MacroScan (Printable Version) - A War on the Economy

There is a strange complacency about the impact a U.S.-led aggression on Iraq will have on the world economy and, at home, the effect on the Indian economy. Short or long, a war will damage the economy. This will happen at a particularly inappropriate time since the world economy continues to show sluggish growth. The effect on India will not be insignificant, notwithstanding the large foreign exchange reserves that the Reserve Bank now has.

It is sometimes argued that a war boosts demand and is therefore 'good' for the economy. The distasteful decision of USAID earlier this week to award contracts worth $900 million to U.S. firms for the reconstruction of a war-ravaged Iraq -- before the first shot has been fired -- would appear to be one indication that the conflict would at least benefit the U.S. economy. However, the gains to the civil construction firms and the armament industry are not the only things that count. In addition to the terrible human and social costs that a war imposes on a society, it unsettles the economy in numerous ways. It increases uncertainty, which affects business investment decisions. It causes personal insecurity, which affects consumer behaviour. It consumes vast financial resources, thereby putting strains on a Government's commitments to the economy. It causes dislocation, which again pulls down the economy. And, in the victim country, it causes considerable economic loss by destroying the infrastructure. The injury to Iraq, already suffering from a decade of U.N.-led sanctions, rarely figures in the calculations. But even the U.S. will not escape the ill effects of a war that it threatens to unleash on Iraq and on the global economy as well.

An early warning is contained in a report leaked from the International Monetary Fund, which now projects global economic growth in 2003 at just 3 per cent, down from the 3.7 per cent the institution had predicted last September. Horst Kohler, IMF chief, has recently spoken of the "great uncertainty" a war will create around the global economy. While Mr. Kohler puts all his hopes on a 'short' war containing the global effects, there is no escaping the expensive bill the U.S. will present to the world economy. The 1991 Gulf War ended quickly. Global oil prices, after touching even $50 a barrel, subsided gradually to their pre-war levels. The world economy was, however, left dealing with the after-effects of the Gulf War for at least a couple of years. Global economic growth, according to World Bank data, halved between 1990 and 1991, falling from 2.8 per cent to 1.4 per cent. It remained under 2 per cent over the next two years and it was not until 1994 that the global economy climbed out of the trough. In high-income countries annual GDP growth plummeted from 3 per cent in 1990 to 1.3 per cent in 1991, again recovering to over 3 per cent only in 1994. Low-income countries too went through the same experience.

And under George Bush senior, the U.S., victor in the Gulf War, went into a recession and showed a negative GDP growth of half a per cent in 1991. This must be a warning for George Bush junior, for his father went on to lose his presidency in the elections in 1992, where the economy was the major issue. In the early 1990s, the U.S. economy recovered much more quickly than the rest of the world and the Gulf War was not the only cause of the downslide. But the war certainly aggravated the economic situation and even a 'short' war in 2003 could do much the same thing.

The numbers being mentioned as the direct financial costs of a new war for the U.S. alone are huge. There can be no certainty about the costs of a war that is yet to break out. But there is enough information available to suggest that it will not be a small or easily manageable amount. The cost of the 1991 war has been put at $78 billion at today's prices. The initial internal estimates placed the cost of a war in 2003 at just $35-40 billion or half the cost of the 1991 conflict. But that has now been shown to be a gross underestimate. A number of panels of independent experts and former senior U.S. Government officials have generated estimates which are two to three times higher. The first cost is of a 'long' versus 'short' war. A conflict brought to an end quickly may cost under $40 billion, but a war that goes on for more than a fortnight may cost anywhere between $80 billion and $100 billion. The second cost, which was ignored in the early estimates, is of a future U.S.-led "peace-keeping force" in Iraq. This has been placed at as much as $15-20 billion a year for three to five years.

And the third cost is of post-war reconstruction of Iraq, which has been put at $40-50 billion. Of course, as Afghanistan is learning to its bitter cost, the promise of reconstruction is not always met. When these numbers are added up, the 2003 edition of a Gulf War will cost at the very least between $100 billion and $200 billion. These are just the financial costs that the U.S. (and its partner in crime in Iraq, the U.K.) will have to incur. No one knows or has cared to add up the financial costs, leave alone the human costs, that Iraq will have to suffer. A financial burden of $100-200 billion is a huge amount and it is not surprising the Bush presidency has been less than forthcoming about the numbers. Proposals for major tax cuts threaten to send U.S. finances topsy-turvy and the last thing the presidency wants is to inform the U.S. public how much worse the situation will become after a war. To put these numbers in perspective, the U.S. defence budget for this year, excluding the cost of a West Asian conflict, has been placed at $380 billion.

The effect that the war will have on India is easier to assess. Of course, the economy will not be tipped over the edge as it was in 1991. Then, the temporary rise in global oil prices, the fall in remittances from West Asia and the flight of NRI bank deposits were too much to bear for an economy saddled with a huge external debt and already weakened by political instability brought on by three Governments in less than 18 months, social conflict caused by the anti-Mandal agitation and communal violence provoked by L.K. Advani's Rath Yatra.

This time there is adequate cushion to absorb the balance of payments impact of a likely rise in global oil prices. But that is not the only factor that matters. First, while there may be enough foreign exchange to pay for oil imports, if global petroleum prices stay high they will have an impact on inflation at home. Of course, the Government, which is already taking decisions focussed on the next Lok Sabha elections, may instruct the oil companies not to raise retail prices. The costs of such short-termism will badly hurt the economy later. Second, if the U.S. economy takes a dip, the world economy too will be affected and with that India's export growth rate will slow down. The only question is by how much and for how long. In one respect the Indian economy is more vulnerable today to the effects of a Gulf War than in 1991.

The economy is now linked much more to the world than in 1991; that by definition makes it more susceptible to the fallout of wars and global recessions. Trade will be affected, foreign direct investment will be affected and the direction of foreign portfolio investment may change. Since the Indian economy at this point is not in a particularly vibrant phase, the complacent attitude that the $70 billion of reserves has generated in the Government and the RBI is not warranted.



Themes > Current Issues	15.03.2003


A War on the Economy

C. Rammanohar Reddy

There is a strange complacency about the impact a U.S.-led aggression on Iraq will have on the world economy and, at home, the effect on the Indian economy. Short or long, a war will damage the economy. This will happen at a particularly inappropriate time since the world economy continues to show sluggish growth. The effect on India will not be insignificant, notwithstanding the large foreign exchange reserves that the Reserve Bank now has. It is sometimes argued that a war boosts demand and is therefore 'good' for the economy. The distasteful decision of USAID earlier this week to award contracts worth $900 million to U.S. firms for the reconstruction of a war-ravaged Iraq -- before the first shot has been fired -- would appear to be one indication that the conflict would at least benefit the U.S. economy. However, the gains to the civil construction firms and the armament industry are not the only things that count. In addition to the terrible human and social costs that a war imposes on a society, it unsettles the economy in numerous ways. It increases uncertainty, which affects business investment decisions. It causes personal insecurity, which affects consumer behaviour. It consumes vast financial resources, thereby putting strains on a Government's commitments to the economy. It causes dislocation, which again pulls down the economy. And, in the victim country, it causes considerable economic loss by destroying the infrastructure. The injury to Iraq, already suffering from a decade of U.N.-led sanctions, rarely figures in the calculations. But even the U.S. will not escape the ill effects of a war that it threatens to unleash on Iraq and on the global economy as well. An early warning is contained in a report leaked from the International Monetary Fund, which now projects global economic growth in 2003 at just 3 per cent, down from the 3.7 per cent the institution had predicted last September. Horst Kohler, IMF chief, has recently spoken of the "great uncertainty" a war will create around the global economy. While Mr. Kohler puts all his hopes on a 'short' war containing the global effects, there is no escaping the expensive bill the U.S. will present to the world economy. The 1991 Gulf War ended quickly. Global oil prices, after touching even $50 a barrel, subsided gradually to their pre-war levels. The world economy was, however, left dealing with the after-effects of the Gulf War for at least a couple of years. Global economic growth, according to World Bank data, halved between 1990 and 1991, falling from 2.8 per cent to 1.4 per cent. It remained under 2 per cent over the next two years and it was not until 1994 that the global economy climbed out of the trough. In high-income countries annual GDP growth plummeted from 3 per cent in 1990 to 1.3 per cent in 1991, again recovering to over 3 per cent only in 1994. Low-income countries too went through the same experience. And under George Bush senior, the U.S., victor in the Gulf War, went into a recession and showed a negative GDP growth of half a per cent in 1991. This must be a warning for George Bush junior, for his father went on to lose his presidency in the elections in 1992, where the economy was the major issue. In the early 1990s, the U.S. economy recovered much more quickly than the rest of the world and the Gulf War was not the only cause of the downslide. But the war certainly aggravated the economic situation and even a 'short' war in 2003 could do much the same thing. The numbers being mentioned as the direct financial costs of a new war for the U.S. alone are huge. There can be no certainty about the costs of a war that is yet to break out. But there is enough information available to suggest that it will not be a small or easily manageable amount. The cost of the 1991 war has been put at $78 billion at today's prices. The initial internal estimates placed the cost of a war in 2003 at just $35-40 billion or half the cost of the 1991 conflict. But that has now been shown to be a gross underestimate. A number of panels of independent experts and former senior U.S. Government officials have generated estimates which are two to three times higher. The first cost is of a 'long' versus 'short' war. A conflict brought to an end quickly may cost under $40 billion, but a war that goes on for more than a fortnight may cost anywhere between $80 billion and $100 billion. The second cost, which was ignored in the early estimates, is of a future U.S.-led "peace-keeping force" in Iraq. This has been placed at as much as $15-20 billion a year for three to five years. And the third cost is of post-war reconstruction of Iraq, which has been put at $40-50 billion. Of course, as Afghanistan is learning to its bitter cost, the promise of reconstruction is not always met. When these numbers are added up, the 2003 edition of a Gulf War will cost at the very least between $100 billion and $200 billion. These are just the financial costs that the U.S. (and its partner in crime in Iraq, the U.K.) will have to incur. No one knows or has cared to add up the financial costs, leave alone the human costs, that Iraq will have to suffer. A financial burden of $100-200 billion is a huge amount and it is not surprising the Bush presidency has been less than forthcoming about the numbers. Proposals for major tax cuts threaten to send U.S. finances topsy-turvy and the last thing the presidency wants is to inform the U.S. public how much worse the situation will become after a war. To put these numbers in perspective, the U.S. defence budget for this year, excluding the cost of a West Asian conflict, has been placed at $380 billion. The effect that the war will have on India is easier to assess. Of course, the economy will not be tipped over the edge as it was in 1991. Then, the temporary rise in global oil prices, the fall in remittances from West Asia and the flight of NRI bank deposits were too much to bear for an economy saddled with a huge external debt and already weakened by political instability brought on by three Governments in less than 18 months, social conflict caused by the anti-Mandal agitation and communal violence provoked by L.K. Advani's Rath Yatra. This time there is adequate cushion to absorb the balance of payments impact of a likely rise in global oil prices. But that is not the only factor that matters. First, while there may be enough foreign exchange to pay for oil imports, if global petroleum prices stay high they will have an impact on inflation at home. Of course, the Government, which is already taking decisions focussed on the next Lok Sabha elections, may instruct the oil companies not to raise retail prices. The costs of such short-termism will badly hurt the economy later. Second, if the U.S. economy takes a dip, the world economy too will be affected and with that India's export growth rate will slow down. The only question is by how much and for how long. In one respect the Indian economy is more vulnerable today to the effects of a Gulf War than in 1991. The economy is now linked much more to the world than in 1991; that by definition makes it more susceptible to the fallout of wars and global recessions. Trade will be affected, foreign direct investment will be affected and the direction of foreign portfolio investment may change. Since the Indian economy at this point is not in a particularly vibrant phase, the complacent attitude that the $70 billion of reserves has generated in the Government and the RBI is not warranted.



© MACROSCAN 2003