TAPAN MUNROE: GLOBAL VILLAGE Cost of conflict may be high

www.bayarea.com Posted on Sun, Feb. 23, 2003

Only a few years ago, the United States was enjoying the unprecedented economic boom of the late 1990s. What a difference a few years make -- the nation's mood and economic outlook have sagged dramatically. We have been hit hard with a relentless stream of bad news, from the dot-com debacle to corporate malfeasance, from terrorism to a sinking stock market, from a jobless economic recovery to the space shuttle explosion. To make life even more difficult, our nation is on the brink of a war with Iraq.

In these difficult times, many analysts think that a war is likely to exacerbate our economic problems. What are the economic implications of an invasion of Iraq and, more important, the economic implications of post-war restructuring and rehabilitation of Iraq?

It is a real challenge to be precise about the cost of the war and its aftermath because there are so many unknowns. These range from the length of the war to the extent of American involvement in post-war Iraq. Other questions include: How many U.S. soldiers will be involved? Will Iraq use chemical and biological weapons? Will there be urban fighting? Which of our allies will be with us in the war, and how many will be involved in post-war reconstruction?

War is always a time of national anguish. The biggest concern of a war has to do with the loss of life and pain and suffering that will be inflicted on U.S. and allied soldiers and their families and friends. Of course, pain and suffering will also be enormous for the millions of innocent people of Iraq who have been drawn into this fray.

From an economic perspective, the problem with the current situation is fear and uncertainty, and they are the enemies of vital decisions that range from consumer purchases of big-ticket items to business investment in technology and facilities. War jitters have paralyzed capital markets since December.

Even if the optimistic scenario of a quick war lasting a few months with minimal loss of life and no destruction of Iraqi oil fields materializes, the short-term economic impact could be large. Let us not forget that the 1990-91 U.S. recession was exacerbated when Iraq invaded Kuwait and the United States responded with a major attack on Iraq. Oil price hikes could be very damaging to the economy, particularly in light of the current crisis in Venezuela. It would not surprise me to see oil prices spike up to $50 a barrel at least during the first few weeks of the war, and that translates into higher inflation and a higher cost of doing business.

Some of the other economic effects include:

• A weaker dollar during the conflict, but it will rally once the war is over. This may be good news for U.S. exporters, at least for a while.

• Higher energy costs will increase shipping and trucking costs as long as the war lasts. The larger carriers will pass the costs to customers, and the smaller ones may not be able to do so and go out of business.

• Longer delays in international freight shipments as a result of heightened security checks will have particular impact on trade between the United States and its NAFTA partners Mexico and Canada. The crowding of ports such as Long Beach and New York by military ships will cause additional delays. This certainly adds to the cost of doing business.

• Movement of employees out of businesses into the war effort via reserve and National Guard call-ups will have considerable impact for many businesses. So far, nearly 100,000 reservists have been called to duty in the Middle East, and tens of thousands more will be asked to join them. Implications for businesses include finding new employees in addition to guaranteeing jobs and salary to the departed employees on their return.

• The beleaguered airline industry will be further damaged with the onset of military action even though some of the losses in passenger and freight businesses will be compensated by military needs such as troop and equipment transport.

• The tourism and hospitality industry has already been affected by fear of terrorism and a potential war, and things will get much worse with the onset of war and remain shaky for a few months even after the war is over.

• Military purchases of all kinds ranging from spare parts to newly designed gas masks and clothing (to withstand chemical warfare) to freeze-dried meals and personal supplies has been rising at a rapid rate and will continue to do so in the next several months.

A recent estimate by Mitch Daniels Jr., director of the Office of Management and Budget, estimates that the direct cost of the war to the United States will be in the $50 billion-$60 billion range. This number could be lower if other major European countries such as France and Germany, in addition to Great Britain, also join the United States in the war against Iraq. The extent of cost-sharing could be very significant if we use the gulf war as a benchmark. The allies paid for nearly 90 percent of the costs of the last gulf war. The logic of not going alone for the United States in a second war not only makes great sense in geopolitical terms, it also makes eminent sense in economic terms, particularly in light of the current state of the U.S. economy with its escalating budget deficits and a host of unmet domestic needs.

If we think the cost of war is high, we should be ready to face the cost of bringing peace and a civil society to post-war Iraq. A recent study by William Nordhaus of Yale University suggests that the post-war costs of rebuilding Iraq could range from $127 billion to $682 billion depending on optimistic or pessimistic assumptions relating to length of the program as well as extent of damage to the Iraqi infrastructure. The range of expenses includes the cost of a peacekeeping force, rebuilding of the infrastructure, paying for government services and humanitarian aid.

It is quite likely that even in the case of an optimistic scenario of a short war, the U.S. economy may be flirting with a mild downturn in the immediate aftermath of the war. In the past few years, I have been amazed by the resiliency of the U.S. economy. The recovery has continued for the past two years despite numerous hits ranging from the failure of the high-tech sector to the Sept. 11 terrorist attacks, and Enronitis. Based on our record, I am optimistic about the recovery of the stock market as well as the economy once the cloud of a second gulf war disappears.

Tapan Munroe is president of Munroe Consulting Inc. of Moraga and the former chief economist for PG&E Corp. His column runs every other Sunday. His e-mail is tapan@tapanmunroe.com.