THE EC BUDGET: CRISIS AHEAD

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000403910001-3
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 10
• Document Creation Date: December 22, 2016
• Document Release Date: March 1, 2011
• Sequence Number: 1
• Publication Date: May 2, 1986
• Content Type: REPORT

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Memorandum for:
This memorandum was prepared for
Mr. Frank Vargo, Deputy Assistant Secretary
of Commerce by the
Office of European Analysis, to be used
for general background information.
F, DATE 5 t g b
DOC NO (U l'/
OCR
EUR M86-20067
2 May 1986
E URA
Office of European Analysis
DISTRIBUTION:
1? - Addressee ? 1 - D/SOVA
1 - DDI 1 - D/OSWR
1 - D/EURA ' 1 - D/CPAS
2 - EURA Production 1 - Author
4 - IMC/CB
1 - C/EURA/EI
1 - EURA/EI/EI
1 - PCS
1 - D/ALA
1 - D/OCR
1 - D/OEA
1 - D/OGI
1 - D/OIA
1 - D/NESA.
DDI/EURA/EI/EI/ I(14May86)
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DIRECTORATE OF INTELLIGENCE
2 May 1986
The EC Budget: Crisis Ahead
Summary
The European Community is facing a budget
shortfall this year of at least 2.9 billion European
currency units (ecu) as now estimated by the
Commission, mostly because of larger export refunds on
agricultural commodities necessitated by the more than
34-percent depreciation of the dollar against the ecu
since early 1985. This figure is probably understated
by as much as 1 billion ecu because world farm prices
are likely to fall as a result of the new US effort to
subsidize agricultural exports, costing the Community
even more in export refunds. The shortfall will throw
the Community into one of its periodic fiscal crises,
requiring the 12 members to implement a supplemental
budget with additional member contributions. To avoid
spending beyond the current maximum of 1.4 percent of
member state value-added tax collections, some cuts in
the budget will have to be made, but agriculture is
likely to survive unscathed.
Most cuts and spending deferrals will likely come
in the social and regional programs, important to many
of the poorer member states, and in spending for job
creation and research. The budget crisis will set back
the Commission's efforts to establish a role for itself
outside of agriculture, exacerbate tensions between the
northern and southern tiers of Community members, and
make it more difficult for the EC to find the funds
needed to compete with the other major agricultural
exporters, especially the United States.
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This typescript was prepared by the 25X1
Office of European Analysis for Deputy Assistant Secretary of
Commerce Frank Vargo. Questions and comments may be directed to
Chief, European Issues Division,
EUR M 86-20067
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The Budget Shortfall
The European Community's impending budget crisis arises
because:
o The Treaty of Rome founding the EC forbids the
Community from borrowing money to cover ashortfall.
o The Community can finance only 2.4-billion of the 2.9-
billion ecu gap by upping to the maximum--l.4
percent--member state contributions to the budget from
their value-added tax (VAT) collections.
The remaining 500 million ecu of commitments, as in past
crises, will likely be dealt with through a combination of cuts,
deferral of spending, and counting extra spending in 1986 towards
the 1987 budget. The 2.9-billion ecu shortfall includes 1.5
billion ecu of additional agricultural spending that violates the
1984 EC agreement on fiscal discipline, stating as a goal that
farm spending increase at the same rate as available revenues.
The rest of the 2.9-billion ecu shortfall is made up of 800
million ecu of unfunded commitments from past EC budgets for
social and regional development, 400 million ecu for an
unexpected increase in the rebate to the UK, and 200 million ecu
for unexpected regional development spending in Spain and
Portugal.
Factors Influencing the Crisis
The 1.5 billion ecu in extra agricultural spending is the
direct result of the depreciation of the. dollar against the ecu
and an aggressive EC'farm export strategy to dispose of its vast
stockpiles of surplus production. The dollar/ecu rate affects
the farm budget--one-third of which is made up of export
refunds--because EC commodities sold on the world market are
denominated in dollars. In general, as the dollar declines, the
Community receives fewer ecu from EC exports, thus widening the
gap between the world price--as expressed in ecu--and the
internal EC ecu price. The Commission has estimated that a
10-percent fall in the dollar costs the Community an extra 800
million ecu in export subsidies, and some outside observers put
the figure at 1 billion ecu. Thus far, the dollar has fallen
16.5 percent against the ecu since last September, and 34 percent
since February 1985. The Commission's original dollar/ecu
exchange rate assumed for the 1986 budget was US$1=1.2 ecu, or
about 20 percent above the current rate of 1.03 ecu.
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The 1985 US Farm Bill also threatens to require raising EC
export refunds later this year--perhaps another 1 billion ecu
beyond the Commission's estimate of 1.5 billion ecu--and put even
more pressure on the budget by lowering the level of world
prices. Thus far world prices have not been a significant factor
in causing the shortfall. However, the US Department of State's
INR has estimated that lower US support prices already in effect
and increased export subsidies mandated by the bill could lower
world wheat and corn prices 30 percent or more and keep them at
that level until 1990.* The Commission's own plans for
selling off the EC's farm surpluses using even larger subsidies,
and the plans of other major exporters to do the same, will also
act to depress world commodity prices.
The other elements of the shortfall--the backlog of unpaid
commitments and the larger than expected UK rebate and Spanish
and Portuguese spending--are primarily the result of past
budgetary decisions. The Commission counts a total of 1.169
billion ecu of unpaid commitments in the structural funds--monies
appropriated to the member states for regional and social
development--but proposes that only 800 million ecu be considered
for funding this year. In past years the EC had deferred certain
discretionary spending, often to accommodate agricultural
spending. The unpaid commitments have begun to reach
unmanageable heights, however. This year, because of higher than
expected collections of VAT, the UK is owed a larger rebate--400
million ecu more--under the terms'.of the 1984 budget deal
providing the UK an automatic reduction in its budget
contribution amounting to two-thirds of its net contribution.
Likewise the Commission was taken by.surprise at the speed--twice
as fast as expected--with which new members Spain and Portugal
began to spend money under the regional and social development
funds, creating a 200-million ecu shortfall.
Options to Resolve the Crisis
*The estimate is based on cuts in US support prices of 27 percent
for wheat and 25 percent for corn and the use of over $2 billion
in export subsidies over the next three years to make US farm
exports more competitive. The US, with 150 million tons of grain
stockpiled, is the world price leader. The support price cut is
not likely to discourage US production because farmers will
receive additional direct payments that will make up the
difference between actual market price and a higher "target
price" set by Congress to guarantee farm income. The estimate
assumes normal growing conditions around the world. F --- ]
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As the EC is forbidden by its founding treaty to indulge in
deficit spending, the budget shortfall must be made up by a
supplemental budget funded by special member state contributions,
which are limited by a 1.4-percent of VAT contribution ceiling.
Supplemental budgets are often necessary to adjust for
factors--farm prices and the dollar exchange rate--which can only
be estimated in the 'formal budget; this year, they proved grossly
understated. The member states probably will not act upon the
supplemental budget proposed by the Commission until sometime
this autumn when money is literally running out. The European
li
P
ar
ament must also vote its approval.
The supplemental budget will likely cut non-agricultural
spending--on research, social and regional development, and job
creation. The Commission also has the option--though technically
illegal--to spend amounts above the ceiling by counting the
expenditures in the next year's budget, or to stretch out
payments over several years. This is the same practice, used by
the Commission for-many years to accommodate member state
political compromises on spending, that created the at least
800-million ecu shortfall in unfunded commitments this year.
Agricultural spending has traditionally never been cut to meet
the requirements of the budget because of the enormous political
pressures in the member states to appease the farm vote. The EC
Agriculture Ministers just agreed on 25 April-to freeze the level
of ecu farm prices for the next marketing year. In practice',
however, the "freeze" means price increases. of between 1.5 and 18
percent in national currency terms--except for West Germany and
the Netherlands--because of the recent realignment of the
European Monetary System.
The member states are not likely to agree this year to raise
the VAT contribution ceiling above 1.4 percent. 'The 1.4-percent
ceiling just came into effect at the beginning of this year as
part of the solution to a long budget dispute concerning the UK
rebate and the need to boost revenues available to cover the
increased spending associated with the addition of Spain and
Portugal. Any increase in the VAT ceiling requires ratification
by all member state parliaments. The UK and West Germany--the
strongest advocates of fiscal restraint because of their position
as net contributors to the EC budget--are firmly against raising
the VAT ceiling until at least 1988. Advance budget estimates
prepared by the Commission indicate that the ceiling will have to
be raised to 1.6 percent in 1988 to meet the growth in spending
as Spain and Portugal become integrated into the Common
Agricultural Policy.
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I I
The 1984 agreement on fiscal discipline will probably not
play a major role in the present budget crisis. The agreement,
with no legal force, allows for spending to exceed the
restrictions under "exceptional circumstances" such as
enlargement. Italy has suggested that the present shortfall
represents such a circumstance. However, the EC Court of Justice
could rule this summer that the 33.3-billion ecu 1986 budget
voted by the European Parliament and now in force is illegal
because it exceeds-the 32.7-billion ecu budget agreed to by the
Council of Ministers under the fiscal discipline agreement. The
Council brought suit against the Parliament, alleging that the
Parliament had overstepped its constitutional bounds, and the
Court in a preliminary ruling has forbidden the Commission from
spending any more than 32.7 billion until the Court provides a
final judgment. The dispute, although significant in
constitutionally delineating the Council's and Parliament's
powers, is largely irrelevant to the budget crisis and would not
affect the implementation of a supplemental budget.
Implications
The budget crisis will rob time from EC decisionmakers'
consideration of other issues and create dissension among the
member states, even as the shortfall and the need for spending
restraint have made the budget the main forum for policy debate
over the future of the Community. The Community will be forced
to weigh carefully what new policies and programs it thinks it
needs and can afford. It seems likely that the spending cuts on
research, high technology, and industry will frustrate the EC's
effort to establish a role for itself outside of the agricultural
sector in support of greater European competitiveness. An
ambitious 10-billion ecu research program proposed by the
Commission for 1987-91 has already been shelved until at least
1988 at the s gestion of West Germany because of the lack of
funds.
A Community embattled over budgetary priorities will find it
increasingly difficult to match the new US export subsidies
mandated by the Farm Bill and similar new export subsidy schemes
under consideration by other major exporters such as Canada, and
could feel threatened with a loss of its world market share. The
Community under these circumstances is likely to seek some kind
of an accommodation with the United States on the use of export
subsidies and is probably inclined to try to set up market
sharing arrangements. The EC is faced with disposing of its
surplus production--which is even more costly to store--while
having to spend more and more on export subsidies to get rid of
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it in a world market of falling prices, partially caused by
exporters using subsidies. Agricultural Commissioner Andriessen
recently proposed a surplus disposal-program for butter, beef,
and other products costing over 1 billion ecu that could be paid
for only with the proceeds of the proposed tax on grain
production and other savings on the Commission's commodity
management practices. Serious budget pressures over the long
term--especially as Spain and Portugal come under the-CAP--will
probably encourage incremental reforms of the CAP. Member states
acquiesced in the 1984 reforms of CAP largely because of the
budget crisis of that time.
Tensions between the richer northern countries and poorer
Mediterranean countries of the Community are likely to increase
because of the likely budget changes. The near sacred
agricultural spending is disproportionately oriented to northern
products such as wheat and milk while the spending most likely to
be cut, the social and regional funds, are resource transfers to
the poorer regions of the Community in the southern Mediterranean
countries. The southern countries are thus much more in favor of
raising the VAT ceiling to provide additional revenues than the
guardians of fiscal restraint in the north, the UK and West
Germany.
The potential north-south conflict could have serious
consequences for the Commuinity's drive to achieve a completely
free internal market by 1993. Greece made its acceptance of
recent institutional reforms, designed to speed the progress
towards the free internal market, conditional on making explicit
in the Treaty of Rome that the goal of the social and regional
funds is to promote the convergence of member state economies.
Should these resource transfer funds be decimated by the budget
crisis, the least developed Community countries--Greece, perhaps
joined by Spain, Portugal, and Italy--would have little direct
incentive to cooperate in the complex task of creating the free
internal market.
Finally, the budget crisis, especially because it has been
fostered by the falling dollar, is likely to sharpen the
Commission's and some member state's interest in international
monetary reform in an effort to stabilize exchange rates.
Commission President Delors is likely to raise monetary reform at
the Tokyo Summit and at a minimum support recent G-10 and IMF
Interim Committee recommendations to study the possibility of
devising "objective" indicators of economic stability.
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US Dollar. Average Value Against the ECU
83Q1 83Q2 8303 83Q4 84Q1 8402 84Q3
84Q4 85Q1 85Q2 85Q3 8504 86Q1
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European Community: Total Spending, 1980-1986
Billion ECU
1980 1981 1982 1983 1984
33.3
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EC: Budget Expenditures b Type,1986
(33.3 Billion ECUs
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