US Trade Relations with The USSR and Eastern Europe

Submitted Testimony by Roger W. Robinson, Jr.

President, RWR, Inc.

before the U.S. House of Representatives

Committee on Ways and Means

30 January 1990

Mr. Chairman, I am pleased to have the opportunity to appear before the House Committee on Ways and Means to examine U.S. trade relations with the Soviet Union and Eastern Europe. I have had the good fortune to participate in the management of East-West economic and financial relations from both public and private sector positions. As Senior Director for International Economic Affairs at the National Security Council and Executive Secretary of the Cabinet-level Senior Interdepartmental Group on International Economic Policy for three and a half years (1982-1985), I participated in many of the Reagan Administration’s major international economic policy decisions, including those pertaining to East-West trade. Prior to coming to government, I was a Vice President in the USSR/Eastern Europe Division of the Chase Manhattan Bank.

The Administration and the Congress are now faced with a number of major decisions concerning the future conduct of US-Soviet/East European economic relations. The policies of our allies will be profoundly affected and hopefully shaped by U.S. decisions made over the next six months. Among the issues requiring congressional action are:

1. the likely waiver of the Jackson-Vanik amendment and eventually the Stevenson amendment to the Trade Act of 1974;

    

 

2. the terms of settlement with the USSR on defaulted czarist and other debt obligations to the United States (permitting Soviet borrowing in the U.S. bond market);

    

 

3. policy decisions required in the context of a comprehensive bilateral Trade Agreement with the Soviet Union now being drafted for signature during the June summit of President Bush and Chairman Gorbachev.

    

 

4. the review of U.S. positions formulated by the Administration for the Conference on East-West economic relations scheduled to take place in Bonn in late March under the auspices of the Conference on Security and Cooperation in Europe (CSCE); and

    

 

5. decisions related to consolidating the movement toward democracy and market economies in Eastern Europe.

    

Before examining certain of these policy considerations, it is useful to review briefly the backdrop against which these decisions are likely to be made.

Deteriorating Soviet Creditworthiness

From earlier days as an East-West banker, I have found that an assessment of Soviet creditworthiness can be instructive in highlighting commercial and political risks for both U.S. business interests and taxpayers. Accordingly, some of the "bottom lines" of such an assessment are outlined:

• Perestroika, at least as currently configured, is dead in the water with little prospect for revival.| This view is shared by observers as diverse as leading Soviet economists and NATO.

 

• The new Soviet Five Year economic plan is symptomatic of the causes of perestroika’s decline as it represents a continuation of bankrupt central planning and further postpones genuine systemic reform such as decontrolling prices, privatizing industry, and permitting forms of private ownership.

 

• Other major contributors to the demise of what may be termed "perestroika I" were the estimated 3 percent real increases in Soviet defense spending in each of the first four years of Gorbachev’s government and the precipitous drop in tax revenues caused by his anti-alcohol campaign.

 

• The fledgling Soviet private sector — exemplified by the cooperatives — is being increasingly vilified in the media and Congress of Peoples’ Deputies as engaged in "price gouging and profiteering." Inordinately high taxes, price controls, and other newly imposed restrictions are undermining entrepreneurial incentives for this otherwise productive sector.

 

• Soviet oil production, the most strategic sector of the civilian economy, is declining which bodes ill for meeting the rigid requirements of the domestic economy, Eastern Europe, and the crucial hard currency export market. Production dropped in 1989 from 12.6 million barrels per day at the beginning of the year to 12.1 million barrels by year-end. It will be very difficult for the domestic economy alone to absorb even a six percent supply shortfall.

 

• Moscow’s total annual hard currency income remains only about $37 billion or roughly one-third of the yearly sales of General Motors Corporation. Between 80-90% of Soviet annual hard currency earnings stem from just four export items — oil, gas, arms, and gold — commodities which face substantial price and market volatility.

 

• Virtually all of Moscow’s hard currency income is used just to purchase imports from the West and to service debt. This means that the majority of the hard currency requirements to meet Soviet global commitments (client-state support, financing of arms sales, espionage, technology theft, disinformation, etc.) have had to be financed through Western borrowing and possibly the sale of portions of Soviet strategic gold reserves.

 

• According to a recent defector from the Moscow’s economic hierarchy, Soviet leadership has been spending a portion of its strategic gold reserves annually since 1986 in the expectation of a turnaround in perestroika’s fortunes which has yet to materialize. If true, this could mean that rather than possessing strategic gold reserves traditionally estimated to be in the range of $25-32 billion, remaining Soviet reserves could be as low as $17-24 billion (assuming about $2 billion in annual depletions).

 

• The Soviet hard currency loan portfolio to Third World countries, often viewed as an important "asset" by Western creditors, is estimated to be somewhere in the range of $40-$50 billion. As the majority of these loans were in support of arms sales to impoverished client-states like Nicaragua, Vietnam, Ethiopia, and Syria, the real value of this portfolio may be only in the range of 10-30 cents on the dollar or less depending on the country.

 

• Moscow has been borrowing rather heavily since the fourth quarter of 1988. In 1989, the Soviet Union engaged in gross borrowing in the West totaling about $9 billion and continues to borrow at a similar pace this year. Total Soviet gross indebtedness is now about $50 billion, more than double the amount in 1984. The USSR’s debt service ratio has similarly doubled in this period to about 28 percent.

 

• The promises made by Soviet leadership to striking coal miners last summer have not been kept. This has caused serious resentment in the labor force which could easily result in new strikes by miners and possibly transport workers. Any large-scale labor unrest in these crucial sectors could create a dire economic emergency.

 

• Finally, the political landscape within the USSR is highly volatile, fueled by increasing labor unrest, ethnic strife, consumer shortages, huge pent-up inflation, and division at leadership levels. The political tensions currently afflicting Azerbaijan, Georgia, Moldavia, the Baltics, and other republics need not be explained here.

In sum, Soviet creditworthiness is in the process of significant deterioration as evidenced by gradually rising interest rates on Western credits to the USSR. This is not to imply that the Soviet Union no longer enjoys substantial access to foreign credit markets. Indeed, given the current dearth of creditworthy sovereign borrowers elsewhere in the world, due to the ravages of the international debt crisis, Western bankers and securities firms continue to offer Moscow more borrowing opportunities than the USSR needs. Nevertheless, should Soviet indebtedness continue to rise at the present rate and hard currency earnings remain depressed, the need for either formal or informal debt rescheduling arrangements could materialize when the gross debt level reaches $60-$70 billion. The highly uncertain domestic political environment, particularly the prospect of debilitating strikes by the work force, could accelerate the downside risk for Western private and official creditors significantly.

Issues for Congressional Consideration

Granting of Most-Favored Nation Status.

This traditional symbol of U.S.-Soviet trade impediments warrants reconsideration due to much improved Soviet performance on emigration. Nonetheless, it is important that President Bush’s initial terms for the granting of equal tariff treatment to the USSR be observed, namely codification and implementation of emigration as a right of the Soviet people, not a privilege. The Congress should be particularly concerned over indications of significant erosion in the Administration’s demands for this latter condition.

There is a clear need for the "words" of codification to be reinforced by the "deeds" of implementation or a track record of performance on truly free emigration prior to the President’s waiver of the Jackson-Vanik amendment. Without a track record of at least several months, there is a susbstantial risk that subtle bureaucratic slippage could de facto deny emigration to Soviet citizens as an inalienable right. For example, the recent Soviet decision to devalue the exchange rate of the ruble by tenfold for tourists has the restrictive effect of drastically reducing the amount of hard currency that Soviet citizens can obtain when departing the Soviet Union, effectively limiting them to roughly $30. Assuming a credible track record on codified free emigration is established by Moscow, I would support a temporary waiver of Jackson-Vanik pertaining to MFN status.

Restored Soviet Access to Eximbank Credits and Guarantees

The other issue covered by the Jackson-Vanik and Stevenson amendments pertains to the restoration of Soviet access to U.S. Export-Import Bank (Eximbank) credits and loan guarantees. In my judgment, this is far more problematic than granting MFN. Since 1974, U.S. taxpayers have been free of either direct or contingent liabilities related to the financing of U.S. industrial projects and trade with the Soviet Union. Private creditors and investors have appropriately assumed the risk of any future debt rescheduling or default by Moscow of the type that took place in Poland in March 1981. Repeated Polish debt reschedulings have, in effect, led to U.S. taxpayer losses totaling about $2.3 billion. (Although Polish debt obligations to Eximbank and the Commodity Credit Corporation (CCC) are still carried as "assets" on U.S. books with the hope of eventual recovery, virtually every commercial bank in the world has written off its Polish debt.)

Before this advantageous situation for average Americans is changed by the Administration and the Congress, there should be a clear understanding of the implications and risks of such a policy shift. First, unlike MFN which was used as an effective lever to increase emigration from the USSR, restoring Soviet access to Eximbank and CCC programs should not be based on nonfinancial criteria, such as emigration. Instead, the Congress should focus on five basic issues in considering the restoration of Soviet access to Eximbank programs:

1. Eximbank credits and loan guarantees constitute U.S. taxpayer subsidies of trade with USSR — pure and simple;

    

 

2. The disturbing increase in Soviet commercial and political credit risk would be transferred from U.S. commercial banks onto the shoulders of U.S. taxpayers already beleaguered by the savings and loan debacle, the international debt crisis, troubled leveraged buy-outs, the HUD scandal, and other U.S. government-guaranteed credit programs that have gone sour;

    

 

3. The signal sent to allied governments, notably Japan, and the world’s commercial banks would be a "political green light" for large-scale Western government-backed lending to the Soviet Union that, in turn, would probably delay further genuine systemic reform in the Soviet Union; and

    

 

4. The need to justify to the fledgling governments of Eastern Europe, Latin American democracies, poverty-stricken African nations and others how the Soviet Union warrants new taxpayer-backed loans when Moscow can borrow at very low rates on private Western credit markets and when availability to such U.S. government loans and guarantees is so limited.

    

 

5. The fact that a recent Wall Street Journal/NBC News poll indicated that 66 percent of the American people oppose any forms of direct economic aid to the Soviet Union.

    

Eximbank direct loans and credit guarantees represent subsidies because the U.S. government is either taking on all the credit risk up-front (i.e., direct loans) or on a contingency basis (i.e., guarantees) in the event of Soviet inability at some future time to meet its obligations to private U.S. lending institutions. Commercial banks that are covered by U.S. government credit guarantees would price their loans to the USSR on the basis of U.S. government risk, not on an assessment of Soviet risk. Not surprisingly, this practice artificially lowers the interest rates on loans to Moscow below normal market terms. Senator Bill Bradley in testimony before the House Banking Subcommittee on International Finance, Trade, and Monetary Policy on September 22, 1988 summed up this aspect of Eximbank credit guarantees when he stated:

"When are these government guarantees important? First, they are just like any other subsidy. Because the financing is backed by the full faith and credit of the lender’s government, the borrower gets better terms. Second, they insulate lenders from the full extent of the risk of doing business in the USSR and pass that risk onto the taxpayers. Third, the data on the extent and magnitude of insurance and guarantees is quite sketchy. Western governments are apparently reluctant to let voters and taxpayers know just what good deals the Soviets are getting."

 

In this connection, the Soviet Bank for Foreign Economic Affairs can, for example, borrow on Western securities markets at rates as low as 6 3/8 percent for eight-year maturities. The interest rate for the USSR on medium-term, untied syndicated loans is about 1/4-3/8 over LIBOR (London Interbank Offered Rate) for similar maturities, up from as low as 1/8 percent in 1987. At a time when many developing countries, like Poland, have lost normal access to private Western credit markets, it is important to reserve limited Eximbank availability for those countries in greatest need.

For those who suggest that Eximbank funding is essential for the competitiveness of U.S. exports to the USSR, the burden of proof is on them to explain how Eximbank, under current circumstances, could be expected to "make the difference" for U.S. firms. Eximbank has encountered the prospect of serious losses in recent years, as evidenced by the need to establish a $4.8 billion loss reserve for the bank’s loans and guarantee portfolio. In fact, a "subsidies war" with our allies on export credits to the USSR is a losing proposition and would only add to an already heavy U.S. taxpayer burden wrought by subsidies for wheat sales to the Soviets. Finally, it is useful to keep in mind that U.S. exports and jobs stemming from our trade relations with Latin American democracies and elsewhere dwarf those associated with trade with the USSR.

Permitting Soviet Borrowing in the U.S. Securities Market

The State Department has already held at least two sessions with the Soviet Union designed to settle defaulted czarist and other debt obligations (eg., Lend-Lease) to the United States reported to exceed $1.5 billion. Such a settlement, perhaps for a few cents on the dollar, would release Moscow from the restrictive provisions of the Johnson Debt Default Act of 1934. This U.S. legislation was intended to disallow untied U.S. bank lending (eg., the underwriting of Soviet bonds) to countries in default on any debt obligations to the United States. Over the past two decades, however, U.S. banks have circumvented this legislative restriction on untied, general purpose loans to the Soviet Union by simply lending out of offshore subsidiaries and branches.

Although this bilateral debt-settlement exercise appears harmless, it has major strategic implications for the 1990s and beyond. One of the principal components of Moscow’s financial agenda toward the West is to develop an expansive presence in the international securities markets (eg., through issuing bonds, notes, commercial paper, etc.). Achieving this goal would broaden the sources of Soviet borrowing in the West from only Western governments and banks to include securities firms, pension funds, insurance companies, corporations, and even individuals. Over time, hundreds and perhaps thousands of Western nonbanking institutions (like securities firms and pension funds), and millions of Western citizens could be either knowingly or unknowingly holding Soviet paper in their bond portfolios and pension funds.

Moscow is very mindful of the enormous political advantage of recruiting powerful new constituencies throughout Western societies which would have a financial vested interest in supporting continued economic and even political concessions to the USSR. Such support could easily take the form of lobbying efforts to expand Western government loans, guarantees, and energy-related assistance to Moscow should the Soviet Union have its access to private credit markets curtailed by its deepening economic and political crises.

Other factors which argue strongly for NATO and Japanese government discouragement of Western bank and nonbank underwriting of Soviet bond and note offerings are as follows:

1. This form of Soviet borrowing is, by definition, untied to any specific trade transactions or projects, hence loan proceeds can be used by Moscow to finance any purposes it deems appropriate, including activities inimical to Western security interests. (Undisciplined, general purpose Western lending to the USSR is already costing U.S. taxpayers billions of dollars annually in the form of additional defense spending required to counter the harmful consequences of funding Soviet global operations⁽¹⁾.)

    

 

2. The extension of credits by nonbanking institutions to the Soviet Union are not recorded in any Western statistics as adding to the total indebtedness of the USSR and thus constitute hidden Soviet borrowing.

    

 

3. Soviet entry into the securities markets represents a fundamental penetration of Western societies for the first time without a commensurate ability to determine those institutions and individuals holding Soviet paper and what amounts are involved.

    

At this writing, the Soviets have successfully concluded seven or eight bond offerings in the West since market entry in January 1988, valued at between $1.3-1.6 billion, (4-5 West German-led deals, 1 Dutch, 1 Austrian and 1 Italian.) U.S. banks and securities firms are already involved in this new line of commercially unsound sovereign lending.

Bilateral Trade Agreement

It is as yet unclear which specific items will be covered by the new U.S.-USSR bilateral Trade Agreement. The Administration may be considering a "scaled down" agreement that provides the Soviets with MFN, restored access to Eximbank credits (possibly deferring waiver of the Stevenson amendment), a favorable settlement on defaulted debt obligations to the United States, energy cooperation initiatives and other benefits. There may not be sufficient time to include provisions which protect intellectual property rights and offer investment protection for U.S. companies. The Administration may argue that they can address these issues in a follow-on Bilateral Investment Treaty. This approach, however, runs the risk of providing the Soviets most of what they have requested, while postponing the U.S. agenda of benefits.

One of the most important negotiating objectives which should be pursued by the Administration is the break-up of the Soviet trade monopoly overseen by the Military Industrial Commission (VPK), the KGB, the Ministry for Foreign Economic Relations, and the Soviet Chamber of Commerce and Industry, in that order.

These entities screen virtually all Western investments in the USSR, intervening when necessary to carry out defense requirements of the central plan. According to a 1987 State Department White Paper,⁽²⁾ they are responsible for an enormous amount of Western trade diverted to the military and intellectual property theft. As long as this import monopoly exists, Soviet enterprise managers will have limited freedom to engage in normal international trade and conduct independent transactions with U.S. firms; U.S. partners in joint ventures will find that Soviet promises of "national treatment" ring hollow; and Soviet defense industries will reap a trade bonanza from technologies made available by the relaxation of COCOM controls. The Congress will probably wish to ensure that this and other trade and investment liberalization measures are achieved in the Trade Agreement.

CSCE Economic Conference

In the final days of the Reagan Administration, Secretary of State George Shultz caved in onlong-standing U.S. opposition to FRG Foreign Minister Hans Dietrich Genscher’s insistence on an East-West economic conference under CSCE auspices that would address major issues such as technology transfer, finance and energy relations. The FRG expectation appears to be that the Soviet Union in particular would benefit greatly by the development of an "alliance consensus" on these and other priority issues that would accommodate Moscow’s economic and financial gameplan toward the West.

The United States should be very cautious concerning this rather heavy-handed FRG intervention designed to stimulate a "follow the flag" march by private Western banks and companies into Soviet markets. This could easily result from allied business communities witnessing a cornucopia of government-sponsored investment protection agreements, energy cooperation initiatives, and trade and credit support programs at the Bonn conference.

Regrettably, FRG interests and those of the United States do not coincide in selecting this kind of formal "governments to governments" structure to promote East-West economic and financial relations. For example, the Administration has consistently resisted calls by our friends in Latin America and elsewhere for similar North-South and debtor-creditor conferences which will presumably have to be reevaluated in the interest of fairness and equal treatment. Foreign Minister Genscher’s utter disregard for the national security dimensions of technology, financial and energy transactions with the USSR should also be cause for significant U.S., Japanese and British concern. (The Administration is currently in the process of being stampeded by Bonn and Moscow into a CSCE "heads-of-government" meeting to deal with the sweeping changes in Eastern Europe and the USSR, in a manner reminiscent of the economic’s conference.)

Eastern Europe

The still incomplete "revolution of 1989" has produced some optimistic prospects for making the difficult transition from command to market economies, from one-party rule to democracy. As such prospects for economic and political reform vary widely in the region, Western assistance efforts are being appropriately tailored to individual country circumstances. At this time, the countries showing the best prognosis for successful Western investment and systemic transformation are Czechoslovakia and Hungary. Those countries with a less certain future include the GDR, Poland, Bulgaria, and Romania. On the political front, the communist parties of Romania and the GDR are currently attempting to reassert control against the will of the people which risks renewed social turmoil and possible violence in 1990. (MFN for Romania and other U.S. trade and financial assistance measures for these countries should be withheld pending the outcome of free and fair elections.)

Czechoslovakia has emerged as the pacesetter for regional economic and political reform movements, with its commitment to: a market economy; the quick removal of all Soviet forces; ceasing cooperation with Moscow in the areas of foreign espionage and technology theft (thereby lowering Western security costs); banning the export of Semtex plastic explosives used by terrorists; and, challenging COMECON’s debilitating nonmarket trading arrangements. Hungary is in close competition with Czechoslovakia in several of these areas. Poland has shown great courage in its "cold turkey" shift to more market conditions, but the country’s massive debt overhang and other infrastructure bottlenecks are likely to hobble any near-term turnaround. Prague’s willingness to help reduce Western security costs by discontinuing damaging intelligence-related cooperation with Moscow should be adopted immediately by other East European recipients of Western economic, financial, and technological assistance.

There are two key areas where the West can selectively expand its already impressive array of trade and financial assistance to Eastern Europe. One would be through the establishment with our allies of a Contingency Energy Fund (CEF) to offset any energy supply shortfalls from the Soviet Union resulting from either oil production problems or political arm-twisting. Such a CEF for Eastern Europe (and in the future, the Baltic republics) would be similar to initiatives such as the currency stabilization fund and emergency food supplies to Poland and would likely reduce Moscow’s temptation to exercise its substantial energy-related leverage in the region.

The second area involves the structuring of the French-proposed European Reconstruction and Development Bank for Eastern Europe (ERDB). It now appears as though the USSR may be invited to have a place at the table in the management of the ERDB. This structural error would be compounded by also permitting Moscow to be a recipient of bank funds, particularly loans on concessionary terms. In this regard, the experience of the Asian Development Bank (ADB) may be instructive. During the Reagan Administration, India and China — both countries that can easily attract private credits — had swallowed as much as 40 percent of the ADB’s total loan portfolio, thereby squeezing out more needy member countries. Given the USSR’s enormous capital requirements to jump-start its stagnant economy, hard currency credits urgently required by, for example, Poland and Hungary, could be rerouted to Moscow.

Conclusion

In sum, I support the prudent expansion of U.S. economic and financial relations with USSR and particularly with Eastern Europe, so long as such relations are properly managed. The overarching task of the Administration, the Congress, and indeed the Western Alliance, is to determine how best to advance the movements toward true democracy and free markets in these countries. For example, large-scale infusions of Western capital and technology into the USSR have served to retard, not catalyze, genuine systemic reform. Accordingly, a more cautious and disciplined approach to the channeling of Western assistance resources to the region is essential to maintaining the kind of "constructive pressure" which is working in favor of those seeking the fundamental, structural transformation of these societies. In short, greater Western discipline, transparency, and selectivity will ultimately do more to "help" Mr. Gorbachev initiate a far more radical and productive "perestroika II," than simply rewarding continued economic mismanagement.

Finally, the Soviet Union is now in the rearguard, not the vanguard, of political and economic reform in the East. The more restrained Japanese and American attitudes toward trade and financial relations, in part shaped by several instances of Soviet retreat from such systemic changes as a multiparty system and price reform, stand in sharp contrast to most of Western Europe’s unbridled enthusiasm to prop up increasingly untenable economic half-steps. It is crucial that the Alliance partners in the coming months forge a more visionary consensus than exists today on directing limited Western financial resources to those countries clearly committed to our common economic and political goals.

1. For more information on this point and related subjects, it is strongly recommended that the video tape and/or transcript be obtained of a one-hour special entitled "Follow the Money" produced by the Blackwell Corporation, Washington, D.C. which was aired by the Public Broadcasting Corporation nationwide on July 12, 1989.

2. Intelligence Collection in USSR Chamber of Commerce and Industry, U.S. Department of State, 1987.