The Economic Consequences of War with Iraq

War with Iraq seems inevitable, with or without the support of the UN. The economic costs of such a war could be huge, both in direct American outlays for war and its aftermath, and in the indirect spillovers on the world economy. This war would take place against a background of weak economic conditions globally, and would exacerbate those weaknesses, perhaps throwing the world economy into recession. The economic outcome of war could well depend on the diplomatic context. If America acts alone, the likely costs of war to the world economy will be higher than if it has the backing of the UN.

The costs of war must be balanced against the costs of alternative actions. A high cost of war is certainly not a case for inaction, especially in the face of a serious risk that Iraq could obtain, and eventually use, weapons of mass destruction. Yet pursuing war where diplomatic means - weapons inspections, threats of retaliation in the face of Iraqi aggression, readiness of the UN to act if dangers from Iraq become imminent - might suffice could result in huge and avoidable economic (as well as other) costs.

The traditional textbook view of war is that war stimulates an economy, at least in the short term. But that simple view of wartime economics is too narrow to describe the possible effects of an Iraqi war. We must also recognize that a war with Iraq, even a limited war, could profoundly disrupt the international flow of goods, services, and investments upon which our global economy now rests.

These disruptive effects would not only dampen production, but would undermine investor and consumer confidence and thereby limit both private investment and consumer spending. The direct macroeconomic stimulus that could arise from military spending may be overwhelmed by the uncertainties and disruptions that would accompany military conflict.

Such uncertainties are already visible. Oil prices have risen several dollars a barrel since late summer. Since June, US and world stock markets have declined by around 20% in dollar terms. Each rise in the probability of war has tended to push the markets down further.

The modern world economy is built upon a complex network of global economic connections, and those connections are directly threatened by war. War would pose obvious and direct risks to shipping, notably shipping of oil from the Middle East.

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The increased costs could further depress the drop of cross-border capital flows that has been underway for two years, since the end of the US stock market boom. The decline in cross-border flows intensified after the September 11 attacks last year. Foreign direct investment in many developing regions has dried up, and emerging markets that depend on such capital flows, particularly in South America, have seen their economies thrown into a renewed financial crisis.

Even if the US economy might experience some short-term demand boost from increased military spending, the rest of the world would not. Most countries would feel only negative effects - disruptions of trade, higher oil prices, withdrawals of international capital, cutbacks on investment plans - without any offsetting direct stimulus.

America's macroeconomic situation is also worrisome. The Bush Administration's fiscal policies, combined with the bursting of the US financial bubble of the late 1990s, have pushed America onto an unstable fiscal trajectory. In contrast to budget surpluses "as far as the eye could see," the US now has large budget deficits that will linger for many years to come. War with Iraq would likely cause those budget deficits to soar.

Rising budget deficits will poison US domestic politics and lead to budgetary gridlock. That in turn, could lead to a loss of consumer confidence. Since consumer spending has been the remaining bulwark of the US economy since the collapse of the financial bubble, war with Iraq could puncture the last point of stability in the US economy.

Of course, US policymakers have a hidden "ace in the hole." They believe that the war will be quick, virtually effortless, and self-financing, as the US. effectively gains control of Iraqi oil supplies, which will not only drive down world oil prices but also finance Iraq's postwar reconstruction. An alluring prospect, but perhaps improbable. War might not be quick at all. Postwar Iraq could be unstable even if the war is brief. An alternative scenario is huge uncertainty and turmoil throughout the Middle East, with major disruptions in oil flows, for political if not military reasons.

The geopolitical costs of a unilateral US war will be even higher. A quick and successful war, strongly and explicitly backed by the UN, offers the greatest chance of avoiding a huge negative economic fallout. A war that pits America against the world could call into doubt the progress of globalization, particularly international trade negotiations. Moreover, if the US acts alone, no doubt the post-conflict costs that America will bear alone will be higher as well. Open and deep political divisions between America and other major countries will incite a loss of investor confidence, undermining global economic stability.

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