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Global View: The Sept. 11 recovery

By
IAN CAMPBELL, UPI Chief Economics Correspondent

LONDON, Aug. 21 (UPI) -- It is almost two years on from the Sept. 11, 2001 tragedy. For the financial markets that tragedy is largely over. Yet its political and economic impact is still being felt and will be felt for years to come.

In what sense might the tragedy's economic impact be seen as past?

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Sept. 11 was judged in the immediate aftermath of the attack as a grievous blow to an already ailing economy, one that might ensure the brief recession of mid-2001 persisted. But the recession did not persist. The U.S. economy grew by 2.4 percent in 2002 after its minimal 0.3 percent growth in 2001. And now in the United States, Japan and Germany some of the economic data looks brighter than for a long time.

U.S. gross domestic product growth will come in at (an annualized rate of) close to 4 percent in the third quarter: not a bad figure at all.

In Japan, growth was surprisingly high by Japan's depressingly low standards, at an annualized rate of 2.3 percent in the second quarter. Some Japan economists are revising up their growth forecasts. To them things look a little better than thought previously.

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In Europe's lagging giant, Germany, meanwhile, the so-called ZEW expectations index, released this week, showed a big leap in August to 52.5 from 41.9 in July. The ZEW index surveys the views of financial analysts. It is normally -- though not always; the ZEW index soared in 2002 without a corresponding rise in growth -- a good indicator of a forthcoming upturn in German growth. If the survey's pointer is reliable this time, growth in Germany should climb to over 2 percent early in 2004. (In the second quarter of this year, the most recent, the economy contracted.) A rally in German growth would do much to bolster the European economy and the global one.

Better news in the world's three biggest economies, then. But, strange though it may seem, part of the reason for the better news is Sept. 11.

What was the strongest element in U.S. GDP growth in the second quarter? It was government spending and, above all, defense spending.

Government consumption and investment GDP rose by 7.5 percent. Within this total, defense spending rose by a staggering 44.1 percent. This meant that defense spending contributed almost 1.7 percentage points of the overall 2.4 percent GDP growth in the quarter. Take that big leap in defense spending out and U.S. GDP growth goes down to a far less encouraging 0.6 percent.

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Moreover, such is the size and influence of the U.S. economy, that its improvement has a huge knock on effect elsewhere in the world: German business confidence rises; Japanese exports perform better; commodity prices are bolstered; emerging economies look more solid.

So we come back to the U.S. economy as the driver of world sentiment. U.S. defense spending was generated chiefly by two invasions: the first of Afghanistan, the second of Iraq. The second, in particular, was a controversial and indirect response to Sept 11: an action which, leaving aside questions of its desirability, would never have been politically possible had Sept. 11 not occurred and the American public's fear of attack and willingness to attack not been heightened.

The political justification for a very big increase in U.S. defense spending therefore comes from Sept. 11. And that increase in defense spending propelled not just U.S. growth but the U.S. fiscal deficit, now projected by the White House itself to measure $455 billion in the current fiscal year.

Of course, defense spending has not been the only contributor to the soaring deficit. U.S. President George W. Bush has also cut taxes in three rounds, relieving the tax burden of Americans but also depriving the government of tax revenues.

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The tax-cutting might also be seen as a response to emergency. The recession experienced in the United States in 2001 strengthened Bush's call for tax cuts even as the projections of an enormous surplus to be distributed headed for oblivion. For Bush called on the Congress for urgent action to give Americans the growth and jobs they need.

Sept. 11 simply strengthened Bush's case. At this time of emergency, economic and terrorist, radical action seemed required. The Congress and Americans as a whole tended to back Bush. Not to have done so might have seemed unpatriotic. Thus the terrorist attack probably changed U.S. economic policy, making it easier for Bush to pursue an activist policy.

The atmosphere of crisis also helped to justify the activist policy response of Federal Reserve Chairman Alan Greenspan to economic weakness. Greenspan's loosening of monetary policy, taking the short-term interest rate down to just 1 percent, is unprecedented in its speed and scope--paralleling, therefore, the astonishingly abrupt turnaround Bush has effected in fiscal policy, from sizeable surplus to big deficit.

Greenspan has sought, too, to talk down long-term interest rates. This has propelled the likely annual mortgage issuance this year to over $3 trillion, a level not far short of 30 percent of GDP, and close to three times higher than the highest level of issuance ever seen in the United States before 1997. Property values have been inflated. Refinancing has fed huge sums into the economy.

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But, just as with the stock boom of the late 1990s, this boom cannot go on perpetually and brings the risk of a fall-back: a drop in house prices and a bad debt problem for over-mortgaged households. Yet Greenspan's activist policies have barely been questioned.

The economic results of the policy activism are plain to see in the strengthening of U.S. growth this year. But is policy activism paving the way for sustainable growth? How sound a recovery is one achieved through a staggering rise in government spending, a staggering level of mortgage issuance and ultra-low interest rates that have helped to propel house price inflation?

These policies, in our view, will not generate sustainable growth. They are more likely to hamper recovery, by delaying the necessary correction in U.S. consumer spending and the trade deficit, by eventually driving up long-term interest rates through a rising fiscal deficit, and by weighing down U.S. consumers with mortgage and other debt that will eventually act as a drag on their spending.

Sept. 11 wrought changes in U.S. foreign policy and U.S. economic policy that are being felt two years on--positively, most economists would judge. But the full costs of the radical changes to U.S. policy-making have yet to be counted.

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Global View is a weekly column in which our economics correspondent reflects on issues of importance for the global economy. Comments to icampbell@upi.com

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