January 26, 2003

An American win could be an economic loss for the world

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All the while the financial markets continue to weaken as equities fall. The dollar remains weak and the price of gold continues to soar. Both on the diplomatic and financial front, war — whether it is long or short — is being priced in.

Weak markets reflect the widespread uncertainty about the nature of the coming conflict. If it is quick, cheap and decisive, we should see a rally of sorts, but if it is long, expensive and messy, financial markets can kiss any putative 2003 recovery goodbye.

There has been little debate about the cost of the war to America in financial, political or human terms. For Americans, it stands to reason that the costs will only be acceptable as long as they are low. If American casualties mount to the thousands, if the costs to the economy are major tax increases, a deep recession and a dramatic fall in the dollar, or if the US becomes a pariah in the world due to attacks on civilian populations, then we are all in for a global disaster.

A ‘quick war’ would require that Saddam Hussein and his top leadership are captured or killed, with the Iraqi army surrendering overnight and the US forces preventing civil war in the south or in the Kurdish region. A bit like the Yugoslavian/Kosovan conflict, this envisages between 30 and 60 days of air war and very limited scrapping on the ground.

The ‘quick war’ scenario sees the Yanks only sticking around for a few months while the post-Saddam political infrastructure is secured. This scenario sees no permanent problems with the oil market, no Israeli involvement of any sort and no future terrorist attacks. It implies no knock-on political repercussions in the Muslim world.

Against this background, financial markets would rally, as they did after the first Gulf War, the dollar might stabilise and the world would breathe a sigh of relief.

Even so, the costs could be significant. Only two studies have been published in the US to assess the cost of the war to the US, not just in terms of the immediate budget but to the nation as a whole.

A recent article in the New York Review of Books by William Nordhaus summarised the findings.

The first study uses the first Gulf War as the benchmark. It involves 250,000 troops and a cost of between $48 billion and $60 billion, excluding interest. This figure is slightly less than the cost of the first Gulf War, which ran to about $80 billion in today’s dollars.

The second study calculates the price of the different components of a war with Iraq. The central case involves 370,000 military personnel in and near Iraq. Based on the short war scenario, this rough estimate puts the cost of war at around $50 billion.

Neither study countenances the long war scenario. What would happen if the US got bogged down in the suburbs of Iraq?

Declaration of total war on Saddam personally does not give him the Milosevic option. After 73 days of bombing, Milosevic cut a deal to save his skin, with his army remaining more or less intact. This allowed the US/Nato to declare victory without casualties. The ‘regime change’ principle underpinning the US action has ruled out this option.

But before we entertain the long war scenario, think about the other costs, such as the cost of occupation, reconstruction or regional aid packages — all of which will be substantial. For example, it costs the US $250,000 per year for every peacekeeper in Bosnia. Imagine the corresponding figure for a country the size of Iraq.

The idea of ‘regime change’ will only be sustainable if the US succeeds in rebuilding and unifying the Iraqi nation under a new man. This will involve huge investment.

For instance, if a stable new Iraq were to attain a per capita GDP equal to Egypt or Iran and let’s say the rebuilding of 50 per cent of its capital stock, international estimates put the figure at $800 per capita or a total of $20 billion.

This estimate resembles the World Bank estimates for the postwar reconstruction of Lebanon, East Timor and Bosnia of about $1,000 per person.

Or what about the US desire to make the region stable for a long period? This might require a Marshall Aid plan. Marshall Aid cost the US 4.5 per cent of GNP back in the 1940s and 1950s. Today that figure would amount to somewhere around $400 billion.

With exploding populations and over 30 per cent unemployment even in oil-rich Saudi Arabia — not to mention the likes of Syria, Jordan and Iraq — the cost could escalate rapidly.

And what about basic humanitarian assistance for refugees and the homeless in postwar Iraq? This cost approximately $500 per person per year in the Balkans.

If between one and five million residents of Iraq (out of a total population of around 24 million) were to require assistance for a number of years, the figure could range from $1 billion to $10 billion.

So who will pay? The US over the past 40 years has tended to bomb and disappear without sending in repair crews. Figures for the Afghanistan war suggest that $12 billion was spent on bombing and thus far just over $10 million has been sent in aid by the Pentagon.

And what about the nightmare scenario of a long war where casualties are high and the disruption to oil supplies severe?

The well-respected Brookings Institute in Washington suggests that in the worst case scenario, oil prices could stabilise at $70 a barrel, having spiked to $200.

Obviously the impact of this on the world economy does not bear thinking about, but if things go wrong in the field, we might be facing this type of scenario.

Is it any wonder that equity markets have fallen for nine straight trading days? The interest rate cost of such a massive demand for capital to rebuild the region would be immense, which is probably why it won’t happen.

The US is likely to win the war and, due to the excessive cost of the reconstruction, lose the peace. When you’re starting with an over-borrowed consumer, a widening budget deficit and the largest current account shortfall in history, going to war is just about the last thing an economically sane president could do. Who mentioned sanity?