Why War Won’t End Our Jitters - We prefer temporary explanations to a grimmer possibility
www.msnbc.com NEWSWEEK INTERNATIONAL Feb. 10 issue
— Let’s call it the “excuse du jour.” For three years, we’ve heard serial explanations for the economy’s weakness. The latest is a looming war with Iraq. Aside from increasing oil prices, the war specter (it’s said) has created huge uncertainty that’s causing companies and consumers to postpone big spending decisions. Once the uncertainty lifts, we’ll get a decisive recovery. Don’t count on it.
SINCE MID-2000, the U.S. economy has grown at an annual rate of 1.3 percent. Some quarters have been up, some down and some nearly stagnant (the growth rate for the last quarter of 2002 was a mere 0.7 percent). Every economic sputter inspires a new theory. The dot-com collapse. The “popping” of the stock “bubble.” The trauma of September 11. Corporate scandals and shattered investor confidence. And always: a strong recovery lies just ahead.
There’s a pattern here. It involves psychology more than economics. We prefer temporary explanations to a grimmer possibility: that the U.S. economy faces prolonged slow growth—or stagnation. Better to believe that, once “temporary” problems are settled, the economy will spring back. After the dot-com funerals, things will be fine. If investor confidence is shot, then we’ll throw corporate crooks in jail and “reform” accounting.
The war-with-Iraq theory fits the pattern and reigns in high places. Last week, the Federal Reserve endorsed it. (In a statement, the Fed said that “aspects of geopolitical risks have reportedly fostered continued restraint on spending and hiring by businesses.” An “improving economic climate” would emerge when the risks disappeared, as “most analysts expect.”) But there are two problems.
First: temporary problems often aren’t temporary. Accounting scandals didn’t kill investor confidence. Low profits and big stock-market losses did. Maybe corporate “reforms” can cure the first. But they can’t cure low profits and the resulting portfolio losses. In the third quarter of 2002, U.S. corporate profits were 10 percent below their peak in 1997, says the Commerce Department. Likewise, the dot-com collapse was more than a temporary setback. It symbolized an ongoing absence of commercially viable—and needed—innovation.
The thinking now is that a rapid victory over Iraq will mean lower oil prices and less uncertainty. Perhaps—or perhaps not. Consider a report from economists at Goldman Sachs. It says that a war could drive up oil prices by $10 to $15 a barrel, from today’s price of roughly $30. But even a quick U.S. triumph might not lower them to, say, $16 or $17 a barrel, says the report. Iraq can’t increase its output quickly. And hopeful analysts are said to have underestimated long-term production losses from Venezuela, now crippled by a national strike. Even if the strike ends, 15 percent of capacity may have been lost unless there’s “significant new investment.”
Second: temporary explanations downplay the damage from the 1990s boom. It wasn’t just a stock-market bubble. Companies invested lavishly, expecting strong demand forever; now there’s surplus capacity almost everywhere. (The Fed’s industrial capacity utilization index is 75.4 compared with a 1972-2001 average of 81.5.) Consumers spent lavishly, enjoying new stock wealth. Both companies and consumers borrowed heavily.
All this suggests a period of retrenchment. Companies cut investment and jobs. Gradually, surplus production capacity dwindles and profits revive. Consumers respond to falling stock prices and rising job insecurity by spending more cautiously. Both try to reduce debt. To some extent, this adverse logic has been muted: the Fed cut interest rates; Congress cut taxes; automakers offered cheap car loans; homeowners refinanced mortgages at lower interest rates. Still, the logic remains.
It wouldn’t matter much if the rest of the world economy were robust. The United States would then export its way out of trouble. Unfortunately, Europe and Japan are both economically moribund. One lesson of the 1990s boom is that other countries became overdependent on America’s appetite for their exports. Global trade is now sputtering, too. The great danger is that simultaneous economic weaknesses in Europe, Japan and the United States feed on each other, intensifying pessimism and creating a new wave of financial crises.
There’s no doubt the prospect of war with Iraq has deepened economic anxiety. Companies that say they’ve postponed projects are probably telling part of the truth. What they don’t say is that many of these projects were likely doomed anyway, given the weak underlying economy. The big picture matters most, and it’s dark, Iraq or not. It’s understandable that people favor a diagnosis that offers greater hope for a strong recovery. And a strong recovery may even come. It’s just that the odds in its favor aren’t especially good.