Calculating the economic consequence of war

Cliff Taylor, Economics Editor, was online this week discussing the economic consequences of the Iraqi crisis. He was joined by Jim Power, chief economist with Friends First. These are a selection of questions submitted to debate@irish-times.com. A full transcript is available at www.ireland.com/business

Question: You may be aware that the US has been contemplating taking a World Trade Organisation (WTO) case/introducing trade sanctions against the European Union over the issue of GM foods. Since France is the EU member-state with the strongest views against GM foods, is it not likely that the Bush administration will introduce trade sanctions against the EU after the Iraqi War, precipitating a major trade war between the US and EU?

Raymond O'Rourke

Cliff Taylor: I think the outlook for trade issues could be seriously affected by the diplomatic fall-out from the war. However, how serious the fall-out will be between the US and France remains to be seen.

Some French industry leaders have been quoted as saying that, despite the politics, it is "business as usual". However, reports from the US of "French fries" being replaced by "freedom fries" suggest otherwise.

It would be a major step for the US to start taking an aggressive approach on trade issues in the aftermath of a war. However, it could happen.

Certainly the outlook for the Doha round of trade talks now under way under the aegis of the WTO must be affected. In the area of farm trade, the US and France are key players in the talks, with the US pushing for restrictions on the Common Agricultural Policy and France trying to persuade the EU negotiators to fight to retain as much as possible to benefit its farmers.

What chance a compromise in this area in the wake of the diplomatic bitterness now evident?

While a major trade war may not be a prospect, I think the danger is of a failure of the Doha round and a gradual slipping in the move to free trade that has underpinned world growth over the past 50 years.

Question: The US stock market rose by close to 5 per cent on Monday following the revelation that President Bush was to issue an ultimatum to Saddam. Why?

Terry McLure

Jim Power: The one thing that markets and investors hate is uncertainty, be it political or economic. For the past three months the markets have been waiting and wondering if Bush would go into Iraq.

Monday's ultimatum signalled that the period of waiting was about to end and the war was about to begin. This came as a relief to markets, not because they like conflict but because the beginning of the conflict would remove a major source of uncertainty.

The markets breathed a sigh of relief but I believe this sense of relief is only a temporary phenomenon and does not signal a sustained recovery. There are still huge economic problems in the US and at a global level, and an attack on Iraq will not solve these problems.

The imbalances left after the bursting of a bubble take some time to eradicate and will impact on economic activity and markets for another 12-18 months.

Attacking Iraq has the potential to open up a huge can of worms. Once war starts, the markets could jump by up to 20 per cent depending on the newsflow from Iraq but reality will strike home and that rally will prove difficult to sustain.

Cliff: I agree with Jim that a period of market volatility is a prospect. The markets appear to be starting to price in a quick war with no complicated or economically dangerous fall-out. Life is seldom this straightforward. Expect more price swings in the weeks ahead.

Question: In the long term, will this war bring more or less stability to the financial markets?

Conor O'Dea

Jim: Long term, I believe the markets will have to live with the legacy of the US IT and economic bubble bursting and a radically changed global geo-political environment post 9/11. The Iraqi war will not end the global terrorism threat and, arguably, will increase it.

So I don't believe the war will bring more stability to financial markets - quite the contrary. What will Bush do about Iran, Syria, Saudi Arabia etc? Imposing US-style "liberal" democracy to those countries would logically result in the rise to power of more powerful Islamic fundamentalist forces and make life even more difficult for the US.

Question: Do you think a sustained war in Iraq would have any negative impact on American companies who have major investments in Ireland and, if so, how badly do you think the Irish economy would suffer?

Kenneth Lang

Cliff: The war and the fall-out from it is bound to have some impact on US companies based here. Of course, they will suffer from any wider fall-out for the US and world economies. Most are also quoted companies, so their fortunes rely to an extent on the markets and many have suffered falling share prices.

In turn, this may have put investment on hold and contributed to a fall-off in job creation here. This environment is unlikely to lift until the war is over and, even then, it could be disrupted by the political and diplomatic fall-out.

However, I think the major influence on US investment here will be the competitiveness of the economy. We clearly face new competitors for international mobile investment in Eastern Europe and the Far East and this puts pressure on industry here to move into higher-value and research-based areas in the years ahead and on policymakers to put in place an environment that allows this to happen.

Question: Will Bertie's backing of the war ensure that Irish companies will be up for consideration when the US is doling out the reconstruction of Iraq contracts?

Conor O'Dea

Jim: In my view, Bertie's backing of the war will do nothing to improve the prospects of Irish companies getting a slice of the action. Bush's buddies in Texas and a few of Blair's cronies will take the major slice of that particular cake. Bertie will get a few crumbs off the imperial table but, then again, that should keep him happy.

Question: Will the Iraqi war depress world economies and push interest rates lower or have an inflationary effect (rising oil prices etc), requiring higher interest rates to dampen such inflation?

John Lacy

Jim: In 1974 and 1979, in the aftermath of two oil crises, global central bankers increased interest rates to prevent higher oil prices from leading to higher inflation. This time around, the situation is very different.

Inflation is much lower coming into this crisis and the world economy was already in trouble coming into this crisis.

The net result is that higher oil prices will have a greater and more negative effect on an already weak global economy, than on inflation. Central bankers will be forced to work more aggressively to reflate the world economy.

The duration of the war and the longer that oil prices stay high will be important considerations. I think it will be a short war and within three months or so oil prices will have come back.

Regardless of duration, however, the European economy, led by Germany, will remain depressed for many reasons apart from the war and these problems are not going to go away.

Over the coming months, I believe the Bank of England will cut rates by up to 0.5 per cent, the Federal Reserve by 0.25 per cent, and the European Central Bank by at least another 0.5 per cent. Longer term, I believe the euro zone (including Ireland) will remain a very low interest rate environment, dominated as it is by a German economy that is in long-term decline. Good news for Irish borrowers but bad news for savers.

Question: Is this a good time to get into the stock market?

Greg

Cliff: I don't think it's a market in which investors will soon be able to make a "quick buck", as was the case in the mid-1990s.

Share valuations have obviously fallen considerably over the past three years. However, they are still not a raging "buy" by historical standards, particularly in the US. The risks of the current situation and its fall-out are likely to keep markets volatile over the next couple of months.

For those taking a longer-term view, it may be time to start looking at investment opportunities but stock selection will prove crucial. Shares in solid profitable and growing companies are bound to prosper in the long-term but the market will punish any company suspected of financial "rinky-dinks" and will take with a grain of salt projections of profits in the years ahead from those currently in the red. Profitability and cash generation will be the order of the day for investors.

Question: Do you think the duration of the war will have any bearing on its economic impact?

Dominick O'Brien

Cliff: Yes, I think it will be a central factor - the longer the war, the greater the economic damage. A longer war could maintain oil prices at a relatively high level for long enough to damage an already fragile world economy.

The financial markets are likely to be affected by the length of the war - signs of a short war will push prices higher, any danger of the war being drawn out will push them down.

Question: Do you think the war with Iraq will affect Ireland's international competitiveness? What do you think the general affect will be on Ireland's economy?

Natasha Checkley

Cliff: I think the general effect will be to delay economic recovery. If oil prices stay high, the war will hit our competitiveness, and that of all oil importers, by pushing up costs to industry and consumers. This will add to a difficult environment for business, which is facing competitive difficulties due to rising costs in a whole range of areas.