SINCE VJ day the United States has given or loaned about 40 billion dollars to foreign governments. In Europe alone this process of extending foreign aid has been marked by overlapping phases--from relief to recovery to rearmament, from UNRRA to E.C.A. to NATO. Each has been described as temporary and as the next to the last, if not the last, venture of its kind. Yet each has involved larger outlays than its predecessor. By the end of 1952, the United States will be spending more money for foreign aid, at an annual rate, than at any other time during the postwar period.

In January, the new administration will fall heir to the two operations now in progress: Point IV and the Mutual Security Program. They involve appropriations for the current fiscal year of six billion dollars, of which more than 90 percent is going, as it has since World War II, to the European partners of the United States. Although the problems of the underdeveloped areas are on a smaller financial scale, they are no less difficult and pressing than those of more highly industrialized Western Europe, and they may turn out to be of even greater importance to the United States. Hence a fully-rounded treatment of foreign aid would perhaps give equal attention to both these programs. However, the discussion that follows will be concerned exclusively with aid to Europe, in part because Point IV and military aid to other areas are less significant for the American budget, but mainly to make the subject matter manageable.

Against the background of seven years of recent history, two quite divergent attitudes toward foreign aid are developing on both sides of the Atlantic. On the one hand, people are getting used to it and are coming to accept it, perhaps fatalistically, as a normal feature of the landscape. Many Europeans increasingly take it for granted that the United States, by far the wealthiest member of the Western coalition, should contribute military and economic aid as well as armed forces and their equipment to the common enterprise of defense. Many Americans are beginning to regard it as natural, if on the whole unfortunate, that they should have to continue at least moderate "charitable" contributions to their allies as a part of the price of preventing a third world war and maintaining the strength and cohesion of the non-Communist alignment, actual and potential.

Some thoughtful people on both sides of the Atlantic, however, display growing dissatisfaction with a policy which seems to be little more than a succession of ad hoc improvisations, none of them clearly foreseen, and leading to no visible end. Perhaps more Europeans than Americans recognize that foreign aid, as presently conceived, cannot continue indefinitely without "corrupting both the Europeans and the Congress and turning an alliance of self-respect into a confederacy of clients," as the London Economist has warned.

Neither the attitude of fatalistic giving and receiving of charity nor that of growing impatience with a procedure which seems to have outlived its usefulness is healthy. It is time, therefore, to reexamine the practice of using subsidies to other countries as an instrument of national policy, to speculate on how long they may be needed, and to assess the benefits and burdens that they bring to the American people. If, as will be argued here, subsidies will probably be essential for some time to serve the interests of the United States, this likelihood should be frankly realized by both Americans and Europeans. In this event, the real problem is to handle these transactions in ways that clarify and intensify understanding of their mutually advantageous character. Otherwise they may foster the frictions associated with charity, and thus corrode the relationships between self-respecting allies.

II. THE SITUATION OF THE UNITED STATES

Perhaps the most fundamental fact about the position of the United States in the world is that its greatest comparative advantage over the Soviet bloc, and indeed over any other Great Power or Powers, is its economic strength. The basic data are familiar enough. After all, the United States has only 6 percent of the world's area and 6 percent of its population. In both respects it is considerably inferior to the Soviet Union alone, to say nothing of the whole Communist bloc. The United States is also probably weaker in its possession of basic resources. The report of the President's Materials Policy Commission has made it clear that this country will depend increasingly upon the rest of the world for imports of petroleum, iron ore and most of the non-ferrous metals. The reason, and the sole reason, therefore, that the United States today is the strongest single nation in the world is that it has accumulated an unparalleled structure of capital assets and has so raised the productivity of its population that its economic strength, no matter how measured, is incomparably greater than that of the Soviet bloc.

Although these points are familiar, their significance for foreign policy seems to be less generally perceived. If the United States is relatively "poor" in area, population and basic resources, but "rich" in productivity, capital equipment and current output, then its world strategy surely must be to make the most skillful and effective use of its own kind of economic strength in order to compensate for certain deficiencies in its rôle as a Great Power. One way this can be done is, of course, through our system of alliances. They add to the wealth of the United States some of the human and material resources of other nations; at the same time, they augment the human and material resources of the other nations with some of the wealth of the United States. The very purpose of the North Atlantic Alliance must be, then, to develop methods by which the strength of the United States can render more effective the manpower, strategic position, productive capacity and skill of the Europeans and by which, conversely, these can render the economic strength of the United States more effective not only for defense purposes but also for building the conditions of a dynamic and durable peace.

Now the mere fact that the resources of two countries are complementary (as, for instance, those of the industrial nations of Europe and the primary producing nations of Latin America and South Asia) does not create a case for a subsidy of one by the other. But the United States and its European allies are engaged in a joint enterprise which regrettably requires the diversion of enormous resources to the economically unproductive activity of building martial might. This task calls for manpower, strategic locations for construction of naval bases and airfields and other installations, the production of materiel, and a constant flow of supplies to sustain armed forces as they are brought into being. Only Europe can contribute to the coalition certain elements that go into a satisfactory military posture, notably strategic positions and military facilities. The nations of Europe can contribute manpower in proportion to their populations with no more (or less) sacrifice than the United States, and at a very much smaller cost per man. But their economic capabilities are far more limited than those of the United States, in terms of income per capita, plant and organization to produce heavy military equipment in volume at low cost; and they suffer from an adverse balance of payments. Under these circumstances the Europeans can contribute to the common cause less in wealth than in manpower and other resources such as land. What is more important is that the ratio of the economic burden the Europeans can assume to the manpower they can contribute, as they reach the ceiling of their capabilities, will be far below both the similar ratios in the United States. It is below the ratio required by modern warfare.

The implications are clear enough. If the United States is contributing a larger proportion of wealth than of manpower to the common enterprise, then a part of that wealth can best be used to help the Europeans rearm. If it were not being so used, the Europeans would certainly set up many fewer divisions than they are now preparing. Only if the different potentialities of America and Europe are combined in this fashion can they be efficiently utilized.

Few would disagree with this proposition if it were not constantly confused with another. If we concede that the United States should, on a comparative basis, contribute more heavily in one form and its European allies more heavily in another, is not the total American contribution unduly large, in view of the stakes at issue for everybody and the individual and collective strength of our allies? This is a key question. It reflects the suspicion that the Europeans do not "need" as much help as they claim, that they are not sufficiently "interested" in their own defense, and that the United States is carrying too big a share of the load. It is this suspicion which prompts many Americans to question the need for subsidies, or at any rate subsidies of the size of those proposed and currently being granted.

But the difficulty with this question is that no criteria exist for an answer. How can one measure the value that Frenchmen place on preserving the liberty of France or the value that an American places on preserving the independence of the United States? In short, "how much" is freedom? Moreover, can we be sure that our appraisal of Soviet motivations and ambitions is valid and that the somewhat more optimistic British and French appraisal is false? Even if we all place the same values on freedom and accept the same appraisal of the common risk, by what standards is a common burden to be allocated as between the relatively wealthier and the relatively poorer members of an international coalition? The Europeans, applying the principle of progressive taxation, would argue that the American share is certainly not excessive and is quite possibly less than it should be. Few Americans would accept this opinion. And there is neither a supreme court nor a legislature where the differing views may be resolved. The abstract question of the equities must, then, be left unanswered.

III. THE ECONOMICS OF SUBSIDIES

The concrete question, however, as to whether the subsidy is a useful instrument of United States foreign policy, whether it should be continued and in what sizes, and forms, and for how long, must somehow be reduced to quantitative terms. The starting point for any such inquiry, of course, is to determine the forces that today limit the economic abilities of the Europeans. Before going into this subject, something must first be said about the economic process involved when one government furnishes aid to another, as well as about the type of judgment invoked to assess the economic capabilities of any country. It need hardly be said that a subsidy from one nation to another comprises a transfer of resources, that is, of goods and services. The simplest way to effect a transfer of this sort is to make a payment in currency, or in gold, and allow the recipient to use this money to purchase goods and services as it sees fit. But it has been the general policy of the United States since World War II to grant subsidies in kind. We have supplied military equipment, under the Mutual Security Program, and have financed general imports of goods and services--the method employed under the Marshall Plan.

There is a great deal to be said for this procedure. Yet it has given rise to the fallacy that the composition of a subsidy in kind, the sheer make-up of the goods and services that may be provided, determines the impact of the subsidy upon the economy of the receiving country. From this premise, it is argued that there is one kind of subsidy called economic aid which differs from another kind of subsidy called military aid, and that they differ not only as to the purpose each is designed to serve, but also as to the physical nature of the goods that can appropriately be sent to the receiving country. It is argued that the way to help people achieve economic recovery is to give them machinery and, possibly, raw materials but that the way to help them rearm is to give them military equipment.

This line of reasoning has led to many wrong conclusions. If it is believed that the way to help the Europeans rearm is to provide them with tanks and planes, but not with any economic aid, then it follows that the extent of aid they need should be determined by calculating their total requirements for military equipment, subtracting the amount they can produce for themselves, and taking the difference between the two as the gap which must be filled by means of subsidy. This type of calculation would appear to make the whole problem a tidy and technical one. Its only defect is that it ignores reality. It provides no answer to two crucial questions: why is it that the Europeans cannot produce more equipment for themselves, and why is it that they cannot pay for the equipment they need to import from the United States? The moment these two questions are raised, the tidy, technical calculation is shown to be incomplete, if not actually irrelevant. In turn this ought to suggest that whatever the purpose to be advanced by a subsidy, the amount required depends upon the general economic position of the receiving country as well as upon the course of action it is expected to pursue. Since failure to grasp this point is the source of widespread confusion, it may be helpful to try and clarify the economic nature of a subsidy.

A subsidy is a transfer of resources, whether in cash or in kind, from one nation to another. It benefits the receiving country in two ways. First it enables the people of the recipient nation to consume more than they otherwise could, or to devote more resources to capital investment, or to rearmament, or to any other major goal which claims a part of the output of their economy. Second, a subsidy adds to the foreign exchange resources of the receiving country. In the 19th century world it would have been unnecessary to make the distinction between these two benefits, because the country which was sufficiently productive could always borrow at home or abroad, when it could not divert a sufficient portion of its goods and services into foreign exchange by taking them out of current production and selling them in world markets. For a variety of reasons, this condition no longer prevails generally. Few nations--even by invoking the most stern and judicious public and private policies--are today able to expand their exports of goods and services, quickly, flexibly, and to the extent they may require, and thus expand the rate at which they convert domestic output into foreign exchange.

What especially requires understanding is that a subsidy is only an addition to the flow of goods and services or the foreign exchange earnings already and independently available to the receiving country. If it is furnished in the form of particular goods and services it may increase the quantity of these available to the importing country. Alternatively, it may simply spare that country the necessity of buying them with its own foreign exchange or turning them out with its own facilities, and thereby enable them to buy or produce something quite different.

It is for this reason that the physical nature of the goods and services supplied to another country as a subsidy in kind need not determine, or even greatly influence, its economic position. The financing of European imports of American wheat, cotton and tobacco under the Marshall Plan, in amounts which the countries would have been compelled to import anyway, may well have allowed them to use their own dollars to buy Brazilian coffee and Canadian lumber. Thus the gift of a particular market basket of commodities from the United States might have had exactly the same effect as an unrestricted subsidy paid in dollars. When the subsidy is viewed as an addition to the total output of the receiving country, even greater possibilities of substitution emerge. The financing of European imports of foodstuffs and raw materials under the Mutual Security Program may release for production of military equipment both European labor and plant capacity that would otherwise have to be used to produce exports. Conversely, it does not automatically follow that aid in the form of military equipment will augment the military effort of the receiving country. Conceivably, a contribution of American military equipment to France will permit the French to devote less of their own production to military purposes and thus allow them to enjoy a better standard of living than they otherwise could. A market basket of U. S. commodities may be transformed, through the exchanges of international trade, into Canadian lumber or Brazilian coffee, or it may be transformed by substitution within the receiving countries into weapons, workers' houses or machinery.

There are physical and economic limits, of course, to the possibility of such substitution, but the limits are wide. Within them, what constitutes a subsidy in goods does not determine either the physical composition of the increase in real income which the subsidy brings, the amount of the increase, or the use to which it is put. Whether its net effect is to increase the supply of lumber, cotton or machinery, and whether it ultimately finds its way into an increase in consumption, in capital investment, in government expenditures for rearmament, or simply in the gold reserve of the central bank, is decided not by the composition of the subsidy but by the actions of the receiving country.

A grasp of these facts will focus attention on the considerations that must be weighed in determining the size of a subsidy. The shortage of a particular commodity in a country, whether it be food in India, or machinery in Europe during the Marshall Plan, or military equipment today, does not determine the "need" for a subsidy. The basic judgment which led the United States Government to undertake both the Marshall Plan and the Mutual Security Program was that the Europeans could not afford to pay for the food, raw materials, fuels, machinery, and later the military equipment, which they had to import from the rest of the world in order to live, produce, invest, trade and rearm.

Nor was this a purely economic judgment in either case, any more than it was a technical judgment as to a shortage of military equipment or of some particular commodity. It cannot be said that either economic recovery or rearmament in Europe was physically impossible without foreign aid. If the Europeans had sufficiently reduced their own standard of living, pursued deflationary fiscal and credit policies, forced the transfer of resources first into export industries and then later into military production, and maintained the whole apparatus of wartime controls, they could perhaps have rebuilt their economies. But it would have imposed greater sacrifices than most of them had to undergo in wartime. And, coming on top of the war, it would have destroyed the hope of a better future. There are few experienced observers who believe that the social fabric of Europe could have stood the strain. It is in this sense that the Europeans "needed" (and still need) more than they could "afford." The gap that has to be filled with a subsidy is the difference between what the Europeans may require to accomplish the broad purposes of recovery and rearmament, and what they can afford to pay for under prevailing circumstances. In all such cases, the basic judgment is political no less than economic or technical.

IV. THE ECONOMICS OF EUROPEAN REARMAMENT

The next step, then, must be to consider the cost of subsidies involved in rearming Europe (the NATO bloc plus Germany), and the circumstances that determine what the Europeans "need" in order to rearm and what they can afford to pay for.

The general magnitude of the rearmament program of the Western European countries was defined with reasonable accuracy by the Temporary Council Commission of the NATO Council a year ago. If the Europeans were to pay their own way completely, they would be spending, roughly speaking, at the rate of 15 billion dollars per annum by the end of the calendar year 1952. This rate might rise slightly higher in 1953 and 1954 and, thereafter, would begin to taper off slightly on the basis of present plans. Even at its peak, this rate of expenditure would be equivalent to some 12 percent of the gross national product of these countries. Actually, current schedules call for European military outlays to reach an annual rate of some 11 to 12 billion dollars by the end of 1952, which on the average will constitute some 7 to 8 percent of the gross national product. This program, which allows for substantial American aid, will permit the standard of living (per capita consumption) to be at least maintained at pre-Korea levels, except in the Netherlands and probably the United Kingdom.[i] It will also allow capital investment to continue at about the pre-Korea rate, with curtailment of some segments of civilian investment to make room for requirements of the defense program.

What is actually happening, then, and on present plans will continue to happen, is that the European contribution to Western rearmament is coming almost entirely out of the production increase that has occurred since the advent of the Korean War. If, however, the Europeans paid the whole cost of their rearmament, including that of equipment produced for them in the United States, they would have to cut their living standards drastically and reduce their non-military investment even more sharply.

Can it be said then that this is what the United States is "buying" with its subsidies, and, if so, are the advantages thus acquired worth the price? To take the second half of the question first, a very cogent case could be made to the effect that the subsidies are well worth while from the standpoint of the interest of the United States if all they do is to make rearmament easier for Europe, that is, to prevent a serious cut in the standard of living and to continue to broaden the economic base of the European countries. After all, the Communists still get nearly a third of the popular vote in France and Italy; neutralism of one kind or another is widespread in France, Germany and Britain; and rearmament is popular nowhere. The majority of seasoned observers affirm that rearmament would be politically impossible if it were made more painful for the masses of consumers. Moreover, much of the investment that is going forward is in such basic industries as transportation, utilities and steel, which are "defense supporting." Then, too, only long-sustained increases in the total output and productivity of the European economy hold out any hope for a Europe that is both strong and self-supporting.

A judgment as to the value to the United States of continued subsidies does not, however, depend mainly upon whether the Europeans could "afford" to reduce their standard of living or their rate of investment, or on whether it is in our interest to make it unnecessary for them to do so. To discuss the question in these terms implies that, in the absence of any help from the United States, the Europeans would be confronted with a difficult but relatively clear and understandable choice between rearming adequately and continuing to live reasonably well. In fact, however, the alternatives, defined by institutional and economic circumstances, would be much less clear. Even if the Europeans collectively were willing to reduce consumption and investment to an extent that would enable them to pay the full cost of their own rearmament, they most likely couldn't swing it. Rather, they and we would find that institutions susceptible only to slow change, together with circumstances beyond their control, such as United States tariffs, would prevent them from achieving their objective.

This may be most easily seen by considering what steps the Europeans would have to take in order to assume the whole burden of their own rearmament, say at the end of this year. Two major operations would be imperative. First, the European governments would have to lower consumption and investment by approximately 6 billion dollars a year (about 5 percent of their gross national product) below presently planned and expected levels in order to divert enough resources into military channels. And this operation would have to be accomplished in the face of reasonably full employment (except in Italy and Germany), a high level of production, high profits (at least before taxes), and rising consumer incomes. Second, the Europeans would have to enlarge their dollar earnings by some 300 percent, since the major military expenditures they would be required to assume are those which are now being borne by the United States Government.

Consider the first of these operations. Broadly speaking, the only way it could be accomplished would be by some combination of higher taxes (to reduce consumers' disposable income), tight credit (to discourage capital investment), direct controls (producer or consumer rationing, or both), and inflation (either repressed or open). Quite aside from politics, the institutional obstacles which block this approach remain formidable. In some of the NATO countries, the machinery of income tax collection is not yet as efficient as could be desired. Taxes already on the books are by no means fully collected, especially among the upper brackets and in the agricultural sector. A heavier tax burden would therefore magnify the existing inequities and intensify social discontent. As it is, tax collections in Italy and France, for example, amount to some 20 percent and 28 percent respectively of gross national product.

In northern Europe the machinery of tax collection is efficient. But there the tax burden is already crushing for all income brackets, in large measure the result of the heavy costs for social services, war-induced debts and damages. These outlays, many of them to cover such quasi-contractual obligations as pensions and interest payments, could not be cut down much more rapidly than the fiscal machinery could be reformed in other countries. And with the burden of taxation running 25 percent in Norway to 35 percent of gross national product in Britain, it is difficult to see how more revenues could be raised without crippling the incentive to produce.

The other available measures--high interest rates and tight credit--are already in effect in the countries under consideration, though this policy has only recently been adopted in Britain and something more may be expected from its use there. In Western Germany, too, it would no doubt be possible to curtail private investment by stringent financial measures. But broadly speaking, little further can be accomplished in this way. Any new substantial cuts in private investments would demand the more rigorous use of direct controls. To be sure, the barriers that hinder further curtailment of private investment by direct controls, and public investment by budget cuts, are not institutional in character. In part they are economic considerations: the necessity to maintain basic plant and equipment and to expand at least military production and the export industries. In part they are political considerations: the pressure for at least a modest amount of housing and the less defensible pressure to continue some rather unessential war reconstruction. But, at best, the savings theoretically possible would be only a fraction of the added military burden that would have to be assumed.

For these reasons, then, there is comparatively little that European governments could do to reduce the demand for goods and services in their countries in order to make way for larger military expenditures. Nor should this be surprising. Any such achievement would require a more austerely orthodox policy than any free Power would find it feasible to pursue except in war.

The truth is that consumption and investment could not be cut back nearly enough except by a combination of inflation and direct controls, as in wartime. But to use these devices is to run two hazards. The first is that inflation, even if inhibited by direct controls, eats away at the social fabric, especially in countries which have witnessed a spectacular rise in prices within the last few years, and whose citizens have lost confidence in their own money.

The second and fatal hazard is that this method of curtailing investment and consumption thwarts any movement to carry out an operation indispensable to Europe if it is to finance its own rearmament, namely, to expand appreciably its earnings of foreign exchange. The whole problem of the European economies, while they are rearming, is to shift resources not only away from domestic consumption and investment but into exports. But ten years' experience since the war (not to mention the teachings of economists for many generations) merely validates the precept that domestic inflation impedes exports.

Assuming, however, that the Europeans could contain inflation as a prologue to raising exports, is any such venture likely to prove feasible? The answer is conditioned by three economic circumstances. The first is the massive size of the necessary changes in Europe's balance of payments. In 1951-2, the Western European countries had exports to the United States of about 1.6 billion dollars. Their imports were very close to four billion dollars excluding military equipment furnished under the Mutual Security Program. Their balance of payments deficit with the United States was about 2.3 billion dollars, leaving out the deficits of the associated monetary areas (chiefly the sterling bloc) and still excluding the cost of military equipment. Moreover, Western Europe's dollar deficit with areas other than the United States is customarily substantial. Merely to close this gap with the United States alone within one to two years would require about an 80 percent increase in earnings through exports and the provision of services. To close this gap and, at the same time, to earn the five billion dollars plus per annum required for several years to pay for military equipment would entail an increase of nearly 360 percent in dollar earnings. Any such change is beyond the realm of possibility, at least without a major revision in United States commercial policy, and a European resumption of the same kind of triangular trading pattern which prevailed during the "century of stability," from 1815 to 1914.

A second set of circumstances has to do with the behavior of world prices since Korea and, more generally, with the state of markets here and abroad. It will be recalled that prices of raw materials rose dramatically in the first six months after June 1950. The consequence was a drastic deterioration of the terms of trade for most of the West European countries. But this inflationary world climate in the last half of 1950 and the early part of 1951 had its favorable side as well. During that period European exports, in physical volume, increased some 25 percent to 30 percent. Yet this did not suffice to make up for the deterioration in the terms of trade, let alone to close the gap between foreign exchange earnings and foreign exchange expenditures. In more recent months, prices of raw materials have come down, while markets for manufactured goods have softened. Although the terms of trade have improved again, they remain less favorable than before the Korean War and, in the light of today's world economic environment, the expansion of exports is bound, at best, to be a slow, difficult process.

The final set of circumstances has to do, not with whether the Europeans can "afford" to divert more output from domestic consumption and investment to export, nor with the general state of supply and demand in export markets, but rather with the character of the demand for Europe's exports and the ability of the European countries to supply particular kinds of goods. Almost every industrial country in Europe could afford to export more soft goods without depriving its fellow citizens. Unfortunately, however, markets for soft goods are generally saturated. In this sector, then, where the Europeans have facilities less than fully utilized, the limitation on their export earnings derives from stationary or declining demand. On the other hand, export markets would almost certainly take more of the products of the engineering industries, and more steel and other semifinished goods from Europe than can now be made available at attractive prices and on satisfactory delivery terms. Moreover, these present trends indicate what will probably be the prevailing pattern of demand over the longer run. Europe faces increasingly stiff competition and probably shrinking markets for the soft goods that are today abundant; it is the demand for fabricated metal products that is unsatisfied and expanding around the world. But it is precisely this expanding demand that competes directly with rearmament needs in Europe. Thus, the competition between exports and rearmament for particular goods and resources, not the competition for "output in general," makes Europe's position even more difficult than it otherwise would be.

All in all, it must be concluded that, even if the first of the two necessary operations--the curtailment of domestic consumption and investment in order to free economic resources for military uses--could be accomplished with a minimum of inflation, the second operation, that of diverting these resources into exports, would still prove quite impossible on a scale sufficient to pay the full import costs of Europe's rearmament. It would, indeed, be exceedingly difficult even on a scale sufficient to pay for all of Europe's imports other than actual military supplies and equipment. In short, even if they could "afford" to live less well, the Europeans could not spend more than 12 billion dollars in their own countries for rearmament and still earn enough foreign exchange, in the face of the inevitable inflationary pressure, the adverse terms of trade, the altered character of the export demand for European goods, and the tariffs and other barriers to imports in the United States and throughout the world. American aid is valuable as an addition to gross national product. But it is indispensable as a supplement to the foreign exchange resources of the European allies. It alone permits them to make the largest contribution of which they are capable to the common task of rearmament. It is the key which is unlocking their efforts.

V. MAGNITUDE AND DURATION

These remarks on the economics of European rearmament have been addressed to the question of whether subsidies should be granted at all and what they can accomplish rather than to the question of how large they should be and how long they should be continued. The foregoing considerations do suggest, however, how the scale of the European effort influences the size of the gap between what the European countries need to buy from the rest of the world and what they can earn by the sale of goods and services to it. As defense expenditures rise, the level of business activity and of industrial production is pushed higher. Consumers receive more income. Larger imports of foods and raw materials are required. Inflationary pressure mounts along with the difficulty of even maintaining exports. Thus, as a European government buys for military purposes an ever-greater amount of its economy's output, part of its expenditures spill over, as it were, and take the form of a foreign trade deficit. To estimate how large a foreign trade deficit must be tolerated in order to allow rearmament to go forward would call for the review of voluminous evidence bearing on import needs and export possibilities. Since such reviews and calculations are out of the question here, only two comments will be ventured.

The first is that, if the above analysis is substantially correct, the Europeans are going to have a hard enough time earning the wherewithal to pay for their general imports, and cannot possibly afford to pay for the special military supplies they have to import from the United States. Hence, debate as to the "need" narrows down to the size of the foreign trade gap, excluding the cost of military equipment produced in America. The second comment is that the request for approximately 1.6 billion dollars to cover a balance of payments deficit of about the same size in the current fiscal year would seem to be reasonable in the light of recent experience. Most countries in Europe were able to improve their trading position greatly in 1951-52 in comparison with the first year after the outbreak of the Korean War, even while making their expanding contribution to their own rearmament. Their balance of payments deficit is expected to be only slightly larger in the current fiscal year despite still heavier military expenditures. But the international trading position of Britain and France suffered heavily from the impact of the Korean War and rearmament. They are the two countries which (together with Greece, Turkey and the United States) are devoting the largest proportion of their resources to rearmament. Moreover, their rearmament began in earnest earlier than that of the smaller nations and was affected by special circumstances.

The international financial position of the United Kingdom is greatly complicated by her function as banker for the sterling area. One result of this special relationship with a group of primary producers is that, although the British suffer acutely in the form of adverse terms of trade when raw material prices are high, the dollar position of the sterling area is apt at such times to be comfortable. Conversely, low raw material prices mean lowered production and living costs in the United Kingdom, but a decline in dollar earnings for the sterling area as a whole. Britain's position has worked peculiarly to her disadvantage since the Korean War. The original and dramatic rise in raw materials prices had much to do with setting off a wave of domestic inflation in the United Kingdom. Then, just as the effect of higher wages and of rearmament again was felt, falling raw material prices damaged her dollar earnings and gold reserves.

The situation of France is, perhaps, simpler. Since the war, the French authorities have not been able, except for short intervals, to control what seems to be a chronic inflation. France apparently remains more susceptible to any kind of inflationary impulse than the other countries of Europe. The rise in world prices in the latter part of 1950 promptly detonated another wave of inflation, heightened by the fear that rearmament would unbalance the budget.

Against this background, there is reason to hope that the Continental countries will be able slightly to improve their trading position; that the measures recently taken by the British Government will prevent any run on sterling and reduce the sterling area's imbalance to less than one quarter of what it was in 1951-52 (2.61 billion dollars); and that the French will be able to hold their own as compared to 1951-52, when it was very serious, indeed. Since the rate of military expenditure is expected to rise in these countries by 20 percent as a whole these seem to be reasonable appraisals.

More perplexing is the problem of how long subsidies to the European allies will be necessary to enable them to maintain a satisfactory level of military strength. Broadly, the answer depends on two sets of circumstances: first, the pattern of the military build-up; and second, the rate at which Europe's industrial base and economic potential expand. Present official planning is founded on optimistic assumptions concerning both these developments.

A fundamental premise, of course, is that there will be no major war with the Soviet bloc and that the cold war can be continued without resort to full mobilization. On this basis, present plans envisage a build-up of armed strength in which use of resources would reach a peak within the coming year and would begin, sometime during 1954, to taper off. After a tapering-off period of perhaps two years, it is held that the annual defense outlay of the world would be stabilized at a level significantly below the peak. If this approach is realistic, the Europeans should find themselves in the not-too-distant future with declining expenditures for their military establishments, and, presumably, a rising gross national product. Under such conditions it is expected that the Europeans could steadily assume more of the cost of their own defense, and ultimately all of it.

But is this expectation realistic? One source of doubt is that unit costs of offensive and defensive armament appear to have risen sharply even since the latter days of World War II. There is little evidence to imply that this trend has since been reversed or that any explicit allowance has been made for it in NATO military plans. Moreover, the analogy between the expansion of military establishments and the expansion of, say, an industrial plant is of doubtful validity. To be sure, construction costs for such fixed assets as airfields, barracks and training sites, and the "capital" cost of military hardware such as tanks, planes and ships, account for a much larger proportion of military outlays than do the payment of troops and the procurement of "soft" goods, especially during a period of build-up. It is, however, extremely dangerous to argue that, as soon as these "non-recurring" capital costs have been covered, it will be necessary only to cover the costs of maintenance. Experience strongly suggests that the obsolescence rate of military equipment is extremely high, and that the bulk of the "capital" required to build up an effective military force goes for items which cannot be used very long, even disregarding depreciation in use or destruction in combat. These technical considerations would seem to have particular point under present circumstances when air forces, whose expensive equipment is notoriously subject to obsolescence, account for so large a part of total cost, and when the possibilities of guided missiles and of tactical use of atomic weapons threaten to discard even present designs.

Moreover, it is far from clear on what political assumptions or, more precisely, what assumptions concerning the behavior of the Soviet bloc, the official strategic plan is based. The grim and unpleasant fact is that the Western World is now engaged in an armaments race with the Soviet bloc. There is not the slightest doubt that up until, say, a year ago, the Communists were not only leading in the race but widening their lead. It is dubious whether, even today, the Western World has begun to close the gap. As the pace of rearmament quickens in North America and Western Europe, it is by no means certain that it will not also be quickened east of the Iron Curtain. But suppose this does not happen; suppose the Soviets are either unable or unwilling to devote any more of the output within their sphere to the military build-up than is now going into it; even on this assumption, their total military strength will continue to increase. If and as the West overtakes them, a balance of military power could perhaps be maintained with a reduced rate of build-up of Western forces, but not with stabilized military strength.

Looking at the other element in the equation, Europe's economy will continue to grow, at least during 1952, almost as rapidly as it has since the beginning of the Marshall Plan--an average of 4 percent a year. It is also predicted that about half of this increase in gross national product will be taken up by an increase in the military expenditures of the European governments. This estimate is probably a generous one, especially if projected beyond 1952. There is not much unutilized productive capacity left in the industries that face an expanding demand (notably the metal-fabricating industries), except in Italy and possibly Germany. As for growth in plant and productivity, the long-term rate for the European economies will almost certainly turn out to be less than 4 percent, especially while rearmament competes with capital investment. Moreover, the significance of any such expansion in gross national product, if it can be achieved, should not be misunderstood. A sizable portion of such an increase will consist of consumers' goods such as textiles, and leather goods, construction, and services of a sort that will not find their way into either military uses or export. So long as even half of the total increase must be channeled into expanding military establishments, therefore, not much of the growing total supply of goods will be available for export in the form of the commodities that can most readily find markets, i.e. the products of the metalfabricating industries. Moreover, if full employment is maintained and so rapid a rate of increase of output is achieved, inflationary pressure cannot be eased decisively and much high-cost industrial capacity will have to be utilized, notably in Italy and France. Accordingly, the situation which will probably prevail in 1952-53 and beyond does not warrant the belief that the Europeans can again create internal economic conditions as favorable to exports as they were, say, in the first half of 1950, or that they can greatly improve their export performance while their military budgets are growing.

Looking at the European scene, therefore, the following is the most that can be said. If defense expenditures are reduced, or at least stabilized; if output continues to expand; if the production of the right kinds of things is enlarged; if the terms of trade do not further deteriorate; and, above all, if inflation is really contained (it will not do for this purpose merely to suppress it with direct controls as in wartime), the Europeans should be able in due course to increase their earnings of foreign exchange sufficiently to cover the cost of their general imports. (This would still exclude the cost of imported military equipment.) At least, they should be able to do so to the extent to which the present imbalance is the result of rearmament, and can be cured if the European governments adopt the appropriate policies. It is not particularly useful to try to guess just when this might be accomplished. At a minimum, it should not be expected in less than two years, that is, before the end of 1954; more likely that it will take until the end of 1955, or even longer.

It must be emphasized, however, that this result can be accomplished only to the extent that the prevailing imbalance arises from short-run factors within the power of European governments to remedy. It is increasingly clear that many causes of European foreign exchange difficulties are deep-seated and chronic, having little to do with current rearmament programs. In part they are internal: the lack of immunity to inflation, the heavy overloading of fiscal machinery which amplifies all the difficulties of diverting resources into rearmament, of controlling inflation, and of overcoming the shortage of capital. In considerable degree they are rooted in the obsolete political organization of the European continent. There can surely be little doubt, at this point in history, that the national state on the scale of even the largest countries of Western Europe is an unworkable institution, and one which is losing or has lost the effective loyalty of many of its members. It is economically unworkable because the financing and marketing mechanisms of the European countries fail to encourage either low cost production or a competitive, dynamic economy. It is politically and socially unworkable for the quite fundamental reason that national states of this size can no longer promise their citizens either security from external military threats, or economic well-being in the face of unforeseeable changes in the broader economic environment to which the smaller state is particularly sensitive.

But all the persistent causes of the imbalance in Europe's trade are by no means to be found within Europe. In part they have to do with the pattern of world production: the failure of primary production to keep pace with industrial production and the increasing trouble that highly industrialized nations encounter in finding complementary trading partners. And, in part, they arise out of the commercial policy and the course of economic and political events in the United States which make it difficult for the Europeans to earn dollars either directly or by way of triangular trade.

These are long-run problems and it seems unlikely that they will be solved in the next two or three years. Hence, there is at least a possibility that if the European allies are to maintain a satisfactory military posture, they will require, even after 1954, subsidies sufficient to pay for whatever military equipment they must still import from the United States, as well as to ease their balance of payments position at least up to a few hundred million dollars a year.

VI. CONCLUSION: THE HANDLING OF SUBSIDIES

Perhaps the greatest defect of subsidies is that they are thought of as charity and, therefore, tend to undermine incentives and defeat their own aims. A long-continued series of gifts from a wealthy donor to an impoverished recipient will always tempt the former to assume a dominating rôle. An embittered relationship is the certain outcome. And the long-continued receipt of aid in amounts determined on the basis of "need" may make it possible for a government in the aided country, a political party, or a whole nation to evade the truth about its own predicament and to postpone and avoid actions to cope with it. Today subsidies are a device for gaining objectives that have a value to the United States at least equal to their cost. It should, therefore, be feasible to make them coincide in concept and in form with what they are in fact, and thus eliminate the idea of charity.

Without seeking to set forth a full range of policies to accomplish this result, four rules of management can be suggested. All of them have been tested in some degree during the last five years. The first rule is that the relationship with the receiving government should be placed insofar as possible on a basis similar to that of a contract between a buyer and a seller. The second rule is that subsidies should usually be payments made to finance the purchase of particular goods, or the performance of particular activities that are demonstrably identified with the broad purpose to be served. The third rule is that a subsidy should customarily be made in the form of a contribution, presumably matched by contributions from other sources, to a common enterprise, in the management of which the United States would share. And the final and most important rule is that, wherever possible, subsidies should be channeled through such international institutions as the O.E.E.C., the European Payments Union and the emerging European Defense Community which American policy wishes to strengthen. The meaning of these rules is, perhaps, reasonably clear, but they could all do with a word of explanation.

To grant subsidies on something closer to a contractual basis will be bitterly resisted on the ground that the arrangement would be inflexible, and that it would be a means of imposing the will of the United States on its allies. But this argument evades a fundamental issue. Either foreign aid is simply a form of charity, given in the hope that the recipient will make good use of it, or it is, as generally represented, a payment for which benefits will be received. If it is the latter, then it is given in the expectation of some specific performance on the part of the recipient to promote a particular result--recovery, rearmament, or whatever. There is a decided advantage in arriving at a lucid advance understanding as to the obligations undertaken by both parties. The contract should be freely negotiated (its terms should certainly not be fixed by statute) and remain firm for at least a year at a time; the payment of the subsidy by the United States should depend only on whether the recipient meets its freely-assumed obligations. One incidental advantage from such an arrangement would be that the amount of the subsidy, even though it would of course reflect "need," would not be adjustable with every change in the economic climate; less of a premium would then be attached to actions tending to increase "need." The basic argument, of course, is that a contractual relationship is a dignified and self-respecting one, while a charitable relationship is not.

The second rule assumes that subsidies will continue to be in some way given in kind. So long as this practice is followed, there is a real advantage in identifying a subsidy with specific transactions. Under the Marshall Plan, the United States financed general imports into the European countries. This was a logical procedure because the acute shortage of foreign exchange was probably the decisive limiting factor on economic recovery in Europe. But most of the funds went to purchase items quickly consumed, such as food stuffs and raw materials, so that the ephemeral and apparently charitable character of the whole enterprise was unduly stressed. Although these commercial transactions obviously helped Europeans to eat and produce, they did not have any particular connection with such highly desired results as the lowering of trade barriers, sound financial policies, and the unification of Europe.

By contrast, one method by which the United States is currently providing its allies with foreign exchange is through the off-shore procurement of military equipment produced in Europe. Instead of focusing attention upon aid as an increment of foreign exchange by financing import transactions, this technique identifies it with the increment to the country's output of goods and services, more particularly of military hardware. There is a danger that the aid furnished through military procurement will obscure the considerations that determine how much assistance the receiving country requires in order to carry out its rearmament program. Although this is a peculiarly effective means of supplying vitally-needed foreign exchange--since it allows the Pentagon to stimulate and exert some influence over military production in Europe--off-shore procurement could not be justified if the European governments had the foreign exchange and the internal revenue to fulfill their NATO commitments, even when somewhat scaled down. Like other forms of aid, off-shore purchases are fundamentally a means of closing the financial gap between what the Europeans need and what they can pay for. However, this process has the great merit that it does identify aid with visible military transactions, which symbolize in tangible form the way in which the United States is assisting European defense. It would be equally valid to apply the same principle to funds that are being used to finance general imports, under the title of "defense support." This is precisely the change in procedure I am proposing.

The third rule, that subsidies take the form of contributions to common enterprises, is in a sense being currently applied in the Mutual Security Program. After all, this consists of American contributions to the common enterprise of rearmament. But the mutuality of this situation would be dramatized more fully if it were thoroughly understood on both sides of the Atlantic that each member of the coalition is making a defined contribution of men, money, and other resources, in the light of corresponding contributions by the other members.

The fourth rule is the most important and the most promising. By channeling aid through appropriate international institutions, the United States can often give it the form of a contribution to a common enterprise, can sometimes reduce the amount to achieve a particular end, and, above all, strengthen immensely the institutions involved without added costs or sacrifice of important alternatives. As American policy toward Europe has been redefined and clarified over the last three years by the sweep of events, by successive acts of the Congress, and by decisions of the Executive branch, it has gradually become plain that a continuing objective is nothing less than the unification of Europe: on the economic side, the creation of a single market and the pooling of Europe's resources, and on the political side, the creation of a single military establishment and ultimately a federal union. In view of the growing importance of this objective, the the E. P. U. was supported and buttressed by channeling E. C. A. funds through it. An even more promising opportunity to apply the rule may materialize in the course of the next six months. If the European Defense Force is actually established, it would be only appropriate to channel through it all, or nearly all, aid extended to its members. Funds available for off-shore procurement of military equipment in Europe, or for "defense support," might well be turned over to the proper agency of the European Defense Community to finance military supplies and equipment in accord with a program worked out with the United States Government. Decisive action by the United States along these lines might within a few months' time bring about the centralization of military procurement for the six countries of Western Europe. This would encourage quantity production at lowest cost. Few steps within the realm of practical politics hold out such promise of reducing the price of European rearmament. And, in the process, the centralization of military procurement would contribute immeasurably toward the economic unification of Europe.

As the events of the past three years have unfolded, it has become ever more apparent that no British Government will go far toward joining the British economy with that of the Continent, or any distance at all toward political federation. Gradually this British attitude has come to be both understood and accepted on the Continent and in the United States. Accordingly, aid to the United Kingdom could not be channeled through any instrumentality of European union and particularly, of course, not through the E. D. C. of which the United Kingdom is not a member. The United Kingdom presents a separate problem.

In this connection, it may be suggested that the British Commonwealth of Nations, and the sterling area, require strengthening in certain respects. In the light of the experience of Britain and the sterling area since World War II--on the whole unhappy--it may be that the management of sterling and the supervision of the relationship between sterling and the dollar should be more than ever before recognized explicity as common enterprises. The United States is inevitably concerned with both to such an extent that they might conceivably be carried on by a single institution. If such an institution were to be set up, some or all of the aid required by the United Kingdom might be channeled through it.

The rules here proposed would define a rather new pattern for the management and handling of aid to the European allies of the United States. Many of the changes suggested are, in a sense, changes of form. But if they brought people to think differently about the nature of international subsidies, to look at them less as charity deserving of gratitude, and more as payments for benefits to be received, we would all be better off.

[i] In Denmark, also, a reduction seems to be necessary but this results primarily from the country's general economic condition rather than from the burden of rearmament it is assuming.

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