purchase a specific percentage of its input
requirements from Canadian suppliers. In Japan, US
direct investments have been greatly restricted, and
those few firms allowed in have been constrained by
the same social-cultural barriers discussed earlier. A
tougher US stand on foreign barriers that adversely
affect US market entry would be possible in light of
the significant stake foreign direct investors now have
in the United States. The major problem in so
pressuring foreign governments on this issue would be
that they believe the United States would find it
difficult to use its retaliatory power in any substantial
way. Foreign government officials and business lead-
ers realize that their US counterparts are highly
reluctant to take such action because foreign invest-
ments most often boost US economic activity.
Western Europe's current economic malaise will
increasingly aggravate normal Atlantic Alliance
frictions.
Although certain of Western Europe's fundamental
political-economic troubles have been building for a
decade, they began to surface as serious issues only in
the past year or so. Until recently, the region's leaders
and public seemed to believe that they were making
the adjustment to the 1973-74 energy shock reason-
ably well, especially when compared with the United
States. In fact, in the late 1970s when the dollar was
eroding badly, many Europeans believed they had to
take a much greater leadership role in developing new
initiatives in the international arena. Now there exists
a crisis of confidence, especially in northern Europe-
West Germany, Belgium, the Netherlands, and the
Scandinavian countries. Leaders in these countries
feel a striking loss in their ability to manage political
and economic affairs.
Underlying this mood of despair are worsening eco-
nomic problems. Unemployment has reached new
heights, with little relief expected until the mid-1980s,
when there will be a sharp reduction of new entrants
into the labor force. (Such a demographic trend
already is under way in the United States.) West
European industry has been slower than the United
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States to adapt to new technologies. Employment
costs have been excessively high because of mush-
rooming fringe benefits and a guaranteed continuity
of employment. Enormous outlays for social welfare
benefits have pushed government outlays as a share of
GNP far higher than a decade ago and well above
those in either the United States or Japan. These
problems differ considerably among countries, but to
some degree infect all of them.
The West European malaise probably will turn out to
be only a passing phase. Eventually, public awareness
of the difficulties and public debate on causes and
solutions may generate powerful new forces for
change. The next few years, however, will be difficult.
Economic activity will increase, but probably at a
somewhat slower clip than in the United States.
Dissatisfaction with economic leadership will take
divergent political forms. Consequently, the West
Europeans will be especially difficult to deal with.
? Trade. Protectionist forces will be particularly
strong, especially in France. Trade and investment
policies of the EC members are likely to become
more nationalistic, and the European Monetary
System (EMS) will be under a severe strain as
France and West Germany pursue much different
fiscal and monetary policies. The EC, thus, will be
less inclined to strongly pursue new international
free-trade arrangements although they probably
will want to avoid any serious breakdown in the
current trade practices. In this last regard, the
desire to maintain the basic EC structure will be
among the chief factors inhibiting rampant protec-
tionism. Each member will be forced to moderate its
trade actions to maintain the Common Market.
? Defense. Much higher defense spending is highly
unlikely in the absence of some blatantly outrageous
act by the Soviet Union directly affecting Western
Europe. Budget deficits will not subside until Euro-
pean states begin to trim their social-welfare out-
lays, and there are few signs of a movement in that
direction. Defense outlays that boost local economic
activity-manpower, manpower support, and do-
mestically produced arms will be given a higher
priority than imported defense items-mainly US
sophisticated equipment.
? East-West Trade. Western Europe's economic trou-
bles probably will have little if any impact on this
issue. Even if unemployment were much lower,
West Europeans would continue to pursue trade
with the Soviet Bloc because they strongly believe
that it helps contain Soviet aggressive tendencies
and because political pressure is constantly applied
by the many local firms that are highly dependent
on exports to the Soviet area. The higher unemploy-
ment nonetheless provides the Europeans with a
stronger argument to continue to sell the Soviets
whatever they can in goods other than those that
could directly enhance Soviet military power.
The deteriorating hard currency position of the Soviet
Union provides the United States and its allies with an
enhanced source of subtle leverage against Moscow.
The sharp erosion in the Soviet hard currency position
which began last year probably will be long lasting.
Unlike previous bouts with foreign financial stringen-
cies, this time there is nothing on the horizon that is
likely to bring relief. In 1974 and 1979-80 Moscow
enjoyed large windfall gains from large oil price
increases. Throughout the 1970s there was a boom in
Soviet hard currency revenues from arms sales. And
Moscow has benefited from soaring gold prices.
Now, however, oil prices have fallen and the Soviets
are having difficulty sustaining the volume of oil
exports; gold prices have plummeted since the 1979
peak, and arms sales have leveled off. Moreover,
Western banks are extremely reluctant to extend new
unguaranteed long-term credits because of the eco-
nomic disaster in Poland, a general weakening of the
East European economies, the severe worsening of
East-West political relations, and the vanishing Soviet
financial umbrella over Eastern Europe. The pressure
on the banks to make new loans also has declined with
the falling inflow of OPEC deposits. The only poten-
tial large new source of foreign exchange earnings is
gas sold via the Yamal pipeline, but those sales will
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not be important until the late 1980s. By that time
these gas sales might only be replacing faltering oil
sales.
Moscow has been adjusting to its foreign exchange
bind by drawing down its sizable assets in Western
banks, borrowing short-term, and selling more gold.
With export earnings probably declining this year, a
cut in industrial imports or grains will be required in
order to hold the balance-of-payments deficit within
reasonable limits. In the longer term, and even with a
firming of Western markets for Soviet exports, Mos-
cow will be hard put to increase its import capacity.
After considering the chronic need for large food
imports and the heavy dependence on Western pipe
for developing Soviet gas, there will be enough hard
currency to pay for only the highest priority imports
of machinery and equipment. Without massive new
Western credits, feasible only in an easier political
atmosphere, Moscow will not be able to use imports of
Western equipment and technology as a major factor
in improving productivity.
Although Moscow retains some financial flexibility, it
is beginning to face politically tough decisions be-
tween and among domestic and foreign policy consid-
erations as a result of the foreign exchange bind. Now
the Soviets must think harder about the burden of
defense and of empire. The tough choices they will
have to make include:
- How they should divide the limited foreign ex-
change among urgent domestic needs-for exam-
ple, grain versus microprocessors.
- How much hard currency earnings to forgo in
providing subsidized commodities, especially oil,
to client states.
Whether to take on additional foreign commit-
ments that may impose a burdensome financial
drain.
Under these circumstances, a limitation on the flow of
Western credits to the Soviet Union seems to provide
a powerful means of applying leverage vis-a-vis
Moscow.
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