Foreign Relations of the United States, 1977–1980, Volume III, Foreign Economic Policy

42. Memorandum From Robert Hormats of the National Security Council Staff to the President’s Assistant for National Security Affairs (Brzezinski)¹

Washington, July 8, 1977

SUBJECT

• PRC Meeting on Economic Aspects of the Schmidt Visit²

This meeting has two aspects: the first substantive, the second bureaucratic.

From a substantive point of view, it provides an excellent opportunity to ensure that (a) economic issues are put to Schmidt in a political context, and there is a consistent approach among the various officials who will be seeing Schmidt. The results of the meeting will also be incorporated in the overview memo for the President.³ At Tab A is a paper I have prepared for these discussions. It provides background on the various issues and puts them in a political context. It also identifies the specific economic problems which are likely to be discussed during the Schmidt meeting. At Tab B are papers prepared primarily by Treasury with State input, except for the paper on EC enlargement which was prepared by State.⁴ Blumenthal will lead off on most issues; Vance on EC enlargement; and Strauss on MTN.

From a procedural point of view, this meeting puts the NSC mechanism into the international economic picture on a key subject. I have prepared the background paper with this very much in mind—specifically to demonstrate the linkage between economics and politics.

Tab A⁵

Paper Prepared in the National Security Council

Washington, undated

PRC DISCUSSION ON APPROACH TO SCHMIDT ON INTERNATIONAL ECONOMIC COOPERATION

Background

A deep sense of apprehension today characterizes European economic and political life. On the economic side, this results not so much from a single dramatic crisis, although conditions have worsened in some cases, but from a prolonged period of serious difficulties and the likelihood that they will continue. The EC expects growth in 1977 to be 3% as compared to an earlier anticipated 4%, and compared to 4.5% in 1976; unemployment is 5.4 million (5.1% of working age population, roughly 6.6% in US terms); inflation remains at between 9% and 10%; investment rates are low, and savings are high.

This unsatisfactory economic climate has both contributed to, and resulted from, major political problems. Continuing economic troubles are seriously eroding popular confidence in the ability of Europe’s leaders and its economic and political systems to bring about solutions. If unabated, they risk profound changes in, and perhaps radicalization of, many of Europe’s fundamental social, political, and economic institutions. The prospects of governments with Communist participation coming to power in France and Italy are enhanced by these countries’ serious economic problems (e. g. industrial production in April down 1.6% and 3.1%, respectively). The possibility of Communist participation (which at the extreme implies a dramatic transformation of both countries from market-oriented to state-run economies) in turn contributes to a loss of economic confidence in the rest of Europe. The Germans are particularly concerned about the economic, as well as the enormous political and security, implications of Communists gaining or sharing power in either country, but particularly in France.

The Mediterranean countries face special problems. Portugal, Spain, Italy, Greece and Turkey have large current account deficits which are difficult to finance. Spain and Turkey, in particular, could, in the near future, suffer acute financial problems (inability to repay debts, the need for massive borrowings) which would disrupt their societies, further shake confidence in Northern Europe, and raise new concerns about the stability of international financial banking systems.

In Northern Europe the political problems resulting from an unsatisfactory economic situation are further complicated by a lack of popularly perceived national “purpose”. The post-war period has seen vast economic progress, particularly for Europe’s middle classes. But the ethic of “reconstruction” and “economic growth” is no longer seen as a driving force in European societies. Less easily achieved social and distributional demands are now levied on governments. Traditional party politics no longer seem to touch the lives, or inspire, the average man. Governments are neither strong enough to resolve the major problems these nations confront nor small enough to address specific “local” or “special interest” problems. They frequently cannot, simultaneously, meet the competing needs of domestic interest groups while achieving traditional goals of economic growth and price stability.

In such circumstances, governments can be out-flanked on the left by parties promoting radical social improvements and those on the right who criticize the high expenditures and government interventionism to support the social and distributional progress which has already taken place. Leaders in the middle are often paralyzed—fearing that reduced unemployment and further social progress, which they need for political credibility, cannot be cured except through additional expenditures which would turn their more conservative allies against them, erode trade positions, or risk inflation. The left promises reduced unemployment and more social benefits, along with more efficient government, but avoids announcing a “price tag” which the more conservative parties can shoot down. Unless the moderate leadership can achieve an economic success, either reducing unemployment or inflation, or hopefully both, voters may come to believe that they have little to lose by turning to a more extreme alternative—which at least holds out the promise of an improvement.

Schmidt’s Concerns

The continuing political and economic malaise in Europe is of enormous concern to Schmidt in its own right and because it has had a major psychological and economic impact on Germany (eroding the confidence of consumers and investors, and in part contributing to the slowdown in German exports, investment and growth). He will be particularly concerned about the risk of Communists gaining or sharing power in France and Italy, the potential for deterioration in the Mediterranean, and prospects for the longer-term recovery of economies and confidence in Western Europe. He will explore possibilities for bolstering the prospects of Giscard, Andreotti and the democratic forces in the Mediterranean, and perhaps convey ideas discussed at last week’s London meeting of the leaders of the EC Nine.⁶

US-German Cooperation in a Political/Economic Framework

While a supporter of European unity, Schmidt recognizes that many of the answers to the West’s problems require strong cooperation between his country and the US. All of the problems on the agenda below require, more than any other single factor, a common approach and effort by the US and Germany.

It would be well to underline to Schmidt at the outset both the positive results of cooperation between our countries in recent months and the objectives we share, stressing:

—Common support for the Witteveen facility;

—Cooperation in assisting Portugal (Germany providing $200 million; US, $300 million);

—Common enthusiasm for the multilateral trade negotiations and resolve to resist protectionism (the President and Schmidt were the strongest spokesmen for free trade at the Summit);

—Effective management of our domestic economies; and

—Similar views on North-South issues.

The over-arching consideration which should guide US-German economic thinking and cooperation is the relationship between economic progress and political moderation and stability in Europe—particularly efforts to strengthen the Majority in the March elections in France, help Andreotti in Italy, and strengthen democratic forces in other parts of Europe. The US and Germany must play the primary roles in this effort. To the extent possible, we must agree on common objectives and how to achieve them, bearing in mind that the political future of much of Europe hangs in the balance. Cooperation requires especially close consultations between the leaders of the two countries in order to establish the political directions necessary to ensure that our officials work together with a sense of common purpose.

The Agenda

Within this framework several key issues should be explored with Schmidt:

—The adequacy of international financing. Availability of adequate international financial resources would both instill greater confidence in Europe and encourage deficit countries to take necessary adjustment measures. The Germans prefer to help member Europeans through multilateral institutions to avoid bilateral pressures and to ensure internationally imposed conditionality. The Witteveen facility ($10 billion expected) is less than the $16 billion we had hoped for. Is it adequate? If not, should we augment IMF resources through other means, move ahead with the Financial Support Fund, or consider some other vehicle?

A special situation may exist with respect to France. If prospects of a Socialist/Communist victory lead to a further deterioration of confidence and trigger a capital outflow, might the French require financial support from other nations? If so, should we begin to plan now for such an eventuality? When might it be announced for maximum political impact, or would premature announcement merely lead to the panic we hope to avoid?

Are there any other ways we should consider bringing the Arab OPEC nations into a more active financing role, either directly or indirectly?

—Trade. Protectionist pressure is growing. The latest evidence of concern about “sensitive industries” and hint of consideration of protectionist measures was reflected in the London meeting of the “European Council” (the nine EC heads of state and government), which expressed its concern at the unemployment situation in certain sectors that are adversely affected by structural changes in the economy. And it invited the EC commission to study “all factors involved”. Callaghan afterwards explained that “we are all aware that there are sensitive areas in our economies where strict application of an open and liberal commercial policy can produce results which were really not anticipated in a period of world recession”. We should express our strong concern about any movement toward protectionism in these areas.

Further, the US and Germany need to work together, as the two countries most interested in progress in the Multilateral Trade Negotiations and in avoiding protectionism, to reverse what appears to be a gradual slide toward protectionism and to achieve progress in the MTN. We want Germany to use its influence in the EC in support of a forthcoming position in the MTN and attainment of the Summit objective of substantive progress this year in key areas such as: a tariff reduction plan; codes, agreements and other measures that will facilitate a significant reduction of non-tariff barriers; and a mutually acceptable approach for agriculture. For our part, we have worked out a comprehensive approach to the MTN which avoids threatening European economic institutions, which is flexible, and which suggests objectives on which the EC and US can agree on to ensure a more open and well-managed international trading system. Bob Strauss will shortly present our position to the EC Commission. We should also stress that we are doing everything possible to avoid an outcome to the Zenith and US Steel Customs Court cases which disrupts trade; that we are hopeful of winning a reversal of the Zenith decision;⁷ and that if not, we will assess other options, including that of seeking new legislation.

—Growth. The central factor in dealing with the political/economic issues facing Europe, and indeed other nations, is the ability of the US and FRG, plus Japan, to achieve stable growth, and to stimulate substantial amounts of new exports from weaker economies. The political situation in countries like Italy, France, Spain and Portugal limit the severity of the stabilization programs they can implement. Stronger input demand by the stronger economies is therefore essential.

The US and Germany have made important commitments at the London Summit with respect to achievement of growth targets. Germany has made efforts to stimulate its economy, but will fall below its 5% target—perhaps to 4%. In part, the problem has been the lack of response by the German economy to earlier stimulus and in part the reluctance to introduce new stimulus for fear of triggering new inflation, despite the expectation of only 4% inflation in 1977. We want Schmidt and his economic officials to see adequate growth and increasing imports as key international economic and political objectives (essential to moderate outcomes in France, Italy, and elsewhere in Europe) and to pay extremely close attention to this problem in the months ahead. Even if targets cannot be precisely met in 1977, and we hope the Germans will come as close as possible, we must be certain that actions are taken to ensure maximum non-inflationary growth in 1978.

Regarding current account imbalances, the Germans, Japanese, Dutch and Swiss surpluses may add up to $12 billion, added to a roughly $40 billion OPEC surplus. This puts undue financial stress on those countries which we have the greatest interest in helping—France, Italy, (as well as poor countries). The US deficit of roughly $12 billion makes economic sense, since it results from growing oil imports, a growth rate in the US that is higher than most other countries, our highly elastic demand for imports, and stabilization policies in some of our more important markets. We can sustain this level for a time, but unless Germany and Japan reduce their surpluses, we will be subject to increased protectionist pressures from those people here who say that it is unfair for the US to have a deficit while Germany and Japan and others maintain surpluses.

Is there anything further we can do together to strengthen consumer and investor confidence in Europe?

Enlargement of the European Community

Enlargement of the EC (to include Portugal, Spain and Greece) contains positive as well as negative factors. First and foremost, it should help stabilize the governments in those countries and strengthen their democratic forces. And over the long run, enlargement will contribute to growth in Western Europe through the addition of economies with a potential to achieve high growth rates and act as new markets.

But there are enormous problems in the short-run. Without a substantial transitional period, the three economies will be unable to compete in most manufactured goods with the present EC members. In the agricultural area, however, they will be extremely competitive and thus pose a threat to the agricultural interests in Southern France and Italy. Schmidt is also understood to have expressed concern at the London meeting of the EC Heads of State that admission of these three countries would pose special difficulties for the EC’s policy of free movement of labor—i.e. he does not want these countries to send their laborers to Germany and undercut the jobs of more highly-paid German workers.

Because this issue will become increasingly important in the months ahead, both to the EC and to the three applicant nations who regard admission as the European seal of approval of their democratic directions, we have an interest in doing what we can to avoid a breakdown in negotiations between them and Europe and smoothing their way into Europe. We should probe with Schmidt whether there is anything we can do to help these countries assume the responsibilities of Community membership.

North-South

Continued momentum on North-South issues is important in its own right and because close coordination among industrialized countries, and a cooperative framework with OPEC and other LDCs, can help to reduce tensions in the event of Arab pressures, or threats, regarding the Middle East.

The CIEC Ministerial Meeting, fell short of the expectations of both developed and developing nations, but it did provide the developing countries with a better understanding of the points of view of the developed nations and of the reasons why we cannot do certain things the developing countries want.⁸

The thrust of US policy is to be forthcoming toward the developing countries through measures which we believe to be economically workable. We want to continue a dialogue that concentrates on specific issues in forums most conducive to substantive progress—e.g. World Bank, GATT, UNCTAD commodity groups. We also want to make the UN General Assembly’s overview role more productive, perhaps through a new economic committee. We want to build on the improved industrial country coordination and solidarity which worked well in CIEC; based on this we should attempt to develop a constructive counter-proposal to the UNCTAD Common Fund. The idea of a continuing energy dialogue should be reexamined and played low key. We want the North-South dialogue to give more attention to basic human needs, and have suggested that OECD countries come up with a plan on this.

The Germans, at CIEC, took a slightly harder position than the US on a number of issues, and are particularly concerned about commodity agreements, which they see as having the potential to distort markets. Beyond this, the Germans are somewhat more reluctant than the US to go along with any sort of “common fund”—although they grudgingly agree to a pooling arrangement among the funds of individual buffer stocks. Schmidt has pushed a global scheme to stabilize commodity export earnings as an alternative to extensive new international commodity arrangements, but we believe this comes too close to duplicating the IMF’s compensatory finance facility.

This meeting provides an opportunity to convey our position on the above issues and probe the German position. This might also be a useful occasion to determine whether Schmidt has given any further thought to how to induce the Soviet Union to play a more constructive role in the development process—a desire he expressed at the Downing Street Summit. And, given the domestic political benefits which Giscard seems to derive from French-sponsored progress in the North-South dialogue, are there any new measures for which we should let him take partial credit—e.g. co-sponsoring the idea of a new economic committee in the UNGA framework?

1. Source: Carter Library, National Security Affairs, Brzezinski Material, Brzezinski Office File, Country Chron File, Box 13, Germany F R: 7–9/77. Confidential. Sent for action.
2. In a July 2 memorandum to Carter, Brzezinski indicated that he was “increasingly concerned about the erosion of political confidence in Europe, which is both resulting from and contributing to serious economic difficulties.” Noting that “the Schmidt visit provides an excellent opportunity to review these issues and consider possible actions that can be taken,” Brzezinski proposed a PRC meeting “on how to approach Schmidt on the economic issues.” Carter indicated his approval of the recommendation. (Carter Library, National Security Council, Institutional Files, Box 63, PRC 023, 7/9/77, Schmidt Visit) No minutes of this PRC meeting were found.
3. Not found.
4. Attached but not printed are papers entitled “The Adequacy of International Financing Mechanisms,” “Estimate of Supply of IMF Resources Through Remainder of 1977,” “Follow-up to the Summit,” “Increased Protectionism,” “The Future of the International Monetary System,” “Adequacy of German Growth,” “EC Enlargement,” “Portuguese Economic Situation,” “Turkey,” “Spain—Economic Prospects,” and “Revitalizing the MTN.”
5. Secret.
6. See footnote 4, Document 38.
7. On April 12, the United States Customs Court ruled in favor of the Zenith Radio Corporation’s contention that the Secretary of the Treasury was required to levy countervailing duties on imported Japanese consumer electronics exempted from taxes normally imposed within Japan. (Robert Cole, “Court Orders Duties on Electronic Goods Coming from Japan,” The New York Times, April 13, 1977, p. D1)
8. See footnote 6, Document 27.