Global View: Jaw-jaw. War-war?

"Careless talk costs lives," said the posters in wartime Britain. Talk, careless or not, may also cost growth and jobs. Talk of an invasion of Iraq has pushed up the world oil price by $3 to $5 per barrel. That is a cost for Western consumers and companies and a large deterrent to economic recovery.

The talk, of course, is not idle. It is on the vital topic of how to respond to murderous terrorism and may itself be an instrument of policy. "To jaw-jaw," said Winston Churchill, "is better than to war-war." But the Churchill-admiring men in the United States who are talking war may soon start it -- which is not what Churchill did.

Global View considers this week a topic laden with uncertainties: the probable impact of a possible U.S. war on Iraq. The column is longer than usual. We hope the interested reader will bear with us.

An attack on Iraq has been a possibility ever since the terrorist outrages in the United States almost a year ago. Whether the Iraqi dictator, Saddam Hussein, had any involvement in those attacks remains unclear; that he is hostile to the United States and the West is not. It is also possible that he has developed weapons of mass destruction, as have other powers around the globe.

All the talk in the United States of attacking Saddam might be intended itself to attain a policy goal, that of encouraging Saddam to let United Nations weapons inspectors into Iraq. But now that "regime change" has become a mantra of US President George W. Bush and of his administration it is unclear whether such inspections would deter a U.S. attack. Weapons may be hidden and Bush's team appears to have decided that the possibility that Saddam has weapons and might use them is reason enough to launch a pre-emptive attack.

"If we wait for threats to fully materialize, we have waited too long," said Bush June 1 in a speech at the U.S. military academy at West Point. That is a new way of thinking, which goes far beyond Churchill's rejection of appeasement. But leave that aside. If the attack goes ahead, what will be the economic impact?

First we need to give the most cursory of answers to other big questions: what sort of attack would it be? And when would it be made?

If the aim is to overthrow Saddam it seems certain that land invasion of Iraq will be needed by a sizeable force. The reservations on the part of other Western countries, even Britain, normally the most loyal of US allies, about launching an attack may well mean that the United States goes to war alone. If its troops are to wage war in the desert, the attack must be made in winter. October is the earliest time. November, after the US congressional elections, seems more likely. If the attack is not launched by December, it is unlikely to be until most of another year has passed.

This gives us our parameters. What would be the economic impact of an attack of this kind on Iraq?

The first impact would be a jump in the oil price of at least $5 per barrel and probably much more. As the Nymex crude oil price is currently not much below $30 per barrel, it would be surprising if a price of $40 per barrel were not seen in the immediate aftermath of an attack. The reason for that is partly the removal of Iraqi supply but, much more than that, the uncertainty created about oil supply by instability in neighboring oil-producing countries.

It is impossible to say how long the oil price would remain high because it depends on the unknowable consequences of the attack on Iraq. If the invasion goes smoothly, with little meaningful resistance, and Saddam is overthrown, markets will be relieved. But it will then be necessary to establish a new government and help rebuild Iraq. Nation building tends not to be easy.

Then there is the international dimension to the conflict, especially its repercussions on the already troubled Middle East. Though Saddam's neighbors all distrust him, none will be comfortable with a U.S. occupation. Opposition to the United States will be fanned. Protests and demonstrations in the Islamic world are certain, from Malaysia to Pakistan. Financial markets will watch most closely of all the reaction in Saudi Arabia.

Saudi Arabia exports more oil than any other country. Its royal family may be vulnerable to an uprising by Islamic fundamentalists. Serious instability in Saudi Arabia, with the threat of a takeover by sympathizers of Osama Bin Laden, would pose the global economy with a huge risk and the United States with a huge policy problem. Should Saudi Arabia, too, be occupied? The global oil price would soar.

How serious is a high oil price for the United States and the world economy? According to a study on the impact by the Energy Information Administration, a US governmental agency, in 2000, world oil prices have been around $20 (in constant 1998 dollars) since 1986. The EIA writes that "in 1990 prices rose beyond $30 dollars and the growth rate of the economy fell below 2 percent in 1990 and became negative in 1991." The EIA judged the U.S. economy to be more robust in 2000 than a decade before but warned that a "sustained world oil price of $30 would result in ... an additional loss in GDP growth on the order of 0.5 percentage points." While Bush struggles to encourage economic recovery now the oil price is close to $30--largely because of his administration's promise to attack Saddam.

Professor Andrew Oswald of the University of Warwick in England would tend to go much further than the EIA. He sees the real (after inflation) price of oil to be critical to the level of growth in the world economy. Oswald calculates that it takes approximately 18 months for a substantial increase in oil prices to feed through into growth. In an interview in March 2000, when the US economy was booming, he predicted recession on the basis of the fact that world oil prices had shot up from their lows of 1998-99. Oswald was right in both direction and timing. In 2001 the US economy experienced recession.

Yet for all Oswald's success in predicting the 2001 recession, this correspondent would tend to disagree with the extent of his emphasis on energy prices as the central determinant of global growth. Our own belief early in 2000 was also that the United States was heading for recession though on the grounds that a stock market bubble was beginning to burst. Because of the lingering effects of a burst asset price bubble, we feel that in 2003 renewed recession or very low growth is already likely even if oil prices were to fall. But Oswald's vies on the negative impact of high oil prices have both historical experience and common sense for backing. If an attack on Iraq were to push up oil prices further for any length of time there can be little doubt that the recession of 2003 will be deeper and that energy prices would exert a strong recessionary force in 2004 and perhaps beyond.

We should say again, however, that all this would depend on how an attack on Iraq plays out. A spike in oil prices is a certainty. How long they stay up all depends on numerous uncertainties.

Another cost may be a little easier to evaluate: the direct one. Sending soldiers and their equipment to fight in Iraq will have a financial cost as well as the all too regrettable human one. Again that cost depends but seems unlikely to be less than $50 billion--roughly half a percent of U.S. GDP--and could easily be double this amount. As the federal fiscal deficit seems to be heading for a level of about 2 percent of GDP, it seems likely, all else being equal, that it would begin to run to a level of 2.5 percent of GDP. If oil prices do soar, however, other things would not be equal: recession would cut growth and fiscal revenues and push the US deficit higher still.

A rising deficit is already obliging the US government to issue more debt. The danger if the deficit worsens is that long-term bond yields, currently supportive of recovery, will push up, with a negative influence on investment and the U.S. housing market. A confidence shock to economic activity in the United States and elsewhere from war in the Gulf is also likely. The stock market, making a summer recovery at present, would fall heavily, with only oil and defense stocks faring well. This, in turn, risks exacerbating the loss of consumer confidence and the negative wealth effect from falling asset prices.

It would be possible to go on. Our point is made. If an attack on Iraq were to go astonishingly well and not provoke serious unrest elsewhere, the rise in the oil price might be short-lived and the removal of Saddam might even help confidence in the West and elsewhere. But if the attack runs into difficulty or instability develops in other countries, above all in Saudi Arabia, the negative impact on the world economy would be huge.

Sept. 11 did great harm to the US and Western economy but its impact was, thankfully, short-lived. There is an unhappy irony in the fact that a retaliatory invasion of Iraq could do much greater economic harm. Recession could persist throughout the whole of Bush's presidential term, creating hardship for millions in the United States and elsewhere.

Those in the US administration who decide whether or not the United States should attack Iraq have huge dangers in mind: the dangers posed by this most repellent and vicious of tyrants. Yet in troubled times even a tyrant may have his sympathizers. Tackling him carries huge political and economic risks, particularly if he has not been seen to cast the first blow.

(Global View is a weekly column in which our economics correspondent reflects on issues of importance for the global economy. The author would like to thank UPI's Arnaud de Borchgrave, Martin Sieff, Claude Salhani and Lou Marano for generously sharing with him their insights into the policy debate on the issue of Iraq. Comments to icampbell@upi.com.)