WESTERN EUROPE: ECONOMIC LINKS WITH THE SOVIET BLOC (EUR 83-10132)

Created: 5/1/1983

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wesiern europe: liKonomic links with she soviet bloc

Western Europe: Economic Links With the Soviet Bloc

Wvstvni Europe: Economic Links Willi lhc Soviet Bloc

Judgment

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force's economic links lo lhc Sovietrc dominated by merchandise irade. While other catceories of ewrtomic relatwnsruirs, such as flows or services and mvcsimeots. arc generally extremely small, ihe large loans made lo Bloc countries duringake some West European banks vulnerableloc default.efaulliiifilc counlry probably would noi cause majorloc-widr. defaull might force the West European governments lo intervene lo protect their banking systems.

Even lhc trade links lo ihe Bloc are relatively small Usl year the Bloc's share of capons from the NATO countries of Western Europe washc lowest level in al leastears; over half of these exports came from Wesi Germany. Imports from lhc Bloc have held up belter, due mainly io purchases of Soviei oil and gas. The Bloc's share of total European NATO importsercent, its highest level

Over lhc years the Soviet Union has accounled for an incicasine proportion of lhc Bloc's trade wiih NATO Europe Innd, the Soviet share of total trade (exports plus imports) was typically about one-lhird. Usl year, for lhc first time, it exceeded one-half- On the import side. NATO Europe's purchases were increasingly concentrated on the USSR because of its ability io provide oil and natural gas. Meanwhile financial problems forced East European countries to reduce (heir imports and tailed the Soviet share in Europe's exports lo the Bloc.

NATO Europe's trade with the Bloc is largely an exchange of capital-ioiensivc manufactures (or simpler goods. Exports to the USSR arc dominated by machinery and sled, although chemicals and foodstuffs are also importani. Exports io Eastern Europe are more diversified. Machinery is still the largest category, bui coosumei goods, foodstuffs, chemicals, steel, and other semifinished goods are also significant. Four-fifths of imports from the USSR consist ofoil. oil products, and naturala wide range of products is imported from Eastern Europe.

TheOloen ihe USSR andine. ol Poland. Easlaeeboslovalis. Huneary. Buliaris. and Romania

' All Had* daia presented in UMs paper are from Wesiern iou'-r. In all eases ihe capon data is shown on an fob basis while ibe Import data

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The importance of Easl-West trade for employment tends to beby the JVesi Europeans. For West Germany, where tbe data arc best, we estimate,-tha(2 onlyercent of the labor force dependedj2#cptfjobs. The pereentagein the rest of NATO Europe was pVrSUmabVy even lower because thtse^oountries combined sold slightly less to IhcBXcfc than did West Geritlfcny:

ties between Western Europe and the Soviet Bloc arc not likely to increase substantially during thisdecadc. Western banks will remain

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Western Europe: Economic Unfcs Will.oviei Oloc

Attitude* Toward Kail-West Trade The WeWeriliy believe tail inetcased trade wilhothresultiomoler of detente. Ihe view probably it leu firmly bchl lhan in ibeecaote ca* (he dropoff in ciportshe decade, the continuing Sonet military buildup, and the eveotl in Poland and Afghanistan.most West Europeans still argue that Soviet behavior wul be snore reauaicec if tbc USSRarge slake in the international eMCstMak system.

West European govenunents generally icjcct tbe use of coonomic unci iocs against the Soviet Bloc cacept in veiy limited cases for lhc purpose ofolitical point. An eiample would be the very nsodest trade rcttxicuoos imposed by the EC on the USSR in response to tbc declanilion of mania) lav in Poland. The West European rationale bssically is thaimay hurt the West as much as Ihe East and. in aay event, do not affect Soviet behavior. Undcrtyiag "his attitudetrong feeling thai ihe cost of sanctions svill not be distributed evenly among the Western countries and thai Western Kuiopc inwillisproportionate shaie of tbe burden.

Figure I

NATO Europe: Trade Wilh the Sovietw us s

West Europeans nonetheless do noi view irade with the East purely as an economic phenomenon Thb is shown, for eiample. by the participation of the major West European government in COCOMon capons that could improve Soviet mili-tary capabilities. Even here, however, ihey tend touch narrower view than does Ihe. in deciding what goods fall into Ibis category.

Trade Patterns

Takenhole, the trade of the NATO Couniiies of Western Europe with the Soviet Hloc it relatively (mall. Over the last two decades ibe Bloc share of Iheir capons usually has been in the J-etccnt rnnge.eakercentS. Thetpon boom was financed mainly by Soviet Oil

earning* and credits from Western banks andSince then tbe Bloc's share of NATO Europe's exports has fallen dranutically. relVctisg tbe Woe's attempts to curb tbe growth of its hard currency debt. Last yeat the share was downercent, ihc loweai level in at leasl 2t> years, at NATOxports to the Bloc declined even in value terms

The Bloc's relative declinearket for NATO Europe's capons is due mainly to Eastern Europe. In theipons to these countries were double

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efficiencies coupled with recession toin tbe West dashed iheirfor strong growth of hard currency sate?

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erally forced all except Bulgaria to cut haid currency

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esull NATO Europe's exports lo Eastern Europe fell sharply in dollar terms--ending iwo decades of steadyibe( year NATO Europe's exports lo Eastern Europeillion and accounted forercent of totalhalf the percentage recorded4

Tbe Bloc's share of NATO Europe's imports has risen in recent years,ong period of decline duringnd stagnation during ibe. The pickup mainly re fleets increased purchases of energy from ihe USSR. Imports from the Blocillionf which almost tbree-fiflns came from the Soviet Union. The Bloc's share of importsercent, its highest level4

Higher imports from the Easl coupled with slumping exports have pushed NATO Europe's trade with Ihe Soviet Bloc sharply into deficit.illion surplus5 had1 turned4 billion deficit, and Insl year the deficit soared io5 billion was with the USSR.

NATO Europe's Irade wjih ihe USSR is largely an exchange of Steel and machinery for fuels. Energy products now account for about four-fifths of Soviet exports to the area: roughly two-thirds of ihese energy exports consist of crude oil and oil products, wiih natural gas accounting for mosi of ibe remainder. By the end of the decade most energy forecasters expeci natural gat to become Ihe dominant commodity as Soviet oil exports taper off and the new gas pipeline comes into operalion. Other significant Soviet exports are raw materials, chemicals, gold, and diamonds. West European ciports to tbe USSR are dominated by machinery, especially heavySndunrial machinery, and sled products, especially large-dinmeler pipe. In recent years exports of agricultural products have gained importance, accnur-ing for mote ihanonc-fiflhof tbe total1

Trade wiih the Other Bloc countries is considerably more diversified. More than three-fourths of NATO Europe's shipments to Eastern Europe aregoods--primarily machinery, semifinished products (mainly steel andnd chemicals.

Foodstuffs have gained tmpoitancc as lhc Eastcul back on invesioseni and now account forerceni of exports. Oo the import side foodstuffs and raw materials cacti account for cnorc ibanerceni, fuels for more lhanercent, andfor jus! over half of lhc total. About one-third of ihe manufactured imports are semifinished goods, particularly textiles and basic metals, while another one-lhird consist of clothing and other consumer goods

The Jobs Factor

The importance of exports lo ibe Soviei Bloc for West European employment probably bas beenai least In purely economic terms. The best data available are for West Germanyajor economics instituteteuilcd, sector-by-scctor study of the employment effeci attheir resulue estimate thai ibe total number of West German workers lhai depend,r indirectly, on exports to the Bloc is probably closeerceni oferceni of ihe labor force While ihe number of jobs is rdaiively small, the politicalis magnified by the fact that Ihe jobs lend to be concentrated in industries that are both highly union-iicd and badly hurt by the current recession. For example, in the steel iodusliy we estimateercent of the jobs0 workers) depend on exports lo ihe Bloc, white in the machineryihe figureoikcisk

For the other NATO European countries combined, the iotai number of jobs dependent on exports to the Bloc probably is gf eater lhanigure that we estimate for West Germany. Their exports to lhc Bloc almost matched West Germany's in dollar valueod the goods (hey sold probably were, on aveiage. more laboi intensive than those of Wesl Germany, ll is likely, however. Ihai in each of Ihe other NATO European countries, the perceniage of total employment dependent on exportslie Bloc is belowercent estimate for West Germany.

OtherReUlioarstup* Oiber catetorier of economic (id thatajor toie irwni Wetter nas flowsd investmenteilremely small be-tween East aad Wess Tbe majorhe In ft ckbi thai ihe Bloc countries ran up "ilkrope, mostly dennj. Although Ibe West tuiopcans do* find themselves cereipused. -<

hat ihey could cope reasonably veilefault by any sirujle Bloc couniry. The neatest eiposnrc is Ihai of Weal German banks io Poland, and (heir nervousness hat been an important detenu runt of Weil tier mac attilcdc* and pofaCy oat Easl-Weaivert be lest, as of last year each of Ihe

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six moil heavily involved bank* had sufficient toss reservesrite off itt Polishn fact, the tironger banks have already beguno to. Although it.seems highlyloc-wide default would obviously be Tar more serious, and we suspect It would leadajor inlerventioo by the Weal European governments loanking crisis.

Tbe Siberian Gas Pipeline The acrimonious pipeline dispute arose in pariboth Americans and West Europeans initially underestimated the importance that the other side attached to the pipeline. By the tune Washington raised strong objections, tbe West Europeanbad already com mined themselves to the deal, and contract ncgotiaiions were well under way.tbe US arguments initially focused on tbe Question of energy dependence on theissue that the West Europeans said they had already studied carefully and resolved to their satisfaction. Given the advantages that the West Europeans sec in the pipeline deal, however, we doubt tbal any shift intiming ot nature or *'*bjections would have altered the outcome

The West Europeans clearly arc convinced, that the pipeline dealood one for them, taking into account their rnojected energy needs and considering such aspects as the cost and reliability of Soviet gas. the cost of their cipoct credit subsidies, and lhc ciport sales for West European industry thai arc likely lo result. And. despite less bullish demand forecaststhan three years ago. they remain convinced lhat ihey will need targe additional gas supplies, especially in. The West Europeans stress lhai thewill noi increase their overall energy dependence on Ibe Soviets because iheir oil imports from the USSR will fall sharply over the next few years. In our judgment ihey have not focused estensivcly on what the additional gas icvenuc might do for Sovietpower, but they tend to argue that the Soviei military will get ibe resources it wants whether or noi ihe pipeline it built They are skeptical lhai it is in the West's interest to cause cutbacks in Moscow'soriented and civil investment cipcnditurcs that they believe would resul'-airings from the pipeline wcic iduCcd Oi Cut off.

Numerous tialcmcnls by West European leaders make il dear (hat their prime energy goal is to reduce Iheir dependence on OPEC. While tbal dependence has fallen significantlyustained OPEC embargo would stillevastating impact. In searching for OPEC substitutes, ihe Wat Europeans obviously vcaild prefer to find energy sources in the industrial Weal because ofiabilrly. Il is partly for this reason lhat they plan lo capaad substantially tbear use of coat and nuclear power. Tbe Soviet gas will help feddencc on OPEC by sabslitatiat lor oil ia bcanc beating, and lo date there have been no alternative gat source* tbal could match tbe Soviei offer. West Earopean gai producers have been neither willing nor able to cipand produclion mffioently in, or to boost espiocat ion/development to ensure deliveries down tbe tine, moreover, potential con-Europeanas Algeria, Nigeria. Qatar. Indonesia, han. ortooloo eipentive. or both

The West Europeans aigue fuilhcr tbal tbe Soviet gas deal is relatively advantageous in terms of security. flcAibilliy. and price.

Seturlly. The deal ptovidea Ihe West Europeansas supplyartner that Ihey tlcaily considei to be morelhan OPEC They have lepeaiedly stated their bdirl lhat Moscow will deliver the gai on schedule both toard cuiiency earnings and to preserve its tepoiilto* sireliable iradr partner

ra.Mur The Sonets also agreed to significant fletibtbiy in gai deliveries

^JVcsl Germanyne-time Option to peroce the base smouat of gas in itsdbonmelees per year, eadud ing West Berlto) by up toore impsr law. each purchasing country in each year of ihe connect willhe right lo reduce deliveries during that yeai up loercent below tbe base ansuunt This optwn likely vill be uti'ited during the caily yean of the conliacl. when ihe West Europeans appear to beas suiplus

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NATO Europe: Energy IVpcodenee on Iht0 *

Price. While Ihe recent decline in oil prices makes the Soviet feat deal appear less aliraeiive than when i! was signed, recent reporting from C

J make ii dear thai ihe Westpurchasers are still satisfied. We believe that all the contracts are pauerned on ibe one signed by Ruhrgas or West Germany. Accordinghis contractinimum deutsche mark price for the gas. which, at3 exchange rate6 deuische marks per US dollar, works out ioer million Blu. On an energy-cquivatem basis, ihis correspondser barrel. For comparison, ai the lime of signing the price of oilod was expected lo continue rising. The contract also contains an escalator clause linked to oil prices. Although ihe link it mainly to heavy fuel oil and heating oil rather than Crude. Ihe escalator clause probably would Eo into effect only when ihe price of crude rises above ho. At that point the gas price would begin rising

above the minimum figure, in proportion tooil price increases. The purchasersassured of always gdting the gat at abelow the energyeqoivaleot priceThe recent drop In oil prices, along withof further declines, has created ansituation. II appears, however, that thea bo contain an escape clause lhatpurchasers lo pay ibe prevailing market raleshould ii drop below the minimum price forperiod. In any event, press

reports agree thai Ibe companies buying ihe gas do not seem lo be worried by the drop in ml prices.

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West European Gat Option, in the laaOt

The key mera quettlon now toeing the Westit how ihey will cater their gas needs innd beyond. Although gat consumption has declined for three consecutive years, most energy forecasters believe that ihtt trend wtll be reverted when economic recovery begins and thai consumption will Increase by one-third or more by the end of ite century. Domestic gas production meanwhile will fall substantially. In particular, production In the Netherlands will drop sharply, due to both declining fields and government policy: The Hagur warns to preserve more gas for domestic use and thus does noi plan to renew many gas export contract! ihai expire in. French gas production also will fall as its malar fields near exhaustion. All told, the Well Europeans appear to btas deficit toward the end of the century thai could equal ihe throughput ofpossibly evenexport pipelines

offers Western Europe's only hope of meeting Its additional gas needs from domestic sources.offshore reserve! are large enough, but the gai would be expensive because of the difficult operatingecond problem is the go-slow approach of the Norwegian Government, which does not want the economy to become Overly dependent on energy production The Netherlands could produce more gat inhan it now plans: if budget deficits remain la;* the Hague might be pushed In this direction. Another possible optionutchgas swap, whereby the Netherlands would step up gas output through ihend receive Norwegian gas in later years in exchange. We doubt, however, that the economics ofwap would be atiractive to The Hague. Among non-European gas sources, only Algeria seems clearly ableupply large additional amounts of gas ai reasonable cost In. Buying Algerian gas would not, however, contribute to thr West Europeans' goal cd reducing then energy dependence on OPEC. Algeria, moreover, hos so firather'"motion for rrliabilisy as an energy supplier

Outlook

Economic ties between Western Europe and ihc Soviei Bloc aie noi likely to increase substantially during lhc remainder of ibis decade. The surge in irade thai occurred in theas financed mainly by increased lending from Western banks and higher Soviet oil earnings following3 OPEC price increase; there is lilile chance ihat either of these events will be repeated. The banks clearly do not want to increase their exposure io Eastern Europe, and Soviet oil exportsatt certain lo fall over the next fewmore lhan offteiiing increased earnings from gas exports via the new Siberian pipeline. Bloc exports of rawnd manufactured goods will be restrained by theof economic growth in Western Europe and by continuing high unemployment rates tu industries such as Clothing and textiles With ill access to hard currency ihus leslrictcd, the Soviet Bloc it not likely lo increase its (hare ol NATO Europe's exports much aboveercent figure iccordcdJ..

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the Wcit Buropcaiit me anaiooi inepeat ot the pipeline dispute, ihey atnicnl certainly mat be adanant on severalagree-Men on future. tc-.ir. the USSR (I) lhc burden must appeal to be shaicd evr.nly among the Westernhe mcaiures must not It applied retroactively, and.neasijees ovsti be aimed al Soviet military power, not al Ihe civilian economy Possible areat of compromise might incluilc

The second si'ond of theecond Sonet papciine "cmld be one mayeet Western Europe's projected gas shortfall in Ihc IvflOs. although there are noprospect The West Europeans noa-ld be concerned about substantially increasing their dependence on Soviet gas The gas needs, moreover, perhaps could be satisfied by some combination ofialures conservation, substitution of other facts, or cap* tided gasot may and the Netherlands Given these possibilities, lite Wett

Europeans might be willingenounce the Soviet option

Tightei COCOM rciiricsiorj We believe that tent, ttviiy to COCOM issues In Western Euiopc has inctea led over the last year or so. in pari because of evidence presented by the United Stales showing that technolofy transfeii have contributedto Soviet military improvements N'cverihe^ less, the West1 coni.nuc touch nirro-erof litean docs the United Siaici and likely will agree io only limited changes in COCOM procedures;.

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lOil particularly frurusadired inurest tales on Sown credits Paris siiU s'ronjU oppose! the eltmiaaiion of lubudies. al though there is at least some technical-level lupf't lot theiihin the Frencli Ciovcrninem. lhc West Europeans are likelyrgue, however, that formal agreement is no longer necessary became US objective? in this arcs haie already beenachieved They will point oui that private ciedit to lhc Soviet Bloc has been sharply curtailed and Ibst future official subviGiet will be much reduced by bit July's agtccnvrai vhIuh ibc OECU consensui lo raise the minimum talc ondits4 percent The subsidy issue ha- also been defused to some eaten; by lhc decline in

interest rates over ihe past year, ii -ould revive if inates tarn up agau>ssues (he West Europeans aie noi likely lo yield any ground.(l) Ihat capon credit guaranteesegitimate capon promotion device,hai the intent of Ibe OECD consensus can be satisfied by charging low noantnal ia iciest rates on opori credits and inflating ihe price of the goods to compensate

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