posted 27 January 2003 11:51 AM            

Markets loathe uncertainty and volatility. Conflict brings both

Joseph Stiglitz
Wednesday January 22, 2003
The Guardian

War is widely thought to be linked to economic good times. The second world war is often said to have brought the world out of depression, and war has since enhanced its reputation as a spur to economic growth. Some even suggest that capitalism needs wars, that without them, recession would always lurk on the horizon.
Today, we know that this is nonsense. The 1990s boom showed that peace is economically far better than war. The Gulf war of 1991 demonstrated that wars can actually be bad for an economy. That conflict contributed mightily to the onset of the recession of 1991 (which was probably the key factor in denying the first President Bush re-election in 1992).

The current situation is far more akin to the Gulf war than to wars that may have contributed to economic growth. Indeed, the economic effects of a second war against Iraq would probably be far more adverse. The second world war called for total mobilisation, requiring a country's total resources, and that is what wiped out unemployment. Total war means total employment.

By contrast, the direct costs of a military attack on Saddam Hussein's regime will be minuscule in terms of total US spending. Most analysts put the total costs of the war at less than 0.1% of GDP, the highest at 0.2% of GDP. Much of that, moreover, includes the usage of munitions that already exist, implying that little or no stimulus will be provided to today's economy.

Bush's (admittedly wavering) commitment to fiscal prudence means that much, perhaps most, of the war costs will be offset by cuts elsewhere. Investments in education, health, research, and the environment will almost inevitably be crowded out. Accordingly, war will be unambiguously bad in terms of what really counts: ordinary people's standard of living.

America will thus be poorer, both now and in the future. Obviously, if this military adventure were necessary to maintain security as its advocates claim - and if it were to prove as successful as its boosters hope - then the cost might be worth it. But that is another matter. I want to debunk the idea that it is possible both to achieve the war's ends and benefit the economy.

There is also the uncertainty factor. Of course, this is no reason to invade Iraq prematurely, for the costs of any war are high, and are not to be measured primarily in economic terms. Lives will be lost - possibly far more than were lost on September 11. But the wait for war adds to uncertainties that already weigh on the US, and the global, economy: uncertainties arising from America's looming fiscal deficit and a tax cut that the country cannot afford; uncertainties arising from the unfinished "war on terrorism"; uncertainties associated with the corporate accounting and banking scandals, and the Bush administration's half-hearted efforts at reform, as a result of which no one knows what America's corporations are worth; uncertainties connected to America's massive trade deficit, which has reached all-time highs - will foreigners be willing to continue to lend to the US at a rate in excess of a billion dollars a day? Uncertainties associated with Europe's stability pact. Will it survive, and will it be good for Europe if it does? Finally, uncertainties associated with Japan: will it at long last fix its banking system, and if it does, how negative will be the short-term impact?

Some suggest that the US may be going to war to advance its oil interests. Few can doubt the influence that oil interests have on President Bush - witness the administration's energy policy, with its emphasis on expanding oil production rather than conservation. But even from the perspective of oil interests, war against Iraq is a risky venture: not only is the impact on price highly uncertain, but other oil producers, will not easily be ignored.

Indeed, should the US go to war, no one can predict the effect on oil supplies. A peaceful, democratic Iraqi regime could be established. Desperate for funds for reconstruction, that new regime could sell large amounts of oil, lowering global oil prices. Or the turmoil throughout the Muslim world could lead to disruptions of oil supplies, with high prices the result. This will please oil producers in other parts of the world, but will have adverse consequences for the global economy, akin to those resulting from the oil hikes in 1973.

Whichever way one looks at it, the economic effects of war with Iraq will not be good. Markets loathe uncertainty and volatility. War, and anticipation of war, bring both. We should be prepared for them.

· Joseph Stiglitz is professor of economics and finance at Columbia University, the winner of the 2001 Nobel Prize in economics, and author of Globalization and its Discontents. He was formerly chairman of the council of economic advisers to President Clinton and chief economist at the World Bank.
www.project-syndicate.org

posted 27 January 2003 12:22 PM            

Two issues are dominating this year's annual meeting of the World Economic Forum in Davos, Switzerland. One is the US economy. Is it heading for the sustained recovery many were predicting a year ago, or will it slump back into recession, dragging the rest of the world with it? The second is inextricably linked – the gathering chances of war against Iraq.

I've long thought a US assault on Iraq inevitable, and nothing I've heard from the sizeable contingent of American business and political leaders here over the past three days has led me to change that view. Rather the reverse, in fact.

US political and business opinion, some of it informed, most of it still inevitably speculative, is that war is about to break out and it will happen sooner rather than later. Few think the benign outcome, that Saddam voluntarily gives up power, at all likely.

Many think the military build-up has reached an unstoppable momentum, reinforcing and underpinning the Bush administration's determination to achieve regime change, with or without UN backing.

Public opposition to the war, both inside and outside the US, continues to mount, and if Davos is any guide, anti-Americanism has rarely been as much in the ascendant, but it isn't going to make a difference. The die has already been cast.

So what are the likely economic and business consequences of war against Iraq? There have been some truly alarming estimates of the monetary costs of war floating around the conference centre here in Davos.

Analysis undertaken at Yale University suggests that even a short war of perhaps two months' duration would cost the US $121bn. That estimate includes the costs of military spending, reconstruction, peacekeeping and the likely impact on financial markets and economic confidence.

However, if the war becomes prolonged, necessitating a US military presence in the region for say 10 years, the costs rise exponentially to perhaps as high as $1,700bn at the upper end of the range.

Of themselves, the figures may be fairly meaningless, but they do give some sense of the scale of the undertaking. As one participant put it, if the underlying purpose of this war is about securing oil supplies, as many on the political left seem to believe, then it is an incredibly costly and high-risk way of achieving it.

The effect of the war on the oil price none the less remains the dominant macro-economic risk. If the precedent of the Gulf War is followed, then the price will spike sharply upwards on the outbreak of war.

If the war is short and successful, involving little or no disruption to oil supplies, then the present war premium in the price will disappear and eventually the cost of oil is likely to settle at a level maybe a bit lower than the mid-point of Opec's target range.

That's going to be a boon to the world economy. Most US business leaders here suggest that the uncertainty created by the possibility of war against Iraq is the biggest barrier as things stand to a revival of business investment. Remove that uncertainty and companies will start spending again, helping to revive the stagnant US and world economies.

Unfortunately, there are far less happy scenarios. According to Alan Blinder, a former vice-chairman of the US Federal Reserve and now Professor of Economics at Princeton University, any prolonged war is highly likely to induce recessions in all the major economies.

During the Gulf War, the short-term oil price spike helped prompt a shallow recession in the US, but that in Mr Blinder's view was partly because the Fed was slow to counter the oil price spike by cutting interest rates. He expects a much more rapid policy response this time around, with the Fed reacting to the outbreak of war with perhaps an immediate 50 basis point cut in short-term rates.

According to US business leaders here, the US economy may not have grown at all in the final quarter of last year, despite still strong consumer spending, and may even have been mildly negative. The double-dip recession, so much talked about at the last WEF annual meeting in New York but widely dismissed as unlikely, may already be upon us, and that's before an Iraqi war has even begun.

As one chief executive puts it: "We need a quick and successful outcome. If we don't get it, we're dead." This seems to me still by far the likely outcome, but don't bet on it. A senior Bush adviser told me: "If the war is still going after a month, then we may be in trouble."

In the less benign scenario, the war proves difficult and protracted. The price of oil rises sharply and then stays there. Developed economies are not as reliant on oil as they used to be, but the consequences would still be catastrophic, turning a weak recession of the type that followed the Gulf War into something much more serious.

As war stretched into a third and fourth month, with no end in sight, the Fed would continue to cut rates, perhaps down to zero if necessary. With the federal funds rate already at an historic low of 1.25 per cent, it can readily be seen that the US is already very low on monetary ammunition. Furthermore, higher oil prices might eventually prove inflationary, necessitating a rise in interest rates and deepening any economic downturn.

All very scary, and alarmingly, only too possible. Set against that there may be some light at the end of the tunnel for the US economy. Possibly it is the proverbial oncoming train, but most business leaders here expect a mild pick-up in corporate profits this year and perhaps a significant increase in corporate spending, depending on how the war goes.

The big unknown remains the US consumer. Just how much more credit can he stand before he runs out of puff? Perhaps as important, just how much more credit can the US financial system extend before there's a systemic collapse?

Paul Krugman, another Princeton University economics professor, is not optimistic. He points out that the US needs to create 1.5 million jobs a year just to keep pace with the growth in the working population, and he thinks that any fiscal stimulus from the federal government will be swamped out by fiscal contraction at the state level.

The US version of Europe's much criticised Growth and Stability Pact is the rule that forces all states to run balanced budgets, regardless of the condition of the local economy. President George Bush can cut taxes all he likes, but it won't have any effect if it is being countered by rising taxes at a state level.

Whatever the medium-term prognosis for the US economy, there remains a high degree of faith in the fundamentals.

Productivity growth remains strong, and despite the wave of corporate scandals, American innovation and management savvy has yet to be equalled elsewhere in the world. Both the administration and the Federal Reserve are focused on a strong, pro-growth agenda, in apparent contrast to the paralysis in policy that has gripped much of the eurozone.

I've never known anti-American feeling as strong at these meetings as it is this year, but the underlying self confidence of American business remains strong. The same cannot be said of Europe, where the pace of reform is depressingly slow. Few European business leaders I've spoken to here are unambiguously optimistic about the economic outlook for Europe.

There are some hopeful straws in the wind. Both France and Germany have largely accepted the case for reform of the Growth and Stability Pact. Germany's finance minister, Caio Koch-Weser, conceded that the pact needed "refining" to concentrate more on structural than cyclical deficits. That message was repeated by Francis Mer, the French economics minister. "Without damaging the purpose of the pact, we need to reform it to promote growth," he said.

Only one thing is clear. With war looming, the future is even more impossible to predict than ever. For better or worse, the picture will seem much less fuzzy six months hence.

posted 27 January 2003 09:48 PM            

These articles are very informative, for example: the ones posted here tell you how a New war in Iraq could hurt the economy of the world, starting with the USA.