The Changing Face of Communist Europe:

New Challenges For California Industry

By Jock O'Connell

(This article originally appeared in the Sacramento Bee Forum section on Sunday, November 26, 1989.)

American attitudes toward Eastern Europe have always been rich in ambivalence. While tens of millions of us could trace our roots to this realm of surplus consonants, many elected to obscure this fact for social or professional reasons. Even those who proudly trumpeted their cultural heritage generally ignored the hardship, cruelty and discrimination that drove their ancestors to America. But for all of us who lived in postwar America, the old countries of Eastern Europe, dominated by the Soviet Union, represented a hostile force that proved more successful in distorting our social and economic priorities than in defeating our armies.

Mere mention of the phrase "Eastern Europe" conjured images of concrete and steel barriers topped by barbed wire, and of dispirited, frightened citizens leading barren existences. For the majority of Americans whose knowledge of these lands behind the Iron Curtain came by way of espionage thrillers and "Mission Impossible" episodes, Eastern Europe embodied the nightmare world of Kafka and Orwell.

What's perhaps surprising is that many of us who have travelled in Eastern Europe and the Soviet Union periodically over the past twenty or so years have a nearly identical reaction. For once, it would seem, Hollywood's characterizations were not entirely absurd.

Given the circumstances, therefore, all of us can be forgiven if we find the recent stirring of democratic sentiments in Poland, Hungary, East Germany, Czechoslovakia and even Bulgaria -- all prompted in no small way by the current proprietor of what was not too long ago the Evil Empire -- to be positively surreal. Nonetheless, for the first time in generations, a stable peace in Europe really does seem attainable on terms that would turn our most ardent Cold Warriors giddy with delight.

Yet even as we bask in the euphoric glow of East-West detente, the changes unfolding in the Soviet Union and Eastern Europe are beginning to have far-reaching repercussions. So it would be prudent to begin taking measure of the myriad implications associated with the startling reformation of the Soviet bloc.

Apart from bringing us a welcomed but somewhat vague sense of relief, the latest developments in the East may seem more interesting than relevant to most Californians. Yet once the dust of a crumbling Berlin Wall has settled, and our television network anchors -- conceivably the most banal men in Christendom -- have found other crises on which to pontificate, will we in California continue to feel the impact of what is happening thousands of miles away in Eastern Europe?

The answer should be obvious. Distance no longer offers refuge from momentous developments, regardless of their epicenter. In the most respects, California will be affected in the same way that America will be affected.

But in some ways California will experience unique repercussions, partly because of our economy's reliance on Pentagon spending and partly because, as the nation's leading trading state, we have grown increasingly susceptible to developments in international commerce.

For one thing, the apparent advent of peace in Europe inevitably involves what are euphemistically known as economic dislocations. At the same time, the growing sense that the Soviet bloc does not present a clear and present threat to Western security may drastically alter relations among the Western allies precisely at a time when critical issues of international trade must be addressed.

To be sure, it would be foolish to expect a uniformly smooth transition from totalitarianism to "socialism with a human face" in the Eastern bloc. Nor should one assume that the Soviet Union and its Eastern European allies will turn themselves into liberal democracies with market-driven economies by a week from next Tuesday. Under the best of circumstances, setbacks occur.

Still, the unmistakable evidence of economic decline and the effective disintegration of the Warsaw Pact as a cohesive military force have led most experienced observers to discount the potential of armed conflict in Europe.

Not surprisingly, such evaluations of the situation have led to renewed demands in this country for both substantive cuts in defense spending and accelerated progress in conventional and nuclear arms reduction negotiations with Moscow. Needless to say, such cuts would have a disproportionate impact on those states which have enjoyed disproportionate benefits from defense spending. Among these is California.

According to a report last year by the Commission on State Finance, California firms captured 17.5% of total U.S. defense outlays in 1988. More remarkably, though, the state got over 30% of all defense outlays for research and development. As the Commission's report concluded: "Sharply rising defense budgets were responsible for a significant portion of California's manufacturing growth during the early and mid-1980's." Conversely, sharply declining defense budgets will likely retard near-term economic growth in California, especially in those industrial sectors most affected by Pentagon spending.

There are no precise figures on the number of Californians employed in defense- related jobs. The Employment Development Department places total manufacturing employment in the "aerospace" sector at 760,300 last year or more than a third of all manufacturing jobs in the state. This broadly defined category includes industries producing aircraft and aircraft parts, guided missiles and space vehicles, office computing and accounting machines, radio and TV receiving equipment, electronic components and accessories, and measuring and control instruments.

Certainly not all jobs in these industries are related to Pentagon programs. Nor, of course, are all defense-related jobs to be found in the field of high-tech. The majority of our high-tech firms derive most of their earnings from commercial projects. Moreover, in recent years, California's "aerospace" industries have accounted for approximately 70 percent of the state's exports. Still, whether it be through direct expenditures for hardware and services or expenditures that ultimately benefit civilian industry through the funding of advanced research, the Defense Department (along with NASA) plays a significant role in California's economic life.

The standing imperative of slashing the federal budget deficit is by itself bringing pressure to bear on the Pentagon to reduce expenditures. Even Secretary of Defense Dick Cheney, who has been among perestroika's chief skeptics, has just now directed the services to draw up plans for cutting $180 billion in projected defense spending. In addition to this, greater stability in Europe will naturally feed demands for paring back on the 300,000 American troops currently deployed in Western Europe.

(Most debates about the virtues of reducing the size of our commitment to Western Europe invariably refer to "bringing the troops home." This is misleading. As the British learned during their postwar recessional from military commitments overseas, troops garrisoned abroad cannot be simply transferred home as though they were pieces on a game board. Because host nations generally help defray the cost of stationing U.S. forces on their territory and because a redeployment of large numbers of service personnel would require the construction of facilities needed to accommodate them stateside, the odd truth is that, unless we are prepared to cut overall force levels, it is actually cheaper to keep the troops overseas. For these reasons, a reduction in U.S. troop strength in Europe or the Far East will likely result in a smaller military buying fewer weapons as well as other goods and services.)

More economically insidious, perhaps, is the Pentagon's retrenchment on advanced research in areas that often have either direct commercial application or serve to complement commercial research and development activities. According to recent news reports, the Defense Advanced Projects Agency has been singled out for major cuts, leading to concern that its funding of research on several emerging technologies may ultimately undermine U.S. economic competitiveness in a number of areas. Among the technologies affected are those involving high definition television, x-ray lithography, and a variety of robotics projects.

Such peace-driven cuts in defense spending will eventually resonate throughout California's most advanced industries, forcing them to concentrate more on commercial projects and on developing new markets overseas. Yet here too Western perceptions of a lower level of military threat from the East may result in a meaner climate for trade negotiations involving the United States and its principal allies.

More than anything else, it has been the Soviet bloc threat that has furnished the principal raison d'etre for the alliances that have bound much of Western Europe as well as Japan to the United States for over four decades. But since both Western Europe and Japan have outgrown any economic dependence on America, the diminished perception of threat from the East means that our allies will now have much less reason to look to the United States for protection, let alone leadership.

Ironically, the emergence of a more amiable and agreeable leadership in the Soviet Union may serve to reveal just how much influence the United States has lost with its friends. To varying degrees and at various times, the partners in the Western alliance have subverted commercial interests to the transcendent needs of collective security. In fact, domestic critics of U.S. trade policy have often charged that America has repeatedly sacrificed its commercial interests at the altar of foreign policy or national security considerations. But with the absence of a palpable threat to our collective security, Western nations will presumably feel less constrained about pursuing unalloyed commercial or economic objectives.

Thus, a more unified European Community (E.C.) would be less inclined to make concessions regarding its economic and commercial objectives for the sake of the security needs of the Western alliance. Similarly in the Far East, Japan will be less moved by the need to insure a continued U.S. commitment to maintaining the defense shield protecting Japan. While this does not necessarily imply a resurgence of Japanese military power, it does mean that Japan will have less reason for moderating its goals to suit American sensitivities. For better or for worse, increasingly over the next few years, Japan will be Japan.

That concerns about Western security will be less likely to inform trade policy may make for more bitter and protracted trade disputes between the U.S. and both the European Community and Japan. This is a crucial consideration for California. Not only are we America's foremost exporting state, Japan and the E.C. together buy nearly half of our exports.

On a less strategic plane, new opportunities are emerging for business ventures involving Eastern Europe and the Soviet Union. With few exceptions, though, we may be a bit late off the mark, especially in comparison to our competitors in Western Europe. Moreover, we face a range of intellectual, regulatory and financial hurdles in pursuing commercial opportunities in the Eastern bloc.

For one thing, most Californians are simply preoccupied (sometimes to the point of obsession) with the Pacific Rim. Europe may be a fine setting for a holiday, but the Pacific is where the future lies. Then too, in California we are simply on the "wrong side" of the continent to get involved with the Europeans. That's the popular myth.

The truth, however, is that California trades extensively with Europe, albeit not with Eastern Europe. In fact, California actually ships a higher proportion (31%) of its exports to Europe than does the U.S. as a whole (28%). Yet, for a variety of reasons, California's exporters have barely penetrated the markets of Eastern Europe.

In 1988, when California's exports worldwide totaled $36.8 billion, the Soviet Union, Poland, East Germany, Czechoslovakia, Hungary, Romania, and Bulgaria altogether bought just $90 million in goods from the Golden State. Yugoslavia, which broke from the Soviet bloc in 1948, purchased another $25.8 million in goods from us, while with everybody's least- favored-nation, Albania, we did no business at all.

By itself, the Soviet Union bought just $57.6 million in goods from California firms in 1988, mostly agricultural products including almonds from the Sacramento-based Blue Diamond Growers. By contrast, the People's Republic of China imported more than seven times as much ($434.2 million) from California that same year.

Collectively, the Soviet Union and its Eastern European allies would rank as California's 38th largest export market, right behind Egypt. To the optimist, this implies ample room for growth. More realistically, though, this low level of business suggests that most California companies are far from familiar with the markets of Eastern Europe and the Soviet Union and lack experience with some of the unusual ways business is conducted in that area of the world.

Much attention has been devoted to the problem of getting paid in "hard" or negotiable currencies for goods sold to Eastern bloc buyers. But where hard currency shortages limit how much the East can buy (while also testing the ingenuity of entrepreneurs), there are also strict limits on the types of products California firms can sell in Eastern Europe and the Soviet Union.

There are in fact two major obstacles to increased exports by California industry to the Eastern Bloc. The first takes the form of U.S. Government controls on high-technology exports. The other is the failure of the Bush Administration to grapple aggressively with the need to devise new methods of financing U.S. export transactions to Eastern Europe and the Soviet Union.

Both the substance and the implementation of U.S. regulations governing the export of the high-technology products have always been matters of considerable controversy in California. To be sure, the issue has never been whether to remove such barriers entirely. Certainly, no responsible person would advocate free trade in valuable, advanced technologies with hostile powers. Rather, the debate has centered on whether the restrictions strike a truly equitable balance between America's national security requirements and its commercial interests. Despite some recent improvements in the situation, there is still a widespread sentiment that U.S. export regulations continue to reflect a hardline, Cold War mentality.

The U.S. and its allies regulate trade in sensitive technologies through a Coordinating Committee on Multilateral Export Controls (COCOM), which includes the members of NATO except Iceland, along with Japan and Australia. Recent COCOM meetings have not been pleasant affairs for U.S. delegates who have found our allies less and less willing to go along with U.S. views.

Reports circulated following a COCOM meeting in Paris October 25-26 that the U.S. was out-voted 16-1 on the question of proceeding more quickly with streamlining the list of items now prohibited for export to communist countries.

Under the Bush administration, the U.S. has shown a greater willingness to ease COCOM controls on high-technology products that are widely available in areas outside of COCOM jurisdiction, such as Southeast Asia. For example, controls were abolished just this past summer on exports of laptops and certain other portable computers to Soviet bloc countries. Still, U.S. exporters face substantial obstacles in obtaining the permission to ship goods overseas even though similar goods are often readily available in nations like Brazil and Taiwan which are not obliged to follow COCOM restrictions.

Without a decisive move by the Bush administration to moderate existing controls, there may be little hope for a significant expansion in California exports to the Eastern Europeans and the Soviet Union. Unfortunately, the Administration announced on October 31 that it does not plan any further easing of restrictions on exports of strategic goods and technology to Warsaw Pact countries.

Even with less draconian export controls, California exporters would still encounter the problem of receiving payment for their goods. Because the currencies of all Eastern European economies are not legally convertible to other currencies, buyers of foreign goods are expected to pay either in a "hard" currency such as the dollar, pound or franc or through a countertrade arrangement, of which bartering is the most common example.

In contrast to Western European businesses, relatively few American companies are familiar with countertrade. These arrangements are often very complicated and risky, involving as they do the need to find a market in the West for the goods one has taken in trade. More than one U.S. company has wound up handing out Polish canned hams or Romanian jackets as gifts to workers at holiday season.

A substantial expansion in East-West trade will ultimately require Eastern Bloc nations to assume more external debt to finance imports of capital equipment and consumer goods. At the same time, the East will need greater access to government-backed credits, loan guarantees or outright grants aimed at facilitating purchases of foreign goods, normally from the countries providing the assistance. The West Germans, along with several other Western European nations, are busily structuring aid packages to stimulate trade and investment. Whether Congress and the Bush administration follow suit quickly will have a considerable impact on the ability of California businesses to compete successfully for Eastern European markets.

Perhaps next weekend's non-summit between Presidents Bush and Gorbachev will provide some useful clues as to how far the U.S. is prepared to go in abetting positive change in Eastern Europe and the Soviet Union. It now seems likely, however, that Bush will confine himself to granting Most-Favored-Nation (MFN) status to the Soviets, a step which will effectively lower the tariffs on Soviet products entering the United States.

Although this move may enhance the atmospherics of Soviet-U.S. relations, it may be of less practical benefit to the Soviets than is generally assumed, at least in the short run. For what, in short, would we buy from them?

In light of the notoriously low quality of Soviet goods, it is unlikely that a substantial market for Soviet-made products will develop in the United States in the near term. Chic New York department stores or San Francisco socialites may open boutiques where the innocent may purchase -- presumably at vastly inflated prices -- the same merchandise found in the foreign-currency shops located in all major tourist hotels in the Soviet Union. Such business, however, will not ripple the trade statistics.

One only need recall that the chief critic of Soviet quality control has been Mikhail Gorbachev himself. This does not amount to much of an endorsement for the output of Soviet industry, and for that reason the Soviets have sought to encourage Westerners to invest in the Soviet Union, usually in the form of a joint venture with a Soviet partner. Similarly, the Eastern Europeans are also pushing foreign investment but usually with fewer restrictions and therefore with more success.

The Hungarians have been the most open to foreign enterprise. This past August, the Getz Corporation, a San Francisco-based firm which describes itself as the largest non- commodity trading company in the United States, acquired a Budapest trading company. The purpose of the move was to enable Getz to balance its traditional strengths in the Asia-Pacific market by gaining access to Eastern Europe. More recently, General Electric acquired a majority stake in Hungary's principal light bulb manufacturer.

According to the U.S.- U.S.S.R. Trade Council, some 72 joint ventures involving American companies have been signed through last July. While a small number have involved California firms, a representative of the California-U.S.S.R. Trade Council complained that most of the joint ventures with which he is familiar exist only on paper.

If nothing else, the emergence of Mikhail Gorbachev and his policies of glasnost and perestroika have had one salutary effect. If only for a moment, they have distracted Californians from their usual preoccupation with the Pacific Rim. Whether California business can now successfully exploit these new opportunities remains an open question.

In addition to the need for positive actions by the Bush Administration and the Congress, California's entrepreneurs will have to overcome challenges that will test their patience and ingenuity before any dramatic gains in trade with the Eastern bloc can be recorded.

Copyright (c) 1989 by J. A. O'Connell

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