BRIEFING BOOK FOR SECRETARY OF LABOR W. J. USARY, JR., FOR THE J

Created: 5/1/1976

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ITALY: THE POLITICAL-ECONOMIC SCENE IN8

Currrot Political Dynamics

Italian political leaders are preoccupied with one overriding iac* at ttcy prepare for the seventh postwar ptruameolary election onune; for the first time the Communistseal chance to replace the Christianargest party and tohare of power at the rutiocal level

The air of uncertainty characterizing the current Itallw poHtical scene Li traceable to the unprecedented gains scored by the Communist Party ba nationwide focal clcctiorts last June. By comingercentage points of the CVisrtan Democrats, tbe Communistsrocess that they and Ibeir opponents thought would take years. Had tbe Communists gained in June at the same average rate as in previous local aod national elections, the party would not have achieved its presentn the regionalntil the.

Tba time stolen by tbe Communal surge thus deprived Itihan politiciansuxury to which they had become accustomed over the yean: tbe freedom to postpone difficult political decisions. The possibility that tbe Communists win emerge from ths parliamentary election as Italy'a largest party brings Italian political leaders face to faceroblem they assumed could bo deferred. Tha resulting -'It to settle on policies to deal with the Communists hu deepened divisions among and within the DOn-Conununist parties. National congresses held Last month by tho Christian Democrats and the Socialists did little to improve the situation.

Period of Tunritton

ore general sense. Communist gains have pushed the Itihan political system out of oneyear period of rule by four center-left parties -and into another, in which the political rules ara not yet dearly defined. The system has experiencedhift twice before in the postwar period:hen the expulsion of the Communisti from tho government ushered bt moreecade of conservative centrist coalitions, andbui the admission of the Socialiiti to the government initiated the center-left cabinets that were the rule until this year.

The transition that is taking place now diffen fundamentally, however, from the previous ones. The Christian Democrats' dominant positionsacrosanct during both the centrist and center-left coalitions under serious challenge

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the flnt time. The underlying theme of the Socialist congress last month was the party's determination to ensure that the next government, whatever form ft takes, is not based on Christum Democratic hegemony. Tha center-left formula -Christian Democrats, Socialists, Social Democrats, ands seen by the Socialists as tbe Christian Democrats' means of maintaining dominance tnd thus was declared "finished and buried" by the Socialist congress.

TU Socklnt Alternative*

The Sees Ha prescription for the future has not been cut in categorical terms but, rather, is designed to keep the party's remaining options open. For the near term, the Socialists have declared their willingness to enter another government with the Christian Democrats. Tbey have made ft clear, however, that they would Insist on government influence commensurate with their pivotal rote in assuring the Christianoo-Communist majority In parliamentaryractice, this would mean more important cabinet po.tsarger say in the formulation of policy, particularly ia the eccooeaic field. In brief, the Socialists want the Christian Deinocrats to treat them as political equals, even if it means dropping the Social Democrats and Republicans from the coalition.

The Socialists also have refused to participate in any government that excludes Communist supportatter of principle, as ail governments havehe Socialists are not pushing for Communist membership In tbc government; rather, they are trying to Tons the Christian Democrats to abandon the practice of seeJtiag behind-the-scenes support from the Communists while professing opposition to them in public The Socialists want these ccosututkns brought out into the open io order to pin some responsibility for gowrnment actions on the Co mounds. Otherwise, the Socialists are convinced that their own role will gradually shrink and that Communist chief Berlinguer win be able to by the groundwork for tho alliance that he wants with the Christianhe to-called "historicbe Socblhts are likely to call for an arrangement that would Involve open Communist participation in the formulation of government programs and, in effect, make tbe Communists part of the governing parliamentary majority.

The Socialists abo have made it punh that they set any future cabinet cooperation with the Christian Democratic Partyere stop along the way to the ultimate Socialistoalition of leftist forces, including the Communists, that would replace tht Christian Democrats is the major politicalSocialist chief Deresenting the leftist litems tireistant possibility, rioting

thai it would not be feasible until the Socialist!'had pined enoughheyasto minimize the risk of domination by the Communists. In addition, De Martino says that the Communists would have to cut their last ties to Moscow. The left Is, moreover, still fararliamentary majority, although an eventual Communist-SocMst majorityore realistic possibility

The heavy stress that Delacing on Use bftisf altenutrve reflects notssni io keep the parry's options open but also his recognition lhat most of the Socialist rank and file stand to the left of the national leadership. The rankit appear on the whole to be ready to cooperate with the Communists now at the national level; they are already doing sof theegions and In most major cities.

Divided Christian Democrats

The Christian Democratic congress revealed that thenited in its desireew alliance with the Socialists but still deeply divided over how to deal with the Communists.

The voteew party leader showed the delegates split almost evenly into two groups. Party leader Zaccagnini was narrowly reelectedoalition drawn largely from the left The rest of the delegates, mainly center-right in orientation, supported Defense Minister Forlani

The differences between the two groups flow mainly from their positions on the Communbt question. Both oppose Communist entry Into the government, but Zaccagnini's supporters gene-ally see continued confrontation with the Communbt Partyounterproductive strategy. They want toialogue that would cast the differences between the two parties more in terms of bread-and-butter issues than ideology and possibly lead co com promises on major questions. Those who backed Forlani argue thatolicy would amountoftening of the Christian Democrats' traditional opposition to the Communists and would ultimately make it more difficult to keep them out of the government.

The narrowness of Zaecagnsni'i victory means that he will probably have trouble implementing bis desi'i toialogue. aUccagnini's majority in tbe nationalhe party's chief deliberativelimmer than that of any recent party leader. He will probably have to make substantJaJ concessions lo the center-right group that opposed him.

longstanding "hatone compromise" preposal, which callsommunist-Christian Democratic alliance, in favorroader grouping. Apparently hoping to avoid frightening uncommitted or wavering voters, he has proposed creation, after the election, of an emergency government (hat would include all parties except the neo fascists.

A CoBaga of Economic Troubles

Political impasse has added to Italy's worst postwar economic plight. In the past few years, the economy has srruggkd lo adaptarge redistribution of income favoring laoor and to higher energy prices. The government, in hxreasing disarray, dealt in stopgap measures and did utile to help the adjustmentutt, price increases consistently haw outpaced those in most oifaer major industml countries, and the belief has persisted that the current account deficit would btos-om anew when economic recovery took place. With the economic outlook already shaky, the political crisis thai led to the fail of the Moro government in January spawned anxiety in financial circles and ledun on the lira.

The Lira in Trouble

Tolunge in the value of the lira in the face of massive capital outflowi, the Bank of Italy spent nearly SI billion In the six weeks before it stopped intervening ooanuary. By then, reserves were downare minimum, and the speculative attack showed no Ogn of ebbing. During the neat six weeks, no official quotations were griTS,

Roma used the suspension period to impose sweeping new monetary RgulatLons and formulate an economic stabilization program to prop up The lira. Higher bank reserve requirements were adopted to limit monetary growth, ard curbs on export credit were imposed. These measures are designed to syphon off SI billion in domestic liquidity and limit the growth of creditess than the expected rate of inflation. Tha government also espoused greater fiscal responsibility in the public sectoratered down incomes policy.

The lin rievertheless has continued to be in troubio since the Bank of Italy resumed official quotationsarch. In the first week of trading. Romeillion to support the lira, reducing by about one-third its remaining foreign exchange res-eves. Even so, the lira continued to fail,ower US do Oar oaarch. The announcement of more austerityew days later gave thesychological boost; but that respite was short lived. With the resignation of the Moro government and the scheduling of early elections, the lira resumed its downward course, dropping to the astounding lowgainst the dollar in cany May.

To prop up Us crOcing currency before the ejections. Rome imposeday an import deposit plan, an export financing scheme, and additional currency controls. The import deposit plan requires importers and othersoreign exchange to deposit half the value of their foreign purchases in aoointerejt bearing account! at the central bank for three months. Imports financed by external borrowing are exempt from this deposit requirement. This restriction, besides discharging the outflow of foreign exchange, should sop up domestic liquidity and help reduce the money supply. The blocking of funds onajor scale wul exert further pressure on bank interestlready at IS* andnd increase the financing problems of small businessmen.

To increase the inflow of foreign exchange, Rome has imposed additional export financing rules and currency controls. Exporters are now required tof the value of any export credit in foreign currencies. Furthermore, an foreign currency receipts must be converted Into are within seven days of acquisition. Tbe Bank of Italy has abo probibited short-term Bra loans to foreign banksay of sternming speculation.

The lira rebounded after the imposition of these latest measures. It is now hove ring atgainst tbe US dollar. Since mid-January, the trade-weighted exchange rate of the bra has depreciated.

Setback in Trade Accounts

The latesthe lira have been precipitated not only by political anxiety but also by bad news on the trade front. Past devaluations have driven up import prices, and numerous businessmen have used the trade account to hide capital flight by padding import invoices. Tbe first quarter trade deficit this year3 million (seasonallyontrasts sharply9 million surplus in

Italy: .Selected Economic Indicators

Production Indoa:sionaltr

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Prices ind Wages

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Tba recent deteriorarioa In the trade account!eriod of remarkable approvement li Italy's foreign iocouadl Declining domestic demand and Improved terms of trade enabled Roma to shift from anuuon trade deficit4 to oear-equiLorfamS. Behind the overall improvementraaallc shift ta Italy's non-oil tradeaboo trade deficit46 WDioo surplusS. Italy's od toil deficit registeredoderate Ircjtovement over6 billion Incurredn current account, Italy's surplus was0 millionompareduuon deficit

Underlying the Lira's Decline

Tha root cause of the bra'staly's severe and persistent taflarjon. Even In tbe midst of Italy's deepest postwar recession, consumer prices climbed annflatkm. in turn, has its roots in the massive power of Italian libor and the jweQtai of government Indebtedness.

A key factor bt inflation has been skyrocketing unit labor costs, which reflect increased muscle in tha labor unionecent yean.nit labor costs haveht highest rate among maior industrial eouotiie* (sea Utaith. Urgesecurity coetributioas and generous fringe benefits addingents to each dollar paid ta wages. Italian unit labor costs are now among the highest bt Wntero Europe,

As Italian labor unions have become increasingly powerful ia, they have learned to work together for common economic and social gosh.he three major unions have been linkedoosejy organized federation, which acts as then common bargaining agent.

Together, the unions hare pushed through sharp waga hikes for their members, gains which have soused over Into noo unionized sectors. Asastvd by automatic escalator clauses to compensate for price increases, real industrial wages have risen anhb ranks as the steepest rise among industrial oountries except for Japan, whkh began ths decade with the lowest wage costs among the Big Seven. Even recession did not quell the unions' ability to win hefty pay hikes. In last year's depressed labor market they managed toncrease in nominal wages, leadingonsiderable jump in real purchasing power. Kir^-srze rises in the money wages of public employees helped swell an already sizable tpvemment deficit.

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Tba frequent strikes employed to enforot union demands hrre been carefully orchestrated to rruutmize production disruptioai while niruniixiag woncttme lost. Production costs have suffered ta tba process because employers are unable to scale down operating expenses. Increased absenteeismhen the internment pnsaed kgjsiation miking It Ilk pi for employers to require proof ofas cut Into productivity growth. Labor disruption? combined with the recessioe-kd dropoff fat capacity utilization to force an actual decline ta productivity last year.

In Um loag run. Rome cannot hope to come to grips with Its inflation probkms unless otalkasteps are taken to leak down the level of its own debts.he Treasury borrowing requirements* of CNP, the highest ratio in the major developed countries. Ia recent years, the debt burden has increased markedly.he Treasury's cash deficit stoolllCon, doubk that of the year before, ind represented IS* of CNP.

Sinca most of theinanced by mcoey creatioa, the government debt hasontinuous source of excess liquidity. Last year, about half the deficit was financed by expanding the monetary base. These Treasury financing requirements have thwarted attempts by tbe Bank of Italy to bring liquidity growth under control. During theonths ending in October, growth of the monetary base, compared with in avenge growth rata

Output and Unemployment

Because of iiuTitiooary expectancies and political uncertainties economic recovery has lagged three to six months behind upswinp In many other large Industrial countries. Indeed, consumer and investor confideocQ hive been so low that even Last August's aghaanoedjatternpt atgainst the advice of the Bank of Italy and theerely added to the coafunoo. Nonetheless, with some help from export sales, asdusfrial production is rising once again. After% last year, output hasseasonally adjusted) since December.

On the demand side, fixed investment remains severely depressed,echhe last year. Business pessimism, squeezed profits, substantial spare capacity, and tight credit in the face of weak demand ensure another drop this year. The sharp fourth-quarter mcretse in imports aim oat certainly reflected antidpatloo of lira depreciation rather than stronger demand; Imports fell off again inth job uncertainties stuj high, consumer demand remains weak -after%S. Exports are the brightest spot oa the horizon. They

began picking up in second5 nd should improve over the course6 ii tb* affect) of lira depredation an felt and demand in major marketsba Umled States, France, and West Germany improves. Overall, GNP, after%kery tottlo growth thb year.

Unemployment continues to creep up, addmg to labor union tensions. Because union strength hu mada it difficult for employers to by ofT workers, unemployment officially Isowever, the total number of workers employed less than full rime% of tha Ubor force. Little, If any, improvement inxpected thb year. Bacasaw^ibjodifTkall torr-slibor. ItiLtri employers are"meretatdng

Tbt FoHtkaJ Srrangsebotd on Erooomfc PoBcy

Attempts to srappk with Italy's irduuionary spiral have been bamstrung by the ccculicring policy goab of tbe center-left political parties.inority position, the bar Christian Dernocntic aoreraraent of Aldo Moro needed support, or al bast abstention, from the Socialists and the Republicans lo pass corrective kgbhlion. The Socialists, fearing vole losses to the Communists, would not challenge the union, or support bgbUtion cutting into workers' earnings. At the other extreme, the Rapubucans are rigid advocates of government fiscal responsibility.esult, policy measures were barely half-way houses to socrmg Italy's problems.

A stabilization program proposed carry thb year attempted to reduce public borrowing requirements through improved revenue cofJection, curbs on public spending, and rate adjustments for public utibties. The programatered-down incomes pebey, whkh would freeze salaries of mdosrria] workers earning0 and withhold waga axreases for high-level government employees. Thb program^whicb* apparently never emerged from parbament,!rrombes to improve tax coDections and' curb spending have rarely materialized In lhe past; the weak incomes policy would have coveredillion persons.

More promising, at least in terms of reducing the government's massive borrowing needs, are the tax hikes announced in mid-March. Already in effect by decree lawise in the gasoline lax. an increase in the sales tax on tutor,ise ia the tax on interest from bank income. These measures are

supposed ro cut oil importi tad adduTJon to government% of] Treasury borrowing require meat. Tbc Rank of Italy also tipped the dbceuntercentage, the highest in Europe. Thb btter measure was staph/ one or many mores th* central bank has taken to reduce capital flight and sop up excess liquidity at home.

Weak as theyaie* the austerity moves quickly inspired adverse reaction.0 Alfa Romeo auto workers struck for two hours in protest,eneral strike was held onarch. Meanwhile, the Communist Party made capital out of the measures. Communist editorials deplored the new tax increases because they 'hit the lower classes" aod the rise in tbe bank ratj because it 'creates unbearable cofsditJoca for small- and medium-tiled Gran."

As elections ipproach. the Communisttensifying efforts to present Itself as the only alternative to continuing economic crises In Italy. Party fiscal reforms call for ceilings on central government and state agency budget expenditures and the decentn Uiitkm of spendingevamping of the tax system -higher rates on upper Incomes and tougher measures to curblso recommended. In regard to trade policy, the Communists suggest petitioning tbe EC for escape dame authority to establish import quotas and support the resnstaltaeat of the Import ckposit scheme. To reduce Import reliance, party ecoac^usts urgeof domesticspecially meat production. The party rejects wags cog (rob of any kind aad stresses the need for greater union participation in planning tuvnesi investment

etback; Tradeeterioration

The new government willroublesome economic situation. Inflation, whichas acceleratednnual rate as the past devaluation of the lira has boosted costs for imported fuels tnd foods. Imports an equivalent bt value to about coe-third of GNP. Without some check on unions, wage pressures wul add further push to prices. The metalworkers' contract, promising wage bakes in excesshb year, probably wul serverecedent for remaining wage settlementsillion workers; productivity gains are expected to be minima] because of low capacity utibration and intermittent strike activity. Moreover, even tbe slight pickup in demand expected will probably encourage producers to Improve their severely depressed profit margins.

While lira depreciation has restored the competittveness of Italian exports3 levels, its short-term effect will be to worsen Ihe trade account by raisicg

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Import prion. If Im port an cm ream necessary financing, the deposit plan it likely to hirenited effect on trading patterns. Its low carrying- charges will boost prices of foreign goods only rrurpnally. Imports from the US would be less affected than others became wheatubilant Lxl share of Italian Ua ports from there exempt. The trade deficit could deteriorate froca about MOO million last year to S3 buncoith act services ruruasg dose toS kveL the current account deficit could amount to S2 bUboo thb year.

One of the country's biggest economic headaches throughout tbe year will be finding adequate financial support to cover the current account deficit, repayment of past debt, and sporadic bunts of capital fhghl. Because of the vagaries of capital flight,ifficult to gauge6 borrowing needs. Foreign indebtedness now totalsuoon; thb year alone,cheduled toillion in interest and principle. Currency reserves cannot exceed S2 biHion. So far, Rome has reborrowed the SSOO mflbon previously repaid2 'ban from West Germany, drawn SSOO milhoo3 baboo swap arrartgemcot with the US federal Reserve System, tnd intends to0 million more on thb swap arrangement. Rome has received SI billion in medium-term credits from the ECuthorized to0 million0hort-term credit from tbe EC and Bank for International Settlements, respectively. Italy hopes to0 million from tho IMF under the new credit arrengcrDtnu establishedrifle* j

ITALY: ECONOMIC POLICY OF COfHMUNlST PARTY

The Italian Commuaart Party haa ntemafJed efforu to cootBoo to ten that It) perticspatlon in policy formularies iaor economic stability In antkipotion of lha national electiocs now scheduledune, economic proposals by Party experts bjgery center oa Donooctriaairs solutions to Italy's immediate problems. Manyl^T* proposals, particularfy In the fiscal area, conform closely to those advocated by varioua center-left parties. The Commuaiit programarefully contrived to serve the goals of Party setf-totcrest, protection of worker income, aad lessened economic dependence on the West

Theuch more vague abci hs bnger term economic goals. Enrico Bcrhnguer, Party chbf, promises to push Italyystem of "democraticow this form of market svxaabsm would actually work has never been cieariy defined by tha Party.

Emergency Pruposah

The Ccmmunbts see balance-of-payments equiuoriura as tha most maaedbte goal To relieve pressure on the bra, the Party recommends tighter controb over capital exports and over Import payments. The Party urges petitioning thefor escape clause authority to establish import quotas for horary items and cabs for revival of the import deposit scheme used to contain the externalf coDSunapUoQ of imported goods must be curbed, tbe Cocamunists view rationing as more equitable than adjustments via the price rnccnanbm.

Party economists generally oppose further external assistance. Italy's huge foreigneenymbol of foreign control over the Italian economy.jno, one of lhe Party's leading economic experts, has denounced foreign credits from lhe EC and the IMF as threats to Italian autonomy because they specify constraints on the growth of public spending and credit. Any Further foreign borrowing, he asserts, must come with no strings attached.

The Communists reject any type of incomes policyolution to Italy'scnt because they feel the burden of such policies fafh hrgeiy on tbe lower c'asses. Although the Party admits unit labor costs must be competitive

with those or trading rmb, wag* controls of anyflag attempts lo alter the did ing seals link between wans andm flatly snirned. According lo Peajoo, wage moderation can only come about ones greater union rautioipatiou bt business planning and investment has been established.

The Comrauniita also promise voters relief from the credit squeeze instituted to bolster tbe lira. The Party recommend* the Treasurypecial line of credit to provide financing for priority projects in agriculture, housing, energy, and the empvoymeat of youth. At th* sun* time, it recommends that financial Institutions give priority to small businesses in screening credit pnposals.

Structural Changes

Tbe Communal* see import substitution as essential to long-run improvement in Italy's external accounts. In common with many center-left economists, Eugenio Pegspo recommends the rapid expansion of domestic agriculture and maintenance or tho farm population at current levels. He particularly emphasises the need for increased meat production; foreign exchange expenditures for Imported meat are second only to those for crude ofl.

Tbe Communists go much further than most non-Communist ecoocaxastsmajor surgery for tbe Common Agriculture! Policy (CAP) or thethe Party view, tbe CAf bas served only to keep tne prices or Italianhigh- Th* Communists would restructure EC farm policy so thatbenefiting from the CAP would finance at least half of their own

The Party abo advocates soma shift in trade flows, ostensil/ly to conserve foreign exchange. In regard to Industrial goods, Peggie, urges that trade be shifted toward supposedly less expensive suppliers either in the USSR and East era Europe or asnong the developing countries. He abo recommend* barter agreements based on the East European prototype.

Streamlrnrng government operations is viewed correctly by the Communists as essential for long-term economic stability. Party resolutions recommend ceilings on central government and state agency budget expenditures, as weu as the decentralization of fiscal pro grams. Under the Utter proposal, almost ail public projects in the fields or health, education, housing, and transportation would be turned over to the regional governments for implementation. To bolster government

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revenues, the Party favors lo usher tax treatment for lha upper classes; it urges random tact cuditlng to curb evasion and accelerated collection of overdue taxes.

Democrat*: _

^According to Luciano Bares, chief of the Party economics section, Italy's present ecrxtomic system is obsolete. He expresses the view that freeiary hashe_puTars of cheap labor and aw tensive raw mttmif He claims that the collapse aTsrs, withf the labor union roovement innd with tho .energy crisis, plunged Italy into its present economic morass and signaled the inline of the market-dominated economic system. He woold nonetheless grant broad concessions to the market, if for no other reason than the oeed for continued contacts wtth"outsada market economies.

The Communists Insist that they want to move Italylanned economy through democratic processes. They are purposefully vague about their uhimate system and about ownership of the factors of production in the long run. In the short run. the Communists apparently would Like as full control of the economy as poasibU without completely aufnat'rjg private business. They reject rnassrVe narionabralion. which would quickly extinguish private enterprise; in any event the government already owns at feast one-third of Italian industry. The Communists wouldto control ui*utiuut flows through credit and tax policies, more effective manipulation of public conrpanira, and planning agreements with private companies.

EcwwrrnC planningmdustiyito serve soda] necds-V

The Communists would channel more investment Into housing, schools, hospitals, pubac rzsmsportttion, and economic development in southern Italy. They favor Ubor-mtensive investments and increased capital spending in food-processing mdustries.oanomK and labor polacy_jnartcrsi chumswould reduce duplication of-rmmufacTurin^raciBties and' badeJodustrial ,c

Erahariori

With the lessons of Chile fresh in mind, theautious not to present tooront. The Communist platform has considerable appeal to the mass

of voters, especiallyime whentill rising. Not only does the Paity appear blameless for the current economic raaltiie, but it appears toay out of Italy's economic problems that entails minimum sacrifice on tho part of labor. The Party rejects any type of wage restraint and sponsors numerous specific measures designed to curry favor with theew of obese Include

twc>prke market for gasoline to guarantee low gasoline price* for workers,

ational fund to make unemployment payments to those seeking their fint jobs, and

mtenentjon innegotiations to insure speedy contracts for workers.

the Party's professed allegiance to the EC formal adoption of several Communist proposals would run counter to Coorzuruty doctrine. Communbt demandseform of the subsidy mechanism within the CAP amount to an attack on the system itself. Proposals to control luxury Imports, reduce import cependence, and redirect trade toward the East could only be accomplished by imposing controls or providing subsidies. Such measures would threaten the most soEd achievement of thetmefy. the free flow of goods and serrices among member states.

Itaila many of the party's fiscal proposals have merit, others are dominated by self-interest- Tbe cauls for fiscal decentralization are clearly motivated by the FrcnouncejTirength.cf the Party in regional governments rather than by any clear prospect of efficiency gaksL^hOe proposing curbs on expenditures by the central government and state *ge=ciesV-the Communists say nothing about setting limits ca local government funds or local security funds, th recent years, these two- of special concern to worsen and to theave been respon-sibb for much of the rise in the total Treasury cash deficit. .The Communist proposal to move more trade toward Easternlso motivated,by self-tateseat, as the Partyornmbrion on any deals it brokers with tnese^countries.

qngagajjyjjj

The Communist goal ofpbmning" would increase government interference, especially in the credit market, and push Italy further in the directionlanned economy. The Pirtytrong state to direct industrylanning center to set economic priorities.owerful bureaucracy would be required to implement those priorities.

Original document.

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