THE SOVIET ECONOMY AND THE SUMMIT (ER M 79-10287)

Created: 6/6/1979

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I. Tho Soviet Economy on the Evo of tho Summit

Tho long-term outlook for tho Soviet economy remains blank, and the disappointing performance over the last six months has furthorj driven home to the leadership the fact that rising resource costs, impending energy and labor shortages, and sluggish productivity cannot be overcome easily or soon. Tho winterearly brought economic growthtandstill; raising demand for energy while at the sane time making energy and other raw materials more difficult to prodoce and distribute

Outlook

On balance, the short-term outlook for the economy is gloomy. Poor industrial performance9 will impede the investment programs that underlie Moscow's efforts to turn the economy around. Investment growth will be harder to achieve9 because of shortfalls in construction materials, machinery, and ferrous metals. This, in turn, will hinder efforts to accelerate additions of new Industrial capacity, setting back Moacow'.'s proqram to modernize the economy's stock of plant and equipment

Moro important', longer-term prospects are worse. Our forecasts on energy! production seem to bo holding true. The USSR's oil industry}is likv.lyo-growth stage

ollowed;;by staad> production declines in theWast Siberia, which accounted forlmore than two-fifths of Soviet:oilrproductions the key to oil prospects for .Ithe .foreseeable future because risinc output in this region' is^currently orxsecting progressivelyisteep declines in tha remainder of the USSR. West Siberia; however, faces serious difficultiesrobable decline in output

in the Enpccially significant Is the anticipated

drop in oil production at the super-giant Samotlor oilfield. We baliovo thatoderate decline in West Siberian production would leadharp drop in national production.

Soviet officials also acknowledge the challenge to policy

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implicit In tho adverse demographic trends expected In. The natural:increase in the working-age population will drop off toor year by the Moreover, from inow until the lateto tho labor forco will coma almost exclusively from tho less-skilled and less-mobile Turk.'c populations of Central Asia and tho Transcaucus republics. But most of the growth in energy and raw material supplies, especially energy, is occurring east of the Urals, while most industrial capacity is still in the European areas of the USSR.

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Ine critical policy issue will bo the ccntntiT-ion ior investment/entral Asia, where most of the growth in labor will occur, iberia, whoro the infrastructure and industrial facilities noeded to exploit energy and other raw materials are sorely lacking, the European USSR, which is labor short and raw materials and energy poor but whoro invostment can be carried out more cheaply by modernizing and expanding existing facilities rather than by building plants from the ground up. In any case. Central Asian and Siberian development will preempt an increasing share of total investment, while the giowth of total investment continues to decline.

The impact of impending resource constraints on the USSR's economic growth cannot behe Soviets arc no more successful than in the past in using labor, capital, and natural rosources more efficiently. Although tho leadership recognizes the need for change, the Soviet system is not designed to

change easily. Tho foundations of the system

directive plar.ning, central allocation of resources, ndiiiinis-

tratlvely-ant prices, and incentives oriented toward quantitative

production goalsdiscourage innovation and encourage redundancy

and waste in the use of resources. Thus, productivity

gains fromabor and capital aro lov and havs

slumped in, Rising costs of extracting,

processing, and delivering raw materials, together with slower

growth of fixed capitalebound in productivity unlikely

undor tho present system.

Meanwhile agriculture,ajor" ecoTfom.'c headache

for the Soviet leadership. Although Sovio; farm production

has clit'bed well abovo the levelecade ago, severe

shortages of meat end quality food persist. Some of tho rise

in farm outputassive infusion of investment,

but relatively good weather has been responsible for roughly

half of the incroaso in grain production between the early

nd the. This situation could change in the

f weather conditions become more normalthat is,

harsher. While the outlook, for agricultural production is

uncertain at best, consumer incomes and expectations will

continue to rise and with them the demand for more and hotter

quality food. Soviet leaders will probably have to continue

buying large quantities of grain and other agricultural products On balance we expect growtho continue to slowaveraging

ercent per year for the next few years and then dropping to little

moreercent in theecame of incrcasitg energy and

constrainti.

Economic Policy Choices Faced with those prospects. President Brezhnev and his colleagues must cone to grips with hard choices over resource allocation in the very near future. Fundamental policymust be taken over the next year as the economic plans being formulated and as measures looking forwora0 aio upprovad. Those decisions are further complicated by the necessity to consider the future needs and potential of the East European client states, whose dependence on the

USSR tor enerqv and other raw materials is likely to-tkj- it fa

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So far Ch^ro io no ev|acnce wine the Sovieu leadership has settledong-term strategy for coping with its economic dilemmao. Instead, it has been temporizing on policy decisions; reacting rather than redressing; Arg-^aients ever allocation decisions and management of the economy reveal conflicting claims and divided advice at the middle levels of government, and caution verging on immobility in the Politburo.

II. Impact of Economic Problems on Arms Limitation and SovIeT Defense Spending

The Soviet Attitude Toward Defense Spending

President Brezhnev and Premier Kosygin have frequently

alluded to the woight of the arms burden on the economy, and

the Soviets obviously recognize that high levels of defense

spending impoie serious economic costsnotably In investment,

but also in consumption. Although Brezhnev is likely to

deplore these costs at the summit, the perceived benefits

derived from military spending have made Soviet leaders loss -

resentful than we are of high defense budgets, and more willing

so fare the economic tradeoff- They accept the economic

sacrlfico because they believe it does in fact enhance Soviet

military security. They also accept it because tho achievement

of substantial military gainsis the USoundation for dema-d

ing acceptance of all tho Othur claims of superpowerstatus,

and for projecting Sovlat influence across tho globe- They

realize that the Soviet Union's rolereat power has ito origin far more in military might than in economic efficiency or in tha attractiveness of the Soviet political model. Nonetheless, the deteriorating economic situation

could well lead the Politburo toew balance between tho

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economic costs and!political benefits of continuing growthof the Soviet Arms Buildup

If the Soviets follow through fully on programs now in train, overall defense outlayswhich presentlyercont of GNPwould continue to riseate ofpercent annually through thoven if SALT II enters into force. esult, growth in defense spending would far exceed growth In GNPualitative factors alone will tend to push Soviet defense spending up in, especially the requirement for high technology solutions to current force deficiencies and future US threats. High technology weapons systems projected forill be particularly costly. Advanced aerodynamic weapons, high technology ulectronicsespecially sophisticated radars, submarine detection and communications systemsnd advanced nuclear woapons doslgna will accountarge share of procurement expenditures. Theseogether with continued rapid growth in RDTtEill shape tho trend of total defense expenditures

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Decisions regarding military programs now In train were reached soma time ago and probably could be altered only at the marginperhaps by stretching out and some selective pruning if mounting economic pressures forced action on this front. However, decisions made from now on, which will affect resource allocations for defense in the mid-to-late eighties, may show greater concern for the military drain on the economy.

From tho economic standpoint, the importance of SALT II to the Soviets therefore lies not in immediate savings, which are small in relation to the total level of military spending, but in future cost avoidance that SALT II makes politically conceivable. Ratification of the SALT II Treaty by the Senate would make it easier for Soviet leaders Inclined to do so to argue that the danger from the West has slackened and that more resources can be directed to meet civilian economic needs. Such an argument would also come into play in justifying further arms limitation initiativesfor example SALT II or MBFR.

SALT II and followup arms talks would alsoolitical bafiis for advocatingand obtainingan expansion of trade tics withWest. Given the present state of the economy, Soviet leaders may see theiru militaryest servedolicy oi" increasing commercial relations with the West and encouraging an influx of Western

machinery anddvanced Western equipment and technology Imported by tho USSR often haa both civilian and military-related applications,reater flow of such technology inevitably helps milltary-rolatod production. The flow of technology! already!touches sensitive areas in tho computer and electronics fields. Warmer relations, especially with the US, would;nleo encourage the West to grant more credits

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on better terms to!tho USSR in, when we expect an economic crunch. ime such credits wouldelcome Inflow of resources, whichhoweverwould have to be repaid by an excess of Soviet exports overrobably in.

III. Impact of Economic rroblems on Trade with the West

In-the, the Soviet leadershipconfronted with rising hard-currency debt, difficulties in assimilatingechnology, and perhaps some domestic opposition to squandering tho national patrimony seems to haveoro cautious attitudo toward commercial relations with tho West. They have learnod that even under detente Western governments cannothoir private sectors to increased trade with tho USSR. In addition, the cyclical behavior of Western markets his made export planning difficult, and Soviet manufactured goods havo raado little headway in these markots. Tho conservative stance toward trade takenrobably will yield in, however,olicy of exploiting East-fcest trade for all possible help In surmounting domcatic economic problems,C

and governments consider the Soviot Union tooodand bank liquidity is*high. As domestic oiloff,il oxports for hard cjrrency arefall as Moscow balances the requirements of Easternthe growing reeds of the Soviet economy. Wetho^ USSR will have to import Western oiletthehift that will encroach onto buy grain and Import Western machinery andj

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Thus, tho expected economic slowdown, ind the energy situation iraXe commercial and scientific relations with the West all

tho rooro valuable ,to the USSR. Firat of all, the USSR will need imports from 'the West to deal with pdrticular domestic shortfalls:

The leadoi'.ip's polioy of improving the consumer

diet ia ^expected to require betweenillion and

illion tons of imported grain annually for the next soveral years.

do nothe Soviets to overcome rapidly tho difficulties in steal production that hava lod

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to large purchases of Western steel products in

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recent years. In particular, planned Soviet natural

gas and oil pipeline construction will require

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.impofcts of Western large diameter pipe.

y the USSR probably will have to

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spend hard currency to import oilmainly for

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Eastern

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Because of tlio prospective'decline ,in Soviet oil .I

the impetus to obtain assistai.ee in energy exploration and

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development will be especially strong. Meanwhile the importance of boosting productivity throughout the economy, probably will lead Moscow to seek additional Western technology and equipmentroad range of sectors. But, Soviet imports will be held down by the competition with oil and grain for available hard currency. Under these circumstances, maintenance and expansion of Soviet trade with the developed West will depend increasingly its success in negotiating compensation agreements with Western firms so as to assure an expansion of exportsts willingness and ability to increase markedly Soviet raedium-and long-term dobt to the West.

Role of the

Although the USSR can find most of the equipment, and creditsit needs in Western Europe and Japan,

Soviet policymakers; stilligh regard for US technology

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and believe that the US market has the potential to absorb

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substantial amountsj of Soviet exports. Moscow seeks,toustained and secure trading relationshipUS.complemented by unhampered access to long-term

The USSR views US participation in Soviet projects as highly desirable .'or several reasons. US firms are often uniquely suited to provide the technology, equipment and services needed for- the large projects envisioned by the USSR. This is particularly true in the field of energy exploration and development. Only tho US at the momentompletely Integrated petroleum industry that can provide the necessary engineering know-how, experience, equipment, services, andperhaps most the capital to putomplete technology packagecale which can benefit the Soviet

petroleum industry.. Given current Soviet economic and energy

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problems, Moscow may well view this as an opportune timeroad technical assistance program between the US and the USSR in which US firms would become more actively involved in Soviet oil exploration and production and other large-scale energy development projects. US firms for their part, are likely to become increasingly Interested in such participation as the world oil supplies tighten.

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VI. Thesumn.^

:hat the

General Objective. !The leadership in approaching the

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summit -would undoubtedly'like to encourage a

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dialogue with tho US government that would lead over time

redictable* sustained, and growing economic It would like to be able to count on tho par^lcipa-tton of tho US private1 sector as if formulates Its economic plansnd bey'o.xd; it believes such participation couldifference in how the USSR copes with its economic problems in.

Repeal of Jackson-Vanik and Granting of Host-Favored-Natiori Status. In economic terms, the most immediate hoped-for gainepeal {or dependable waiver) of Jackson-Vanik would be access to government-backed credits. Passage of the Stevenson Amendment to Exim-bank legislation limiting credits to the USSRear0 million over four yearn (without Congressional approval) was probably more important than the Jackson-Vanik Amendment in loading the Soviets in5 to disavow the trade agreement roochod with the Nixon Administration. Moscow could hope for large-scale credits only If Stevensonrestrictions are eased substantially.

Although the Soviets renliir MFN is unlikely to lead Lo any short-term direct economic gain, Moscow undoubtedly

t. would improve the long-terraiprospe-cts foi1 manu-

factured goods exporta to tho United States. Indirectly, the receipt of MFN would be of value to the exteiit that it

signifies'an-improved economic climate and encourages US

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firms to enter into negotiations with tho USSR.

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Credits. inimum, the USSR would like assurances that it can count on substantial US government-backedover the next five years. Currently, Western credit lines which have been made available to the USSR aretho availability of US credits would thus not

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necessarilyise in overall Soviet purchases under credits but would enable:the USSR to divert some of itshases to tho United States.

1 ; rade Agreement. According to tho Trade Act

trade agreement'must be signed before MFN may bo extended to any

given country. The Soviets would consequently almost certainly

like to' conclude an updated version of2 trade pact, which

inimumaddress the MFN and credit issuos.

A Long-terra Cooperation Agreement. The Soviets would

.probably like to set the groundworkore comprehensive

| US government involvement in trade issues. Aside from obtain-

ing credits and MFN, Moscow would probably like to conclude

an overall cooperation agreement similar to the trads and

cooperation pacta it has signed elsewhere in the West.

Renewed Grain Agreement. If grain issues ara not resolved in tho bilateral

,' talks on this aubjoct scheduled at tho end of May in Moscow,

the topic might arise at tho summit. The Soviets

might ask thato raisa tho purchase limits stipulated by

the grain agreementaillion ton coiling in the

next Long Term Agreement.Tear.

Technologyho Soviets clearly desire tneof present controls on the export of petroleum technology and equipment. President Brezhnev might stress the importance for detente of continuation of the bilateral exchanges on science

and technology. Tho major issue outstanding at tho moment is

renewal of the energy agreement, which comes up for resolution

oint Commission meeting in June. The OS has proposed a

three-year renewal, while tho Sovietsull five-year

tons. The access to US work in the energy field provided by

the agreement is highly valued by Soviet scientific leaders and

energy administrators.

Restraints in Military Spending. Ai.ong with apprehension

over US advances in military technologyesire to restrain

NATO modernization, economic constraints

. may induce President Brezhnev to offer new proposals

for expediting ongoing arms negotiations or speeding up

SALT III. On the other hand, if Brezhnev tables only a

variant of earlier Soviet proposalsutual reduction

of military budgets, this should not bo seeneflection

of Soviet economic difficulties orerious arms control

measure. Previous proposals of this sort have not provided

for verification, and the Soviets arc aware of US objections

to them.

What the Soviets Will Pay At tho present juncturo, economic difficulties will not forco the Soviet leaders to make significant concessions

to the United states in areas considered by Lnem to be central to the USSR's economic, political, and military security interests, or to its global great powerhe debate on the Soviet side in likely to:be over concessions at the margin, largely economic but partly political and military. Here it is probable that the leadership is divided on how for to go. Accordingecent account by C

tJie subject of expanded trade with

the DS had been discussed "seven times" by the Politburo, with members split over the issue of assisting the US Administration in resolving the problems posed by the JacksoQ-Vanik Amendment.

was ordered by

tho Politburo to attend tho recent US-USSR Dartmouthin order to Inform the leadership of any new developments in the trade field

Perceptions of Leverage. The Soviets probably feel that theyubstantial capacity to resist USin the economic sphere, and that this capacity will permit them to minimize any non-economic concessions we might demand at Vienna in return for greater access to US technology, goods, and credits- Theyh justification, that their import needs with the exception of grain and to some extent petroleum equipmenton if necessary be largely satisfied outside the United States.

The Soviets also see certain political forceb within

tho DS working in thoir favor. They oro fully aware of the

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r^bstacloB that; constrain: OS manipulation of. grain exports

for political ends. 'They think, not without reason, that

thoy can count on considerable pressure from OS business

elaxation; of trade constraint. And in

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Washington they observe that Congress end the Adminlstra-

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tionctively; interested in resolving the issues

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of MFN and credits.

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"Good Behf.vior" in the_Thlrd World. On the basis of experience to date, the Soviets have no good reason to bolievc that what they do in Africa, the Middle East, or elnewhere in tho|Third World significantly affects' their economic relations with Western industrialized nations other than the US, and they must suriously doubt whother it even has any lasting impact on economic ties with the

US. Tho Soviets!count upon tho need of Western countries for thoir business, and competition among these countries, to counter any tendency toward collective Western attempts to use trade to inhibit an aggressive Soviet foreign policy in Third World countries. What inhibitions there raoy_be in promoting Soviet objectives in those regions ariso more from political and military than economic considerations.

Civil Riqnco.

rrutb President Brezhnev's standpoint the

emigration;decision;eal concession to to, Americannd it is!doubtful whether he will" be

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muchifurthiarj down this,t is highly unlikely that President Brezhnev-would ox, could provide any assurance

written orhat: could!be seen to link Soviet emigration

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policy and trad^.;

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indicated, however, that; President Brezhnev would be receptive

to on approach that treated emigration and trade as quite seperatc

agenda items. seem; to suggest that President Carter could

raise the emigration issue in the contextuestion about

Soviet viaws on implementation of the Helsinki accords. which

would give President Brezhnev an opening to observe that Soviet

emigration policy was in line with Helsinki, that large numbers

of people were currently emigrating, ond that this level cf

emigration would be maintained in the future provided that there

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were sufficiento maintain the flow. This statement

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would provide the assurance President Carter needed, without a

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politically unacceptable explicit obligation on the Soviet side.

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Following such an exchangej the trade issue could be treated completely on its own, Vith no reference to emigration.

The Soviets probably will notresidential finding that they.are in compliance with Jackson-Vanik, if this

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finding ana ccuaresslonal-octi-jn on it are presented in

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temperate terms and as .discretely as possibleperhaps in

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tandem with authorisation of MFN for China. aiver or

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repeal of Jackson-Vanik is Inot forthcoming or is not'followed

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by guaranteed largo and continuing credits, then theiincentive

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to permit continued large-scale emigration would be reduced.

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A grant of MFN to I'China but: not :the USSR would reinfdrco tho

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Soviet's worst suspicions of usinimumevoke a' forcoful denunciation and demonstrative cutbacks of contracts

wherever possiblei

Economic Concessions. President Brezhnev will almost

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certainly dwell upon 'the bright prospects for compensation deals, and is unlikely to raise the question of forms of US participation inside the USSR that involve equity, production sharing, or even quality control. However, what ho would say.if pressed on those issues is uncertain. Lenin himself encouraged concessionary deals when tho young

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Sovlot economy was in sorious trouble, and thore wore many of them inPoland and Hungary (not to mention Romania and Yugoslavia);today permit equity participation

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in their economics by' Hestorn firms, such as Volvo in Hungarypresumably with Soviet acquiosconco. More flexi-bllity in this matter could bo very beneficial to the

Soviets, especially in offshore oil exploration and dovolop-

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mont and in the onorgy field in general. There is.otmg

evidence that some Soviet officials wouldofter

line here, although the issue is controversial.

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