NATO: Implications of European Integration for Allies' Defense Spending
(Letter Report, 06/30/1999, GAO/NSIAD-99-185).

Europe is undergoing profound changes, including the enlargement of the
North Atlantic Treaty Organization (NATO), the adoption of a common
currency, and the planned enlargement of the European Union. Members of
Congress have raised concerns about Europe's ability to share in the
cost of providing a common defense through NATO. This report analyzes
(1) the projected defense spending for several European countries, (2)
the budgetary effects of European Economic and Monetary Union
implementation and enlargement of the European Union, and (3) other
significant factors that may affect the countries' ability to share in
the costs of NATO over the long run.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  NSIAD-99-185
     TITLE:  NATO: Implications of European Integration for Allies'
	     Defense Spending
      DATE:  06/30/1999
   SUBJECT:  Economic growth
	     International organizations
	     International relations
	     Foreign governments
	     Cost sharing (finance)
	     NATO military forces
	     Future budget projections
IDENTIFIER:  NATO Defense Capabilities Initiative
	     NATO
	     European Union

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    United States General Accounting Office GAO                 Report
    to the Chairman and Ranking Minority Member, Subcommittee on
    Defense, Committee on Appropriations, U.S. Senate June 1999
    NATO Implications of European Integration for Allies' Defense
    Spending GAO/NSIAD-99-185 United States General Accounting Office
    National Security and Washington, D.C. 20548
    International Affairs Division B-282890
    Letter June 30, 1999 The Honorable Ted Stevens Chairman The
    Honorable Daniel Inouye Ranking Minority Member Subcommittee on
    Defense Committee on Appropriations United States Senate Europe is
    being affected by a number of changes, including the enlargement
    of the North Atlantic Treaty Organization (NATO), the adoption of
    a common currency, and the planned enlargement of the European
    Union (EU).  Concerned about Europe's ability to share in the cost
    of providing a common defense through NATO, you asked us to assess
    how European Economic and Monetary Union (EMU) and the enlargement
    of the EU may affect U.S. allies' ability to sustain or increase
    their defense budgets.  As agreed with your office, this report
    provides information and analysis concerning (1) projected defense
    spending for several European countries, (2) budgetary effects of
    EMU implementation and EU enlargement, and (3) other significant
    factors that may affect countries' ability to share in the costs
    of NATO over the long run.1 To address these issues, we collected
    and analyzed information from the U.S. Departments of Defense,
    State, and the Treasury; and from NATO, the EU, the International
    Monetary Fund (IMF), the World Bank, the Organization for Economic
    Cooperation and Development (OECD), the European Central Bank
    (ECB), and several research organizations.  Our work focused on
    seven European countries--the four West European members of NATO
    that collectively accounted for over 75 percent of total European
    NATO defense spending in 1998 (Germany, France, Italy, and the
    United Kingdom [U.K.]), and the three newest members of NATO (the
    Czech Republic, Hungary, and Poland).  We collected and analyzed
    information from government officials and private sector analysts
    in these countries.  We visited each of these countries except
    France, which is not 1We have ongoing work reviewing the progress
    made by our European allies in changing their military forces to
    meet the requirements of NATO's Strategic Concept, and will report
    its results later this year. Letter           Page 1
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 part of NATO's integrated military command. (See app. IV
    for a detailed description of our scope and methodology.) Results
    in Brief        The United States' security strategy depends on
    the ability of its allies to join in military operations.  This
    ability includes being able to train and equip forces to meet
    certain requirements.  Although EMU requirements for additional
    deficit reduction are likely to mean tighter budgets, NATO's West
    European member countries generally plan to maintain their defense
    budgets at roughly constant levels through 2002.  EMU's budgetary
    constraints may be offset over time by fiscal benefits and
    economic growth.  A large number of observers are optimistic about
    EMU's effects on economic growth, but concerns remain.  The costs
    and budgetary impacts of EU enlargement are not readily
    identifiable, since several key political decisions regarding the
    timing and specific requirements of membership have not been made.
    However, these costs are likely to fall largely on prospective,
    not current, EU members. Over the long term, defense spending will
    face increasing pressure as Europe attempts to deal with a number
    of domestic social issues, in particular escalating entitlement
    burdens.  Spending for public pensions, for example, is already
    near or above 10 percent of gross domestic product in France,
    Germany, and Italy-more than twice the U.S. percentage-and is
    projected to begin to increase sharply in 10-20 years as
    populations age. Governments' spending for health care is also
    expected to rise, increasing the budgetary pressures from coming
    demographic changes.  This budget environment means that member
    countries are likely to continue to face significant challenges in
    modernizing their defense forces to meet NATO requirements.
    Ultimately, the amount of resources allocated to defense is a
    political decision, driven substantially by views of military
    threat as well as other competing budget priorities.  If EMU's
    fiscal constraints require further spending cuts, for example,
    impacts on defense budgets will clearly depend on policy decisions
    regarding where those cuts are made.  Should EMU and EU
    enlargement contribute to stronger economic growth in Europe,
    there will be more budgetary resources to address competing needs.
    The outcomes from these economic developments and political
    decisions have important implications for U.S. defense planning.
    Letter    Page 2           GAO/NSIAD-99-185  NATO:  European
    Integration and Defense Spending B-282890 Background    The NATO
    military alliance of 19 European and North American countries is
    supported by its members through several means.  First, countries
    contribute to NATO's three commonly funded budgets, including the
    civil and military budgets and the budget for funding
    infrastructure improvements (about $1.6 billion total in 1999).
    The United States contributes about 28 percent of these commonly
    funded budgets. Countries also support NATO by maintaining forces
    and assets that they pledge to NATO through a defense planning
    process.  NATO does not quantify the cost of forces national
    governments commit to NATO, but one way to measure this
    contribution is through the level of defense spending. The EU is a
    political and economic body of 15 European countries, including 11
    NATO members.  Member states jointly administer the EU through
    three major institutions.  The European Union Council of
    Ministers, composed of the governments of the member countries,
    establishes common EU-wide policies.  The European Commission
    proposes legislative initiatives and implements policies agreed to
    by the Council of Ministers and the European Parliament.  The
    European Parliament, in tandem with the Council of Ministers, must
    approve most of the legislation introduced by the Commission
    before it goes into effect.2 EMU is an effort by EU countries to
    more closely link their economic policies to achieve greater
    economic cooperation and political integration. The most
    significant and far-reaching aspect of EMU is the adoption of a
    common currency known as the "euro."  On January 1, 1999, 11 EU
    countries, including 8 members of NATO, locked the exchange rates
    of their national currencies to the euro,3 redenominated their
    national debt into euros, surrendered control of monetary policy
    to the European Central Bank, and began using the euro in
    electronic transactions. 4  (Euro currency will not be circulated
    until 2002.) The Maastricht Treaty on European Union, signed in
    1992, set forth several economic conditions for countries to join
    the euro area.  These included, in part, reducing general
    government deficits to 3 percent of gross domestic product (GDP)
    and showing progress toward lowering general government
    2Parliament's consent is not required for agricultural price
    reviews. 3There are no procedures for countries to leave the euro
    area after they have joined. 4EU countries that chose not to adopt
    the euro are Denmark, Sweden, and the United Kingdom.  Greece
    wanted to adopt the euro but could not comply with the economic
    criteria. Page 3                GAO/NSIAD-99-185  NATO:  European
    Integration and Defense Spending B-282890 debt to 60 percent of
    GDP.5   The 1997 Growth and Stability Pact requires countries
    adopting the euro to further reduce their annual budget deficits
    and reach the medium-term objective of having budgets close to
    balance or in surplus.  Countries that do not comply with these
    requirements are subject to sanctions, ranging from public rebuke
    from the European Council to fines. In addition to "deepening"
    European integration through EMU, the EU is also "widening" to
    include the countries of Eastern and Central Europe. The EU
    believes that enlarging to Central Europe will help cement peace
    and stability in the region through developing closer economic and
    political links.  Countries seeking EU membership concur with this
    potential security benefit and also value the intangible seal of
    approval EU membership provides. 5The Treaty defines "general
    government" as including Central government, regional or local
    government, and social security funds.  It also requires countries
    have low inflation, low interest rates, stable exchange rates, and
    independent central banks compatible with the European Central
    Bank. Page 4                 GAO/NSIAD-99-185  NATO:  European
    Integration and Defense Spending B-282890 Figure 1:  European
    Members of NATO, the EU, and the Euro Area, and First Wave EU
    Applicant Countries Iceland Finland Sweden Norway Atlantic Ocean
    Estonia Denmark United Ireland     Kingdom Netherlands
    Poland Germany Belgium
    Czech Republic Luxembourg Austria France
    Hungary Slovenia Italy Portugal        Spain Turkey NATO
    Greece EU Eurozone 1st Wave EU Applicant Page 5
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 In December 1997, the European Council determined that
    the Czech Republic, Hungary, Poland, and three other countries
    were in the best position to meet the EU's general economic and
    political membership criteria.6 The European Council, the European
    Parliament, all 15 EU member states, and the applicant country
    must approve a country's membership before it can enter the EU.
    Defense Budget                The four West European members of
    NATO that we studied plan to Projections
    maintain their defense spending at roughly constant levels, after
    adjustments for inflation, through 2002.  NATO's three newest
    members plan to increase defense spending over the period.  NATO
    countries will generally face substantial challenges in
    modernizing their defense forces within projected budgets, due to
    high personnel costs, funding needs of large-scale procurements,
    and costs of ongoing military operations such as in Kosovo.  In
    addition, such ongoing programs as NATO's Defense Capabilities
    Initiative, as well as the evolving European Security and Defense
    Identity, could have budgetary implications that cannot yet be
    determined. West European Defense         Defense spending levels,
    adjusted for inflation, have begun to level off in Spending Levels
    off After     Germany, France, Italy, and the United Kingdom after
    fairly sharp Post-Cold War Decline         reductions in the early
    1990s.  Budget projections of these countries indicate that
    generally constant defense budgets are planned through 2002, as
    shown in figure 2.  These countries generally could not provide
    budget projections beyond 2002. NATO uses a standard definition of
    "defense expenditure" to facilitate comparison between the defense
    budgets of NATO-member countries, which differs in some cases from
    definitions in national budgets.  For example, some countries do
    not include payments toward retirement pensions in their defense
    budgets, while the NATO definition includes contributions to
    military pensions but not payments to current retirees.  In
    figures 2, 3, 4, and 5, data from 1980 through 1998 are NATO
    figures based on its definition of defense expenditure.  Since
    NATO defense budget forecasts are classified information, we
    calculated projected values using 6Cyprus, Estonia, and Slovenia
    were the other three.  The Council decided that it was too early
    to start bilateral negotiations with Bulgaria, Latvia, Lithuania,
    Romania, and Slovakia and offered Turkey a "European Strategy,"
    while not including Turkey in the accession process at this time.
    Page 6                GAO/NSIAD-99-185  NATO:  European
    Integration and Defense Spending B-282890 defense budget
    projections from host countries and applied the projected growth
    rates in defense expenditures to NATO's 1998 spending level for
    each country. Figure 2:  Historical and Projected Defense Spending
    in Four West European Countries, 1980-2002 Billions of 1998 U.S.
    dollars 60 50 40 30 20 10 0 1980        1985      1990       1991
    1992     1993     1994      1995     1996      1997     1998
    1999     2000     2001   2002 Germany                 France
    Italy          U.K. Note 1: Budget projections from 2000-2002 are
    not available for France; data for 2002 is not available for the
    U.K. Note 2: 1998 figures are NATO estimates.  NATO will release
    actual figures in December 1999. Source: GAO analysis of data from
    NATO and national ministries of Defense. The ratio of defense
    spending to GDP is one measure of the priority countries place on
    spending for defense relative to that for other national goals.
    The average defense share of GDP in 1998 was 2.6 percent for all
    NATO members and 2.1 percent for European NATO members.7  Using
    this measure, defense spending in the West European countries we
    studied has generally fallen steadily since the end of the Cold
    War, as has that of the 7These figures are calculated using
    constant 1990 prices and exchange rates. Page 7
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 United States.  Since planned defense spending is roughly
    constant and real GDP is projected to grow, defense spending as a
    percentage of GDP is expected to continue to decline slightly
    during 1999-2002 for the West European countries we studied (see
    fig. 3). Figure 3:  Historical and Projected Defense Spending as
    Percent of GDP for Four West European Countries and the United
    States, 1980-2002 Percent of GDP 7 6 5 4 3 2 1 0 1980- 1985-
    1990    1991      1992     1993    1994      1995    1996     1997
    1998    1999      2000    2001    2002 84     89 Germany
    France            Italy            U.K.        U.S. Note: Budget
    projections for 2000-2002 are not available for France; data for
    2002 is not available for the U.K. Sources: GAO analysis of data
    from NATO, national ministries of Defense, and Standard and Poor's
    DRI (Lexington, MA). Defense spending in the West European
    countries we studied has generally been lower over time as a
    percentage of GDP than that of the United States. This difference,
    which was particularly significant in the 1980s, continues over
    the projected period.  This is due to a number of factors,
    according to some European officials, such as different spending
    priorities, threat perceptions, and views of the determinants of
    their security.  Other officials Page 8
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 noted that whereas the United States has a global
    military presence and interests, European countries generally have
    focused on European security. New NATO Members             The
    Czech Republic, Hungary, and Poland plan to increase defense
    Project Defense Spending     spending during 1999-2003 to
    modernize their forces and meet NATO Increases
    requirements.  Defense spending declined sharply in these
    countries as they transitioned from a large Soviet-era defense
    force to the post-Cold War era,8 but spending began to increase in
    the mid-1990s as the countries moved closer to NATO membership.
    Figure 4 shows historical and projected defense spending levels
    for NATO's newest members. Poland's budget shows defense spending
    in 1999 declining 0.01 percent in real terms from 1998 in part
    because the Polish government removed military health care costs
    from the 1999 defense budget.  The 1999 defense budget would
    increase about 2.9 percent in real terms if health care costs were
    included.  Similarly, Hungary's 1999 defense budget includes
    funding for items that were not included in previous years. When
    these items are excluded, the budget decreases in real terms
    between 1998 and 1999, according to the U.S. Department of Defense
    (DOD).9 8For example, Poland's 1985 defense spending has been
    estimated to exceed 8 percent of GDP. 9U.S. government officials
    informed us about these changes in the composition of national
    defense budgets between 1998 and 1999 for Poland and Hungary. Page
    9               GAO/NSIAD-99-185  NATO:  European Integration and
    Defense Spending B-282890 Figure 4:  Historical and Projected
    Defense Spending in Three Central European Countries, 1994-2003
    Billions of 1998 U.S.  dollars 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1994
    1995 1996 1997 1998 1999 2000 2001 2002 2003 Poland
    Hungary            Czech Republic Note: 1998 figures are NATO
    estimates.  NATO will release actual figures in December 1999.
    Sources: GAO analysis of data from NATO and national ministries of
    Defense. The Czech Republic, Hungary, and Poland have pledged
    continued defense spending increases until they reach the NATO-
    Europe average of defense spending as a percent of GDP of 2.1
    percent.10  While Poland is currently above that average share,
    projections show that defense spending will fall below that share
    by 2003.  In 1998, based on NATO's definition of defense spending,
    the Czech Republic spent an estimated 2 percent of its GDP on
    10The Czech Republic and Hungary pledged to increase the defense
    budget's share of GDP by 0.1 percent each year.  Hungary's
    intermediate goal is to reach 1.8 percent of GDP by 2001. Page 10
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 defense, Hungary 1.5 percent, and Poland 2.2 percent.11
    Figure 5 shows projected defense spending as a percentage of GDP
    for the new NATO members. Figure 5:  New NATO Members' Defense
    Spending as a Percentage of GDP, 1994-2003 Percent of GDP 3 2 1 0
    1994     1995     1996      1997        1998          1999
    2000           2001      2002         2003 Poland          Hungary
    Czech Republic Sources: GAO analysis of data from NATO, national
    ministries of Defense, and PlanEcon (Washington, D.C.). While the
    three new NATO members met their 1999 defense budgetary
    commitments, they had some difficulty in doing so as a result of
    lower than expected economic growth and other domestic budgetary
    priorities.  In Poland, officials told us they planned to spend
    more on defense in 1999 but could not, in part, due to numerous
    domestic reforms requiring increased funding.  However, they
    stated that defense spending in the year 2000 and beyond would be
    consistent with their planned funding objectives. According to
    Hungarian officials, funding for defense had to be balanced with
    social spending priorities to avoid creating social tensions and
    11Figures for 1998 are NATO estimates.  NATO will release actual
    figures in December 1999. Page 11                GAO/NSIAD-99-185
    NATO:  European Integration and Defense Spending B-282890
    political instability.  U.S. embassy and DOD officials were
    concerned that Hungary's 1999 defense funding difficulties may
    continue in later years even though NATO requirements would
    continue to grow.  Given the experiences of 1999, U.S. government
    officials we interviewed expressed some concern about future
    defense budgets for these countries.  They indicated that to meet
    NATO's target force goals and make other needed changes,
    consistent spending increases are necessary. New Security
    Challenges     The international security environment presents a
    diverse set of challenges Affect Spending Needs       very
    different from those of the Cold War.  NATO's new Strategic
    Concept adopted at the Washington Summit in April 1999 recognizes
    changes in threats confronting member nations and calls for new
    military capabilities.12  This concept stresses that NATO members'
    military forces need to be more mobile, flexible, interoperable,
    and sustainable than in the past.  According to NATO, this means,
    for example, developing capabilities for command, control,
    communications, intelligence, and surveillance. These
    requirements, and others, were laid out at the Washington Summit,
    in NATO's Defense Capabilities Initiative.  A NATO steering group
    has been established to oversee the implementation of the
    initiative, the budgetary effects of which cannot yet be
    determined. Some countries have acknowledged these needs in
    conducting or planning their own defense reviews.  Between 1996
    and 1998, the United Kingdom and France issued comprehensive
    defense reviews that reassessed their security interests and
    defense needs.  They concluded that modern, high-quality defense
    forces can be created without requiring large increases in defense
    spending by rigorously setting spending priorities and making
    difficult choices.  These include reducing personnel and other
    support and operating costs, postponing or canceling certain
    procurement programs and, in the case of the United Kingdom,
    selling unneeded assets and facilities.  Germany has just begun an
    extensive defense review along similar lines.  Some of the same
    issues have emerged in defense assessments conducted by the three
    new NATO members as they adapt their forces to Western standards.
    European officials have stated that improving their defense
    capabilities is essential for implementing the 12NATO's 1999
    Strategic Concept identifies a variety of military and nonmilitary
    risks that are multi-directional in nature and often difficult to
    predict.  These include: regional instability and the resulting
    risk of crises; the proliferation of nuclear, biological, and
    chemical weapons; the spread of potentially dangerous technology;
    the threat of terrorism, sabotage, and organized crime; and the
    uncontrolled movement of large numbers of people, due in some
    cases to armed conflicts. Page 12                GAO/NSIAD-99-185
    NATO:  European Integration and Defense Spending B-282890 European
    Security and Defense Initiative, intended to give European
    countries the ability to take military action in cases where NATO
    as a whole is not militarily engaged.  They confirmed this
    position at St. Malo, France, in December 1998 and, in June 1999,
    the EU member states agreed on the need for capacity for
    autonomous military action, which requires having a credible force
    and the readiness to use it. Competing Needs Present     The
    countries we studied face considerable challenges as they try to
    Challenges for Defense      balance competing needs within defense
    budgets.  DOD officials told us Budgets                     that
    prioritizing defense needs is one of the key challenges facing
    NATO countries as they seek to modernize and restructure their
    forces.  However, shifting priorities within defense budgets can
    be difficult.  For example, personnel costs represent a large
    portion of defense spending in several countries, such as 60 to 70
    percent in Germany, Italy, and Poland, which have traditionally
    relied on conscription to staff their armed forces.  These
    countries are currently examining the cost, as well as other
    implications, of reducing their reliance on conscription.  In
    addition, planned procurements of major items such as the West
    European aircraft, the Eurofighter, can consume large portions of
    countries' procurement budgets.  Finally, out-of-country
    deployments, particularly in Bosnia and Kosovo, are requiring
    significant budgetary resources in the NATO European countries we
    studied.  Combined with the expense of large aircraft purchases
    and high personnel costs, these operations are affecting the
    ability of NATO countries to carry out restructuring and
    modernization, according to foreign officials and U.S. embassy
    officials.  According to DOD and foreign government officials, the
    efforts of the Czech Republic, Hungary, and Poland to modernize
    and reorganize their defense structures are made more difficult by
    limitations in the defense planning and management capabilities
    needed for effective resource allocations. (See app. I for
    additional information on defense modernization challenges.) In
    addition to the costs of military operations, addressing regional
    instabilities is expected to have other budgetary effects for EU
    member countries.  In particular, they have committed to funding
    the major portion of the costs of reconstruction operations in the
    Balkans, although the specifics regarding funding levels and
    sources have not yet been established. Page 13          GAO/NSIAD-
    99-185  NATO:  European Integration and Defense Spending B-282890
    Consequences of EMU  EMU and EU enlargement's impacts on defense
    spending depend on both and EU Enlargement                 direct
    effects on national budgets and how these institutional changes
    will affect the European economy over the long run.  The EMU's
    requirement for Defense Spending               for countries to
    limit deficits and debt will continue to constrain government
    spending options.  At the same time, the enhanced integration
    brought about by the euro can have positive effects on economic
    growth that may offset fiscal constraints and provide greater
    budget flexibility over the longer term.  While EU membership may
    bring economic benefits to new entrants, meeting membership
    criteria will impose significant costs. The magnitude of these
    costs and thus their budgetary impact depends on several key
    political decisions that have not yet been made, such as the
    timing and specific requirements of membership.  Applicant
    countries are likely to bear most of these costs. EMU's
    Implications for             EMU has no direct effect on defense
    spending, but it can affect the Defense Spending Remain
    availability of national resources for defense spending depending
    on how Uncertain                          the euro and its related
    requirements influence budgets and economic growth.  Adopting the
    euro constrains national spending, because countries are required
    to attain roughly balanced budgets in the next few years.  The
    degree to which this will require cuts in government spending
    depends in part on economic growth in euro area countries.  EMU's
    impact on economic growth remains uncertain.  A key determinant
    will be how national economies restructure in reaction to the
    enhanced competitive pressures from EMU. Significant Deficit
    Reductions     The fiscal requirements associated with EMU have
    resulted in significantly Achieved, but Further Cuts         lower
    budget deficits throughout the EU and will require further
    reductions Required                           among those
    countries that have adopted the euro.  Since the early 1990s,
    countries have significantly reduced their national deficits
    through a combination of spending cuts and tax increases. (See
    fig. 6.)  For example, between 1994 and 1997, Italy reduced its
    deficit from 9.2 percent to 2.7 percent of GDP. Page 14
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 Figure 6:  Annual General Government Deficits for Four
    West European Countries as Percent of GDP, 1990-98 Percent of GDP
    12 10 8 6 4 2 0 1990     1991     1992         1993         1994
    1995          1996            1997    1998 Germany
    France            Italy            U.K. Source: European
    Commission. Countries can achieve required deficit- and debt-to-
    GDP ratios by cutting spending, raising taxes, or as a result of
    increases in GDP.  According to the OECD, countries have so far
    achieved compliance with EMU requirements largely through raising
    taxes; cutting investment spending and subsidies; and implementing
    a series of one-time measures that included Italy's euro-tax, and,
    in some countries, the postponement of certain expenditures 1 week
    into 1998.  In the case of Italy, significant spending reductions
    have also been achieved through decreased debt service payments
    due largely to lower interest rates.13  Table 1 shows the
    combination of spending cuts and revenue increases used to meet
    deficit criteria for several countries. 13Italy's long-term yield
    on government bonds, a measure of the cost of government
    borrowing, dropped from 11.88 percent in 1992 to 6.85 percent in
    1997. Page 15               GAO/NSIAD-99-185  NATO:  European
    Integration and Defense Spending B-282890 Table 1:  Sources of
    Deficit Reductions in Four West European Countries as a Percent of
    GDP, 1990-97 Country                                    Changes in
    spending                   Changes in revenue Germany
    -0.3                                2.0 France
    1.7                                2.5 Italy
    -5.0                                4.8 United Kingdom
    -2.0                               -0.1 Note:  The OECD data
    calculates changes in various spending and revenue categories as a
    percentage of the country's potential GDP over the 1990-97 period.
    Spending includes government transfers as well as other types of
    spending.  The OECD did not specify the breakdown of government
    spending cuts across functional categories. Source: GAO analysis
    based on OECD data. Countries within the euro area must make
    additional reductions in both debt and deficit levels over the
    next few years to comply with the provisions of the 1997 Growth
    and Stability Pact.  Although 1998 debt levels in France, Germany,
    and the United Kingdom were near or below the required 60 percent
    of GDP, Italy's debt was 118 percent of GDP.  While this
    represents progress from the peak debt level of 125 percent of GDP
    attained in 1994, Italy must continue to show progress in reducing
    government debt to 60 percent of GDP to remain in compliance with
    EMU requirements.14  In addition, as table 2 shows, all four EU
    countries studied plan to continue to cut deficits to comply with
    Stability Pact deficit requirements, although three of the four
    countries plan to cut deficits at a slower rate over the next 4
    years than was achieved from 1994 to 1998. 14The relationship
    between deficit- and debt-to-GDP ratios is complex and depends on
    factors such as GDP growth rates, inflation, and interest rates on
    outstanding debt.  In general, high-debt countries will face
    greater fiscal constraints than low-debt countries.  For example,
    to bring debt below 100 percent of GDP by 2003, Italy plans to
    have general government revenue exceed general government
    expenditures, except for debt service payments, by 5.5 percent of
    GDP. Page 16               GAO/NSIAD-99-185  NATO:  European
    Integration and Defense Spending B-282890 Table 2:  General
    Government Deficit for Four West European Countries, Selected
    Years, as a Percent of GDP Country
    1994 deficit     1998 deficit             Planned 2002 deficit
    Germany                                        2.4
    2.1                             1.0 France
    5.8              2.9                       0.8 to 1.2 Italy
    9.2              2.6                            1.0a United
    Kingdomb                                6.8              0.8
    0.2 aItaly's plans are for 2001. bThe United Kingdom chooses to
    abide by the euro area's fiscal constraints. Source:  European
    Commission. Achieving further deficit reduction over the medium
    term may prove difficult for some euro area countries.  Countries
    have made limited progress in reducing deficits since 1997, and
    budget plans promise little improvement in the near term,
    according to the IMF.  OECD officials told us that many European
    governments were suffering "fiscal fatigue" from the effort to
    meet euro area deficit requirements and did not continue to cut
    spending in 1998 to reduce deficits.  In March 1999, the European
    Central Bank issued a report criticizing governments for this
    slowdown in deficit reduction and for assuming that sustained
    economic growth and low interest rates would bring compliance with
    EMU requirements without further cuts in government spending.  The
    European Central Bank, the OECD, the IMF, and the European
    Commission have expressed concern that, in the event of a severe
    or prolonged slowdown in economic growth, government deficits
    could fail to meet Stability Pact requirements or could even
    exceed the 3-percent deficit limit.  According to European
    officials, this would reflect badly on the credibility of EMU and
    could trigger a political crisis if countries were required to pay
    the fines for non-compliance spelled out in the Treaty on European
    Union. While discussion of EMU's fiscal requirements focuses on
    constraining government spending, the requirements also have
    beneficial economic and fiscal effects.  European Central Bank
    officials have stated that the lower deficits and debt brought
    about by EMU will create a more stable economic environment and
    contribute to greater economic growth in the future.  We have also
    reported on the potential benefits to economic growth of lower
    Page 17                GAO/NSIAD-99-185  NATO:  European
    Integration and Defense Spending B-282890 deficits.15  In
    addition, as Italy's case shows, reducing deficits can also lead
    to lower interest rates on sovereign debt and thus reduced
    government spending on debt service.  Moreover, reductions in debt
    levels over time also directly lower debt service costs.  Lower
    interest payments and levels of debt will increase budgetary
    flexibility making resources available for other policy
    priorities. If EMU's deficit requirements require further spending
    cuts, impacts on defense budgets will clearly depend on policy
    decisions of individual governments regarding where those cuts are
    made.  We heard a range of views from officials and analysts
    regarding the potential impact of further budget tightening under
    EMU.  Several officials told us that defense budgets had already
    been affected by deficit reduction measures to date in several
    countries.  Other officials stated that because current defense
    spending levels are low by recent historical standards, they are
    unlikely to be cut further.  Many officials and analysts stressed
    that it is hard to develop a causal link between deficit reduction
    requirements and changes in a particular category of spending,
    since a number of factors are involved, including political
    priorities and rates of economic growth.  For example, during the
    1990s, Italy cut its general government deficit the most and its
    defense spending the least, among the countries we studied. EMU
    Should Benefit Economic     EMU has broad and important effects on
    several aspects of European Growth, but Concerns Remain
    economies, including competitiveness, structural reforms, and the
    ability of national governments to react to economic downturns.
    The impact of EMU on economic growth in Europe depends on how EMU
    affects these and other economic factors.  On balance, analysts
    are guardedly optimistic about the implications of EMU for Europe.
    However, concerns remain about how EMU will affect the ability of
    national governments to adjust to economic downturns and derive
    political consensus to pursue structural reforms.  Officials at
    the IMF, the EU, and the OECD told us they believe that EMU will
    ultimately boost economic growth in Europe but have not quantified
    this expected impact. Optimists believe that, in addition to
    providing economic benefits from lower deficits, EMU will tie the
    countries of Europe closer together, 15Economic growth requires
    investment, which over the longer term, depends on savings.
    Government deficits represent dissavings since they use funds that
    otherwise could be used for investment.  For examples of our work
    in this area see Budget Issues: Analysis of Long-Term Fiscal
    Outlook (GAO/AIMD/OCE-98-19, October 22, 1997) and Budgetary
    Policy: Prompt Action Necessary to Avert Long-Term Damage to the
    Economy (GAO/OCG-92-2, June 5, 1992). Page 18
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 increase their prosperity, and ultimately improve
    security through the beneficial effects of integration.  Since
    national governments will no longer be able to adjust to downturns
    through monetary or exchange rate policy, and the use of fiscal
    policy will be constrained, they will have to rely on structural
    reforms, such as revising their policies to increase labor
    mobility, to address economic problems.  Economic efficiency and
    growth will increase because countries in the euro area will have
    no choice but to allow increased flexibility in labor, capital,
    and goods and services markets to stay economically competitive.
    Skeptics fear that EMU will create longer, deeper recessions in
    parts of Europe and possibly increase political tensions between
    countries if workers and firms move across national boundaries.
    They believe EMU will ultimately not work because national
    governments will lack the political support to maintain balanced
    budgets and undertake unpopular economic structural reforms, such
    as making it easier for businesses to fire workers. (See app. II
    for a further discussion of the mechanisms through which EMU can
    affect economic growth.) The link between increased economic
    growth and countries' defense budgets is, of course, an indirect
    one.  In general, stronger growth leads to more resources for all
    spending needs, including defense, and weaker growth can squeeze
    many budgetary categories.  However, changes in the level of
    defense spending over time solely due to changes in economic
    growth can be relatively small.  For example, holding assumptions
    about military threat and political support for defense spending
    constant, if GDP growth increased (decreased) by 1 percentage
    point per year relative to baseline projections, it would take
    about 5 years for real defense spending to increase (decrease) by
    5 percent.16 EMU's impact on economic growth within the euro area
    also has important economic consequences for the newest NATO
    members.  For example, exchange rates of the Polish and Hungarian
    currencies are determined by the values of "currency baskets" that
    include the euro.  In addition, the Polish, Hungarian, and Czech
    economies depend heavily on trade with the countries in the EU.
    16This assumes the defense share of GDP declines slightly over the
    period, based on existing defense budget projections for the
    countries we studied. Page 19               GAO/NSIAD-99-185
    NATO:  European Integration and Defense Spending B-282890 EU
    Enlargement's                 EU enlargement's effect on resources
    available for defense spending Budgetary Impact
    depends on how enlargement affects economic growth and on the
    Uncertain, but Effects on        budgetary costs of meeting
    enlargement criteria.  Both of these impacts are New Member
    Countries             likely to be greater for countries joining
    the EU than for current members. While applicants expect
    membership to improve their economies over the Likely to Be
    Greatest            long run, meeting EU requirements is likely to
    be costly in some areas, although the magnitude of costs depends
    on timetables and specific requirements that have not been
    established.  Current EU members plan to provide financial support
    for enlargement primarily through the EU common budget.  The EU
    financial framework for 2000-2006 limits assistance to applicant
    countries to 11 percent of total spending over the period, which
    is slightly above 0.1 percent of total EU gross national product
    (GNP).17  Most of these funds will not be available until
    countries actually join the EU, which is likely to be several more
    years. EU Membership Should Benefit     EU applicants, whose
    average per capita GDP in 1997 was about 32 percent New Members'
    Economic            of that of current members, expect to derive
    broad economic benefits from Growth
    membership.  Benefits are expected to flow from several factors:
    expanded trade due to reduced trade barriers between entrants and
    current members, increased foreign investment due to lower risks
    and reduced barriers, and overall institutional reforms associated
    with joining the EU. Although the requirements of EU membership
    often coincide with steps toward general economic development in
    applicant countries, the prospect of membership adds an important
    motivation for countries to carry out needed reforms.  In
    addition, because the accession process itself increases investor
    confidence, some of the economic benefits should accrue before
    formal membership.  Finally, applicant countries expect to benefit
    through financial assistance from the EU although, as we discuss
    later, the EU's current budget limits the commitment to assistance
    for applicant countries and new members. Enlargement Requires
    Reforms     The EU requires that new members have by Applicant
    Countries           * stable government institutions guaranteeing
    democracy, rule of law, and human rights; *  a "functioning market
    economy" that can withstand competitive pressure and market forces
    within the EU;  and 17GNP differs from GDP-the total market value
    of all the final goods and services produced within an economy in
    a given year-in that it includes earnings abroad by a country's
    firms and residents and excludes income earned in that country by
    foreign firms and residents. Page 20               GAO/NSIAD-99-
    185  NATO:  European Integration and Defense Spending B-282890 *
    the ability to take on EU membership obligations, including the
    adoption, implementation, and enforcement of the EU's entire body
    of laws, known as the "acquis communautaire." Some of these
    criteria are quite general and open to interpretation.  For
    example, having a functioning market economy can be demonstrated
    through showing sustained economic growth with growing private
    sector participation.  This in turn requires changes across the
    spectrum of economic institutions.  For example, countries' legal
    systems need to include the regulation of property rights so
    contracts can be enforced. Adopting and implementing the full
    spectrum of EU law, however, requires a number of specific
    actions.  Adopting the acquis is a massive undertaking for
    accession countries.  The acquis comprises 80,000 pages of
    requirements, which the European Commission has divided into 31
    categories, or chapters, for the purpose of carrying out
    negotiations with applicants. (See app. III for a complete listing
    of these chapters.)  Some requirements of adopting the aquis can
    be met with simple, technical changes, while others will require
    large investments.  Meeting EU standards for the environment and
    for infrastructure are most likely to constitute the greatest
    challenges and costs for the three accession countries we visited.
    Enlargement Not Likely for     The first accessions to the EU from
    the current enlargement process are Several Years
    not likely to take place for several years, most likely not until
    2004-06, according to U.S. and foreign officials with whom we met.
    Applicant countries' own official timetables remain somewhat
    shorter-2002 or 2003-as does the timetable officially assumed in
    the recently adopted EU budget.  Enlargement cannot occur until
    (1) applicant countries make sufficient progress in satisfying EU
    membership criteria and (2) the EU agrees to reforms in its
    decision-making processes and possibly changes in its budget. The
    timing of accession is ultimately a political decision on the part
    of current EU members.  According to several EU and government
    officials, while current members have made a political commitment
    to the idea of enlargement, they have not made a political
    commitment to the timing or conditions under which it will take
    place.  The degree of support for EU enlargement among current
    member populations is mixed.  According to a 1998 survey conducted
    on behalf of the EU, 42 percent of respondents favored
    enlargement, with support ranging from a high of 63 percent in
    Sweden to a low of 28 percent in Belgium. Page 21
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 In its report on applicants' progress in meeting EU
    membership criteria, issued in late 1998, the European Commission
    indicated that while candidates were "broadly on track," countries
    still had a long way to go in meeting membership criteria.
    According to the Commission, among the Czech Republic, Hungary,
    and Poland, Hungary has made the most progress and the Czech
    Republic the least.  The Commission reports that all the candidate
    countries lack the administrative and judicial capacity to
    implement the acquis.  According to Commission officials, it is
    not realistic to expect that all the requirements of the acquis
    will be met prior to negotiation.  The accession process does
    provide for transition periods- periods after membership during
    which some requirements can be implemented.  Views on how
    extensively transition periods will be granted varied among the
    officials with whom we talked.  Transition periods are generally
    expected in some cases, however, particularly in the area of
    meeting environmental standards. The need to make politically
    difficult changes in EU policies could impede EU enlargement,
    according to officials from the EU as well as member and applicant
    countries.  These include several issues with respect to EU
    decision-making structures and procedures in the Council and
    Commission, and potentially the EU budget-including the allocation
    of funds to support agriculture. EU and member-country officials
    stated that reforms of the EU decision-making process are
    necessary prior to enlargement.  These reforms include reducing
    the number of members of the Commission to one per country to
    accommodate an increasing number of countries (the largest
    countries now have two members); reweighting the voting power of
    members in the Council to offset the loss of commissioners; and
    increasing the use of majority voting in the Council to replace
    the current system of consensus decision-making.  A State
    Department official characterized the prospect for agreement on
    these reforms in the near-term as "dim." The EU financial
    framework for 2000-2006 (discussed later) reflects most of the
    reforms that the Commission had determined would be necessary for
    an expanded EU except with respect to agriculture policy, the area
    of greatest contention.18  This has led to the views of some
    officials that elements of the budgetary framework will have to be
    revisited prior to 18The European Commission laid out in a 1997
    document, Agenda 2000, specific changes to EU policies needed
    before enlargement. Page 22              GAO/NSIAD-99-185  NATO:
    European Integration and Defense Spending B-282890 enlargement.
    In presenting the financial framework, the Council acknowledged
    that further changes in agriculture assistance payments to current
    members may be necessary.  However, EU countries receiving the
    largest amounts of agricultural subsidies could potentially use
    their votes on enlargement to maintain their net level of
    assistance from the EU at the expense of new members.19 Future
    Budgetary Impacts           The budgetary implications of EU
    membership for applicant countries Depend on Specific Enlargement
    depend on the outcome of ongoing membership negotiations with the
    EU. Terms                              At this point, total cost
    estimates have not been developed.  While there is general
    agreement that meeting EU membership requirements will entail
    significant expenditures by applicant countries, quantifying these
    costs remains difficult.  For example, neither the EU nor the
    World Bank, which have both worked with applicants to develop
    accession strategies, has developed broad estimates of accession
    costs. EU requirements with respect to environmental standards and
    transportation infrastructure are expected to be among the
    costliest for applicant countries to meet.  The most comprehensive
    sector-specific estimates are for environmental reforms, where the
    World Bank has recently completed analyses of what Poland,
    Hungary, and the Czech Republic must do to meet EU environmental
    standards.  The World Bank has estimated that Poland's public
    sector costs of meeting EU requirements could be $5 billion to $11
    billion dollars per year for 20 years to cover investment,
    operation, and maintenance.20  This represents about 3.4 percent
    to 7.5 percent of Poland's 1998 GDP and 1.7 percent to 3.7 percent
    of Poland's projected GDP in 2015.  The World Bank estimates
    Hungary's annual costs of environmental reforms as ranging from
    2.1 percent to 5.5 percent of 1997 GDP, and annual costs for the
    Czech Republic ranging from 2.5 percent to 3.7 percent of 1997
    GDP.  The difference between the high and low ends of the cost
    ranges are due to different assumptions about what the specific
    requirements will be and the details of the compliance plan these
    countries and the EU agree to. 19Currently, about half of all EU
    appropriations are for agricultural price supports and direct
    payments to farmers.  Between 1993 and 1997, France was the
    leading recipient of EU agricultural support payments, followed by
    Germany, Spain, and Italy.   Extending these payments to new
    entrants, whose economies are, on average, about four times as
    reliant on agriculture as current members, would increase
    expenditures considerably. 20These calculations assume investments
    are spread over their expected life and discounted to reflect the
    time value of money.  They also exclude what private industry must
    spend to meet EU standards. Page 23               GAO/NSIAD-99-185
    NATO:  European Integration and Defense Spending B-282890 The
    World Bank's studies do not determine what portion of estimated
    costs will be borne directly by national governments.  The
    national budgetary impact of these and other requirements depends
    on a number of factors, including the degree to which costs are
    passed on to consumers-through higher utility bills, for example--
    and the types of financing available. According to these studies,
    much of the costs would be affordable to households under the low-
    cost scenario but not under the high-cost scenario.  Moreover,
    since these studies focus only on the costs of meeting enlargement
    criteria in these areas, they do not attempt to present net
    assessments of the criteria's economic costs and benefits. The
    World Bank emphasizes that these countries will make many of the
    required improvements whether they join the EU or not.  A common
    theme we heard from officials in accession countries is that there
    is substantial overlap between their national development goals
    and EU requirements in areas such as the environment.  However, EU
    requirements can affect the timing of reforms and thus the
    relative impact of their costs.  For example, Hungarian officials
    pointed out that, while commercial vehicles in Hungary will
    eventually satisfy EU emission control requirements, membership
    criteria will force these requirements to be met by a certain
    date.  This will compress the period of time over which
    adjustments take place, thus increasing annual expenses. New EU
    Financial                 EU members plan to support enlargement
    of the Union primarily through Framework Limits
    the EU budget, not their national budgets.  According to the
    financial Expenditures of Current EU  framework adopted in March
    1999, the EU will appropriate about Members for Enlargement
    11 percent of its spending during 2000-2006, about $80 billion
    dollars, to applicant and new member countries.  This is slightly
    above 0.1 percent of current member GNP.21 As illustrated in
    figure 7, the financial framework reflects some increase in total
    spending, since members' GNP is assumed to grow over the period,
    and revenues are limited to a percentage of GNP.  The framework
    shows only a slight decrease in agriculture and regional
    development payments to current members.  It assumes some new
    members would join in 2002, and then receive a portion of
    agriculture and regional development payments. 21Financing for the
    EU budget comes from GNP-based contributions, value-added taxes,
    and agricultural levies and customs revenues.  Member
    contributions are limited to a percentage of total EU GNP, which
    is 1.27 percent in the newly adopted budget. Page 24
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 The framework reflects the decision to set an explicit
    cap on the amount of funds that new members will receive over the
    period.  According to the EU, there are budgetary walls between
    the funding for current and new members.  Thus, if enlargement
    takes place after 2002, current EU members would not get the funds
    earmarked for new members for that year. Figure 7:  Planned EU
    Spending for Current and Applicant Members, 2000-2006 Billions of
    1999 U.S. dollars 120 100 80 60 40 20 0 2000         2001
    2002          2003            2004        2005          2006
    Current members       New members (before joining EU)      New
    members (after joining EU) Source: European Council. Most of the
    financial assistance, 68 percent, given to new members will be for
    regional development.  The amount of assistance earmarked for new
    members is not sufficient to support new members at the same level
    as current members.  EU officials have stated that the EU's
    greatest contribution to the economic development of applicant
    countries is not financial assistance, but rather fostering an
    environment conducive to Page 25               GAO/NSIAD-99-185
    NATO:  European Integration and Defense Spending B-282890
    increased trade and influxes of private capital.  However, a State
    Department official stated that this budgetary framework may have
    to be modified before enlargement can take place. Defense Budgets
    Face  Defense budgets face strong and increasing pressures from
    demands for Strong and Increasing  domestic spending in both West
    and Central European countries. Pensions, in particular, are
    placing pressure on national budgets and Pressure From
    expenditures will increase dramatically as populations age, unless
    difficult Domestic Spending                 reforms are made.
    Health care costs are also expected to rise.  In the long run, the
    pressure from rising entitlement costs may have a greater effect
    on countries' defense budgets than EMU or EU enlargement.  Recent
    budgetary debates in both West and Central European countries have
    highlighted the tradeoffs facing decisionmakers as they try to
    satisfy demands for social spending within a budgetary environment
    characterized by lower economic growth and fiscal constraints.
    Social Spending Is a Large        The countries we reviewed have
    historically spent a large portion of their Portion of National
    Budgets GDP and government budgets on social programs such as
    pensions, health, and welfare.  For example, according to OECD
    figures, in 1995-the latest year for which comparable data are
    available-France, Germany, Italy, and the United Kingdom spent an
    average of 26 percent of GDP on social programs, compared with 16
    percent in the United States.22  Public pensions and health
    programs are the largest component of government spending for
    social programs in these countries, averaging about 80 percent of
    the total.  Central European governments also devote a significant
    portion of GDP to social programs.  According to IMF data, using a
    slightly different measure than the OECD, the Czech Republic,
    Hungary, and Poland spent about 22 percent of GDP in 1997 on
    social programs (including pensions, welfare, and health). The
    cost of public pension programs has been placing increasing
    pressure on government budgets in some countries.  Payroll taxes
    in several countries, although considered high, do not cover the
    annual costs of current pension programs, requiring sometimes
    large and growing portions 22According to OECD figures, about half
    of total government spending in the United States is for social
    programs, about the same as in Western Europe.  However,
    government spending in Europe is a larger portion of GDP than in
    the United States. Page 26               GAO/NSIAD-99-185  NATO:
    European Integration and Defense Spending B-282890 of the national
    budget to fill the gap.23  For example, in Germany, transfers to
    pension funds increased from 16 percent to 22 percent of federal
    government spending between 1994 and 1998.24  In Italy, government
    contributions to the state pension system increased from 2.3
    percent of GDP in 1997 to 2.7 percent in November 1998.  In 1998,
    the Czech Republic's pension system required payments from the
    national budget to finance the gap between payroll taxes and
    pension expenditures equivalent to roughly 1.1 percent of GDP.
    Officials there told us that without serious change in the current
    system, these deficits would continue. However, reforming pension
    programs can increase costs in the short term. For example, in
    1998, Hungary launched an ambitious reform of its pay-as-you-go
    pension program.  Although the move to add mandatory individual
    savings accounts enhanced the long-term viability of the system,
    Hungary's short-term budgetary costs will require payment for two
    parallel pension systems over the next several years, reflecting
    these transition costs. The growing pressures for spending for
    domestic needs such as addressing unemployment and improving
    education are reflected in the 1999 budget debates for all the
    countries we studied.  Germany, for example, increased spending
    for education and to reduce youth unemployment while continuing to
    spend large sums related to the integration of the eastern region.
    France's budget also increased funding directed at lowering
    unemployment and improving education, and Italy spent more for
    social and regional development.  In the United Kingdom, half of
    all planned budgetary increases are in education and health.  In
    Central Europe, Poland is implementing costly pension, health
    care, industrial, and local government reform programs.  The Czech
    Republic's mildly expansionary budget is geared to spur growth.
    And Hungary's budget shows increased spending for pensions and
    education, as the new government attempts to satisfy campaign
    promises while limiting deficit spending. 23Most countries we
    studied have multiple public pension programs, and the complex
    funding and benefit details of these programs differ from country
    to country.   Governments collect payroll taxes to support the
    current year's public pension outlays.  This is known as a "pay-
    as-you-go" funding scheme. General government budgets are used to
    cover any gaps.  Pay-as-you-go schemes are not generally designed
    to accumulate and set aside funds to pay for future liabilities.
    24National budget figures cannot be compared across countries, due
    to significant differences in definitions; spending categories;
    and distinctions between national, regional, and local government
    responsibilities. Page 27               GAO/NSIAD-99-185  NATO:
    European Integration and Defense Spending B-282890 Aging
    Populations Present     Demographic trends present a huge
    budgetary challenge for the countries Budgetary Challenge
    we studied, although the budgetary consequences for the United
    Kingdom are much less negative than those for the other
    countries.25  According to studies by the OECD, the World Bank,
    and national governments, in the absence of substantive public
    pension reform efforts, budgetary stability will come under
    significant strain in the next century.  German Central bank
    officials, for example, described the projected fiscal
    consequences of Germany's demographic problems as catastrophic.
    The share of retired elderly (people over 65) in most developed
    countries, which grew slowly over the last 25 years, will begin to
    rise dramatically after 2010 as the baby boom generation moves
    into retirement and other demographic forces play out.  These
    changes will generally be greater in European countries than in
    the United States, as shown in figure 8. 25The U.K.'s population
    is aging less rapidly and its pension system is less generous than
    in France, Germany, and Italy.  The United Kingdom has also
    undertaken a series of reforms, including partial privatization of
    its pension system, reducing the fiscal burden on the national
    government. Page 28               GAO/NSIAD-99-185  NATO:
    European Integration and Defense Spending B-282890 Figure 8:
    Share of Population Over 65 in Four West European Countries and
    the United States, 1960-2030 Percent of population 30 25 20 15 10
    5 0 1960           1990         2000          2010          2020
    2030 Italy      Germany        U.K.       France        U.S.
    Source: OECD. The projected impact on public pension expenditures
    of these demographic trends for France, Germany, Italy, the United
    Kingdom, and the United States is shown in figure 9. Page 29
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 Figure 9:  Pension Expenditures as Percent of GDP in Four
    West European Countries and the United States, 1995-2050 Percent
    of GDP 25 20 15 10 5 0 1995       2000          2010         2020
    2030         2040            2050 Italy       Germany
    U.K.       France            U.S. Source: OECD. Figure 9 shows
    that, using projections based on current trends and policies,
    public pension costs in France, Germany, and Italy will consume
    growing proportions of total GDP.  Predicted costs for the United
    Kingdom are lower in part due to reforms that have included lower
    benefits.  By several measures, based on current policies, the
    future budgetary consequences of the trends in France, Germany,
    and Italy are very serious.  For example, the OECD has estimated
    that current pension policies will drive the national debts of
    Germany and Italy over 200 percent of GDP by 2030.  To maintain
    their respective national debts at current levels, the OECD
    estimates that Italy and Germany will need to maintain
    unrealistically high budget surpluses of 7 percent of GDP or
    greater per year by 2030.26 26A 1997 OECD study estimated the net
    present value of long-term financing shortfalls of government
    pension programs for a number of countries.  Expressed as a
    percent of a country's 1994 GDP, estimated shortfalls were 24
    percent for the United Kingdom, 60 percent for Italy, 62 percent
    for Germany, and 102 percent for France. Page 30
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 Central European governments face similar budgetary
    problems due to demographic trends.  Polish officials have
    projected they will reach unsustainable levels of spending in 10
    to 15 years.  Likewise, Czech officials reported being in the same
    situation.  Long-term projections for Hungary are somewhat more
    optimistic, given recent reforms, although long-term funding
    shortfalls are still projected. Aging  populations are also
    expected to increase health care costs in these countries,
    although less dramatically.  Public spending on health, which
    throughout the 1980s equaled approximately 6 percent of GDP in the
    EU countries we studied, began to rise early in the 1990s.
    According to one study, this spending is projected to increase to
    approximately 9.5 percent of GDP in 2050, under current trends and
    policies.  Expenditures on health care for the elderly account for
    nearly all of this projected increase. According to the OECD, such
    estimates are highly dependent on the future cost of medical
    technology and the outcome of reforms aimed at improving
    efficiency. Although the dramatic budgetary consequences of aging
    populations appear to be a number of years away, significant
    political and budgetary impacts will be felt sooner, according to
    a number of officials and analysts. The longer pension system
    reforms are delayed, for example, the more stringent they will
    have to be.  Officials told us that achieving the political
    consensus to carry out reforms to temper the budgetary
    consequences of aging populations will be difficult.  They also
    told us that the hardest and potentially most effective choices,
    such as raising the retirement age or reducing benefits, are not
    yet being seriously addressed.  The political challenges are
    compounded by the fact that some long-term reforms can have
    negative budgetary consequences in the short to medium term.
    Conclusions    While neither EMU nor EU enlargement affect defense
    spending decisions directly, they can affect the flexibility of
    governments to allocate resources to various needs.  The impacts
    of EMU and EU enlargement on overall government budgets remain
    difficult to predict.  The estimated costs of meeting some EU
    membership requirements are quite high.  But just how high these
    costs will be, who will pay them, and over what period of time
    they will be incurred remain to be determined.  Clearly, however,
    EU membership is a priority of many Central European countries,
    and support for it could fare well as budgetary decisions are
    made.  Over the next several years, EMU requires additional cuts
    in deficits in participating countries.  While these cuts are not
    large relative to the deficit reductions Page 31
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    B-282890 already made, they are not easily achieved, particularly
    in countries that are experiencing slow growth.  Since defense is
    a relatively small portion of the budget, it can arguably be
    protected from cuts.  However, if the political support for
    defense spending is low, it may be a more attractive target than
    other spending.  Pressures for increased spending on pensions and
    also health care due to aging populations will strain future
    budgets in many European countries.  Strong economic growth is
    clearly a key to governments having any flexibility for meeting
    competing needs for resources. Agency Comments and  The Defense
    Department provided written comments on a draft of this Our
    Evaluation                 report and concurred with our findings
    (see app.V).  The Department of State provided oral comments on a
    draft of this report and concurred with our findings.  DOD and the
    Department of State also provided technical comments, which we
    incorporated where appropriate.  In oral comments on a draft of
    this report, the Department of the Treasury, the European Union,
    the World Bank, and NATO provided technical comments, which we
    incorporated where appropriate. As agreed with your office, unless
    you publicly announce its contents earlier, we plan no further
    distribution of this report until 15 days from its issuance date.
    At that time, we will provide copies of this report to other
    appropriate congressional Committees; the Honorable William Cohen,
    the Secretary of Defense; the Honorable Madeleine Albright, the
    Secretary of State; and the Honorable Lawrence Summers, the
    Secretary of the Treasury.  We will also make copies available to
    others upon request. If you or your staff have any questions about
    this report, please contact me at (202) 512-4128.  Other GAO
    contacts and staff acknowledgments are listed in appendix VI.
    Benjamin F. Nelson, Director International Relations and Trade
    Issues Page 32          GAO/NSIAD-99-185  NATO:  European
    Integration and Defense Spending Page 33    GAO/NSIAD-99-185
    NATO:  European Integration and Defense Spending Contents Letter
    1 Appendix I
    38 Composition of Defense Spending in Selected European Countries
    Appendix II
    44 Possible Effects of European Economic and Monetary Union on
    National Economic Growth Appendix III
    46 Topics of Negotiation for EU Accession Appendix IV
    48 Objectives, Scope, and Methodology Appendix V
    51 Comments From the Department of Defense Page 34    GAO/NSIAD-
    99-185  NATO:  European Integration and Defense Spending Contents
    Appendix VI
    52 GAO Contacts and Staff Acknowledgements Tables
    Table 1:  Sources of Deficit Reductions in Four West European
    Countries as a Percent of GDP, 1990-97
    16 Table 2:  General Government Deficit for Four West European
    Countries, Selected Years, as a Percent of GDP
    17 Table II.1:  Ways in Which EMU Could Benefit Economic Growth
    44 Table II.2:  Ways in Which EMU Could Hurt Economic Growth
    45 Figures              Figure 1:  European Members of NATO, the
    EU, and the Euro Area, and First Wave EU Applicant Countries
    5 Figure 2:  Historical and Projected Defense Spending in Four
    West European Countries, 1980-2002
    7 Figure 3:  Historical and Projected Defense Spending as Percent
    of GDP for Four West European Countries and the United States,
    1980-2002 8 Figure 4:  Historical and Projected Defense Spending
    in Three Central European Countries, 1994-2003
    10 Figure 5:  New NATO Members' Defense Spending as a Percentage
    of GDP, 1994-2003
    11 Figure 6:  Annual General Government Deficits for Four West
    European Countries as Percent of GDP, 1990-98
    15 Figure 7:  Planned EU Spending for Current and Applicant
    Members, 2000-2006 25 Figure 8:  Share of Population Over 65 in
    Four West European Countries and the United States, 1960-2030
    29 Figure 9:  Pension Expenditures as Percent of GDP in Four West
    European Countries and the United States, 1995-2050
    30 Figure I.1:  Trends in Composition of Defense Spending in Three
    West European Countries, 1980-2002, 2003
    39 Figure I.2:  Trends in Composition of Defense Spending in Three
    Central European Countries, 1996-2003
    42 Page 35         GAO/NSIAD-99-185  NATO:  European Integration
    and Defense Spending Contents Abbreviations DOD         Department
    of Defense EMU         Economic and Monetary Union ECB
    European Central Bank EU          European Union GDP         gross
    domestic product GNP         gross national product IMF
    International Monetary Fund NATO        North Atlantic Treaty
    Organization OECD        Organization for Economic Cooperation and
    Development Page 36          GAO/NSIAD-99-185  NATO:  European
    Integration and Defense Spending Page 37    GAO/NSIAD-99-185
    NATO:  European Integration and Defense Spending Appendix I
    Composition of Defense Spending in Selected European Countries
    Appendix I The defense budget challenges of the West and Central
    European countries we studied arise in part from large personnel
    costs, large procurement projects, and deployments.  Officials
    have identified the need to prioritize defense requirements as key
    to effectively addressing new security challenges. Western Europe
    Personnel expenses for the countries we studied in Western Europe
    generally constitute a large portion of their defense budgets-60
    to 70 percent in some cases-and have affected the ability of these
    countries to appropriate additional funding for defense
    modernization.  In Germany and Italy, in particular, personnel
    expenses, as a share of overall expenses, have been rising in the
    Cold War and post-Cold War periods, as shown in figure I.1.  While
    these countries expect personnel expenses to fall in the future,
    this may be complicated by sensitive political and social issues
    associated with the elimination of conscription and the reduction
    in personnel strength.  In the United Kingdom, with its all-
    volunteer force, personnel expenses have decreased relative to
    other expenses since the end of the Cold War. Page 38
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    Appendix I Composition of Defense Spending in Selected European
    Countries Figure I.1:  Trends in Composition of Defense Spending
    in Three West European Countries, 1980-2002, 2003 United Kingdom
    Germany 100% 100% 80% 80% 60% 60% 40% 40% 20% 20% 0%
    0% 84                              89
    94
    84             89             94 1995            1998
    1995    1998    2000    2002 1980-                           1985-
    1990-
    1980-          1985-          1990- Italy 100% 80% 60% 40% Other
    20%
    Equipment 0%
    Personnel 84                              89
    94                                    1995            1998    2000
    2002 1980-                           1985-
    1990- Note 1: Comparable data for France are not available.
    Breakout of future defense spending for the United Kingdom is not
    available. Note 2: "Other" primarily includes spending for
    operations, maintenance, and infrastructure. Sources:  GAO
    analysis of data from North Atlantic Treaty Organization (NATO)
    and national ministries of Defense. Conscription    Compulsory
    military service, known as conscription, has been a fundamental
    element of defense planning for France, Germany, and Italy since
    the end of World War II.  It has both integrated the professional
    core of the military into society and, in some cases, provided a
    source of employment for youth.  While conscription may have been
    effective during Page 39
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    Appendix I Composition of Defense Spending in Selected European
    Countries the Cold War for staffing large territorial armies, the
    restrictions attached to it pose problems for post-Cold War
    security conflicts, according to officials with whom we met.  For
    example, conscripts in Italy cannot be deployed to an overseas
    conflict or crisis except on a volunteer basis. When they do
    volunteer, it can be a costly deployment for the country because
    Italy's laws require that the volunteers be paid at a higher rate
    when on an overseas deployment. France, Germany, and Italy
    acknowledge the lack of flexibility inherent in conscription, as
    well as the expense of maintaining large numbers of these forces,
    and are in various stages of making or considering changes.  A
    shift to a professional, volunteer force can initially result in
    higher personnel costs, although costs can be lower over time as
    the size of the force is decreased, according to U.S. and foreign
    officials.  In addition, ending conscription can exacerbate
    countries' unemployment and associated problems, according to
    military personnel specialists.  In 1996, the French government
    presented a plan for downsizing and professionalizing the French
    military, including a massive reduction of conscripts within the
    French armed forces, to be accomplished by 2002.  Italy has also
    begun to professionalize its military forces but is proceeding at
    a slower pace than France. The Italian government believes a
    gradual transition is necessary because Italy has never had a
    professional military, and also because conscription forces have
    provided volunteer labor that is relied on by both the military
    and the outside community.  As a result of this gradual
    transition, however, personnel costs, as a percent of total
    defense spending, increased from 67 percent to nearly 73 percent
    between 1995 and 1998 to accommodate professionalization and
    maintain conscription.  In May 1999, Germany launched the first
    comprehensive study of the structure of its armed forces in almost
    30 years.  This review, which will look out to the 2010 time
    frame, will include an examination of conscription policies.
    Procurement of Large     The expense of developing and procuring
    large military systems Systems                  significantly
    limits flexibility in defense budgets in many European countries,
    according to U.S. and European officials.  While participation in
    such projects can serve national interests, through increasing
    employment, enhancing technology, and boosting international
    prestige, it can also limit the ability of countries to buy other
    needed systems and equipment for modernization programs.  The
    prime example of this is the EF-2000 "Eurofighter."  Of the
    countries we reviewed, three are participating in this project--
    Germany, Italy, and the United Kingdom.  Our analysis shows that
    Page 40            GAO/NSIAD-99-185  NATO:  European Integration
    and Defense Spending Appendix I Composition of Defense Spending in
    Selected European Countries Eurofighter procurement is accounting
    for a growing portion of the procurement budgets in each of these
    three countries.  Germany, for example, is procuring 180
    Eurofighters, which represents approximately 28 percent of the
    costs of its major combat equipment purchases in 1999. This is an
    increase from 24 percent in 1998.  According to U.S. embassy
    officials in Bonn, Eurofighter procurement, in combination with
    current overseas deployments, has had a depressing effect on the
    funding available for other defense programs.  They stated that
    many German defense procurement programs have been delayed or are
    awaiting a decision whether or not to go forward, as a result of
    funding uncertainty. The Eurofighter is also important to the
    Italian government because it supports Italian industry and jobs
    and provides international prestige.  To fund such a large
    program, the Italian government is relying in part on financing
    sources outside the defense budget, such as the Ministry of Trade
    and Industry.  Because of this funding arrangement, assessing the
    Eurofighter's impact on other defense programs is difficult.
    However, military analysts both inside and outside of Italy have
    expressed concerns regarding Italy's ability to fund the
    Eurofighter as well as other needed systems and equipment,
    particularly given costly military deployments such as Kosovo and
    expenses involved in moving to a professional military force. The
    United Kingdom is procuring 232 Eurofighter aircraft--the largest
    number among participating countries.  U.S. embassy officials in
    London stated that expensive procurement programs such as the
    Eurofighter must necessarily affect other programs, particularly
    when the defense budget is not growing.  Moreover, recent U.K.
    government reports indicate high cost overruns from large weapon
    system purchases, with the Eurofighter accounting for nearly half
    of the total cost overruns. Central Europe    Personnel costs also
    constitute a large portion of the defense budgets for Poland,
    Hungary, and the Czech Republic-between 49 and 61 percent in 1998.
    Operational and personnel costs combined equal nearly 80 to 90
    percent of the defense budgets, leaving 10 percent or less for
    major equipment.  According to U.S. embassy and European
    government officials, a major challenge for these nations has been
    reducing the large, top-heavy, military personnel structures-a
    holdover from their membership in the Warsaw Pact.  Conscription
    is a political and economic issue for these Central European
    countries, as it is in the West, and affects these countries'
    ability to reduce their military force numbers.  Projections
    indicate that Page 41            GAO/NSIAD-99-185  NATO:  European
    Integration and Defense Spending Appendix I Composition of Defense
    Spending in Selected European Countries personnel expenses, as a
    share of overall expenses, will decline slightly in the next 5
    years but will still remain a large percent of the overall defense
    budget (figure I.2 shows the composition of defense spending in
    the Czech Republic, Hungary, and Poland). Figure I.2:  Trends in
    Composition of Defense Spending in Three Central European
    Countries, 1996-2003 Poland
    Hungary 100%                                          100% 80%
    80% 60%                                          60% 40%
    40% 20%                                          20% 0%
    0% 1996     1998      2000     2003             1996        1998
    2000      2003 Czech Republic 100% 80% 60% 40% 20%
    Other Equipment 0% 1996      1998      2000     2003
    Personnel Note:  "Other" primarily includes spending for
    operations, maintenance, and infrastructure. Sources: GAO analysis
    of data from NATO and national ministries of Defense. Achieving
    defense reform and modernization goals depends on the ability of
    these countries to balance competing elements of defense spending.
    Undertaking certain high-cost modernization programs could prevent
    these Central European nations from meeting their NATO force goal
    commitments if the purchases are not carefully planned and
    budgeted, Page 42                     GAO/NSIAD-99-185  NATO:
    European Integration and Defense Spending Appendix I Composition
    of Defense Spending in Selected European Countries according to
    U.S. Department of Defense (DOD) officials.  In recognition of its
    budgetary limitations, Hungary has deferred purchase of new
    fighter aircraft until after 2001 and will continue to use MIG-
    Soviet-built aircraft. The Czech Republic has also deferred
    purchasing new fighter aircraft but is proceeding with the
    procurement of subsonic multirole jets (the Aero Vodochody L-159).
    Poland has decided to move ahead now with new multirole fighter
    aircraft but has not decided whether to lease or buy the new
    systems.  U.S. government officials stated that these aircraft
    purchases are feasible for Poland if the country meets GDP-growth
    projections of at least 4.2 percent and spends defense budget
    increases  primarily on procurement. Funding Requirements  In our
    discussions with U.S. and foreign government officials, nearly all
    of of Peace Support                 them identified the increasing
    number of out of country deployments, particularly in the Balkans,
    as a growing drain on their defense resources. Operations
    Combined with large aircraft purchases and high personnel costs,
    these operations are affecting the ability of the NATO countries
    we studied to carry out restructuring and modernization, according
    to these officials. The expense of the current operation in Kosovo
    is requiring some European countries to draw on other government
    funds or, in the case of Germany, appropriate supplemental funds
    for defense.  Defense officials from France and the United Kingdom
    told us that requests for additional funding from their treasuries
    may be made later this year.  Funding the Kosovo operation has
    been particularly difficult for the new NATO members because of
    their ongoing defense and economic reforms, according to U.S.
    government officials.  The Czech Republic, for example, plans to
    increase its budget deficit in order to fund humanitarian aid.  In
    Poland, contributions are being funded from budget "reserves," as
    a spending contingency fund was quickly exhausted.  According to
    U.S. embassy officials, the Polish Defense Minister has frequently
    complained to the press that the overall budget reserve for
    emergencies will also be quickly depleted. Letter         Page 43
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    Appendix II Possible Effects of European Economic and Monetary
    Union on National Economic Growth
    Appendix I I European Economic and Monetary Union (EMU),
    particularly the adoption of a common currency, can affect
    economic growth in participating countries through several
    mechanisms.  Overall growth effects depend both on how these
    mechanisms individually affect growth, and on how they interact.
    Both are subject to considerable uncertainty.  Table II.1
    summarizes the ways EMU could benefit economic growth.  Table II.2
    summarizes the ways EMU could harm economic growth. Table II.1:
    Ways in Which EMU Could Benefit Economic Growth * Governments will
    be forced to undertake structural reforms, especially in improving
    the flexibility of labor markets.  This will allow economies to
    adjust more easily to economic downturns, and therefore benefit
    long-term growth. * Maintaining low budget deficits, which EMU
    requires, helps establish the foundations for stronger economic
    growth by limiting the government sector's absorption of national
    savings. * Exchange rate variability among euro area countries is
    eliminated. Consumers and businesses will no longer incur currency
    conversion costs, and the macro economy will be spared the impacts
    of large fluctuations in currency values that harmed European
    economies in the early 1990s. * The European Central Bank is
    required to keep prices stable, which should contribute to lower
    interest rates. * A common currency allows consumers to easily
    compare prices across borders, spurring economic competition and
    eventually boosting efficiency and productivity. Page 44
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    Appendix II Possible Effects of European Economic and Monetary
    Union on National Economic Growth Table II.2:  Ways in Which EMU
    Could Hurt Economic Growth * Common economic policies,
    particularly monetary policies, may not be well-suited to the
    needs of various countries that are at different stages of the
    business cycle.  For example, a single interest rate set by the
    European Central Bank for 11 different economies could possibly
    lead to stagnation in some countries and overheating in others. *
    National leaders will no longer be able to use monetary or
    exchange rate policy to cope with economic downturns.  Without
    these tools, some countries may suffer additional pain from
    economic shocks that do relatively little harm to the rest of the
    euro area. * The limitations on government spending will constrain
    national efforts to increase social spending during times of
    recession. * Countries may be unwilling to continue to comply with
    EMU's requirements or adopt politically difficult structural
    reforms, especially in the labor market.  A series of national
    decisions at cross-purposes could place tremendous strain on the
    ability of EMU to hold together politically. Page 45
    GAO/NSIAD-99-185  NATO:  European Integration and Defense Spending
    Appendix III Topics of Negotiation for EU Accession
    Appendix II I Table III.1 presents the 31 chapters of the acquis
    communautaire, or the European Union's body of laws, for the EU's
    negotiations with EU applicant countries regarding those
    countries' adoption of the acquis.  Also shown are examples of
    topics included in each chapter. Chapter
    Examples 1. Free movement of goods                          Export
    procedures; elimination of trade barriers. 2. Freedom of movement
    of people                   Right of residence for employees,
    self-employed persons, and students. 3. Freedom to provide
    services                     Service activities including
    insurance, banking, and stock exchanges. 4. Free movement of
    capital                        Relations between financial
    institutions and consumers. 5. Company law
    Formation, mergers, and division of public limited liability
    companies. 6. Competition policy
    Competition principles; intra-EU dumping practices: and national
    trading monopolies. 7. Agriculture
    Processing and marketing of agricultural products; agricultural
    research; and setting of compensatory amounts. 8. Fisheries
    Catch quotas and management of stock; agreements with nonmember
    countries. 9. Transport policy
    Ground transport safety conditions; shipping vessel registration;
    and air route distribution. 10. Taxation
    Income and corporate taxes; excise duties; and prevention of tax
    evasion and tax avoidance. 11. Economic and monetary union
    Limitations on government deficits; harmonized indexes of consumer
    prices; and provisions for the introduction of the euro. 12.
    Statistics                                     Collection of
    statistical information on tourism; statistics on distribution of
    earnings. 13. Social policy and employment
    Working conditions; wages; and employment incentives. 14. Energy
    Coal rates; nuclear energy safeguards; and oil and gas supplies
    and stocks. 15. Industrial policy
    Research and technological development; competitive pricing and
    other sale conditions. 16. Small- and medium-sized enterprises
    Interest subsidies for loans; taxation; and technological
    innovation. 17. Science and research
    General principles and research sectors. 18. Education and
    training                         Mutual recognition of diplomas,
    certificates, and other evidence of formal qualifications. 19.
    Telecommunications and information             Policy on data
    processing; directive on competition in the markets for
    technologies                                telecommunications
    services. 20. Culture and audiovisual policy
    Resolution on electronic publishing and libraries. 21. Regional
    policy and coordination of structural Monitoring and coordination
    of regional state aid; aid for stricken regions; and instruments
    community loans. 22. Environment
    Nuclear safety and radioactive waste; water protection and
    management; monitoring of atmospheric pollution; prevention of
    noise pollution; and chemicals, industrial risk, and
    biotechnology. 23. Consumers and health protection
    Consumer information; protection of economic interests; and
    protection of animals. 24. Cooperation in the fields of justice
    and home EU extradition procedures; cooperation to combat
    international organized crime. affairs 25. Customs union
    Tariff types, quotas, and ceilings. (continued) Page 46
    GAO/NSIAD-99-185  NATO Defense Spending and European Integration
    Appendix III Topics of Negotiation for EU Accession Chapter
    Examples 26. External relations                       European
    political cooperation; multilateral relations; and commercial
    policy. 27. Common foreign and security policy       Regulation on
    the reduction of economic relations with the Federal Republic of
    Yugoslavia. 28. Financial control                        Decision
    conferring powers to carry out measures of control regarding EU
    revenue and expenditure. 29. Financial and budgetary provisions
    Impact on the EU budget of the accession.  Arrangements for the
    collection of own resources. 30. Institutions
    Principles, objectives, and tasks of treaties. 31. Othera
    None identified as of June 1, 1999. aThe EU set aside chapter 31
    to cover any major issues that arise during negotiations that were
    not covered in the preceding chapters. Source:  European
    Commission. Page 47                GAO/NSIAD-99-185  NATO Defense
    Spending and European Integration Appendix IV Objectives, Scope,
    and Methodology
    Appendix IV The Chairman and the Ranking Minority Member of the
    Subcommittee on Defense, Senate Committee on Appropriations, asked
    us to assess how the implementation of European EMU and the
    enlargement of the EU may affect our European allies' ability to
    sustain or increase their defense budgets.  To address this issue,
    we collected and analyzed information on (1) projected defense
    spending for several European countries, (2) budgetary effects of
    EMU implementation and EU enlargement, and (3) other significant
    factors that may affect countries' ability to share in the costs
    of NATO over the long run. Our work focused on seven European
    countries:  the four members of NATO with the largest defense
    budgets in Europe (Germany, France, Italy, and the United Kingdom)
    and the three newest members of NATO (Poland, Hungary, and the
    Czech Republic).  We chose these countries because (1)
    collectively they accounted for over 75 percent of the total gross
    domestic product (GDP) and defense spending by all European NATO
    members and (2) because they included all three newest members of
    NATO.  We visited all of these countries except France, which is
    not part of NATO's integrated military command.  We also contacted
    officials at DOD, State, and Treasury.  We also obtained access to
    the World Bank and International Monetary Fund (IMF) officials and
    analytical studies through the staffs of the U.S. members of their
    Boards of Executive Directors.  The European governments in our
    study provided us access to reports and staff from a variety of
    ministries. To determine levels and composition of defense
    spending in Europe, we interviewed and obtained data from
    officials in the U.S. government, NATO, EU applicant countries,
    current EU member countries, and academic and private sector
    institutions.  During our visits to NATO countries, we discussed
    planned defense spending trends with officials from the ministries
    of defense, finance, and treasury; parliaments; national audit
    offices; U.S. embassies; and defense research institutes such as
    the International Institute for Strategic Studies in London, the
    Center for the Study of International Politics in Rome, and the
    Government Center for Strategic Studies in Warsaw.  We also
    collected defense budget data and interviewed officials from the
    Central Intelligence Agency, the Defense Intelligence Agency, the
    National Defense University, and the Council on Foreign Relations.
    To determine past and present defense spending trends (1980-98)
    for the figures used in the report, we relied exclusively on NATO
    data and its definition of "defense expenditure."   NATO defense
    budget forecasts for NATO member countries are classified.  To
    present unclassified information on future defense spending
    levels, we obtained Page 48          GAO/NSIAD-99-185  NATO:
    European Integration and Defense Spending Appendix IV Objectives,
    Scope, and Methodology defense budget projections from the host
    countries, calculated yearly growth rates, and applied these
    growth rates to NATO's 1998 spending level for each country.
    Similarly, for the composition of defense budgets and the breakout
    of these budgets into "personnel," "equipment," and "other," we
    relied on NATO data for 1980-98.  For future trends, we relied on
    budget projections from the countries.  We applied growth rates
    for each of these categories, derived from the countries' budgets,
    to NATO's 1998 breakouts. We discussed our methodology with DOD
    officials, and they concurred with the logic of our approach. To
    assess the consequences of EMU on defense spending, we collected
    and analyzed information on EMU's effects on national budgets and
    economic growth from the U.S. Department of the Treasury,  the
    Department of State, and the Department of Defense; the EU; the
    European Central Bank; EMU member countries; the World Bank; the
    IMF; and academic and private sector organizations. We met with
    officials from Germany and Italy to discuss how meeting EMU
    membership criteria has affected their national budgets.  Within
    these countries, we obtained information and met with officials
    from the Central banks, the finance ministries, U.S. embassy
    staff, and academic institutions. To examine the consequences of
    prospective EU enlargement on defense spending, we assessed how
    enlargement could affect national budgets and economic growth. We
    collected and analyzed information and interviewed officials from
    the U.S. government, the EU, applicant governments, current EU
    member governments, multilateral institutions, and academic
    institutions.  We discussed the objectives and total costs of EU
    enlargement with officials at the Department of State, the World
    Bank, and the EU's Council, Commission, and Parliament.  To
    identify the potential impact of meeting EU membership criteria on
    the respective national budgets of current and applicant members,
    we interviewed officials and obtained information from ministries
    of finance and foreign affairs.  In the applicant countries, we
    also met with officials from the national parliaments, EU
    integration offices, U.S. embassies, and local academic
    institutions. To identify primary nondefense domestic budgetary
    trends and pressures, we met with officials from the U.S.
    government, current EU member countries, applicant member
    countries, multilateral organizations, and academic and private
    sector organizations.  We obtained data and analytical studies and
    interviewed officials from the Organization for Economic
    Cooperation and Development, the World Bank, the IMF, and economic
    institutes, including PlanEcon.  In the countries we visited, we
    Page 49           GAO/NSIAD-99-185  NATO:  European Integration
    and Defense Spending Appendix IV Objectives, Scope, and
    Methodology discussed the major areas of the domestic budget with
    officials from the Central banks and the ministries of finance,
    industry and trade, and labor and social affairs; U.S. embassies;
    and local academic institutions. The information in this report
    concerning foreign laws and regulations does not reflect our
    independent legal analysis, but is based on interviews and
    secondary sources. We performed our review from April 1998 to June
    1999 in accordance with generally accepted government auditing
    standards. Page 50           GAO/NSIAD-99-185  NATO:  European
    Integration and Defense Spending Appendix V Comments From the
    Department of Defense Appendix V Page 51    GAO/NSIAD-99-185
    NATO:  European Integration and Defense Spending Appendix VI GAO
    Contacts and Staff Acknowledgements Appenx idVI GAO Contacts
    Harold J. Johnson, (202) 512-4128 Celia Thomas, (202) 512-8987
    Acknowledgements    In addition to those named above, Dave Maurer,
    Elizabeth Guran, Arturo Holguin, Christian Hougen, Bruce Kutnick,
    and Jane Li made significant contributions to this report.
    (711325) Lteter     Page 52 GAO/NSIAD-99-185  NATO Defense
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