“Trade with the Soviet Union: Country Risks and Global Markets”

Remarks of
Roger W. Robinson, Jr.
President, RWR, Inc.
former Senior Director for International Economic Affairs
at the National Security Council (1982-1985)

Before the Electronic Industries
Association Annual Fall Conference
International Business Council

October 3, 1989

(Century Plaza Hotel, Los Angeles): I am delighted with the
opportunity to speak before the International Business Council of
the Electronic Industries Association Annual Fall Conference on
the future of East-West economic and financial relations.
Although U.S. export control policy usually figures prominently
in such discussions, it is a relatively small part of the picture
in making judgments about entering the Soviet market or those of
Eastern Europe. Much more important is whether Mr. Gorbachev and
his associates are actually dismantling Leninist institutions
such as central planning and the single party state. Also crucial
is whether Mr. Gorbachev is willing to allow genuine
self-determination for the Baltic states, Eastern Europe, Angola,
Nicaragua, Afghanistan, and other nations currently under Soviet
influence. Hanging over these issues is the central question —
can Mikhail Gorbachev survive the troubled process of change he
has unleashed within the Soviet empire?

If genuine and enduring Soviet liberalization becomes evident
in concrete terms and Gorbachev survives politically, he would be
rewarded handsomely by international markets, almost irrespective
of U.S. policy. If not, then no amount of cheer-leading from
Western foreign policy establishments would be able to dispel the
clouds that gather over East-West trade and financial relations.

From a global standpoint, most Western companies are
appropriately focusing their trade and investment decisions for
the 1990s on the “Big Three” — the U.S.-Canada free
trade zone, the European Community, and the Pacific Rim
countries. Outside these markets lie the so-called “higher
risk” regions, such as the Soviet bloc and the high debt
developing countries, principally in Latin America.

The conventional wisdom, as portrayed by the media and the
lending policies of many Western commercial banks, is that the
future of “higher risk” lending lies in support of
East-West trade, not North-South. Consistent with this scenario,
next year’s Bush-Gorbachev summit will be crowned by major arms
control agreements; the settling of regional disputes; Moscow’s
codification of expanded human rights; and the triumph of genuine
economic reform throughout Eastern Europe and the USSR. Add a
hefty dose of “the Cold War has ended” rhetoric and the
stage has been set for large-scale Western economic assistance to
Soviet bloc economies. Government-guaranteed credits, substantial
decontrol of high-technology items, official investment support
programs, and “fast track” participation in the key
international trade and financial institutions would be important
components of this “package.”

The media, policy analysts, and many banks are as gloomy about
the developing world as they appear cheerful about the trends in
East bloc countries. For example, the recent decision by three
U.S. money center banks to bolster by some $4 billion their loan
loss reserves for developing country loans has touched off a
spate of skeptical commentary on prospects for the Brady debt
reduction plan and North-South economic relations. As Willard
Butcher, the chairman of my former institution Chase Manhattan
Bank, said succinctly during the recent IMF/World Bank annual
meetings, “Debt forgiveness and new money are
incompatible.” If he is right, the Brady Plan has little
hope.

In my earlier days as a lending officer at Chase, I was
constantly schooled in the need to “get behind the
numbers” when dealing with sovereign borrowers — not to
necessarily accept the conventional wisdom, but examine the hard
realities. I am concerned that many Western commercial banks and
companies are ignoring this sage advice.

This is not just an academic exercise — there are potentially
huge stakes involved. At the heart of policy deliberations are
multi-billion dollar decisions about where the commercial banks
will choose to extend new credits, where your companies will
invest over the long haul, and where the finite resources of the
IMF, the World Bank, the Asian Development Bank, and government
export support programs will be concentrated. Which region — the
East or the South — will receive the most favorable and flexible
treatment at the hands of creditors, and which will enjoy
priority access to OECD markets.

Signs of the new preferred treatment for perestroika and East
bloc countries are almost everywhere. Already, the U.S. and some
EC governments are beginning to direct their trade development
programs, (such as the Overseas Private Investment Corporation)
and government-guaranteed credit lines toward Hungary, Poland and
the USSR. Poland will almost surely be awarded a generous
rescheduling of government debt in the Paris Club without having
implemented an IMF adjustment agreement — a concession with few
precedents. Eastern Europe since 1980 has generally benefited
from lower interest rates and easier terms than most sovereign
borrowers in the developing world. And some policy-makers are
calling for a “Marshall Plan” of economic assistance
for certain East bloc nations.

Such policy moves are having a substantial impact on global
trade and investment flows that may end up actually reducing
markets for many Western companies involved in international
trade, particularly in Latin America. Rather than creating new
business opportunities, large-scale economic and financial
assistance to East bloc countries, particularly the Soviet Union,
could create a kind of sinkhole for precious Western resources at
the direct expense of many developing countries. (For example,
the importance of Latin America as a U.S. export market dwarfs
that of the Soviet bloc.)

The most striking feature of this apparent shift in emphasis
— from North-South to East-West — is its departure from market
realities. The fact is that while systemic economic reform is
making real headway in several developing countries, notably
Mexico, not a single East European nation can point to sustained
economic progress from working with the IMF. If anything, the
rule seems to be that IMF programs in this region have, to date,
brought economic dislocation without laying the foundations for
more enduring prosperity.

Indeed, it is ironic that the healthiest economies in the East
bloc — East Germany and Czechoslovakia — are among the most
rigidly controlled. Far from applauding Stalinism, I am merely
pointing out — as Poland, Hungary, and the Soviet Union have
discovered the hard way — that half way economic reforms can be
worse than no reforms at all. They raise false expectations,
impose painful social costs without measurable returns, and
squander valuable capital, time, political momentum, and the good
will of suppliers and creditors.

As reality sets in, I think you will see a conservative shift
in Western economic policy toward the Soviet Union, as opposed to
the strategy of large-scale assistance originally crafted by FRG
Foreign Minister Hans-Dietrich Genscher. Many opinion leaders,
such as Senator Bill Bradley, are convinced that major infusions
of Western capital and technology into the Soviet Union will
retard, not advance, genuine economic reform. I share this view.
The joke often told by workers in Poland is that their companies
pretend to pay them, and they pretend to work. The West’s more
conservative policy may be that as East bloc governments pretend
to reform, we will pretend to reward them. This game of
“lowered expectations” is already being played out in
Poland and Hungary, which are experiencing the limits of Western
largesse, despite genuine reform efforts.

The West’s increased caution, which I believe is coming, will
probably be based on a recognition by finance ministers (not
diplomats) that the IMF, World Bank, and other multilateral
institutions may well be powerless to catalyze systemic change in
Eastern Europe and the USSR. The absence of markets, the crushing
embrace of central planning emanating from Moscow under the
auspices of the Council for Mutual Economic Assistance (CMEA),
and the region’s debt burden are seriously stalling the reforms.

Additional constraints of a different sort will likely
complicate U.S. policy toward the USSR. For example, there is an
increasing awareness that Mr. Gorbachev is using perestroika, in
part, to mask a Soviet drive for a leaner, more modern military
structure and the consolidation of Moscow’s influence in client
states. (This latter objective is being advanced by what I term
the “internationalizing” of perestroika, defined as the
off-loading of Moscow’s financial obligations to impoverished
allies and client-states from Soviet books to Western balance
sheets — while maintaining Moscow’s political/military control
in these countries.)

On the other hand, perestroika has, thus far, contributed to a
serious loss of congressional support for defense programs.
Against the backdrop of perestroika, Congress has slashed defense
spending over the past four years. Meanwhile, as Secretary of
Defense Cheney points out, the Soviets have significantly boosted
their military outlays, including a 3% increase in real terms
last year — channeling a substantial portion of these priority
resources into strategic nuclear forces. Gorbachev, early on,
appears to have made the choice that building nuclear missiles
and submarines was more important than putting sugar, soap, and
butter in the people’s cupboard.

Even the planned Soviet force reductions and restructuring of
Soviet industries, are designed to enhance future military
efficiency and prowess. According to the CIA and FBI, cuts in
Soviet military research and development budgets are being
augmented through increased espionage and technology theft on the
part of the KGB and Soviet military intelligence. Regrettably,
East European countries also remain engaged in these harmful
activities as they simultaneously seek expanded Western financial
flows. Mr. Gorbachev is certainly aware that improved political
relations with the West provides much easier Soviet access to
NATO’s advanced technologies.

Gorbachev has also not been bashful about pushing his foreign
policy agenda in the Third World. As the U.S. shuts down or
reduces the aid pipeline to the Contras, the Mujahaddin, and
Jonas Savimbi in Angola, the Soviets are rushing in fresh
supplies to their forces. For example, the Soviets have spent an
estimated $300 million per month since March of this year in
weapons delivery to their Kabul regime. Even the Bush
Administration has recently expressed puzzlement over the
“billions of dollars” spent by Moscow in Central
America at a time of desperate shortages in its civilian economy.

Some may suggest that it does not really matter who wins the
superpower competition in these distant places. I beg to differ.
If winning in the Third World is important enough to Gorbachev
that he is willing to put billions of dollars in hard currency
resources on the line, then it should be important to us to
respond. As long as NATO’s attention can be focused by the
Kremlin on arms control and greater East-West cooperation, the
Soviets believe they need not worry about U.S. containment
policies.

What does the future hold for perestroika? The kindest thing
that can be said is that, to date, top Soviet leaders, lacking a
background in economics and the international marketplace, simply
have not understood what they were doing. Under Gorbachev, the
combination of revenue losses, largely through the anti-alcohol
campaign, and vast spending for weapons and unproductive
investment have swelled the Soviet budget deficit to an estimated
12 percent of annual GNP and unleashed powerful inflationary
forces in the Soviet economy. Other essential Gorbachev
initiatives — such as price reform and full ruble convertibility
— are deemed too risky and have been indefinitely postponed.

I believe that the next several years could witness a struggle
by the Kremlin to reestablish more controls over the economy,
while pursuing market-oriented reforms on the margin. In other
words, there may be a significant retreat from economic
liberalization. We can be confident that as Moscow’s economic
crisis deepens, Soviet leaders will seek Western partners, both
in the public and private sectors, ever more eagerly.

Whether Gorbachev can manage the turmoil within the Soviet
Union is anyone’s guess. His accommodation of the expensive
demands of Soviet miners — which Moscow’s budget clearly cannot
afford — could be interpreted by other industry groups as a sign
of weakness to be exploited. Should he continue to try to sustain
his popularity through, in effect, buying off interest groups,
his reforms will likely collapse. Polish governments have been
down that dead-end road several times in the past.

A collapse of perestroika, at least as currently configured,
may not be — as most analysts predict — the worst thing that
could happen. For example, such a development could force Mr.
Gorbachev or his successor to come up with a systemic,
market-oriented program that looks beyond the failed Yugoslav
model of market-socialism. He might finally see the wisdom of
dislodging the military establishment from the commanding heights
of the Soviet economy. Cuba, Vietnam, and Nicaragua would
probably lose their subsidies, making them more amenable to
settling regional disputes. Eastern Europe might be freed from
the debilitating drain of thousands of CMEA trade obligations,
thereby helping to diffuse the region’s debt bomb and create new
markets for U.S. goods.

An important thing to remember is that most of the exaggerated
expectations surrounding perestroika are being generated by
diplomats, on the Soviet side as well as ours, who have a vested
political interest in the appearance of great progress in
bilateral relations. If the diplomats are wrong, there is a risk
that they will merely turn to another policy project, while the
U.S. business community could be left to pick up the pieces, as
in China.

In addition, several U.S. banks and firms seeking the
“no-risk” shelter of U.S. government-guaranteed loans
and investments in the East bloc may well be disappointed as the
Congress is reminded of the estimated $300 billion-plus taxpayer
burden imposed by a combination of the savings and loan debacle,
the international debt crisis, the HUD scandal, and probable
losses associated with troubled leveraged buy-outs. It should be
recalled that the American people have, in all likelihood,
already lost over $2 billion in U.S. government guaranteed
credits to Poland, pursuant to its payments crisis in March 1981.
Finally, the cost to U.S. taxpayers in additional U.S. defense
spending to counter the adverse consequences of undisciplined
Western largesse toward Moscow and its allies — particularly in
the financial and technology portfolios — is on the order of
several billion dollars annually.

Conclusions and Recommendations

The scope of this talk has by no means touched on the full
range of so-called “country of risk” considerations
needed for a proper analysis of business opportunities in the
Soviet Union and Eastern Europe. Among a number of other issues
requiring evaluation are:

Limited Soviet Income Potential

Total Soviet hard currency income annually (roughly $35
billion) only represents about one-third of General
Motors’ total yearly sales;

Narrow Soviet Export Base

80-90 percent of Moscow’s total annual hard currency
earnings stem from just four export items (oil, gas,
arms, and gold), commodities which face substantial price
and market volatility.

High Debt Levels

Moscow’s total gross indebtedness of between $46-$50
billion is more than double the amount in 1984.

Rising Soviet Debt Service

The USSR’s debt service ratio has nearly doubled since
1984 to an estimated 28%; and

Heavy Recent Borrowing

Average new borrowing from the West in the first half of
this year of about $1 billion per month (adjusted for
exchange rates) is considerably higher than usual.

I have tried to propose an alternative economic and political
framework which may help evaluate investment decisions. A
discussion of the risks associated with East bloc markets might
also help temper the avalanche of pro-trade sentiment currently
in the system. The Center for Security Policy in Washington, D.C.
has taken a leading role in the type of risk analysis presented
here and would be a potent resource for follow-up information in
the area of East-West economic, financial, and technology
security.

Highly disciplined and transparent East-West economic and
financial transactions can potentially create incentives for
greater liberalization. A strong political breeze is also blowing
at the back of U.S. companies considering such business
opportunities. This “breeze” is taking the form of a
substantial trimming of the COCOM list of militarily critical
technologies, the imminent waiver of the Jackson-Vanik amendment,
the likely restoration of Soviet access to U.S. Export-Import
Bank loans and credit guarantees, expanded OPIC coverage,
subsidized wheat sales, active government encouragement of
U.S.-Soviet joint ventures, support for limited ruble
convertibility, and several other policy developments generally
welcomed by the U.S. business and banking communities.

Nevertheless, the possibility — if not likelihood — of
repressive Soviet actions against various independence and
dissident movements, escalating Soviet labor tensions, a high
degree of political unrest in Eastern Europe (particularly in
Poland and East Germany) and a deteriorating trend in the Soviet
economy makes a cautious, wait-and-see approach by U.S. firms the
most prudent course of action. Moreover, the cushion of political
support, particularly in the Congress, for government-backed
U.S.-Soviet trade is quite thin. This is evident in the recent
418-0 vote in the House and 81-10 vote in the Senate for stronger
economic and financial sanctions against China when it
experienced social turmoil.

For those firms set on the idea of entering the East bloc,
they should consider investing in Hungary or even Poland over the
USSR. These countries, particularly Hungary, at least have a
tradition of private enterprise and entrepreneurship and are more
likely to accommodate U.S. business requirements. Western
political support for expanded business ties is also considerably
more sustainable for these countries. Finally, it is a major
distortion for Hungary, Poland and the USSR to be increasingly
packaged as equally “reforming nations” of the East
bloc. Hungary, for example, is vastly more reform-oriented than
the Soviet Union, both economically and politically, and down the
road is probably the most likely East bloc investment climate to
yield positive results for U.S. business.

For U.S. companies dedicated to exploring the Soviet market,
or expand an already existing presence, I would offer the
following advice for, at minimum, the next year or so:

• Business exposure could be limited to management,
  technical, or other service agreements;
• Equity contributions should be kept modest and the tenor
  of investments and loan maturities should be relatively
  short-term and tightly structured;
• Joint venture participation and equipment exports should
  be limited to lower-end technologies that are tied as
  closely as possible to the Soviet consumer economy;
• Escape clauses should be well-defined to help mitigate
  the risk of political upheaval resulting from events like
  Tiananmen Square, in addition to solid understandings on
  profit repatriation, quality control, management, and
  other standard business concerns; and
• Minimum levels of working capital or interbank deposits
  should be held in Soviet-owned banks and enterprises.

These and other sensible measures are not only relevant to
minimizing the potential for losses, but are also designed to
protect corporate images during an uncertain period. The next 12
months should prove very revealing concerning the fate of
perestroika and the real intentions of Mr. Gorbachev, as a number
of leading Soviet reformers have publicly predicted. In the best
of worlds, I would take these Soviet commentators at their word
and keep the corporate powder dry at least a little longer.