Price of backing U.S. against Iraq

Editorial, The Japan Times, 3 March 2003

A pall of gloom hangs over the world economy as a war looms with Iraq. If war does come, world oil prices will go higher, crimping growth and investment worldwide. That much is fairly clear. What is not clear is just how much the price of petroleum will rise and how hard the global economy will be hit. It is safer to consider the extremes of the downside risks.

The administration U.S. President George W. Bush is trying to paint an optimistic picture. The prevailing view appears to be that, in the longer run, the world economy would benefit from military intervention in Iraq—because of the assumption that if the war ends quickly, leading to the downfall of Iraqi President Saddam Hussein, global economic prospects will start looking up sooner or later.

The Japanese government, which is expected to support U.S. military action, is speaking in much the same vein. Higher oil prices will have a relatively small effect on Japan, says a Foreign Ministry official. That is probably true, provided that the conflict is short and the price spikes are limited. Only time will tell whether this will actually happen.

It would be wise, therefore, to consider other possible scenarios. The worst case would be a messy war that drags on indefinitely. But even if the war ends in a short period, as seems likely, that in itself is no guarantee of stability in a post-Hussein Iraq and, for that matter, in the rest of the Middle East. One possibility is that the terrorism threat would grow if things worsened for Iraq and its neighbors. And that would cause negative economic consequences worldwide.

Given the rapid progress in economic globalization since the 1991 Persian Gulf War, global turbulence in the financial market, such as speculative attacks by hedge funds, cannot be ruled out. In an uncertain world, developments can take an unexpected turn. The golden rule is to keep a cool head without being optimistic or pessimistic.

Currently the benchmark price of crude is approaching $40 a barrel, which already factors in the possibility of an attack on Iraq. Some market analysts say the price would jump to the $60 level temporarily if war came. That would likely jolt Japan’s economy, which depends almost entirely on foreign oil. In quantitative terms, though, there seems to be little cause for worry because the government and the private sector have combined stocks equal to 170 days’ supply.

Nevertheless, war and oil make for a very costly combination, particularly at a time of deflation. On top of an inflated oil import bill, Japan would be asked to cover part of the cost of nation-building in Iraq and also provide financial assistance to its neighboring countries. Thus some estimates put the overall cost of war, including the cost of postwar reconstruction, at roughly $100 billion.

Japan’s economy in fiscal 2003 will remain almost flat, according to most private forecasts, even if war is avoided. In the event of war, however, the economy will likely contract as consumer spending and business investment drop. The slump will worsen if banks go ahead with their scheduled bad-loan writeoffs. That could prompt them—and the government—to put off debt cleanup. With the economy slipping deeper into deflation, the case for inflation-targeting could gain support.

The government would have to put together an extra spending budget not only to shore up a sinking economy but also to pay part of the war cost. As a result, the goal of fiscal reform would become even more distant. A special tax increase of the kind that was pushed through at the time of the Persian Gulf War—Japan chipped in $13 billion—seems out of the question.

It appears that major countries hold different views on the possible impact of an Iraq war on the world economy—differences that seem to reflect in part their domestic economic conditions. The U.S. economy, supported by fairly strong consumer spending, maintains a relatively high rate of growth, as does the British economy. By contrast, the German and French economies are in the doldrums.

Japan, plagued by ballooning budget deficits, finds itself in a situation similar to that of Germany. (In fact, domestic economic problems may be one reason the Germans are opposed to war.) Japan’s worst economic problem is deflation, but it also has its own political and security interests.

The government is going along with the U.S. administration in dealing with the Iraq problem. Economically, though, a war with Iraq would be a nonstarter in view of the numerous risks, some of them potentially destructive, that seem to threaten the world economy. Japan’s economy, for one, would become even more difficult to manage. Yet the government does not appear to have a game plan to ride out the gathering storm.