EASTERN EUROPE: IMPACT OF WESTERN INFLATION

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R001900030186-0
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 33
• Document Creation Date: December 19, 2016
• Document Release Date: August 18, 2005
• Sequence Number: 186
• Publication Date: November 11, 1974
• Content Type: REPORT

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tir111z:rlc,: D/U Portions of
Material. for Kissinger on Inflation
OER: S-G592
11 Nov 74
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Cl A Io~~l s-O~s-~a-7y
Eastern Europa: Impact of Plc :tern Inflation
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8 November. 1974
T.,la L?er.n I:ur.o1?e: Lmpact of We:;tcr.n Inflation
I.. I..asLeri: Eur.opc* has felt the pressure of, the worldwie n
inflation to a much greater extent than the USSR. Unlike
the USSR,with its vast land mass and enormous natural resource:,,
the Last European countr4 C- . r ?ii.^i. ?-r.lY heavily on for. sign
sources for basic raw materials and semi-finished goods. The
prices of these imports from the West have risen sharply whoreas
prices of exports have not kept pace. As a result, Eastern
Europe's terms of trade with non-Communist trading partners
have declined; in contrast, the Soviet Union has gained from
the global inflation because of its continuing exports of oil,
gold, and other primary products.
2. Eastern Europe's terms of trade with the Soviet Union --
constant since 1971 under five-year trade agreements -- are
expected to decline sharply in 1976 when new agreements, based
on current higher prices, become effective. For example, the
pr.:.ce of Soviet cruae oil 'will 'double in 1976.
3. Eastern Europe has insulated its economies from
Western inflation by subsidizing imports. Except in Hungary,
* Bulgaria, Czechoslovakia, East Germany, Hungary, Poland, and
Romania. Yugoslavia, with its mar}:et-oriented economy, is not
representative of the more highly planned economics of Eastern
Europe. Indeed, the cost of living for the first eight months
of 1974 has increased 20. compar'.d with the same period last
year.
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which officially sanctions come inflation, domestic retail
prices have shown little upward movement because of tight
control. over wages and prices. However, soaring subsidies
and the desiru to conserve oil have prompted the East European-
to raise: internal fuel, prices in 1973-74. in addition, the
governments have adopted a wide range of economy measures in-
Cl.llClirlq conservation programs, emphasis on domestic resources,
and curtailment of
4. These steps have helped the East Europeans to cope
with Western inflation. Nonetheless, the additional burden
of Soviet price hikes in 197G will present the various leader-
ships with perhaps their. most difficult planning problem since
post-WWII reconstruction. This dilcnuna is magnified by Soviet
demands that the East Europeans (a) purchase more of their raw
material needs in the West and (b) invest more capital and
manpower in programs for the development of Soviet raw materials.
5. These developments portend a reduction in the volume
of imports of machinery and ether industrial products from the
West. A reduction of this sort would be especially painful to
the East European economics because of their growing reliance
on the West not only for technology and equipment for moderni-
zation but also for basic chemicals, special steels, plastics,
and other key inputs into growth industries. In an atmosphere
of consumerism exemplified by the Polish riots of 1970, the
East European authorities are reluctant to slash imports of
consumer goods and foodstuffs.
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6. In order to minimize cutbacks in imports, Eastern Europe
will. try to obtain Credits on concessionary terms from the Soviet:
Union, to borrow further in Western money markets, and to
arrange additional barter deals with Middle-Eastern countries.
Nevertheless, planners will have to resign themselves to slower
economic growth ratr:; during the remainde of the decade.
sectors hardest hit by cutbacks ill f>>^? ,.Guppl.ics will be
chemicals, metallurgy, agriculture, and food processing. A
pause in plans for increasing consumer welfare -- possibly
including a slowdown in the auto boom -- is almost certainly
in the cards.
7. The impact of Western inflation varies considerably
from one East European country to another, depending on its
raw material resources. The worst hit will be Czechoslovakia,
Hungary, and Bulgaria. Romania, Poland, and the GDR are better
off. Romania has substantial exports of raw materials including
petroleum. Poland exports coal, copper, zinc, and sulphur.
East Germany is partially sheltered because of its extensive
sales of raw materials to West Germany.
Romania
8. Because of its own large raw material base, Romania
is more sheltered against fluctuations in world market prices
than other East European countries. Bucharest predicts that
consumer prices will rise only 0.9% in 1974, a remarkably
low figure even if overly optimistic.
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9 , Ito:.an ict is the only Eastcc,: n European country where
terms of trade with the West I. y be improving. In value, e>por. t:; of
pc:trolcu:.l products to the lest, for example, offset by
fair imports of Western crude oil in value. The Romanians
arc also taking advantage of high prices on the world market
by pushing c:.:ports of fertilizers and other chemicals. And in
Oc to:)ei, li i::~ es L iv . l 4U
rate for Western
tourists b_' 6 , claiming th t this was intended to equalize
purchasing between Western and the Romanian Markets.
10. Terms of trade are aut to deteriorate after 1975
as Romanian re uirc::.ents for .;.stern coking coal, iron ore,
and bauxite soar. And the Romanians expect that by 1980 one-
half of their crude oil imports will be needed for domestic
consumption instead of being processed for export.
Poland
11. The strong demand in the west for Polish coal helps
offset high world prices for imported oil and other raw materials.
Nevertheless, the Poles have reported some deterioration in
their terms of trade with t'_e- West in the first six months of
1974. Among the counter measures Warsaw has taken so far is
to increase sharply the domestic prices of petroleum products
and to announce its intention to cut back on "unnecessary"
imports. In early October, Premier Piotr Jaroszew?wicz said that
the Polish economy was experiencing difficulties due co price
increases in western markets. He was optimistic that the
government could overcome these proble1;1S.
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12. Iti.si.ng world price:; serve to compound inflationary
pressure:; already e::ir;Ling in Poland. Consumer prices havo
not increased much since the December. 1970 riots in spite of
rising wages, increased costs of procurement from domestic
farmers, and more o>:penriive imports. A 3. 8v rise in the
overall price level between January and June -- due in part to
the increased prices for pe trol.eum products -- was more
than compensated by a 12' increase in money wages. Savi.ngs
deposits, whil.c!' ^'.''1 ?, ?; ,.".:_t :.:?.J}r, :t-re not yet at an alarming
level.
East Germany
13. Mainly because of higher prices for its oil products,
brown coal, and chemicals, East Germany has experienced little
if any deterioration in its terms of trade with West Germany,
which accounts for some 30% of total trade with the West. The
terms of trade with other Western countries have deteriorate:?.
In an attempt to soften the impact of higher world prices, the
government is stressing the need to push exports -- especially
machinery -- and to slow the growth of imports from the West.
Because of the heavy reliance on Western materials and technology,
consumer goods will bear the'brunt of any curbs on imports.
flungarj
14. Purchases in 1973-74 of Western crude oil, chemical
products, and cotton in the West have contributed to a serious
deterioration in Hungarian terms of trade with the West. In
the first six months of 1974 compared with the same period last
year, the prices of Hungarian imports from the West went up by
more than 40 while export prices rose by only 251t.. The
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Hungarian.; have responded by expanding coal production, restrict-?
ing the use of oil products for industrial and consumer use,
and raising the domestic price of fuels 251. in September. 1974.
15. As part of their economic reform,`the Hungarians have
pcrmittcd some domcr;tic inflation. They have attempted to
keep the rate below 3 The rise in world pr. ices would have
resulted in consumer price i.ncrei-^s of 6% in 1973 and 7`. to 8%
in 1974 if the government had not stepped in with massive import
subsidies.
16. Sizable subsidies however, defeat a major goal of the
reform, namely, exposing enterprises to world market forces
and prices. The government intends to abolish subsidies for
and
imported raw materials in January 1975/ at the same time reduce
taxes on enterprises. Enterprises will be generally prohibited
from passing on price increases to the consumer. In another
anti-inflation step, the government plans to revalue the forint-
in 1975.
Czechoslovakia
17. Czechoslovakia depends heavily
priced
on the West for high--
chemicals, cotton, and other raw materials. During
the first quarter of 1974, prices for Western raw materials
and chemical products were more than 50:6 higher than in
first quarter 1973. Export prices have risen at only half
this rate. Budget subsidies to foreign trade enterprises have
been increased more than one-third over 1973 to offset higher
import prices. Subsidies for 1975 will probably be more than
two-thirds . larger than in 1973.
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3.8. So far, the Czochos].ovak consumer has been insulated
from these price rises. I,. the first half of 1974, retail
prices incrca.,;ed less than 1., although gasoline prices
doubled in r~pril.; food costs have shown, almost no increase.
But plans for a large cut in wholesale prices have been
dropped. Accordin to some rumors, retail prices wil]. be
increased 4 across-""hc-boar.d in the near future.
Bu1 gari'l
19 Buic= ri -r -.._ t hit by higher Western
prices -- at least as =ar as oil. is concerned. nigher oil
prices alone could acid more than 25` to total hard currency
imparts by 1 75 ? Al the same ti. e Bulgaria will also continue
9
to require Western materials caught up in the inflation,
such as chemicals and cotton. Prices of exports (fruits and
vegetables, finished steel, and consumer goods) are rising
much less rapidly.
20. Bulgaria has followed the trends in Eastern, Europe high budget subsidies' to hold the line in retail prices and
a sharp increase in done-tic oil prices. Like Ro.nania, it
has revalued the exchange rate for Western tourists.
8 Nov 74
CIA/OEIR/U/EE
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USSR: Concern Over Foreign
Inflation Unfounded
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Office of Economic Research
Central Intelligence Agency
11 Novcmbcr 1974
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USSR: Concer.nOvr_r P'orcign Inf1. t:ion Unfounded
Soviet concern over the impact of double-digit foreign
inflation on the Soviet economy is unfounded, provided
the inflation does not proceed to the point of political
and social chaos in the West.
The inflation is having minimal impact on internal
Soviet budgetary and economic affairs. As for. Soviet
trade with non-conununist countries, the USSR has benefited
much more from rises in export' prices than it has suffered
from high prices of its imports; this advantage may be
eroded by future price changes.
"Creeping inflation" within the USSR itself is a
long-term phenomenon, entirely different in nature from
the virulent inflation in the market eco,lomies and should
be regarded as a secon'1-rate economic issue readily
coped with by the Soviet command system.
Soviet Concern
As part of the widening exchange of views under detente,
Soviet economists have recently been more open in expressing
their concern over the negative impact that inflation
elsewhere might have on the USSR. Speaking before a joint
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US-USSR sy;.;posium in Septcs,!ber, several Soviet economists
departed from the usual view that inflation is a "capitalist
malady," presenting little or no danger to communist states.
They identified two domestic areas especially vulnerable
to continued world;;ide inflation:
Q Agri c.~~.._. finitely a link be-
^
H
tc?,een external inflation and our agriculture,"
admitted one senior Soviet economist. The need
to purchase grain .:broad at current high world
prices sty-ains t Soviet policy of keeping
retail prices, for basic food products at fixed
leve is.
? State budget: Although external inflation en-
hances the value o= Soviet exports and gold
reserves, it also results in higher import bills.
Larger subsidies are required to cover differences
between import and domestic prices-
This concern over world inflation stems in large
measure from a Soviet realization of the deepening inter-
dependence among the :corld's econo:;lies. Soviet observers
are becomirg more sensitive to economic developments in
the west. They are also in a better position to exchange
views with their ;;estern counterparts.
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in the pi:;t, Mo::cow':; economic po] ici.c,s kept: 1'orc'ign
influence at a low level; little trade wan conducted out-
side the comrnunint. bloc, and domestic prices were not with
scant attention to the cost of import!'.
This isolation is being broached by rising conmorc:,al
intorcoursa with the West -- tradc was up 59 percent in
1.973 -- andl by long-term pressures to align domestic
prices with costs, including costs of imports. Purchaser,
of Western equipment and Lechnology -- especially for the
chemical and electronics industries -- have increased
sharply. Fulfillment of Soviet plans to increase the
supply of meat depends on the availability of large supplies
of foreign grain in poor harvest years.
An Assessment of the Soviet Position
We believe that these economists overstate the
effects of Western inflation on the USSR. As a huge con-
tinental economy with tremendous natural resources, the
USSR can satisfy most of its needs internally and thus
conduct a comparatively small volume of foreign trade.
Even though its technology is backward in important
respects, the Soviets demonstrate a crude vitality in
training large masses of engineers and technicians and
conducting wide-ranging scientific and industrial research.
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1'ai. lure:; i,n moving :;mooth l y from the l e::;c~arch and
development: i)ha ;c to the mass producLion of new products
hindors )JUL does not prevent the achievement: of economic
goaIn any case, i.nfla',:ion in the West affects the
prices of only a small fraction of the machinery being
introduced i.ntu 1 ndu;; - .:end the grain going to the consumer.
As for the Soviet budget, inflation elsewhere does
require accounting adjustments, such as s'ubsidies to off-
set increased prices of foreign grain going to the milling
industry and m-cchinc"y going to various branches of indus-
try. While the need for these adjustments complicates the
problem of moving toward a more "rational" system of whole-
sale and retail prices, it is only a minor element, compared
with the major. barriers that block throughgoi.ng price
re form.
Inflation abroad has proved to be an advantage in
one major area. At the swine time that import prices have
gone up, the prices of major Soviet exports -- gold, oil,
and other primary products -- have risen sharply. Indeed,
the rise in export prices has overshadowed the rise in
import prices so that the Soviets are now enjoying a
turnabout in their hard currency balance of trade -- from
a deficit of $1.75 billion in 1973 to a surplus of between
$1 and $1.5 billion in 1974.
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This advanLagc may be eroded by future inflation,
howeve , a ; the prices of manufacture,; are continuing to
rise rapidly, whi.].e the downLurn in worldwide economic
activity is depre:nning the prices of some raw materials.
The admiss .... ', ~ ., at-ion in the W
eat could hurt
the dome:-.tic economy has been accompanied by denials that
inflation exists within the Soviet Union. Soviet spokcsmcn
have long held that inflation cannot develop in their
centrally planned economy. They boast that for many years
retail .prices have been unchanged, with the exception of
prices for luxury items liko caviar, smoked fish, and
gold jewelry.
Official Soviet wholesale and retail price indexes,
however, do not accurately reflect price movements; as
one Soviet participant in the symposium declared, "Up to
now, our economists have not built good price indexes."
Soviet economists 'at the conference privately estimated
the anr:ual rise in the cost of living to be 3 to 4 percent
-- roughly equivalent to the average annual growth in money
wages. Various Western observers have placed the recent rise
in the cost of living at between 4 percent and 5 percent
annually.
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Sem inf laltionary pr.e sure does indeed occur In the
USSR ac; waagc incruzv;cs typically oututrip the availability
of con:nunar good:.. The extra rubles have been absorbed
partly by growing savings deposit; and partly by hidden
and overt i.ncrcar;co in prices.
Hidden increases often take the form of eliminating
the less expensive product lines. Sales of meat and con-
surmar durables have been particularly susccpti.ble to this
form of "creeping inflation."
Western Versus Soviet Inflation
The internal inflation in the USSR differs markidly
in its origins, nature, and consequences from inflation
in the Western world.
0 Internal Soviet inflation stems from the
efforts of industrial and household consumers to
get goods in a situation of chronic shortages
and bureaucratically set prices and wages;
in the West inflation largely stems from the
institutionalized process of 10 to 20 percent
annual. increases in money wages and from serious
supply bottlenecks.
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O "Creeping" ,Soviet inflaL,i.on rcsults in grumbles,
but not: in the acceleration of price i ncrca:cs
or in wholesale flights from the ruble; Western
inflation seriously harms important classes
of consumers and businessmen and brings social.
unrest and oven change:: in governments.
O By continuing the strict controls on wages,
prices, credit, production, and distribution
the Soviet authorities can readily live with
their inconspicuous inflation even if import
prices rise further; in contrast, Western
authorities are hci,ig driven in some cases to
important changes in,fundamental economic policies.
This estimate -- that the Soviet economists are showing
unwarranted concern about worldwide inflation -- is valid
only if inflation does not proceed to the point of politi-
cal and social chaos in the West. Though Soviet propaganda
sur,gests a certain glee at the discomfiture of the capitalist
nations, the Kremlin probably does fear the uncertainties
and dangers that would attend a breakdown in the interna-
tional order. Economic problems then would play second
fiddle to political and military issues.
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( ., /
`%
2
7
GROWTH IN MAJOR NATO COUNTRIES
Economic prospects for the major NATO countries have
dimmed considerably in recent. months. 7:ecent forecasts
made by OECD lowered the projected average annual growth
rate of real GNP of these economies to 2.2% for the
current half and 1.78 err t2ie first half of next year.
Projections made by OECD in July indicated average growth
of 3.4% for both periods. For the second half of next
year, OECD foresees a further deterioration, with growth
averaging only 1.2% in these countries.
We are in fairly close accord with the OECD projections
for this half and the first half of next year. Our September
projections for average 5rowth in the five major, foreign
Atlantic economies were 1.8% for the present half and 2.8%
for the first half of 1975. In view of recent economic
developments, we currently see our September estimates for
the first half of 1975 as overly optimistic for several
countries.
o The growth outlook in Canada is dimmed by worsening
economic conditions in the United States;
o The outlook for France, still re1.A.tively bright,
has been dampened by slackening consumer demand,
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scaled down industrial expansion plans, worker
strikes, and an apparent slowdown in French export
volume;
? In general, the growing realization that potential
production cuts due to drawdowns of large inventories
and a third quarter drop in real exports from major
industrialized roentriss are likely has led to
less optimistic outlooks in all countries.
Our forecasts for the last half of 1975 a:,e not complete but
we do not now see much, if any, decline in economic growth
for that period in the major NATO countries as does OECD.
The inflation projections for next year by both OECD
and ourselves have become slightly more optimistic. With
demand now expected to be lower than originally forecast
and inventories apparently quite high, a slowdown in price
rises of selected manufactured goods is now likely. Combined
with a continued expected decline in industrial raw material
prices, the cha.-ices are that inflation will decelerate more
rapidly than earlier expected..
Inflation rates will remain extremely high .by
historical standards, with only Germany containing its
inflation to a rate significantly below 10%. Inflation
in the United Kingdom and Italy will remain particularly
virulent, with broad-ranging cost-of-living agreements
stimulating inflation.
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 Significant revisions have not been made with respect
to -current account balances of the major NATO countries.
The greater slowing of economic growth will lead to a fall
in the import volume in these countries. But, because so
much of their trade is with each other, declining import
demand will also reduce export volume. The net change on
projected current account balances consequently is small.
Of the five countries,
Germany, and to a lesser
extent Canada are expected to continue their relatively
favorable payments balances throughout 1975. Germany's
trade surplus will slide somewhat in ea;,rly 1975 but
should remain at about a $20 billion annual rate in the
second half. On the other extreme, France, Italy, and
Britain will- probably improve their current account
deficits text year, but the deficits will remain large,
in the neighborhood of $5 - $6 billion compared to about
$7.5 - $8 billion.
CIA/OER
8 November 1974
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GNP-PROJECTIONS FOR FIVE MAJOR NATO COUNTRIES
Pe
rcen
A
t Cheng
t Ai An
e Over Pre
nual Rate
vious
Period
1974 II
1975 I
OECD
CIA
OECD
OECD
CIA
OECD
OECD
JUL
SEP
OCT
JUL
SEP
OCT
JUL
We OGe rmany
3.5
-1.0
0.0
4.2
3.9
3.0
--
France
4.5
3.3
4.5
4.2
3.9
3.0
--
United Kingdom
4.6
2.2
5.0
1.2
0.6
-1.0
--
Italy
0.0
0.4
0.0
1.3
0.6
-0.2
Canada
3.5
2.2
2.5
5.2
4.0
2.5
--
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1975 II
CIA
SEP
OECD
OCT
--
0.7
--
1.7
--
0.7
--
-0.2
--
3.7
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CO-ISUNER PRICE PROJECTIOAIS FOR FIVE MAJOR fIATO COU'ITRIES
Percent Change Over Previous Period
At An Annual Rate
.yes to rmany
France
United Kingdom
Italy
i Canada
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1974 II
OECD CIA OECD OECD CIA OECD
JUL SEP OCT JUL SEP OCT
11.2 8.5 7.0 9.2 8.5 7.0
16.0 15.5 15.2 14.0 13.0 13.2
18.2 16.0 15.5 12.0 13.0 15.3
25.0 25.0 26.0. 18.0 19.0 26.0
8.0 9.0 12.0 7.2 8.1 12.0
1975 II
OECD CIA OECD
JUL SEP OCT
-- -- 6.7
-- -- 10.5
-- -- 14.2
-- -- 12.5
-- 10.5
 Exports
Irports
Trade Balance
Current Accounts
Balance
I.-..p o r ts
Trade Balance
Balance
Exports
I. ports
Trade Balance
Current Accounts
Balance
Imports
Current Accounts
Approved For Release 20a
TRADE AfiD CURRENT ACCOU-NT POJECTIONS FOR FIVE MAJOR NATO COUNTRIES
(MILLIONS US DOLLARS)
1975 I
1975 II
OECD
JUL
CIA OECD
SEP OCT
OECD
JUL
CIA O
SEP O
ECD OECD CIA
CT JUL SEP
OECD
OCT
44,850
44,900 44.950
47,700
47,250 46,
950
49,000
36,000
32,800 35,350
39,200
35,000 37,
35;,
39,000
8,850
12,100 9,600
8,500
12,25G 9
600
10
000
2,000
4,756 3,250
750
,
4,589 2,
800
,
2,700
23,350
24,500 24,750
25,250
26,900 27, .
000
29,000
25,400
26,900 27,600
26,700
29,300 28-
050
30,300
-2,050
-2,400 -2,850
-1,450
-2,400 -1;
550
-1,303
-3,200
-3,700 -3,850
-2,700
-3,750 -3.
050
-2,700
18,300
18,630 19,750
19 , 500
19,840 21
500
23,400
24,400
24,800 24,800
27,700
,
25,750 26,
000
27,000
-6,100
-6,170 -5,050
-5,200
-5,910 -4
500
-3,600
-4,950
-4,955 -3,900
-4,200
,
-4,847 -3,
400
-2,600
15,100
15,275 15,950
16,700
16,634 17,
400
19,150
19,500
18,295 20,350
20,050
19,190 21
000
21,800
-4,400
-3,020 -4,400
-',350
,
-2,556 -3,
600
-2,650
-3,750
-3,370 -4,000
-2,750
-2,906 -3,
200
-2,550
18,050
15,859 17,700
19,400
18,175 18,
500
19,200
17,350
15,086 17,050
-
18,700
17,319 18,
100
-19,200
700
773 650
700
856
400
-0-
-800
-418 -1,000
-850
-358 -1.
35[1
-1,900
 Approved For Release 2005/12/14: CIA-RDP85T00875R001900030186-0
OVERVIEW
Defense spending has been declining as a share of GNP
and of total government spending in the major NATO countries.
Although most of these countries have increased defense
spending substantially in nominal terms, rapid inflation
generally has outpaced these gains. Because of rapid
inflation, defense spending in real terms probably will
continue to decline for the next year or so, except in
West Germany. Italy and the United Kingdom have such
serious economic problems that defense spending will fall
faster in real terms in these countries than in the
other NATO countries.
Rapidly rising wage costs -are, also affecting the
distribution of defense expenditures in many NATO countries.
The percentage of total military spending devoted to
pay and allowances has increased while manpower levels
have declined. In some cases equipment procurement has
had to be lowered because wage gains have cut into appropriated
funds.
Special problems in several smaller NATO nations
present some cause for concern. Political instability
in Portugal, Greece, and Turkey has clouded their
defense spending postures. Greece remains a NATO ally
only in a political sense at present. Turkey is in a
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 Approved For Release 2005/12/14: CIA-RDP85T00875R001900030186-0
stable position but the country remains saddled with its
concern over Greece and Cvurus, which in this oast year
has drained about $1 - $2 billion from the economy.
Turkish intentions include various types of military
buildup and investment in armaments, largely spurred by
its conflict with Greece.
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 Approved For Release 2005/12/14: CIA-RDP85T00875R001900030186-0
WEST GERMANY
West Germany remains in the strongest economic position
among NATO nations. The rate of inflation currently is
running at 6.9%, and unemployment is not yet a major problem.
In coming months, however, exports may soften as nations
importing German goods decrease orders, and unemployment is
expected to rise. The government may decide to stimulate
investment to forestall rising job losses. Defense-related
investments might benefit from an expansionary turn in
policy.
Defense expenditures have increased in both absolute
and -- in contrast with spending in most other NATO countries --
real terms since 1970. Defense expenditure projections indicate
that this trend will continue over the next 3 to 5 years
unless inflation unexpectedly accelerates. Defense spending
has remained a constant 3.9% of the GNP for the last two years
even though it has dropped, and probably will continue
to decline, as a share of total federal spending.
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 Approved For Release 2005/12/14 : CIA-RDP85T00875R001900030186-0
FRANCE
France faces serious economic problems, though less
severe than those in Italy or the United Kingdom. Despite
government austerity measures, inflation continues at a 14.5%
annual rate and the current account deficit stemming from
increased oil Import costs remains large. Decreases in
government capital expenditures should continue to restrict
the equipment procurement sections of the defense budget,
which presently account for about half of defense expenditures.
Even though budget spending has been rising in nominal
terms, defense expenditures are expected to show a 6% decline
in 1974 after adjusting for inflation. Real defense spending
will decline by an estimated 4% next year. As a. share of
GNP and of total government spending defense expenditures
have fallen off in recent years. As a percent of GNP,
French defense spending remains very low, exceeded by
nine other NATO countries.
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 Approved For Release 2005/12/14: CIA-RDP85T00875R001900030t86-0-
ITALY
N
Italy is experiencing the worst economic problems
among the major NATO countries. Inflation has topped
20% annually, fed by large wage increases. The balance
of payments is in massive deficit, and Italy will have
to continue heavy foreign borrowing to remain solvent.
The government has raised taxes and tightcred credit
to ease these problems, but austerity may have to !:c
scrapped because of rapidly rising unemployment, labor
unrest, and union demands for better social services.
Defense spending has decreased in real terms in
recent years, and the defense budget has declined as
a percent of GNP and of the total government budget.
Because of heavy demands on government for better social
services at a time when it is trying to show more fiscal
responsibility, Italy's defense spending efforts are unlikely
to improve. Appropriations for the army and air force for
1974 have already been cut and force reductions are possible.
Italy will not-meet the NATO force improvement goals for
1978. Because wages are rising very rapidly, the share
of defense spending devoted to operating expenses will
rise at the expense of funds devoted to equipment procurement.
ILLEGIB
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 UNITED KINGDOM
The United Kingdom faces economic problems exceeded
only by those of Italy among the major NATO countries.
It is faced with 16.9% inflation at an annual rate, massive
labor problem th at,ueriodically paralyze the economy,
and stagnant GNP. The current account
deficit at close to $10 billion this year will approximat:
6% of the GNP. Rising unemployment and high inflation
are likely next_year.
The Labor government, which promised large defense
budget cuts in the early 1974 election campaign, so far has
not carried out its promises. Denis Healey announced a
small cut in defense spending in his spring budget but
shelved further cuts pending a defense review. Because
of Britain's precarious payments position and pressures
from left-wing Laborites, the defense review probably will
lead to further paring of the defense budget. Meanwhile,
the defense budget has been declining as a share of the
total government budget and of GNP. Increases in defense
expenditures are expected to be thi lowest among the
European NATO allies in 1975-80, and further cuts in
manpower, equipment procurement, and overseas forces
are likely as defense spending declines in real terms.
ILLEGIB
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 Approved For Release 2005/12/14: CIA-RDP85T00875R001900030186-0
CANADA
The Canadian economy has been experiencing problems
similar to those of the Europeans although not as severe.
Inflation is now at a 12% annual rate. Labor problems are
widespread while wage rates have risen 14%. Real growth
of GNP has peen near zero for the past two quarters.
Current Canadian thinking is to sacrifice manpower
and possibly the commitment to NATO forces in Europe
in order to maintain equipment quality, which now accounts
for 20% of the defense budget. Canadians are talking of
reducing their armed forces from 78,000 at present to a
well-trained, well-r-.cauimnpc150,000 man force with reduced
overseas duties. If the government carries out its
plans and inflation proceeds at close to its current rate,
defense expenditures will drop in real terms for the rest
of the decade. Defense spending will also continue to
decline as a percent of GNP and of total government spending.
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 Approved For 14elease 2005/12/14: CIA-RD P85T00875R001900030186-0
DEFENSE SPENDING IN FIVE MAJOR NATO COUNTRIES
Defense
Expenditures
Percent Share Of
Percent Share
(Billion Current $)
Government Spending
Of GNP
1973
1974
1973
1974
1973
1974
West Germany
11.98
13.34
26.5
26.1
3.9
3.9
Frartee
8.59
9.30
18.0
16.0
4.2
3.9
Italy
3.94
4.16
11.8
11.4
3.3
3.0
United kingdom
8.16
8.25
20.3
19.1
5.7
5.4
Canada
2.38
2.55
10.9
10.5
2.4
2.2
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 Approved For lease 2005/12/14: CIA-FDP85T00875R001900030186-0
NATO P'tn.IFCTIn99S OF "!.4TIn!l1\L DEFENNSE SPENDING
1975-1980
(Billion 1974 dollars and Percent Change from Previous Period)
West G
rm
e
any Italy
United Kingdom
France
Canada
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
191S
13.87
4.0
---
?---
8.32
0.8
10.20
9.7
2.58
1.2
1976
14.53
4.8
---
---
8.34
0.2
2.71
5.0
1977
15.28
5.2
---
---
8.44
1.2
---
2.84
4.8
1978
16.04
5.0
---
---
___
---
2.99
5.3
1979
---
---
---
---
---
---
---
---
3.13
4.7
1980
---
---
---
3.24
3.5
--- data not available
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