11. Memorandum From Philip Odeen of the National Security Council Staff to the President’s Assistant for National Security Affairs (Kissinger)1
- Balance of Payments Offset Agreements with NATO
A SRG meeting on NSSM 170—Offsetting the Balance of Payments Costs of NATO Deployments—is scheduled for Friday, April 20, 1973.
The current offset agreement with the FRG expires this June and the purpose of the meeting is to address the major issues to be decided in seeking a new agreement. In particular:
—Should a quick renewal of the current bilateral arrangement with the FRG be pursued?
—Should a multilateral offset arrangement be proposed?
—Should we give priority to expansion of Allied offset efforts at the cost of force improvements programs?
The need to compensate for the cost of our European troop deployments was first formally recognized by NATO in the early 1950s. Actual agreements have been limited to US–FRG bilateral arrangements that initially diverted military procurement to the U.S. In the late 1960s as the initial FRG effort to equip its forces was completed, other measures were introduced including (a) payment for civilian projects of joint benefit, and (b) loans to the U.S. Treasury.
Although offset considerations have also been briefly mentioned in discussions of military procurement with the UK and Italy, neither country has entered into a formal agreement. In 1970 an agreement was concluded between the UK and FRG offsetting some of the UK spending in the FRG.[Typeset Page 41]
The Current BOP Situation
In FY 1972, the U.S. spent about $2.1B in NATO Europe to support our military deployments. About 90 percent was concentrated in five countries: (the FRG (66%), the UK (14%), Italy (7%), and the Benelux (5%)). About half was spent directly by our military personnel stationed overseas with the remainder paying for foreign civilian personnel working on U.S. bases, utilities, other services and supplies.
In the same year, NATO countries spent about $600M in the U.S. (mainly for military equipment) leaving a military deficit with NATO Europe of about $1.5B distributed by country in roughly the same manner as our military spending.
U.S. Military Deficit with NATO Europe in FY 72
|Country||Millions of Dollars||Percent of Total|
This $1.5B deficit with NATO was about half our total military deficit in FY 72 and is about 20 percent of the overall U.S. BOP deficit. The military BOP deficit was not the major cause of the overall BOP problem, however. It was caused by a deterioration of the trade surplus that in the past has paid for military deficits. In fact, our trade balance passed for a surplus of $1.0B in 1970 to a deficit of $2.7B in 1972.
The importance of the military BOP deficit will probably increase in the future because:
—Military outlays have been pushed up by (a) depreciation of the exchange rate (it takes more dollars to pay troop costs); (b) U.S. military pay has increased; and, (c) increasing overseas prices.
—Military receipts have not offset the increased expenditures. Most of this spending is for military equipment and sales have not increased even though prices have decreased because of devaluation. The countries prefer to buy from European producers.
Types of Offsetting Actions
There are two types of BOP offsetting actions—those that have real economic value (known as “hard” offsets); and those of primarily cosmetic value (known as “soft” offsets).
Of the “hard” offset measures, some are more valuable than others because they reduce our defense costs in addition to reducing our BOP deficit.[Typeset Page 42]
—Those that both reduce our defense costs as well as our balance of payments deficits are known as “burdensharing” measures and have the highest value because they represent a shift in the economic burden (in addition to providing balance of payments relief). Examples are (a) direct takeover or reimbursement for costs of keeping our troops in Europe, and (b) FRG payment for barracks improvement and other capital improvements.
—Those that reduce the BOP deficit, but not our defense budget do not constitute a shift in the real economic burden and are not “burdensharing” measures. Examples include: (a) FRG procurement of military equipment in the U.S., and (b) FRG funding of civilian projects in the U.S.
Soft offsets include the FRG loans that have been part of past agreements. These “soft” offsets are of some value with Congress but have no real economic value because they do not permanently reduce our debt to the FRG. They were only included in past agreements because they had a temporary statistical effect on the BOP data. Due to changes in economic conditions (specifically the fact that the dollar is no longer convertible into gold), they no longer have even the statistical impact (although this may not be completely understood in Congress).
The Current Agreement
The current agreement with the FRG provided $2,035 million over two fiscal years, FY 72–73, and consisted of
—military procurement totalling about $1.2B,
—FRG paying for rehabilitation of barracks currently used by our troops ($185M), and
—loans of about $620M at lower than market interest rates with the FRG paying the interest ($31M).
The study concludes these measures covered in hard offsets about 50 percent of the $3.0B we paid to keep our troops in the FRG over the two year period. On the other hand, the Administration has argued in Congress that the current agreement is 90 percent effective. This 90 percent figure includes the FRG loans and other “soft” offsets that in fact have no economic value.
The most recent offset agreement included two new features:
—FRG direct payment in support of our deployments (barracks rehabilitation); and,
—the FRG interest subsidy.
The value of the agreement is somewhat tempered because a portion of the $1.2B in FRG military procurement was paid for from funds paid to the Treasury by the FRG in previous years. Today, this “overhang” from previous years totals about $500M and is due largely to FRG failure to meet procurement goals set under past agreements.[Typeset Page 43]
In developing a strategy for negotiating the next agreement, the study outlines several relevant broad considerations that should be addressed:
—Changes in the international economic environment.
—The probable conflict between increased Allied burdensharing and force improvement efforts.
—Congressional concern with our military BOP deficit and how an agreement should be structured to reduce it.
—Allied views which will determine the acceptability of any plan.
International Economic Factors
The major economic change which has occurred since 1971 is the move towards a more flexible exchange rate system between the dollar and other currencies. Some believe (CIEP, OMB and Treasury staff) these changes will make it easier to attain BOP equilibrium and therefore BOP offset actions need not be pressed. Instead the focus of future efforts should be given to burdensharing.
Force Improvement Trade-off
However, any increased burdensharing effort would involve direct payment of U.S. troop costs that could only be funded by adding to Allied budgets (defense or otherwise). This would obviously interfere with getting more funds for further force improvements. Moreover, current policy, established early in the Administration, encourages Allied force improvements rather than burdensharing. A major burdensharing effort would require that this policy be changed.
One intermediate position would be to encourage Allied spending for measures that contribute towards improvement of defense capabilities but also can be justified on burdensharing grounds. An example is FRG funding of aircraft shelters for U.S. aircraft.
A second would be for the Allies to assume certain combat functions that would make reductions in U.S. budgets possible. This would constitute real burdensharing at near zero costs to the Allies and may be worth further investigation.
The study finds Congressional concern to be focused on two factors: (a) the belief that the economic burden of NATO’s defense is unevenly distributed with the U.S. carrying too much of the cost; and, (b) a belief that BOP costs of our deployments generally weaken our external position. To meet both concerns, an agreement should include budgetary as well as BOP relief. An interesting possibility would be to aim for FRG budgetary relief to cover the $350–380M additional cost of keeping troops in Europe [Typeset Page 44] (compared with the U.S.). Success would mean a unilateral reduction by Congress would have no impact on the defense budget; thus, providing a good argument against unilateral reductions.
Finally, the study finds that Congress is not generally sensitive to the real economic value of various measures—the larger the total, the better, even if “soft” offsets are included.
The study finds that the FRG would resist subsidizing U.S. troop costs directly because they identify this politically with payments made during the occupation. However, if encouraged as part of a new NATO-wide policy, FRG acceptance is more likely. FRG willingness to fund capital improvements (e.g., barracks rehabilitation) is also greater because these measures make improvements that would revert to Germany if U.S. troops withdrew.
The other Allies generally view burdensharing as a means of gaining entrance to the FRG till. State asked embassy views on multilateral plans early in the spring and the response was directly related to whether or not the particular country could gain or lose under the plan.
Alternative Offset Approaches
There are two broad types of offset approaches we could pursue:
—a bilateral arrangement negotiated with the FRG; or,
—a multilateral arrangement which includes several other NATO countries.
Renewal of a bilateral agreement with the FRG could be pursued separately or as part of a multilateral effort.
The key question with respect to a bilateral arrangement with the FRG is the relative priority we should give to the several types of offsetting actions that could be included:
—Direct FRG payment of certain categories of our troop costs (e.g., Germans working on U.S. bases) which have high value since they reduce our defense budget costs and also provide BOP relief.
—Allied funding of more barracks improvement and other “capital improvements.” The FRG will probably offer to continue with the current barracks rehabilitation program but we could press for more efforts perhaps focused on action that directs improved NATO defenses (construction of aircraft shelters). A second alternative would be Allied assumption of certain support combat sales that could lead to reduction in the U.S. budget or deployments at near zero Allied cost. The problem with these measures is that most do not reduce the recurring costs of our deployments since they represent new programs.[Typeset Page 45]
—Military sales might be increased but the study finds that a successful effort to expand greatly the $1.0B projected for FY 74–75 is unlikely because of a German desire to procure arms domestically.
—A lengthy list of civilian projects of joint US–FRG interest that might be funded by the FRG in the U.S. has been drawn up (e.g., sale of nuclear fuel manufacturing facilities). The total exceeds $2.5–3.0B over the next five or six years but only $70M in FY 74. OMB objects to many of these projects on grounds that they are additional to Agency budgets—further investigation of these possibilities would, however, be worthwhile.
—Finally, we could continue (and perhaps expand, the FRG loans despite their lack of economic value. The main purpose would be to provide “filler” to be used in presenting the agreement to Congress. The danger is that U.S. acceptance of this “filler” may undercut efforts to get “hard” offsets of real economic value. Treasury and the other government economists believe these loans should be left out of any agreement or included only as a backstop measure.
A wide range of multilateral offset plans have been suggested ranging from a NATO-wide effort to compensate for every country’s military BOP deficits to more limited approaches that include only three or four countries.
The principal value of these plans is that they would generate enhanced support in Congress because they are a clear demonstration of a NATO-wide concern plus the likelihood that higher payments would be forthcoming in a plan that included several countries.
Most of the plans involve the creation of some sort of payments fund which would receive contributions from various members to cover certain categories of stationing country troop costs. These plans differ according to:
—The type of costs covered. For example, the plan could cover troop costs of all countries with troops stationed outside its borders or only U.S. troop costs. Should the plan cover only basing costs or the full cost of all military related spending—including personnel spending?
—The formula that determines contributions. Some plans would base contributions on a certain percent of each country’s military BOP surplus while others would simply divide total costs between participating countries on the basis of some measure of ability to pay. Other plans include a joint basing arrangement in which the stationing troops occupy a base as tenants with the host country assuming the costs.
The principle disadvantage of these plans that create a fund is that the FRG is likely to end up paying a greater amount than currently. It exposes the [Typeset Page 46] FRG claims from other NATO countries who station troops in Germany but currently have no offset arrangement.
This accounts for the FRG’s past unwillingness to consider multilateral plans since they could end up paying more than in the current bilateral arrangement with the U.S.
Thus a key consideration of any multilateral plan would be to insulate the FRG from the claims made by other NATO countries. This could perhaps be done by developing a plan in which only U.S. troop costs were covered but on a multilateral basis with several countries contributing according to some prearranged plan.
A second, less formal multilateral initiative would consist of a series of bilateral agreements between the U.S. and various NATO Allies pursued under a “multilateral umbrella” and based on a renewed NATO-wide commitment to cover U.S. troop costs—perhaps made at the coming June ministerial. The focus of these bilateral arrangements would be on the four or five major countries which absorb 95 percent of our spending (FRG, UK, Italy, Benelux).
Finally, a third multilateral initiative would involve expansion of the Eurogroups current European Defense Improvement Program in order to encourage expanded military procurement to the U.S., thus providing increased BOP relief.
Issues for Decision
With Brandt’s visit scheduled for early May, broad decisions on our approach to the coming negotiation should be made by the end of this month.
Thus, the immediate decisions to be made concern:
—The type of plan we should pursue and, in particular, whether a multilateral initiative should be attempted.
—If a multilateral initiative is taken, should it be combined with a parallel attempt to renew the FRG bilateral arrangement.
—The emphasis that should be placed on increasing Allied burden-sharing efforts at the possible expense of future force improvements. We should also consider ways of perhaps combining the two—for example, in FRG funding of aircraft shelters or enhanced European Defense Improvement Programs focused on procurement of weapons.
Once these broad decisions have been made in the SRG meeting, we can refine our position further through investigation of the various possibilities for increasing military sales and U.S./FRG civilian projects of joint interest.
State believes that we should press immediately for renewal of the bilateral agreement with the FRG along the lines of the current agreement with [Typeset Page 47] little change. They do not believe any multilateral initiative would be acceptable to the FRG and hence favor continuation of the bilateral agreement. Their reasons have not been well defined and I believe their position represents previous momentum rather than a well thought out view of how we ought to proceed.
Defense believes a mixed strategy should be followed aimed at expansion of a multilateral payments fund to cover the additional costs of keeping U.S. troops in Europe ($360–380 million annually), perhaps combined with a multilateral effort to expand the force improvement program. This would be combined with renewal of the bilateral arrangement with the FRG. They also believe we should accept FRG loans and other “filler” to make a high total for use in Congress.
Treasury objects to including FRG loans and stresses the need to get economically meaningful hard offsets on either a multilateral or bilateral basis even if this means a lower total is presented to Congress. They believe accepting loans degrades the agreement before Congress and results in fewer hard offsets because it weakens our negotiating position. The latter argument has some merit but I believe this view overestimates the economic sophistication of the Congress which tends to focus on the dollar total of the agreement rather than the economic value of each component.
In my view, any approach to the FRG offset should acknowledge the many changes in the economic situation that have occurred since the last agreement was concluded. Recent economic events have demonstrated our economic vulnerability clearly to the Alliance and Congress and increases the need for some new approach. A multilateral initiative would, therefore, be particularly useful this year.
I, therefore, believe we should press for increased economic relief and direct NATO reimbursement for some of our troop costs on a multilateral basis. The objective would be to cover the full $360–380M incremental annual cost associated with keeping our forces in Europe instead of the U.S. In addition to BOP and burdensharing relief, it would be very useful with the Congress. We could state that there would be no budgetary advantage to troop cuts.
The problem, of course, is that it may undercut efforts to get more force improvements over the next couple of years.
In addition, we should press to increase NATO military procurement in the U.S., but give it lower priority compared to direct takeover of budget costs.
Your Objectives at the Meeting
At the meeting, I suggest you discuss first the major background considerations that will influence our choice of a negotiating strategy such as:[Typeset Page 48]
—The burdensharing/force improvement tradeoff.
—Composition of Congressional opinion.
Second, you should press for agency comments on a negotiating plan that leads towards:
—Immediate renewal of the bilateral agreement with the FRG of one or two years with an emphasis on burdensharing measures (direct takeover of some U.S. troop costs). Loans and other “filler” would be accepted only as a last resort.
—Creation of a multilateral payments fund aimed at covering incremental U.S. troop costs of $350–380[M]. This would take some time to create and could give credit for the bilateral agreement with the FRG. The multilateral initiative would be announced at the spring ministerial in time to have an impact on the troop debate in Congress.
Finally, you should discuss the various components of the bilateral agreement and establish the priority for burdensharing—especially those measures which improve allied defense capabilities (e.g., aircraft shelters construction).
Talking points are included in your book that follow this line.
Your book also contains:
—A brief analytical summary which describes in more detail the various type of multilateral agreements, gives more background and describes in more detail the various types of bilateral offsetting actions. It also includes the issues and alternatives section of the NSSM report. This is about 10 pages in length and should be read if possible.
—Parts, I, II and III of the NSSM report which describes the overall BOP situation and various multilateral and bilateral arrangements.
Summary: Odeen reviewed the issue of balance of payments offset agreements and summarized the interagency study prepared in response to NSSM 170, Offsetting the Costs of U.S. Forces in Europe.
Source: National Archives, Nixon Presidential Materials, NSC Files, NSC Institutional Files (H-Files), Box H–67, Meeting Files, SRG Meeting—Cancelled 4/26/73. Confidential. Sent for action. Sonnenfeldt and NSC staff member John Lehman concurred. Attached but not published are the enclosures included in the briefing book. The 43-page study prepared in response to NSSM 170, dated April 1973, is ibid.↩