Foreign Relations of the United States, 1981–1988, Volume V, Soviet Union, March 1985–October 1986

214. Memorandum of Conversation¹

Washington, April 14, 1986, 2–3 p.m.

SUBJECT

• Briefing with Experts on The Future of the Soviet Economy (U)

PARTICIPANTS

• The President
• The Vice President
• James A. Baker III, Secretary of the Treasury
• W. Dennis Thomas, White House
• Admiral John M. Poindexter, NSC
• Donald R. Fortier, NSC
• Stephen I. Danzansky, NSC
• W. Allen Wallis, Under Secretary of State
• Lucian S. Pugliaresi, NSC
• Henry Rowen, Hoover
• Charles Wolf, Rand
• Vladimir Treml, Duke
• Andrew Marshall, Department of Defense

Minutes

Poindexter began the meeting by informing the President that we were pleased to have four eminent experts on the Soviet economy. He stated that the purpose of the meeting was to give the President their views on the prospects for the Soviet economy and the implications for the West. (C)

Poindexter pointed out that this briefing was part of our preparations for the President’s unstructured time at the Economic Summit and that this briefing would also prove useful for the President’s upcoming meeting with Secretary Gorbachev.² (C)

Poindexter informed the President that the poor performance of the Soviet economy could be contrasted with the President’s theme for his Pacific journey: The Winds of Freedom. The successes of the free economies are impressive when compared to the failing and antiquated machinery of the Soviet system. He pointed out that Allen Wallis had already briefed the President on the Tokyo Summit and that it would be looked upon as a celebration both of freedom and unparalleled cooperation in the economic, as well as, political and economic spheres. (C)

Poindexter then stated that it was premature for the President to offer the allies specific policies for addressing a failing Soviet economy, but that it is important that we take this opportunity to raise their awareness of this issue. (C)

Poindexter then went on to introduce Henry (Harry) Rowen and asked him to introduce the other experts. After introducing the other experts, Rowen began the discussion by pointing out that there is growing evidence that the Soviet economy is doing considerably worse than many analysts had suspected and that its outlook was poor. An outline and two charts (attached) presenting an overview of the briefing was given to the President and all attendees.³ The experts discussed the charts which showed declining growth in Soviet GNP and a likely decline in Soviet hard currency earnings for 1986. Rowen stated that these figures don’t tell the whole story. One of the clear indicators of poor Soviet performance was that the health and welfare of the Soviet people were declining. (C)

Treml then added that infant mortality was rising and that life expectancy had declined over the last twenty years—the Soviet Union was the only industrialized country which had such a remarkable drop in health. In addition, alcoholism was now rampant in the USSR. (C)

The President suggested that increased mortality might be the only way people can escape from the Soviet system. In addition, he stated that alcoholism was probably related to the pessimistic outlook the people had of Soviet society. (C)

Baker asked if drug use was extensive in the USSR and Treml answered that it was largely alcoholism. The President commented that Gorbachev’s anti-drinking program must be having some effect. At a recent meeting with the Soviets, one of the officials commented that the only place he could get a drink was in the West. (C)

Rowen then began to outline the Gorbachev modernization program and indicated that it was unlikely to work. Rowen suggested that future Soviet growth will probably be closer to 1½% per annum and with the Soviet population growing by about 1½% per annum, per capita income will probably not rise. In addition, future Soviet economic performance will probably continue to be poor as the result of declining oil prices. Earnings from natural gas will fall as oil prices decline and the Soviets can expect a decline in weapons sales as many oil-exporting buyers experience financial constraints from lower oil prices. (C)

Rowen went on to point out that the Soviet labor force is not growing and that productivity is likely to decline. By the year 1990 Japan will likely overtake the Soviet Union as the world’s second largest economy. This means the Soviets will have less capacity to compete militarily. Harry asked Andrew Marshall to comment on the military burden. (C)

Marshall pointed out that the direct Soviet military burden is 15–17% of GNP. However, the penetration of Soviet military spending into the civilian sector is extensive. For example, 15% of merchant ships are doing military work and it is not unusual for other non-military sectors, such as fisheries, to receive higher funding to build additional ships to support the military. (C)

Marshall said it broke down as follows in terms of the military burden on Soviet GNP: 15–17% for direct military expenditures, plus 4% for civilian subsidies, plus 2% for the civilian mobilization base, plus 3% for the Empire (such as Cuba and Angola), for a total burden of 24–26%. (C)

Rowen then added it’s unlikely that the Soviet society has the capability to sustain this burden over the long-term. As a result, the Soviets will probably be more reluctant to take on foreign adventures unless, of course, the risks are low and the payoffs large, e.g., Iran. Rowen then asked a question: Will the system change? Rowen stated that the Chinese have made changes, but Gorbachev may try and fail or he may not even be willing to take the risk. The betting in the short run is that he will not take the risk. (C)

Treml pointed out that the Soviets are probably not willing to make any further cuts in consumption. Regan asked if they would be willing to cut the military and Treml responded that they might be willing to consider it. (C)

The President then asked about the influence of the generals. He referred to Brezhnev’s comments to Nixon that “you have your Congress but I have my generals.” Rowen added that he thought the generals were under control. (C)

Marshall pointed out that the generals can get into trouble if they are too vocal, e.g., Ogarkov received a demotion when he spoke out about cuts in military spending. Marshall also made two more points:

(1) A large global nuclear war is not now viewed by the Soviet Union as the most likely war, but rather a conventional war with high attrition rates and requirements for large amounts of spare parts. (C)

(2) Soviets will need sophisticated technologies to fight such a war, which are not now available to them. (C)

The President then pointed out that Gorbachev had complained to him that U.S. policy was to bankrupt the Soviet Union because of our tendency to keep developing new weapons. (C)

Marshall responded that there are times when we were only thinking about a new weapons system and the Soviets go to work immediately to develop a counter weapon long before we had made a firm commitment. The President suggested that this might be a good strategy. (C)

Rowen now moved the discussion on to Eastern Europe. Harry pointed out that when oil prices rose in the 1970’s the Soviets subsidized oil shipments to them by giving them oil at less than world prices. However, now with the collapse in oil prices the reverse is true. (C)

Wolf then stated that given the poor economic performance of the Soviet Union the burden of the Soviet Empire on the USSR is getting larger. He indicated that the Soviets are trying to reel back these costs and may not be as willing now to incur costs as in the past. However, Wolf didn’t see the Soviets taking any major risks with Eastern Europe. (C)

Rowen agreed that Eastern Europe is an important consideration for the Soviets but that Eastern Europe is now being dragged down by the USSR. In the future the Eastern Europeans will be reluctant to be taxed by the Soviets. (C)

The President pointed out that some people listen to these discussions on the state of the Soviet economy and see the Soviets not as a sick bear, but as a wounded bear. The President did not view a sick bear as dangerous and stated that he had always believed that the appropriate strategy was to keep the heat on the Soviets. (C)

Rowen replied that this was exactly right and that many of our European friends believe that the more help we give the Soviets the less dangerous they will become. At this point Regan asked if Harry expected Soviet debt to increase.⁴ (C)

Rowen pointed out that the Soviet net debt will increase to about $20 billion which implies a debt service of about $2 billion a year. This is close to their capacity for debt service given minimum import requirements of food and equipment. As a result, this is the point at which the banks should exercise some caution and, in any case, government guarantees should not be permitted to ensure that the private sector appropriately evaluates the risk of doing business with the Soviets. (C)

Regan asked how big the Soviet GNP was and Rowen responded that it was about $2 trillion. The President asked how it compares to our GNP and Regan replied that our GNP would probably hit $4.2 to $4.3 trillion this year. (C)

Rowen talked about what we might do given a failing Soviet economy. For example, although we shouldn’t help the Soviet economy we should not give up trying to reach the Soviet people. We need to keep looking for ways to open up their system, e.g. restore direct telephone dialing and permit parcels to be shipped directly to Soviet people. The main thing is we have to address the internal contradictions within their system. (C)

There are a number of other things we could do. For example:

(1) West Germany could be more imaginative. The FRG could try and get the Soviets to make some unilateral reductions in their forces in Eastern Europe in exchange for better relations with the FRG. (C)

(2) Japan should seek a return of the Northern Islands. The President mentioned that Prime Minister Nakasone complained to him about this at Camp David. Rowen stated that the Japanese should get in a state of mind that this must take place before any major new steps can take place in USSR-Japan relations. (C)

Baker raised concerns about sanctions which only harm U.S. interests and help competing foreign firms, as was the case with Libya. Rowen pointed out that the best way to solve this problem is normal trade: yes, subsidized trade no. This should take care of Secretary Baker’s concerns Rowen stated and Baker agreed. (C)

Poindexter pointed out that we should make the Soviets realize the poor risks they are taking. He also asked Rowen what factors contributed to Gorbachev’s success at the Party Congress. Rowen said that it was his view that the Party Congress was a conservative gathering and did not succeed from Gorbachev’s point of view. Treml then pointed out that Gorbachev is not getting visionary people into the Party Congress and Wolf pointed out that the KGB, however, was doing well in getting high level appointments. (C)

Wallis asked about the use of computers especially personal computers, in the Soviet Union and whether it posed a serious threat to the Soviet Union. Rowen agreed that the use of computers was a severe problem for the USSR. First, the lack of computation power will hurt the Soviet military. Second, such items as disks, tapes, etc, present a legitimate basis of concern for a regime like the USSR. (C)

Poindexter thanked the experts for their presentation and the President expressed his appreciation. The meeting was concluded at 3 p.m. The White House photographer took several photos of the experts with the President. (U)

1. Source: Reagan Library, Stephen Sestanovich Files, U.S.-Soviet Relations: 03/25/86–04/24/86. Confidential. Sent for information. Prepared by Pugliaresi. The meeting took place in the Oval Office.
2. Reagan and Shultz attended the G–7 economic summit in Tokyo May 2–7. Documentation on the summit is scheduled for publication in Foreign Relations, 1981–1988, vol. XXXVII, Trade; Monetary Policy; Industrialized Country Cooperation, 1985–1988.
3. The outline, entitled “Gorbachev’s Predicament,” and two charts, “Soviet Economic Performance and Forecasts” and “Soviet Hard Currency Earnings”, are attached but not printed.
4. Although Regan is not on the list of participants, this indicates that he was present for at least part of the meeting.