INTERNATIONAL ECONOMIC & ENERGY WEEKLY
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Collection:
Document Number (FOIA) /ESDN (CREST):
CIA-RDP97-00771R000706840001-7
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S
Document Page Count:
45
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Case Number:
Publication Date:
February 3, 1984
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REPORT
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Directorate of t
Intelligence
Weekly
International
Economic & Energy
DI IEEW 84-005
3 February 1984
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Weekly
International
Economic & Energy
3 February 1984
iii Synopsis
1 /Perspective-Western Europe: Welfare Versus Defense
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3 Briefs Energy
International Finance
Global and Regional Developments
National Developments
17 Western Europe: Pressures on Welfare Spending and
Implications for Defense
23
rance: Options on Austerity
27 _,Lebanon: Economic Impact of Continuing Hostilities
31 an: Trade Boom Masks Domestic Breakdowns
35 ,/Canada's Aerospace Industry: A Troubled Future
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41 dia's Green Revolution: The Bills Come Due 25X1
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Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligence, 25X1
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International .
Economic & Energy
Weekly
Synopsis
1 Perspective- Western Europe: Welfare Versus Defense
Demands for state services and payments are rising rapidly while revenues are
failing to keep up. The heavy welfare burden has already forced reductions of
the modest increases in military spending agreed to by NATO, and most
governments intend to make further cuts in planned increases in defense
spending
17 Western Europe: Pressures on Welfare Spending and
Implications for Defense F_ 25X1
The budgetary problems that most West European governments confront are
due in large part*to the huge increases in welfare spending that have occurred
during the last two decades.
23 France: Options on Austerity
President Mitterrand appears determined to give industrial modernization and
the battle against inflation priority in 1984. Pushing austerity much beyond
this year would cost him support from the left, and he may attempt to shift his
political base toward the center.
27 Lebanon: Economic Impact of Continuing Hostilities
The normal resilience of the Lebanese economy is being sorely tested by nearly
a year of sustained violence. It is unlikely, at least in the near term, that the
Gemayel government will be able to deal effectively with its economic
problems or stem the decline in confidence.
31 Iran: Trade Boom Masks Domestic Breakdowns
Bureaucratic mismanagement, war-related disruptions, massive corruption,
and ideological rigidities have stifled the Iranian economy despite a strong oil
export performance over the last two years.
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35 Canada's Aerospace Industry: A Troubled Future
Canada's aerospace industry is counting on the government to continue
covering its losses during the present slump and to increase other forms of
support in the future. We believe that Ottawa will step up its support for the
aerospace sector but doubt the goal of doubling sales by 1984 can be realized.
Although India is looking forward to a record foodgrains harvest during the
1983/84 season, the country's agricultural prospects are clouded by slower
growth in yields and rapidly escalating production costs. Any government
move to reduce agricultural subsidies will be difficult because farmers
represent an increasingly important political force.
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International
Economic & Energy
Weekly I
3 February 1984
Perspective Western Europe: Welfare Versus Defense
The West European welfare state is in crisis. Demands for state services and
payments are rising rapidly while revenues are failing to keep up. In France
and Italy, Socialist-led governments are attempting at least to restrain the
further growth of social welfare spending. Conservative or Christian Demo-
cratic governments in the United Kingdom, West Germany, Belgium, the
Netherlands, and Denmark are committed to trimming welfare benefits and
reducing the state's social and economic role. The heavy welfare burden has al-
ready forced reductions of the modest increases in military spending agreed to
by NATO, and most governments intend to make further cuts in planned
increases in defense spending.
programs and prefer reductions in defense spending.
Public pressures limit the ability of governments to cut back social welfare
programs, especially in the absence of even deeper cuts in defense. Recent
opinion surveys in the United Kingdom, France, West Germany, Italy,
Denmark, Belgium, and the Netherlands confirm the West Europeans' strong
support for social welfare programs and their skepticism about military
spending. Although some prefer to see the fiscal policy dilemma solved by
government borrowing, most oppose higher taxes or cuts in social welfare
high unemployment and sluggish economic growth.
We expect governments to opt for a combination of these approaches. Because
social programs consume a large proportion of public budgets, austerity
limited to other areas is unlikely to solve governments' fiscal problems.
Economically necessary welfare cutbacks, however, could politically weaken
northern Europe's fiscally conservative governments, particularly in the face of
overall military capabilities may decline
We believe the need to trim welfare spending will prevent significant military
spending increases in most West European countries. Because their publics
consider defense costs the major cause of deficits, governments will be unlikely
to promote defense increases while cutting back in other areas. Most West
European governments are unlikely even to approach NATO's target of 3-
percent real military spending increases in the next few years, and in some
countries real military spending may actually decrease. As a result, planned
equipment modernization programs are likely to be delayed or canceled, and
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Z
Energy
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u Dhabi Slows Abu Dhabi, the largest oil producer in the United Arab Emirates (UAE), is de-
,Progress of of Upper laying further development of its offshore Upper Zakum oilfield because of
funding cutbacks and the OPEC production quota. Abu Dhabi originally
intended to produce 100,000 to 150,000 b/d from Upper Zakum in the summer
of 1983 and build capacity to 500,000 b/d by late 1984. Actual production,
which began in early 1983, was only about 25,000 b/d at midyear and
currently is averaging about 75,000 b/d. Officials of the Abu Dhabi National
Oil Company reportedly now say that the commissioning of 30 additional
platforms has been postponed until at least mid-1985, and only 12 of the 25
platforms commissioned thus far presently are in operation. Because of the 1.1
million b/d output quota imposed on the UAE by OPEC, production at other
fields cannot be reduced sufficiently to make room for Upper Zakum and still
meet the UAE's associated gas needs. Curtailment of the Upper Zakum project
will have a significant impact on overall capacity development and future
supply availability in Abu Dhabi-one of the few OPEC producers that had
planned to continue increasing capacity over the next few years
Pipeline Agreement Jordan and Iraq have agreed in principle to the construction of a pipeline
Between Jordan across Jordan to the Red Sea, according to press reporting. It will take up to
and Iraq two years to build the proposed pipeline, which will have a capacity of 1.5 mil-
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3 February 1984
lion barrels per day. The project will cost a minimum of $1.5 billion, and
Jordan and Iraq probably will need other government loan guarantees to
arrange financing. The prospect of increased oil revenues would give a
psychological boost to the financially pressed Iraqis and remove some of the
domestic pressure to intensify the war. It also may induce Iran to revise its
war-of-attrition strategy
Venezuela's President-elect Lusinchi has named Arturo Hernandez Grisanti
as Minister of Energy and Mines. Grisanti has a reputation of being strongly
nationalistic, which was earned during negotiations over the nationalization of
US oil companies' assets. The Venezuelan press has called Grisanti "the
architect of Venezuelan oil nationalization" because he authored the 1970 tax
that set a 60-percent flat rate on oil-derived income. Grisanti, who will again
become involved in unsettled questions of oil company compensation, claims he
has moderated his tough stance on the issue. Grisanti has indicated that
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OPEC countries and with Mexico.
Venezuela's role in OPEC will be basically unchanged. According to OPEC
representatives, the new minister sees Venezuela as a moderator in OPEC
meetings, and already has held preliminary consultations with a number of
Japan Agrees To Take Preliminary engineering work on Australia's $2.5 billion Northwest Shelf
Australian LNG LNG project-which has been postponed since early 1983-is now expected to
begin this month In January, Japanese firms 25X1
agreed to take delivery of the LNG beginning in late 1988. The firms cited a
recent reassessment of Japanese energy needs in the 1990s, which indicated 25X1
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Sout Korea Reduces South Korea has scaled back its energy consumption projections for the next
E rgy Demand three years because of increased conservation. Last year, energy consumption
grew only 5 percent, while GNP increased 9 percent. The projected growth in
oil and anthracite coal consumption has been lowered from earlier forecasts,
while bituminous coal demand will grow more rapidly than previous projec-
tions. Seoul is boosting bituminous coal imports to diversify energy sources for
power generation and to reduce its heavy reliance on imported oil. Nuclear
energy will account for a slightly lower share of consumption in 1986 than
originally projected because planned completion dates for four plants under
construction have been stretched out by at least a year. Plans for importing
LNG have been delayed as well.F__-]
1983
1986
(Projected)
Total
100.0
100.0
Oil
56.8
50.9
Anthracite coal
20.1
17.4
Bituminous coal
12.5
16.8
Nuclear
4.5
9.2
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Zimbabwe Faces Sharply reduced foreign exchange availabilities and renewed insurgent attacks
Fu9t'Squeeze on a Mozambican pipeline could force the Mugabe government to adopt fuel
rationing. Harare reduced its fuel stocks 25X1
by nearly 30 percent late 1983 because of foreign exchange shortages and 25X1
the government has been considering cutting imports by 25 percent during the
first half of 1984 to save foreign exchange. 25X1
South African-backed insurgents early this week made
their first attack in a year on the pipeline in Mozambique through which 25X1
Zimbabwe receives 95 percent of its fuel imports. The extent of damage has
not yet been determined, but Zimbabwe has little cushion against a prolonged
supply interruption. Fuel shortages would have the greatest impact on urban
consumers; Harare is unlikely to cut fuel supplies for agriculture because this
would jeopardize harvesting and distribution of the corn crop-the dietary
staple-that begins in April. 25X1
Mexico's Slow Progress Mexico City's 1984 jumbo loan was not fully subscribed by the 27 January
oJumbo Loan deadline, and we believe final agreement may slip until late February or early
P
March. While one press report said $3.6 of the $3.8 billion had been raised
Arab, European, and some US regional banks oppose the loan's easier terms,
including lower interest rates and management fees, a 10-year repayment
term, and a more than five-year grace period.
the larger US banks are tired of "topping off" undersubscribed LDC
loans, we believe they are likely to make up any small shortfall. Unlike 1983,
the delay in arranging the loan probably will not result in foreign financing
gaps-net foreign reserves totaled about $5 billion in October.
I donesia Testing the According to the US Embassy in Jakarta, Indonesia is seeking a $500 million
oan Market loan syndication to maintain its foreign financial reserves at high levels.
the terms probably would be 0.75 percentage point
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over LIBOR for 75 percent of the loan and 0.2 percentage point over the US
prime rate for 25 percent of the loan. Last March, Indonesia obtained a $1 bil-
lion jumbo loan, one-half of which was priced at 0.5 percentage point over
LIBOR. In subsequent b rr w' s during this year, Jakarta found it necessary
to pay higher spreads. b lIlg
in the rupiah.
We believe bankers will respond favorably at the higher terms. Jakarta has
successfully imposed a series of stringent austerity measures, without incurring
domestic unrest, that have improved'its international payments position and
enabled the government to rebuild official foreign exchange and gold reserves
from a low of $3.2 billion last April to more than $4.5 billion by yearend. One
Indonesian official told Embassy officers that Jakarta is determined to
maintain high foreign financial reserves as a means of maintaining confidence
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suspended Central Bank credits to the public sector.
loan to last at least two more months. Discussions stalled in December when.
Santo Domingo rejected IMF proposals for.eliminating foreign payments
arrears, sharply cutting government spending, and unifying the country's dual-
exchange rate system. The government complained that the measures would
cause inflation to triple and would reduce real income. Santo Domingo,
nonetheless, recently announced a series of foreign exchange reforms, includ-
ing a float of the unofficial exchange rate, a shift of additional import
categories to the costlier unofficial foreign exchange market, and an extension
of foreign exchange incentives to exporters. In addition, the government has
The recent measures appear aimed at slowing the demand for US dollars.
Despite these efforts, the government will have little bargaining power with the
IMF-it missed its 1983 program targets by a wide margin. President Jorge
Blanco will face labor opposition should he pursue new austerity measures
because of high unemployment and recent declines in real wages
Syria Considers The Commercial Bank' of Syria, the country's central bank, has proposed to
Scheme To Ease the government new regulations in an attempt to gain access to additional
Foreign Exchange foreign exchange reserves. Private-sector importers would be allowed to open
Shortage. convertible foreign currency accounts with the Commercial Bank from funds
in accounts abroad. After the funds had been on deposit for three months, the
importer could draw on the money to pay for imports of industrial raw
materials, spare parts, machinery, or seeds. Presently, private-sector importers
must smuggle goods into Syria or wait a year or more for applications for let-
ters of credit to be approved. As a result, shortages have developed for
manufactured goods and raw materials.
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The new regulations have been under consideration by the government for
several weeks, prompting Commercial Bank officials to fear that they may not
be approved or may be substantially altered. Government policy in recent ,
years has been to weaken the role of the private sector, according to the US
Embassy. Even if the current plan is approved, importers are unlikely to
transfer large sums back to Syria out of concern that the government someday
might confiscate their foreign exchange. A Commercial Bank official told a
US Embassy officer that the bank needs $250 million each month to finance
import transactions at an acceptable level but is currently receiving only $125
million to $150 million per month; the new regulations are unlikely to make up
the difference. 25X1
Global and Regional Developments
Z minican Republic- The US Embassy expects talks between the Dominican Republic and the IMF
IMF Negotiations on requirements for the second year of a three-year Extended Fund Facility
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Canada To Change Ottawa recently announced that it would comply with a GATT panel report,
foreign Investment which found the domestic procurement requirements of the Foreign Invest-
/Review Act ment Review Act (FIRA) to be trade disruptive. FIRA Commissioner Robert
Richardson has informed US officials that rewording of the Act's offending
sections should be completed before a full GATT ruling on the report later this
month. Richardson restated, however, his belief that Canada's past application
of FIRA's policies did not warrant the criticisms made at the GATT. Instead,
he blamed the ruling on an unclear phrasing of FIRA's intent; he claims the
Act was designed to require equal, not favored, opportunities for Canadian
suppliers. Minister for International Trade Gerald Regan has provided even
stronger support for FIRA, promising that the changes will not reduce the
opportunity for Canadian companies to sell goods and services to foreign-
owned companies operating in Canada. Administrative changes in the Act over
the past few years, primarily resulting from the depressed economic conditions
in Canada, have made FIRA less restrictive in an effort to spur foreign
investment. Ottawa's reactions to the GATT panel report, however, indicate
that the Liberal government still considers FIRA to be an essential part of na-
tional economic development policy.
E, Extends Steel EC Industry Ministers last week agreed to extend the expiring production
uotas quotas for the Community's depressed steel industry through 31 December
1985. EC officials were concerned that Italy might block the quota renewal or
press for a shorter extension if Rome's request for an additional allocation of
1.2 million metric tons was not met. The Italians instead settled for an extra
450,000 tons and plan to challenge the EC in the European Court of Justice in
an effort to gain an additional 600,000 tons.F_~
The quota system is an essential part of the EC Commission's overall program
to revitalize the steel industry. The Commission hopes the extension will
provide greater stability and price discipline in the EC steel market to permit
the phaseout of excess and inefficient capacity. Without the production
restrictions, supply would quickly outstrip demand
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East Germany Buys Iran announced in late January that East Germany has agreed to buy 30,000
barrels per day of Iranian oil in 1984 at official prices
timate
that the roughly $300 million deal will provide 6 to 8 percent of East
Germany's total oil imports and 30 to 40 percent of its imports of crude from
non-Soviet sources this year. The agreement furthers an upward trend in
Iranian-East German commercial relations in recent years,
part of a deliberate .East German effort to expand bilateral ties.
East Berlin has helped pay for previous oil purchases from Iran with deliveries
of arms, vehicles, and machinery. The East German trade delegation in
Tehran last week probably was trying to drum up still more sales to help keep
bilateral trade in rough balance. East Germany is likely to use some of the oil
domestically, while reexporting most as refined products.
National Developments
Developed Countries
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Israeli Bond Market Government bonds linked to the consumer price index are being dumped onto
Under Pressure financial markets in such quantities that the Bank of Israel has been forced to
intervene. The US Embassy reports that the bank purchased $100 million
worth of the bonds in January-most in the last 10 days of the month. Bank
officials believe that recently imposed credit restrictions have left many
businesses strapped for cash, prompting some to sell bonds to pay their bills.
An erosion of public faith in the government's ability to deal with economic 25X1
problems also may be a factor; promises made to a small coalition party to en-
sure its vote on a no-confidence motion on 25 January undermine the austerity
budget approved by the Cabinet just a few days earlier. If the selling wave
spreads to the stock market, the government will be forced to spend large sums
of money to prevent another stock market collapse such as occurred last
October. 25X1
Meanwhile, labor unrest continues. Ten private-sector unions, led by the metal
workers with 100,000 members, are demanding the same 5,000 shekel-$41 at
the current exchange rate-per month wage increase given public-sector
employees last month. In the public sector, the clerks union won additional
monthly pay hikes of up to $16 for lower income workers after staging a three-
day strike. The engineers union held a one-day strike on 29 January in
government-owned.defense industries, and most employees in the Land
Registry Office in the Ministry of Justice are refusing to serve the public. A
Histadrut official told a US Embassy officer that, in a 23 January meeting,
the Histadrut set its priorities for the upcoming wage negotiations with the
government and the Manufacturers' Association; they include "fighting to
maintain real wages," promoting a national minimum wage equal to 50
percent of the average wage, and adjusting tax brackets to help low-income
groups.
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West German Exports West German exports to the United States soared 38 percent and to Canada
Boosted by. the Strong 50 percent in October-November over the previous two months. Sales to the
S Dollar United States represent only 7 percent of total West German exports, but the
strong dollar (up 10 percent against the deutsche mark in the last six months)
ord Japanese
rade Surplus
Tokyo Approves Tight
Budget - ?'I
percent last year, primarily because of the weak DM.
also makes West German products more competitive in third markets- such as
Canada. In addition, Bundesbank profits of $4.4 billion in 1983, in large part
from sales of dollars and interest earnings on dollar assets, will be transferred
to the federal budget and used to reduce the deficit. The Bundesbank
reportedly earned $300 million on dollar sales in the first two weeks of January
alone. Most West German business and government leaders feel the advan-
tages of the strong dollar outweigh the disadvantages. Bundesbank President
Karl Otto Poehl is concerned, however, that further weakening of the DM
could upset West German price stability. West-German import prices rose 5
The trade gap with the United States was $18.1 billion.
Japan registered a record trade surplus in 1983, according to figures released
by the Ministry of Finance on Tuesday. The trade surplus-led by booming
exports and reduced oil imports-grew to a massive $31.6 billion, and the
current account surplus more than tripled to $21.0 billion. The weak yen and a
continued high savings rate caused a widening of the long-term capital deficit
to $17.8 billion, but Japan still recorded a $3.2 billion basic balance surplus.
the investment tax credit and other business allowances.
The Japanese Cabinet has approved a 50.6-trillion-yen ($220 billion) budget
for fiscal year 1984, which begins 1 April. Expenditures are up only 0.5
percent over the initial 1983 budget-the smallest increase since 1955 and a 2-
percent real decline. Ministry of Finance officials lobbied hard for a tight
budget to reduce persistent deficits:
? Defense spending is to rise by 6.6 percent, about the same as last year. The
Ministry of Finance had proposed boosting the defense budget by 5.1
percent, but Prime Minister Nakasone has publicly stated he intervened to
ensure the larger increase to fulfill a pledge to President Reagan.
? Foreign aid will rise by 9.7 percent. Most other categories show little change
from last year. Public works spending-a mainstay of Japanese pork-barrel
politics-will be cut by 2 percent.
? The central government deficit will amount to 25 percent of total spending,
down slightly from last year. Increases in the corporate income tax and
commodity taxes will nearly offset.a personal income tax cut and a boost in
The Finance Ministry remains concerned that the opposition parties' new
strength in the Diet as a result of the December elections will lead to pressure
on the government to loosen fiscal policy. Leaders of the two largest opposition
parties, which have consistently advocated increased spending for social
welfare programs, have already criticized the new budget, and their attacks
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J pan's Complex
Memory Chip Lead
Strengthened
Fift Generation
mputer Prototype
Developed by
Mitsubishi
will heat up after the Diet convenes on 6 February. Officials of the Economic
Planning Agency and the Ministry of International Trade and Industry have
also pressed for measures to stimulate domestic demand. A supplemental
budget is likely to be passed later in the year, and the more free-spending Diet
may use it to boost public works and other spending.
performance without excessive heat.
A Japanese company, Toshiba, has announced the development of the most
complex memory chip to date. The new chip, a 256K SRAM (static random
access memory) has the equivalent of 1.6 million transistors-four times as
many as the recently introduced 256K DRAM (dynamic random access
memory) chip. The Toshiba chip uses complementary metal oxide semiconduc-
tor (CMOS) technology that offers significant performance advantages over
present technology. Toshiba expects to send samples to its customers this year
and begin large-scale production in 1985. The Toshiba announcement demon-
strates the continuing Japanese lead in memory chips and in CMOS technol-
ogy that has considerable potential for defense applications. Over the next few
years, advanced memory chips such as the 256K SRAM and 1 M (one megabit)'
DRAM are expected to be implemented in CMOS technology to attain high
closer to the main Japanese computer community (Hitachi and Fujitsu)
Mitsubishi Electric Company recently announced it had succeeded in building
a prototype fifth-generation computer hardware module termed "personal
sequential inference machine" (PSI), to be used as a programing tool by the re-
searchers at the Institute for New Generation Computer Technology (ICOT).
This is the first product announcement of any kind since the Japanese fifth-
generation program was inaugurated in 1981 and is likely to be the basis for a
computer system to be marketed commercially by Mitsubishi. The system is
reported to be as capable as a DEC 2060 mainframe computer in running the
artificial intelligence language PROLOG. We believe that many of the fifth-
generation computers' functions may be incorporated in the Mitsubishi k L 25X1
prototype. According to K. Furukawa, chief of one of the ICOT research labs,
Mitsubishi was chosen by MITI to develop the prototype to bring Mitsubishi
Japanese Bureaucracy A report prepared for Japan's Cultural Affairs Agency (CAA), the Ministry of
Ashes Over Software Education component responsible for administering copyrights, calls for
Protection extending copyright protection to computer software as in the United States
and some European countries. The report sets the CAA on a collision course
with the Ministry of International Trade and Industry (MITI), which is
proposing to protect the rights of software developers through its own
registration system rather than through copyrights. The MITI plan would
include mandatory licensing modeled after the Patent Law, which gives the
head of the Patent Agency authority to decide the terms for licensing a patent
to others if the involved parties cannot negotiate an agreement privately.
MITI's proposal apparently is intended to ensure Japanese manufacturers of
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Mitsubishi-Chrysler
J int Production
Disclosed
Saudi Arabian
overnment Spending
IBM-compatible computers access to software that would be registered by
IBM. Although the copyright protection favored by the CAA would last for 50
years, MITI would grant registered software only 15 years' protection from
unauthorized use, according to Japanese press reports. Both CAA and MITI
want to submit legislation to the current session of the Diet but appear to be
too far apart to allow for early compromise.
According to a recent Japanese press release, Mitsubishi Motors has reached a
tentative agreement with Chrysler to jointly produce 200,000 subcompacts per
year in the United States. Production is expected to begin by 1986 in either
Chrysler's St. Louis or Belvidere, Illinois, plant. According to the article,
130,000 of the cars will be sold through Mitsubishi's independent dealers in
the United States; the remaining 70,000 will be sold through Chrysler
dealerships. The deal, which has been under negotiation for over a year, is ex-
pected to be completed this spring. Agreement between the two automakers
may have been spurred by Mitsubishi's disappointment over their quota
allotment assigned by MITI under the voluntary export restraint agreement.
Less Developed Countries
Saudi Arabia is avoiding politically risky spending cuts, despite reduced oil
revenues and large deficits in both the budget and the foreign current account.
The US Embassy reports that government spending shows no sign of falling
below the budgeted $75 billion for fiscal year 1984, which ends in April. The
Saudis are taking only painless expense-cutting steps that include curtailing
"nonessential" projects and reducing aid to non-Arab states. The government
is continuing to provide funds for the petrochemical plants at Jubail and
Yanbu; social programs, including food price subsidies; aid to Iraq; and the up-
grading of air defense and other military capabilities. Last week the Saudis
signed a $4-5 billion deal with France for the Shahine surface-to-air missile
The leadership is unwilling to make spending cuts that would
cause public discontent. To finance deficits, Riyadh is re-
ment has not gone nearly far enough in introducing austerity measures.
lying on delayed payments and is drawing on its foreign exchange reserves.
Some middle-level economic administrators, however, believe that the govern-
Bahraini Bahrain's recently announced two-year budget for 1984 and 1985 appears
,overconfidence During overoptimistic in projecting balanced budgets for both years. Manama expects
/ Hard Times a 13-percent increase in oil revenues from the Abu Safaa oilfield, operated for
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3 February 1984
Bahrain by Saudi Arabia, and providing about half of Bahrain's total crude
production. The US Embassy in Manama, however, is unaware of any Saudi
agreement to increase output from the field, and oil prices are not expected to
rise in 1984. Without increased oil revenues, Bahrain either will have to
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undertake additional austerity measures or borrow to finance a budget deficit.
Further spending cutbacks, however, could threaten political stability; two-
thirds of the population are Shia Muslims heavily dependent on government
spending. Spending cuts could make the Shias more susceptible to Iranian
recruitment and subversion. Barring spending cuts, Bahrain probably will turn
to Saudi Arabia and other Gulf states for assistance; these states also are
tnlikely any time soon.
troubled by lower oil receipts.
local bank loans to the private sector are in default
when real GDP roughly matched the 1982 level, according to the US
Embassy. The leveling off reflected three main factors: rising output of corn
and beans for domestic consumption; higher prices for export crops; and
substantial US economic aid that helped manufacturers import key raw
materials. Improvements in key sectors, however, are unlikely in 1984:
? Rising production of food staples is likely to be offset by falling harvests of
key export crops-cotton and coffee.
? Exports of manufactures will be held in check by the depressed economic
conditions in Salvador's traditional neighboring markets.
? The key banking sector will continue to struggle because about one-third of
Chile Liberalizes Chile recently enacted one of the most liberal mining codes in the Third World
alvadoran GDP Flat El Salvador's four-year economic decline appears to have been halted last year
ing Code
in an attempt to attract foreign investment and boost copper production. Chile
earns nearly one-half of its export revenues from copper and possesses the
world's largest reserve base. The new code gives foreigners equal rights with
Chileans to buy and sell mineral concessions and puts the courts, rather than
government agencies, in charge of awarding concessions. The law inhibits
future takeovers by dramatically increasing the cost of expropriation and
obliging the government to pay in advance; compensation would be based on
the estimated value of minerals still in the ground rather than on the cost of
existing investments. The guarantees are intended to reduce the risk of
investing in Chile by prohibiting expropriations like those involving US copper
mines in 1971. Despite the improved laws, world copper market conditions-
depressed prices, inventories at five-year highs, and expectations for only
modest growth in demand-suggest that large new copper investments are
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New CEMA Investment Several East European countries have agreed to develop Soviet iron ore
P/oject deposits in the first major CEMA joint investment project approved since the
mid-1970s. A Romanian official has told the US Embassy in Moscow that
Romania probably will join East Germany, Hungary, and Czechoslovakia in
plans approved at the CEMA Council session in October for construction of
the Krivorozhye iron ore combine in the Ukraine. The combine will cost the
equivalent of an estimated $3.6 billion and on completion in 1990 will produce
12.8 million metric tons of iron ore pellets annually. Under bilateral agree-
ments to be concluded by June, the East Europeans will provide manpower,
equipment, and possibly hard currency in exchange for future production.
Czechoslovakia has announced that it will contribute the equivalent of $493
million and will receive 1 million tons of ore annually from 1991 to 2000. De-
tails on the other countries' participation are not available.
Approval of this project reflects a renewed Soviet push for East European
investments in return for deliveries of raw materials. In the past, such projects
have been hindered by difficulties in reaching agreement on pricing and the
amount of East European investments. The East Europeans are facing poor
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development.
prospects for trade with the West and a hard line from Moscow on future ex-
ports of oil and other raw materials. As a result, they probably now believe
that they have little alternative to greater participation in Soviet resource
Cub n Consumers Get Cuban consumers were able to purchase an unusually wide variety of products
arend Bonus from mid-December through the first of January, according to the US
Natural Disasters
Plague Tibetan
conomy
Interests Section in Havana.-Apples were available for the first time in 10
years, chicken could be bought outside the ration system, and unrestricted
quantities of pork-a Cuban favorite rarely available-were available at
government markets. Dutch jams and canned cherries, as well as Romanian,
Soviet, and Spanish wines, were widely available, although at high prices. This
temporary easing of the normally austere lifestyle-which coincided with both
the Christmas holidays and the 25th anniversary of the Revolution-probably
was intended to offset repeated warnings that economic conditions will not
improve in the near future. Since yearend, normal market conditions have
returned.
China's Xizang Province (Tibet) was hit by natural disasters throughout 1983,
stifling the economy and frustrating Beijing's efforts to make the province a
showcase for minority development. Agricultural production, which accounts
for about 90 percent of the province's output, probably declined in 1983 for the
third straight year because of drought, livestock disease, insects, and a lack of
inputs. Late last year Beijing described the area as suffering from the worst
natural disasters in memory and instituted remedial steps. Beijing:
? Increased highway and air transport capacity to supply the province.
? Accelerated the distribution of relief grain.
? Increased budget allocations for disasters by 16.5 percent.
? Airlifted 100 metric tons of livestock fodder to the province.
Beijing would like the province to become a model area to illustrate the
leadership's concern for minorities and religious tolerance, to encourage the
return of the self-exiled Dalai Lama, and to improve the central government's
control over a remote but strategic region.
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Western Europe: Pressures on
Welfare Spending and
Implications for Defense
The budgetary problems that most West European
governments confront are due in large part to the
huge increases in welfare spending that have oc-
curred during the last two decades. Although there
is widespread concern about budget deficits, public
opinion strongly supports welfare spending and
opposes tax increases. Nonetheless, a number of
governments have begun to trim social programs,
and we believe they will have to continue in this
direction; welfare spending consumes so much of
their budgets that they cannot solve their fiscal
problems without making cuts in this area. The
budgetary problems, coupled with public prefer-
ence for social spending, make it unlikely that real
defense outlays will increase significantly in most
countries.
The West European welfare state has become far
more than a social safety net assuring basic needs.
Although the welfare state began by supplementing
emergency assistance to the destitute with social
insurance for industrial workers, it now also pro-
vides wide-ranging benefits to the middle and upper
classes. Numerous universal health care programs;
family allowances; student grants; and insurance
schemes for the old, invalid, and sick attempt to
assure a rough continuity of income for virtually all
citizens.
In recent years, the costs of welfare programs have
soared while state revenues have grown only mod-
estly. According to the European Community, so-
cial welfare expenditures consumed an average of
27 percent of GDP in EC countries in 1981,
compared with 19 percent in 1970. An EC publica-
tion recently estimated that higher outlays for
social benefits accounted for about one-half of the
total rise in member governments' budgets between
1973 and 1982. During this period:
? Slow economic growth and high unemployment
reduced the growth of tax revenues.
? High jobless rates also boosted unemployment
compensation costs.
? Aging populations required added expenditures
both for pensions and for health
In some ways, the welfare state is as much the
cause as the victim of Western Europe's macroeco-
nomic difficulties. Recent academic studies point
out that large employers' taxes for unemployment,
health, and disability insurance create a "wage
gap" between workers' take-home salaries and
their total cost to firms. By making labor more
expensive to employers, the nonwage payments
reduce the demand for labor and encourage auto-
mation. They also reduce business profits available
for new investment, thereby contributing to slower
growth.
Government Responses So Far
The soaring costs of social welfare programs are
forcing all of the West European governments to
trim benefits in order to at least slow the rise of
social spending. Certain governments are also chal-
lenging basic premises of the postwar welfare state.
Although the Socialist-led governments in France
and Italy are justifying ad hoc cuts as emergency
measures to contain runaway budget deficits, the
Governments of West Germany, the United King-
dom, and Denmark are questioning the principle of
universal benefits. Leaders of the fiscally conserva-
tive governments in these countries contend that
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Relative Costs to Governments
of Major Social Programs :
.Specific Benefits by Type, 1980 a
West
Germany
France
Italy
Netherlands United
Kingdom
Total
100
100
100
100
100
100
100
Sickness
22
27
30
26
23
29
22
Invalidity-disability
8
9
5
20
0
9
Employment injury-occupational
diseases
3
1
4
3
20
1
Old age
26
35
26
35
34
28
40
Survivors
12
1
15
7
10
5
2
Maternity
1
1
1
2
1
0
2
Family
12
10
8
13
7
9
11
Vocational guidance-mobility
2
1
3
0
0
0'
0
Unemployment
10
12
4
7
2
6
9
Housing
NA
1
1
0
0
1
1'
Miscellaneous
3
3
4
1
0
1
2
a The West European welfare state utilizes a mix of cash payments ices, housing, family allowances, old-age and disability pensions,
and services in kind, supplemented by government decisions on tax and unemployment benefits. Funding methods vary widely among
credits, price subsidies, and the behavior of state-owned enterprises. the countries and the specific programs but inevitably involve a
West European governments administer wide-ranging health serv- major element of state subsidy.
the state should provide a social safety net for
emergencies but that it should stop trying to guar-
antee full income maintenance.
In northern Europe, Socialist opposition parties are
attempting to exploit public hostility to cutbacks
but have offered no clear alternatives for reducing
budget deficits. In France, the Communists-who
normally would be the strongest foes of welfare
cuts-are restrained from being too vocal in their
criticism by their participation in the Cabinet. In
Italy, all five coalition, parties have endorsed aus-
terity in principle, but many of their deputies in
Parliament are objecting to specific welfare cut-
backs.
Most governments are attempting to limit their
budget deficits by taking a more parsimonious
approach to defense spending, despite the fact that
it accounts for a far smaller percentage of their
countries' budgets. Last year, for example, only
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3 February 1984
four European allies-the United Kingdom, Lux-
embourg, Norway, and the Netherlands-came
close to meeting NATO's target of a 3-percent real
increase in military spending. In most of the other
countries, real military spending probably in-
creased only marginally. In France, defense spend-
ing stagnated and may actually decline in real
terms in 1984.
Public Opinion and the Welfare State
Polling data, although scattered and often frag-
mentary, indicate widespread support for social
programs, skepticism about defense spending, and
strong opposition to tax increases. In a 1982 EC-
sponsored poll that asked what causes were suffi-
ciently important to inspire sacrifices, 40 percent
named the struggle against poverty-a cause that
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General Government Spending as a Percentage of GDP
50 50 50 50
Total
40 40 40 ~~ 40
30 30
10 Defense 10 10 10
0 1970 75 80 0 1970 75 80 0 1970 75 80 0 1970 75 80
70 70 70 70
60 60 60 60
50 50 50 50
40 40 40 40
30 30 30 30
To- 20 20 20
10 10 10 10
ranked behind only peace and human rights. By
contrast, only 23 percent named national defense.
income respondents and right-of-center voters tend
to reject welfare reductions:
? In a French poll published last July, 58 percent
said the health budget must cover health needs
A large majority of West Europeans oppose reduc- regardless of how national wealth changes.
tions in social spending. In most cases, even high-
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? In a Dutch poll conducted last April, two-thirds
of the respondents opposed any reductions in
social benefits.
In contrast, West Europeans are not supportive of
military spending. A poll in April 1982 found
pluralities opposed to defense spending increases in
France, West Germany, Italy, and the Nether-
lands. A plurality of Britons favored increases,
probably in reaction to the Falklands conflict. In a
July 1983 Gallup survey, however, almost half the
Britons polled said defense spending was too high,
while only 12 percent said it was too low.
Further tax increases are even more unpopular
than social spending cuts in most- West European
countries for which polling data are available.
Various 1983 surveys in Italy, France, West Ger=
many, Belgium, Denmark, and the Netherlands
found that opposition to tax hikes was even more
widespread and intense than opposition to welfare
reductions. In British Gallup surveys conducted
from 1979 through 1983, by contrast, about one-
half of the respondents favored increased social
welfare programs even at the cost of higher taxes-
a sentiment reflecting,-in our view, widespread
dissatisfaction with Prime Minister Thatcher's eco-
nomic policies.
Prospects for Retrenchment
We expect the strains on social welfare budgets to
continue throughout the 1980s.
estern Europe's unemployment
rates are likely to increase still more in the next
several years, primarily because demographic
trends will add even more prospective workers to
the labor force than in the 1970s and because wage
costs almost certainly will not moderate sufficiently
to create enough new jobs. In addition, most econo-
mists expect the recovery in Western Europe to be
much less robust than those following previous
recessions, which means that job creation will be
slower and that government tax revenues will in-
crease less rapidly than during past recoveries.
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3 February 1984
Furthermore, the costs of health care and old-age
pensions will grow as the number of elderly and
retired persons increases.
Despite the political risks of cutting welfare, we
believe West European governments have no other
choice. Social programs consume such a large share
of public budgets that austerity limited to other
areas is unlikely to solve government financial
problems. Some governments will probably try to
raise new revenues. Taxes, however, are already
high in most West European countries, and sub-
stantial increases could impede economic growth
and provoke stiff political resistance.
Because of growing numbers of pensioners and
continuing high unemployment, West European
governments probably will not be able to reduce
their welfare budgets, but they should be able to
slow the rate of growth. Even conservative govern-
ments are unlikely to challenge basic structures of
the welfare state. In making program cuts, most
governments, in our view, will emphasize the wel-
fare state's function as a social safety net and chip
away at the practice of universal coverage. West
Germany, the United Kingdom, Denmark, Bel-
gium, and the Netherlands will probably tighten
eligibility requirements for many social benefits.
These countries are also likely to limit cost-of-living
adjustments in income transfers and make greater
use of means tests for public assistance.F___1
In our judgment, the continuing need to trim social
welfare spending will prevent significant military
spending increases in most West European coun-
tries and could even lead to selective cuts. Although
defense expenditures account for only a small
proportion of West European public budgets, most
governments are sensitive to the linkage between
defense and social welfare spending in the public
mind. They will thus be loath to promote defense
increases while being parsimonious in other areas.
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Even Prime Minister Thatcher, who enjoys a solid
parliamentary majority and does not need to call
elections before 1988, is facing growing difficulties
in maintaining planned increases in the military
budget. Most other West European governments,
which have had an uneven record of meeting
NATO's goal of a 3-percent real yearly increase in
defense spending, are unlikely even to approach
that goal in the next several years.
Slow growth in military spending will probably
delay or eliminate planned equipment moderniza-
tion programs and may decrease the West Europe-
an countries' overall military capabilities. Because
of high inflation in the defense sector and the
growing sophistication of modern weapons, even
real 3-percent yearly increases in military budgets
would probably be insufficient to maintain current
forces and to fund planned modernization pro-
grams. Continued stagnation in West European
military spending could force significant cutbacks
in military readiness, including personnel reduc-
tions, shortened training periods, slowdowns in
weapons procurement, and cancellation of new
weapons purchases.
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France: Options on Austerity
Despite rising labor resistance, the French Govern-
ment appears determined to give industrial mod-
ernization and the battle against inflation priority
in 1984. Continuing such policies beyond early
1985, as may be warranted by economic conditions,
will be politically risky for President Francois
Mitterrand and is likely to cost Mitterrand's coali-
tion support from the left in the 1986 legislative
elections. He thus may attempt to shift his political
base toward the center.
Austerity-The First Fruits
Rising inflation and a soaring current account
deficit forced the Mitterrand government to aban-
don expansionary policies and shift to austerity in
1982. This shift was reinforced last March with a
new austerity package and the ouster of a leftist
spokesman in a cabinet reshuffle. These changes
signaled a smaller role for the government in the
daily running of the economy and an increased
recognition of the cost of supporting sick industries.
The government now acknowledges the need for
profitability, even at the cost of cutting back work
forces. The decision in late 1983 to allow Peugeot
to reduce its work force by nearly 2,000 workers-
despite strong union opposition-was the first sig-
nificant indication the government was willing to
allow some loss of jobs in order to promote modern-
ization.
The austerity measures adopted by the Socialist
government over the past 18 months have yielded
mixed results. The trade deficit last year was about
$6 billion compared with $14 billion in 1982. The
current account improved by $8 billion last year as
well but still recorded a $4 billion deficit. At the
same time, prices, measured from December to
December, rose 9.3 percent, well above the 8-
percent target. Real GDP recorded only a slight
increase last year-after growing by 2 percent in
French Prime Minister Pierre Mauroy serves up
the austerity plan to Georges Marchais, the head
1982-and probably will not do better in 1984.
Consumption spending fell in the third quarter of
1983 and may continue to decline through the first
half of 1984. Exports, which have expanded rapidly
since the devaluation in March 1983, probably will
again be the major source of any growth.
Austerity-Continuing in 1984
Having made some progress thus far, the govern-
ment seems fully committed to continuing austerity
for another year:
? The 1984 budget maintains about the same de-
gree of austerity as the March 1983 package, but
the money-supply target (M2) has been cut by 3
percentage points to only 6 percent.
? Price controls are scheduled to be eased only as
inflation slows. The government hopes that price
controls, wage guidelines, and a tough position in
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negotiations with government workers will hold
down wage increases.
? Paris hopes to slow inflation to 5 percent this
year, which would be the lowest rate since 1970.
? The government expects progress on the foreign
payments front to continue and hopes the current
account will achieve a surplus in 1985-perhaps
$6-7 billion-in order to reduce France's medi-
um- and long-term foreign debt, which now totals
$53 billion.
The improvement in trade and current account
balances may. allow Paris to delay another devalua-
tion of the franc, which many forecasters had
predicted for this spring. The continuing strength
of the dollar, though much maligned by the French,
also will reduce the probability of a franc-mark
realignment in the near term. Stronger growth
among the other industrial countries bodes well for
the foreign balances and the franc for the first half
On the other hand, French inflation probably will
continue to exceed that of most competitor coun-
tries in 1984, hurting French competitiveness. In
addition, reduced OPEC income and LDC debt
problems have weakened demand for French prod-
ucts in traditionally strong markets. Moreover,
interest payments on France's foreign debt will be
higher this year. Given these factors, Paris is not
ready to declare victory on the foreign payments
We believe the most agonizing challenge the
French will face this year will be the management
of structural change. The government could be
called on to authorize a quarter of a million layoffs
in 1984; job losses are likely to be particularly
serious in coal, steel, shipbuilding, and textiles.
Mitterrand's leftist coalition will find this ideologi-
cally and politically difficult and will be vulnerable
to attacks by labor and the Communists.
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3 February 1984
Austerity-When Will It End?
In our judgement,.the French will not fully achieve
their economic objectives in 1984. We expect the
French to exceed their 1984 inflation target by 2 to
3 percentage points and to have one of the highest
inflation rates among the major industrial coun-
tries. Although the current account is likely to
improve through 1984, the anticipated 1985 surplus
will not be sufficient to allow a rapid reduction in
French debt. The structural problems of the French
economy will remain, and unemployment could rise
about 0.5 percentage point to 9.5 percent by year-
By early 1985, even with austerity goals only
partially achieved, the Socialists will turn their
attention toward the National Assembly elections.
scheduled in the spring of 1986. Conventional
wisdom and previous Socialist strategy statements
indicate that the Socialists will feel obliged to
stimulate the economy to improve their bleak elec-
tion prospects. The Mitterrand government knows
such a reversal would be risky for the economy.
The previous Socialist expansion program in 1981-
82 caused a rapid increase in imports and only a
modest improvement in domestic conditions. Mit-
terrand and his advisers are painfully aware how
rapidly the current account can deteriorate and the
franc weaken and thus may consider an alternative
policy.
Political Implications
President Mitterrand has basically three options:
? To move to the right and continue austerity
through 1985 and perhaps beyond, accepting an
increase in unemployment as the cost of
modernization.
? To maintain the current policy of austerity for
this year and then stimulate the economy in 1985
in the hope that an upturn will help Socialist
candidates.
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? To swing to the left and adopt Communist and
leftwing Socialist proposals to head off rising
unemployment with immediate stimulative and
protectionist measures-an alternative he has
already rejected twice.
Mitterrand appears to be leaning toward the first
option. In recent speeches both he and his loyal
lieutenant, Laurent Fabius, the Minister of Indus-
try and Research, have stressed the importance of
pressing ahead with modernization. The govern-
ment's handling of the Peugeot strike suggests that
Mitterrand is willing to accept the political risks of
reducing the number of workers in the troubled
smokestack industries.
Mitterrand probably hopes that political gains in
the center will compensate for the likelihood that
the left will lose its legislative majority in 1986. By
restoring economic health and showing that mod-
ernization holds future promise, he will be in a
position to court support from centrist voters who
were crucial to his victory in 1981 but who are now
disenchanted with the government's economic man-
agement. Such a move to the center may be part of
a broader strategy, suggested by several French
political commentators, in which Mitterrand might
propose a system of proportional representation to
strengthen centrist parties prior to the 1986 elec-
tions.
A move to the center and the continuation of
austerity are not without risks. Mitterrand's uneasy
alliance with the Communists almost certainly
would end. The break could occur through Mitter-
rand's forcing them out of the Cabinet if they
refuse to support his policies, or the Communists
could leave on their own and attempt to portray
themselves as the "true" defenders of labor. The
Socialists could end up as an isolated minority if
the leftist coalition breaks up before Mitterrand
cements his ties to the center. Rising protests
against austerity, however, might become so strong
that he would be forced to abandon the policy
before it achieved its goals.
There will be a number of signposts in 1984 that
will indicate whether Mitterrand has indeed decid-
ed to attempt a shift toward the center. The first
will be the determination with which the govern-
ment pursues its goal of modernization and its
willingness to accept the dismissal of large numbers
of workers in sectors such as coal, steel, and
shipbuilding. Next will be the nature of the Cabinet
shakeup that is widely anticipated in the second
half of 1984. Prime Minister Pierre Mauroy, who is
closely identified with the policy of protecting jobs,
may be replaced, and the political coloration of his
successor will say much about the government's
intentions. A Cabinet shuffle could also provide the
occasion for a showdown with the Communists.
Finally, the 1985 budget, which will be introduced
next autumn, will indicate the intensity with which
Mitterrand has decided to continue with austerity.
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Lebanon: Economic Impact of
Continuing Hostilities
The normal resilience of the Lebanese economy is
being sorely tested by nearly a year of sustained
violence. Disruption in agriculture and commerce
combined with transportation difficulties and par-
tial Arab boycotts have cut drastically into export
earnings. The declining confidence of wealthy
Christian and Sunni Muslim businessmen in the
prospects for stability in Lebanon and the recent
evacuation of many Palestinians have sharply re-
duced remittances, giving Lebanon its first pay-
ments deficit in memory.
Moreover, the efforts of President Gemayel's gov-
ernment to expand its authority through the use of
the Lebanese Armed Forces is putting tremendous
strains on the government treasury at a time when
the limits to government control are hampering
revenue collection. It is unlikely, at least in the near
term, that the Gemayel government will be able to
deal effectively with its economic problems or stem
the decline in confidence.
Emerging Foreign Payments Problems. Beirut has
traditionally incurred large trade deficits because
exports-primarily to Arab markets-normally
cover only 30 percent of the import bill. Last year
exports, by our calculations, fell by almost 50
percent to about $450 million after declining 32
percent in 1982. We estimate that imports of vital
food, fuel, industrial goods, and military equipment
only declined about 10 percent to $2.8 billion
The primary causes for the poor showing of exports
are threefold. Transportation dislocations, particu-
larly those associated with security problems along
the Beirut-Damascus highway, have cut vital over-
land linkages with Lebanon's traditional Arab mar-
kets. Equally important have been the effects of
Iraq's financial problems and the partial boycott of
Lebanese goods by Saudi Arabia; these two coun
tries took over 40 percent of Lebanon's exports in
1982. The Iraqi market for Lebanese goods virtual-
ly disappeared last year because of Baghdad's
foreign exchange shortfalls. At the same time,
Saudi Arabian officials, apprehensive over the
prospect of Israeli goods penetrating their market
disguised as Lebanese products, cut their purchases
by almost 15 percent in the first nine months of
1983, according to US Embassy reports.
Lebanon has previously been able.to count on
remittances to offset its trade deficits, but these,
too, have fallen victim to the continuing strife. In
1982 repatriations from the estimated 250,000
Lebanese and Palestinians working abroad and
funds being transferred directly to the PLO
amounted to $150-200 million per month. From
discussions with local banking sources, the US
Embassy estimates that those remittances have
fallen by one-half. In particular, bankers estimate
that $50 million per month was flowing into Tripoli
before the PLO evacuation; these funds have prob-
ably dried up.
As a result of the decline in remittances as well as
likely shortfalls in other service earnings-includ-
ing transit fees and flows to the banking sector-
Lebanon probably incurred a payments deficit for
the first time in memory. During January-Novem-
ber 1983 foreign reserves had declined by about
$700 million.
The Budget. The drop in the level of trade and port
collections and haphazard tax collection have
sharply reduced central government revenues. Al-
though the Gemayel government did manage to
extend its authority over two illegal ports early in
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1983, falling imports caused customs collections to
decline about 36 percent below government projec-
tions, while expenditures associated with the mili-
tary kept the budget deficit above $1 billion.
Government budget plans for 1984 probably will
prove unrealistic, and the budget deficit is likely to
rise sharply. Revenues are projected to increase by
an unlikely 40 percent to $1.4 billion while expendi-
tures are to grow by only 23 percent to $2.1 billion. .
Allocations to the military are targeted to comprise
almost 20 percent of total budgeted expenditures,
but these figures do not include the costs of addi-
tional ammunition and hardware that military ob-
servers believe are needed. Embassy sources esti-
mate that such additions would require $440
million above currently budgeted figures.F__-]
Domestic Impact
While Beirut tries to cope with difficult financial
problems, everyday economic existence for the .
business community and for the Lebanese citizenry
is becoming more difficult. Activity in the trade
and services sectors has dropped off considerably,
resulting in slowly rising unemployment. According
to Embassy reporting, almost 150 workshops and
small factories in the southern suburbs of Beirut
have shut down completely, while many larger
firms producing consumer goods both for export
and local consumption are operating well below
capacity. Between 20 and 30 percent of the domes-
tic labor force totaling 600,000 are believed to be
out of work or underemployed. Economic slow-
downs in the oil-producing countries have probably
stemmed the flow of new migrants to jobs in the
Gulf. Although the extended family system in
Lebanon has cushioned the impact of growing
unemployment, further dislocations could provide
additional sources of recruitment for the various
confessional militias and radical groups currently
existing in Lebanon.
Widespread layoffs in the services sector have not
yet surfaced, but the potential is growing. With
remittances down and investment activity virtually
halted, many of the smaller family-run banks are
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3 February 1984
overextended and teetering on the brink of insol-
vency. For the larger banks that are still fairly
liquid, the only investment outlet remaining is
government treasury bills; private bankers, who
already hold two-thirds of Lebanon's public debt,
are reluctant to invest too large.a percentage of
their capital in the Gemayel government. Shipping
and insurance firms are weak because of the low
level of trade activity
Trans-Arabian Pipeline Company (TAPLINE)
closed its Beirut offices at the end of 1983 and
formally turned over terminal and storage facilities
to the Lebanese Government. According to Embas-
sy sources, TAPLINE's decision stemmed from
losses accumulated since 1975, war-related dam-
ages to company installations, and continuing un-
certainty about the future.
Deteriorating infrastructure problems are com-
pounding the economic downturn. Damaged elec-
trical lines have resulted in both electricity and
water rationing in Beirut. To cope, resourceful
Beirut citizens have reportedly set up individual
generators and have been illegally tapping into
water mains. So far, however, damage to the
country's main oil installation at Tripoli-incurred
during heavy fighting between Palestinian groups
in early November-has not resulted in fuel ration-
ing, because of supplies from a small storage
facility near Beirut. The possibility of fuel ration-
ing will remain as long as the Tripoli installation is
out of commission-estimates of repair time range
from three months to a year-and fuel shipments
from the Sidon facility behind Israeli lines remain
problematic.
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The Depressed South
Israeli actions have effectively cordoned off the
area south of the Awwali River and continue to
depress the south's primarily agricultural economy.
According to Embassy reporting, agricultural food
prices in the south increased by about 12 percent in
November as orchards and farmlands were bull-
dozed by Israeli Defense Forces (IDF) for security
reasons. According to local businessmen, the IDF
continues to limit access to the port at Sidon to
certain favored shippers, making it difficult to
move agricultural produce to regional markets,
while the Syrian occupation restricts overland ship-
ments to Arab countries. Moreover, detours and
Israeli checkpoints continue to hamper food and
fuel shipments to and from Beirut. Embassy offi-
cers have observed as many as 100 trucks parked
on the shoulder of the road waiting to cross the
river in the course of one day; such long waits often
result in truckloads of spoiled produce.
Prospects Dim, But ...
Although the Lebanese economy has proved amaz-
ingly resilient through almost 10 years of hostil-
ities, last year's nonstop conflict seems to have
taken a psychological toll on Lebanese confidence.
Recent Embassy reporting indicates that Sami
Marun, head of the Economic Council for External
Relations and a prominent Christian businessman,
is now expressing increasing concern about the
state of the Lebanese economy.
business confidence is being shaken by
the fact that Foreign Minister Elie Salim is tempo-
rarily acting as Minister of Finance and has little
time to devote to economic concerns. In our judg-
ment, should the current political-military situation
continue, the government's attention will be further
diverted from economic problems, and the Leba-
nese economy will deteriorate.
Should a cease-fire eventually take hold or should
the Israelis pull out of southern Lebanon-as ap-
pears increasingly likely-the economic situation
would substantially improve. Several factors con-
tribute to this cautious optimism:
? Although there has been a spate of Lebanese
pound-to-dollar conversions-contributing to a
20-percent decline in the value of the pound since
the end of 1982
most of these funds are still being held in
Lebanon.
? The continued high liquidity of many of the
larger banks indicates that investment funds
.would be available to rebuild, should a period of
relative calm occur.
? An Israeli withdrawal-at least to below the
agricultural growing areas in the south-would
allow a partial recovery in agricultural trade and
would ameliorate domestic fuel and food supply
problems.
? Lebanon's foreign debt is still very small-about
$400 million.
Lebanese workers and businessmen remain the
country's most productive resources, and any cessa-
tion of fighting is likely to prompt the same type of
rebuilding effort that has occurred on numerous
previous occasions.
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Iran: Trade Boom Masks
Domestic Breakdowns
Bureaucratic mismanagement, war-related disrup-
tions, massive corruption, and ideological rigidities
have stifled the Iranian economy despite a strong
oil export performance over the last two years.
Much of Tehran's new oil money is being used for
imports to replace lost domestic production and
thus shore up living standards for the war weary
and increasingly cynical populace. Until current
conditions are alleviated, Iranian economic pros-
pects remain dismal.
In response to declining revenues and the need to
finance its war with Iraq, Tehran in early 1982
belatedly reduced its oil prices to bring them into
line with the rest of OPEC.
Iran exported nearly 1.9 million b/d of oil
during 1983, compared with about 1.7 million b/d
in 1982 and 900,000 b/d in 1981. The 1-million-
b/d increase since 1981 represents about $9 billion
in yearly oil revenues at current oil prices. Since
early 1982 the regime has quietly pursued its goal
of raising oil exports with the help of discounting
and barter deals:
? Tehran reportedly has signed 1984 contracts for
up to 1.1 million b/d at spot market prices. Spot
prices have firmed since the signings but are still
$0.10 below official Iranian prices and are ex-
pected to remain weak throughout the year. Iran
reportedly eased other terms of sale.
Nonoil exports are negligible as a result of the
disrupted economy and the overvalued rial. The rial
currently is trading as high as 450 to the dollar,
pegged at about 85 per dollar.
but officially is
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the Iranians are
valuing their oil in barter trade deals at $24-26
per barrel.
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Iran: Non- barter Imports, 1982-83
LDCs- 12 Bob, West Germany- 16
USSR-Eastern
Europe-22
^
Japan- 10
1W
Other OECD-38
Imports Surge
Tehran stepped up nonbarter imports by 75 percent
during 1983, to a level of about $16 billion, accord-
ing to our estimates based on international trade
data. In addition, some $4 billion worth of oil was
also traded directly for goods-largely arms from
Syria, North Korea, and East European countries,
All categories of imports showed large gains as the
government attempted to compensate for domestic
shortfalls. Foodstuffs imports have nearly tripled
since 1978, partly the result of rapid migration into
the cities but also a reflection of Tehran's failed
agricultural policies. Open source data indicate
that Japan and West Germany picked up about
one-half of the overall increase in Iranian trade and
about 60 percent of the increase in trade with
developed countries. Total imports now exceed the
$17 billion level reached immediately prior to the
revolution.
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3 February 1984
Iran's internal economic situation stands in stark
contrast to the orderly and prosperous image con-
veyed to the outside world by its external accounts
and booming trade during 1983.
consumers queue up daily in Tehran
and other major cities to purchase subsidized food-
stuffs despite their extremely low quality. At the
same time, there is plenty of food and other
necessities-even luxuries-for customers willing
or able, to pay four times or more government-
controlled prices. Much of the former middle class
is subsisting only by selling off assets such as real
estate, automobiles, or rugs. The regime-for a
price-turns a blind eye on free-market trade in
food and consumer goods, which has helped to
refocus consumer resentment away from the re-
gime to the bazaars,
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Migration to the cities has strained basic services.
Tehran still experiences scheduled daily power
outages and other interruptions in power service, in
part because of widespread illegal tap-ins to the
power distribution network. Frequent water-supply
interruptions reportedly occur in Tehran and other
major cities, and water filtration and chemical
treatment facilities in at least two major cities have
been out of service for some time.
Iranian public health reportedly has deteriorated
seriously:
? Diseases such as malaria, diptheria, typhus, and
meningitis have reappeared-in some areas in
epidemic proportions.
? No laboratories or regional disease control posts
are operating.
? Trash removal services have broken down in some
cities, and pesticides are in extremely short
supply.
? Iranian physicians have emigrated, been pressed
into military service, or often been barred from
practice by the regime for their political views.
Economic activity is being disrupted by:
? Chronic shortages of skilled personnel-particu-
larly managers.
? Inefficiencies and disincentives due to Islamiciza-
tion, arbitrary government decisionmaking, and
confiscatory social welfare and other taxes.
? Disrupted conditions in higher education and
agriculture.
? Worse-than-ever corruption.
? The war, which takes precedence over civilian
needs, particularly in the beleaguered transporta-
tion and distribution sectors.
Tehran's patronage system ensures,that the re-
gime's adherents-or friends and relatives of those
in power-are placed in key administrative and
managerial positions despite an absence of qualifi-
cations. Others are given nonproductive positions to
monitor religious and political conformity:
by the clergy. He recently appointed his brother-
in-law, a former pickup truck driver, as one of his
two deputies. The Foundation earned less than
0.1-percent profit on its $15 billion-plus holdings
and during 1983 expropriated more than 1,500
businesses-many of which had failed,
? Exile radiobroadcasts claim the Revolutionary
Guards are packing the Commerce Ministry. The
Revolutionary Guards, who have used their police
powers for extortion purposes, are perceived by
many Iranians as poorly educated, lower class
villagers, who in prerevolution times would have
trouble getting jobs as common laborers.
? The Tehran Electricity Board reportedly employs
several hundred Hezbollahis-toughs payrolled
by the regime to maintain order at Friday prayer
rallies and to quell disturbances.
Few qualified individuals are willing to step for-
ward and take full responsibility for managing
government programs or state-owned enterprises
because they do not have the authority to make
even the most needed changes. Several Iranian
leaders have publicly acknowledged the regime's
limited ability to cope with production, allocation,
and distribution decisions and the dangers of grow-
ing centralization and government control over the
economy.
Agriculture
The Khomeini regime has managed to create a
shambles out of the already inefficient agricultural
system it inherited from the Shah:
? Incentives to invest or plant have been destroyed
by controlled government prices and shortages of
fertilizer, pesticides, and machinery.
? Most breeding stock has been slaughtered for
current consumption because of feed shortages.
? Many of the larger, more efficient farms have
been occupied by squatters since the revolution.
? The chief executive of the regime's Foundation
for the Oppressed, a multibillion-dollar conglom-
erate of commercial and industrial enterprises,
reportedly is a former hardware salesman backed
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In the remote areas of the country, agricultural
problems abound. In Fars Province, local Revolu-
tionary Guards have conspired with mullahs from
Qom to bring landowners before revolutionary
courts on trumped-up charges and sentence them to
forfeit their land, In
Khorasan, major crop losses were expected during
1983 as a result of the combination of a declining
water table-a serious problem throughout Iran-
and shortages of irrigation pumps. Since early
1982, electrical power shortages and fluctuations
There is little to suggest a significant improvement
soon in the regime's economic performance, and an
end to the war with Iraq will not necessarily bring
relief. Competition in a weak oil market from other
suppliers strapped for cash will impede Tehran's
attempts to increase oil exports by shaving prices.
If the war ended, Tehran probably would face
increased competition from Iraqi oil exports.
have burned out most electrical pumps, and diesel Iran's longer term prospects will depend largely on
fuel for mechanical pumps generally has been improved economic management and the level of
unavailable, probably because of war needs and foreign participation Tehran is willing to tolerate
earlier damage to refineries. New pumps, engines, and can afford. The regime has not yet demonstrat-
and spare parts are virtually unobtainable. The ed a coherent vision of how to organize the Iranian
regime's disrupted' distribution system generally economy. Tehran's internal disagreements and its
does not extend much beyond the'major cities= claims that the establishment of the Islamic Re-
Industry
go wrong.
public-and indeed its policies-are divinely or-
dained, make the leadership slow to come to grips
with the economic problems they have created.
Instead, Tehran looks for scapegoats when things
Iranian industrial output is running at 40 to 60
percent of the prerevolution level, according to
various observers. Open source economic reporting
indicates that major petrochemicals, iron and steel,
and other industrial facilities are producing little or
are effectively abandoned. In January of this year,
an Iranian official noted that the government was
able to allocate only $4 billion of the $6 billion in
foreign exchange needed during 1983 to supply
industry with raw materials and spare parts. De-
spite the idle capacity, government planners insist
on devoting more than 50 percent of available
investment funds to the industrial sector, mostly to
complete projects, similar to those now idled, held
over from the Shah's period.
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Canada's Aerospace Industry:
A Troubled Future
Canada's aerospace industry is counting on the
government to continue covering its losses during
the present slump and to' increase other forms of
support in the future. The government's aerospace
task force recommended increased export financ-
ing-a vital aspect of the sale of aircraft abroad-
and additional federal aid for research and develop-
ment to improve Canada's position in the world
aerospace market. We believe that Ottawa will step
up its support for the aerospace sector, but we
doubt that its goal of doubling sales by 1987 can be
De Havilland Buffalo military and
civilian transport, sold rimarily to
Third World airforces
realized.
Space
About 50 firms are involved in Canada's space
industry, with the public and private sectors em-
ploying approximately 3,000 of Canada's most
highly skilled workers. Sales grew rapidly during
the past decade, and, in 1982, 62 percent of
Canada's space-related production was exported.
Spar Aerospace, Canada's largest space firm, is a
leader in the design of remote manipulation equip-
ment, as demonstrated by the successful use of the
Canadarm during recent space shuttle flights.
Canada was a pioneer in communication satellite
design and manufacture. Spar Aerospace has con-
tributed to the design and manufacture of 50
communication satellites and subsystems includ-
ing the Canadian Anik A, B, C, and D. Spar
recently won a $135 million contract for a Brazil-
ian satellite system and a $130 million contract
with Nigeria, with the US company Hughes Air-
craft as a major subcontractor.
Structure of the Industry
Canada is the fifth-largest non-Communist produc-
er of aerospace equipment and has held 2 to 3
percent of the world market since 1960. Over the
past two decades, Canada's aircraft industry has
evolved from inward-looking firms predominantly
involved in military subcontracts to export-oriented
producers, primarily of commercial commuter air-
craft. Despite the limited size of the industry,
Canada has gained an international reputation as a
leading manufacturer of such diverse products as
short takeoff and landing (STOL) aircraft, small
engines, simulators, and unmanned surveillance
drones. It is also an important manufacturer of
space products, particularly communication satel-
lites. In addition, Ottawa hopes to capture a large
share of the helicopter market with a new produc-
tion facility in Montreal.
Highly integrated with the US aircraft industry,
Canada's aerospace sector is led by the two govern-
ment-owned airframe manufacturers-Canadair
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Structure of Canada's Aircraft Industry
First tier
(4 companies)
Second tier
(approximately 20
companies)
Third tier
(approximately 100
companies)
Complete aircraft and aeroengine design and manufacture:
? Canadair produces general aircraft and subcontracts for the US military
and commercial industries.
? De Havilland produces for the short-haul commuter market.
? Pratt and Whitney Canada holds 17 percent of the world small airplane en-
gine market and 60 percent of the gas turbine market.
? Bell Textron will begin the production of helicopters in 1985.
Component producers with some design and development capabilities:
? The largest of these companies include Bristol Aerospace, Litton Systems,
Spar Aerospace, Computing Devices, and CAE Electronics. Most compa-
nies are foreign owned.
Provides specialized industry services, and many have nonaerospace activities.
These are mostly small,-domestic-owned companies.
and de Havilland. About 120 smaller companies
provide subsystems, components, and services.
Nearly 80 percent of production is exported, with
two-thirds of the exports going to the United
States. Although Canada is a net exporter of
aerospace equipment, it imports a large number of
products. Both the industry and Ottawa support
free trade with the United States in this sector.
According to press reports, Ottawa perceives a
growing trend toward protectionism in the United
States and fears that measures will be implemented
that would restrict Canada's access to the US
market.
Employment in the Canadian aerospace industry
dropped sharply during the recession and is now
approximately 36,000-about 3 percent of total
manufacturing employment. Five percent of those
employed in the industry are scientists or engineers,
making it the premier high-technology sector.n
The regional economic and political impact of
subcontracting and procurement decisions in the
aerospace industry often plays a major role in
government investment decisions. For example, Ca-
nadian subcontract work for the US-produced F- 18
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3 February 1984
De Havilland Twin Otter STOL aircraft,
probably Canada's most successful
fighters was split 48 percent to Quebec, 40 percent
to Ontario, and 12 percent to other provinces under
the original agreement. Quebec companies, howev-
er, have expressed concern that Ontario is actually
getting a much larger share of the F-18 work.
to offset this criti-
cism-and boost Liberal election chances in Que-
bec-Ottawa mandated that the new helicopter
plant be located in Montreal, even though the
company preferred the Toronto area.
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Canadair Challenger 19
passenger business, car o and
commuter transport
Flight
Financially Troubled Canadair
Canada's largest airframe producer, Canadair,
lost $1.1 billion in 1982, the largest single corpo-
rate loss in Canadian history. Ottawa has provided
the government-owned company with more than
$1.3 billion in loan guarantees and other funds to
keep it afloat, and the company is expected to ask
for $150 million more to get through 1984.
Canadair's losses are attributed to its Challenger
aircraft-a business, cargo, and commuter aircraft
capable of carrying 19 passengers. Design and
management problems plagued the plane from the
outset, and by 1981 costs were 12 times greater
than the original 1976 forecasts. By October 1983
only 79 Challengers had been sold versus current
estimates that 389 planes must be sold to break
even; industry analysts doubt that will ever occur.
The Challenger represents 60 percent of Cana-
dair's total effort and is responsible for one-half of
its employment.
In 1982-83, the recession sharply reduced global
demand for new commuter aircraft, while foreign
competition increased with the introduction of sev-
eral new models. As a result, Canadian companies
produced only 125 transport aircraft in 1982, 45
fewer than in 1981. Sales remained slow in 1983,
and we do not expect them to improve much in
1984. The drop in sales badly weakened the finan-
cial position of the Canadian industry, and Cana-
dair and de Havilland lost a combined total of $1.4
billion in 1982.' Losses continued in 1983, and the
two companies are depending on government funds
to stay afloat.
An Emerging Industrial Strategy
Because of the financial troubles and increased
competition faced by the industry, Ottawa is devel-
oping a comprehensive aerospace strategy, focusing
on those products that have already been success-
fully marketed. A June 1983 task force report
made several recommendations for improving Can-
ada's competitiveness in the aerospace industry. In
particular, the report called for greater government
support for research and development, additional 25X1
export financing, and increased involvement in
joint ventures.
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De Havilland Dash 7 50-seat STOL
transport, sold primarily to commuter
airlines
Research and Development. R&D is probably the
most critical element in the maintenance of a viable
aerospace industry because of the rapid pace of
technological change. Although the industry has
historically devoted 10 percent of revenues to
R&D-making the aerospace industry responsible
for 20 percent of the country's total R&D activi-
ty-Canada still lags other countries in expendi-
tures on R&D. Thirty percent of the $1 billion in
aerospace R&D expenditures between 1972 and
1981 came from the federal government, mostly
through the Defense Industrial Productivity Pro-
gram (DIPP). Originally set up to provide R&D
assistance to defense-related industries, most DIPP
funds now go to commercial aerospace applications.
The development of the Dash 7 STOL transport
and several aircraft engines were funded in part by
A forerunner of Ottawa's new industrial strategy
has been a series of small-mostly less than $1
million-grants made to several aerospace firms in
1983. Ottawa also will contribute $380 million to
Pratt and Whitney Canada's (PWC) $1.4 billion
R&D program over the next 10 years; a large part
will go to develop engines for the new Canadian
helicopters.
The task force report recommends additional gov-
ernment support for the industry through DIPP
and the National Research Council. Most impor-
tant, it proposed that Ottawa make its R&D appro-
priations on a five-year rather than year-by-year
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3 February 1984
basis. If adopted, this recommendation could
smooth out the planning process and speed develop-
Trade Promotion. Export financing is critical in the
marketing of aerospace products, and we believe
Ottawa will provide large and more timely export
credits as recommended by the task force. Sales of
de Havilland's Dash 7 and Dash 8, in particular,
probably would benefit from increased export fi-
nancing. During 1980-82 $453 million of Canada's
aerospace exports received either financing by the
Export Development Corporation or commercial
loan guarantees by the federal Enterprise Develop-
ment Board (EDB).
Ottawa supports the GATT aerospace agreement
controlling the international application of export
financing in the industry but is concerned that the
"consensus interest rate" of 12 percent is frequent-
ly violated. The task force report recommends that
funds be made available to the EDC to be used in
actions against violators of the GATT consensus.
Ottawa, however, may be reluctant to do this in the
face of international pressure to support the GATT.
Joint Ventures. The task force supports Canada's
participation in joint ventures. Given the high cost
of producing aircraft, it is likely that manufacture
increasingly will be undertaken by several compa-
nies under joint and often international agree-
ments. Ottawa currently is negotiating a 10-percent
stake in the 150-seat Airbus Industrie A320 being
developed under the direction of the French. Ac-
cording to press reports, government officials, how-
ever, are not pleased with the limited technological
involvement offered the Canadian industry in the
new package, and the shaky financial positions of
both de Havilland and Canadair may preclude the
Canadians from participating.
Ottawa aims for a doubling of sales of aerospace
products by 1987-a target we consider overopti-
mistic. On the plus side, the economic recovery will
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Canada Moves Into Helicopter Production
In October, Ottawa announced the Canadian aero-
space industry's expansion into helicopter produc-
tion with a new $410 million production facility in
Montreal. More recently, the planned construction
of a second, much smaller plant in Ontario was
disclosed. The announcements culminate three
years of effort by the Department of Industry,
Trade, and Commerce to attract a helicopter man-
ufacturer to Canada. Trade Minister Ed Lumley
believes Canada's "large domestic market and
skilled population make the helicopter industry a
natural for us. "He also believes that the transition
to helicopter production will be easy because "of
the five basic components that go into a helicopter,
four are made in Canada...... Ottawa hopes that
domestic production will help offset a growing
trade deficit in helicopters and parts. The industry
forecasts 15,000 to 16,000 helicopters will be sold
in the next decade, with the new twin-turbine
engined craft-such as these plants will produce-
increasingly replacing other models in the fast-
growing civilian helicopter market. The helicopter
industry, however, is very competitive, and we
believe Ottawa's estimates of obtaining 40 percent
of the world market by the mid-1990s are overly
optimistic.
improve sales, and the commuter aircraft market is
growing more rapidly than other aircraft markets.
Nonetheless, we believe that the industry's finan-
cial problems, coupled with intensifying global
competition, make Ottawa's goal unrealistic. For
example, the venture into helicopter production,
while it illustrates Ottawa's desire to promote more
widely based aerospace industry, is highly risky
given the fiercely competitive market.
Canada's aircraft industry-at least the parts and
components sector-appears headed toward closer
integration with the US aerospace industry. Otta-
wa has expressed interest in strengthening defense-
sharing agreements with the United States to bene-
fit from increased US military spending. Canada is
increasingly reliant on US military products, and
Ottawa, therefore, probably will continue to push
for a large part of the work to be done in Canada to
offset purchase costs.
Secret
3 February 1984
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Secret
India's Green Revolution:
The Bills Come Due
Although India is looking forward to a record growth in rice yields and production has slowed.
foodgrains harvest during the 1983/84 season, the Overall, the improvement in foodgrain production
country's agricultural prospects are clouded by has been modest relative to the investment in new
slower growth in yields and rapidly escalating technologies.
production costs. Already the slowing of the growth
rate in agriculture and rapidly rising costs have
expanded agricultural subsidies and pushed up Higher Costs, Lower Returns
politically sensitive food prices. New Delhi's efforts
to increase food production and keep the lid on Input costs over the past decade have grown twice
consumer prices and budget deficits will challenge as fast as farm income. Unlike industry, where new
policy planners and are likely to strain relations technology is usually associated with lower unit
between New Delhi and state governments. Any costs and higher productivity, in India's small farm
government move to reduce agricultural subsidies 'agriculture the new high-yielding technology has
will be difficult because farmers represent an in- caused unit costs to rise faster than production,
creasingly important political force-] slowing farm income growth.
With the advent of the Green Revolution in the
mid-1960s, India has been able to approach food-
grain self-sufficiency and reduce food imports. The
extension of irrigation, the introduction of high-
yielding seed varieties, and the use of chemical
fertilizers and pesticides have increased foodgrain
production from an average of 66 million tons in
the 1950s to an average of 134 million tons by the
early 1980s. The new high-yielding varieties, un-
known to farmers less than 20 years ago, now are
cultivated on nearly 80 percent of India's wheat-
land and 55 percent of its riceland.
The steady growth in food production, however,
must be weighed against a 12-percent annual in-
crease in the use of expensive farm inputs since
1970 and the lackluster performance of crops other
than wheat. Foodgrain production has grown at an
average annual rate of only 2.4 percent since the
late 1960s, as compared with 3.1-percent annual
growth before the Green Revolution. The average
annual growth of wheat yields has doubled, with
output growing 5. percent per year, whereas the
In the major surplus food-growing states, producers
have devoted an increasing proportion of output to
meet the rising cost of inputs. In Haryana and
Punjab, northern India's granary and the first
states to adopt the new seed technologies, yield
levels have stagnated, while input costs have risen
an average of 7.5 percent per year. The situation in
India's ricegrowing regions is worse; costs frequent-
ly exceed the value of output, according to Indian
agricultural economists.
Indian planners have traditionally viewed agricul-
tural subsidies as a means of stimulating produc-
tion while keeping food prices low. Since the early
1950s, an elaborate subsidy and agricultural mar-
ket control system has evolved. Subsidies were
considered essential to encourage the adoption of
the higher cost new-seed technologies; market con-
trols were instituted to regulate foodgrain prices.
Once subsidies were in place, however, they became
politically difficult to eliminate.
Secret
DI IEEW 84-005
3 February 1984
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India: Agricultural Statistics
Growth of Food Production During
the Green Revolution
Index: 1969/70=100
rn o
Total food grains
Rice
Growth Rates of Agriculture Output and Yields
Percent
0Tn~v~T.~
viaamv~~o nom
o SbNO RmN
?o .O m.n.ocm
Input Costs and Farm Income
Index: 1970/71=100
As oil prices soared, subsidies to petroleum-based
agricultural inputs escalated, straining both state
and national budgets. Most agricultural input sub-
sidies are administered at the state level where
farmers exercise considerable influence. In our
view, farmer pressure since 1975 has played a
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3 February 1984
Growth Rates of Input Cost and and Farm Income, 1970/71-1982/83
Percent
Purchased imports
Gross farm income
major role in the doubling, in real terms, of the
combined subsidies on chemical fertilizers, irriga-
tion, rural development projects, and electrical
power. The World Bank estimates that in fiscal
year 1981/82 $2.7 billion was allocated to agricul-
tural subsidies, an amount close to one-half the
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India: Growth of Agricultural Subsidies
1974/75
US $ 1.3 billion (in 1981 dollars)
1981/82
US $ 2.7 billion (in 1981 dollars)
total public expenditures on agriculture. In addi-
tion, indirect subsidies are provided in the form of
below-market-rate cooperative credit loans. Com-
pounding the burden, approximately one-half of
these loans are overdue, with little chance of recov-
ery.F_
The large and growing Indian subsidy program has
partially masked the higher cost structure of the
new technologies, thereby inducing inefficiency.
World Bank studies of Indian agriculture indicate
that direct and indirect subsidies distort prices
faced by farmers, minimize true costs, and encour-
age a misallocation of resources. Subsidies proba-
bly widen gaps in farm incomes because the larger,
more prosperous farmers benefit the most.
Although we expect food production will continue
to rise in the 1980s, increased output will require
more costly inputs, which not only will push up food
prices and subsidies, but also will limit resources
for alternative investments. Higher foodgrain pro-
curement prices over the past three years have been
spurred by steadily rising production costs. In our
view, higher procurement prices have contributed
to higher food prices despite record harvests. We
believe that if subsidies continue to grow they may
constrain available finances needed to boost pro-
duction of rice and edible oil, and India's imports of
these commodities would continue to grow.
We consider the problem of containing burgeoning
subsidies while providing incentives to farmers to
be the critical agricultural policy dilemma for India
in the 1980s. Any government move to reduce
agricultural subsidies will be difficult because
farmers represent an increasingly important politi-
cal force. Subsidies to irrigation, rural power users,
and financial institutions remain largely the pre-
rogative of state governments. New Delhi has
leverage over state government budgets, but the
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states maintain control of key rural financial insti-
tutions as well as power and irrigation facilities.
Since state assemblies are more vulnerable to rural
constituent pressure than the national government,
needed reforms will be difficult to implement.
Moreover, we believe that both federal and state
governments fear that if commodity prices do not
rise and if input subsidies are reduced too rapidly,
widespread farmer protests-as occurred in 1980-
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