Dollars, cents and Saddam

By HAMISH MCRAE

Assessing the cost of any war involves huge uncertainties because the normal rules of economics do not apply. The greatest variables are the length of the military action and the scale, pace and nature of postwar reconstruction.

In the case of another Middle East war, its impact on the oil market would be a further complication. What can be said is where the costs might come, where we can be sure of the effects and where we are flying blind.

The simplest element is the military cost. The price of the last Gulf War was some US$70 billion ($120 billion). Assuming a similarly swift conflict, the cost this time is likely to be similar. To put that in perspective, it is equivalent to 0.7 per cent of US GDP.

The Gulf War costs were widely shared, with Kuwait and Saudi Arabia paying a large portion of the bill. In this war, such burden-sharing seems unlikely. So the direct military costs will have to be carried largely by the combatants.

That is just the start. Assume the military action succeeds. If the underlying aims of the US - to set up a secure, decent and democratic regime in Iraq - are to be achieved, military protection and reconstruction would last a couple of years.

This will cost at least as much as the war itself, probably several times as much.

That burden will presumably be shared widely. It would be vastly more satisfactory if the military policing were carried out by the widest coalition.

And much of the financing of reconstruction will come as supplier credits: foreign companies lending Iraq the money to buy their products and services. Iraq will be able to rebuild its oil exports and inward foreign investment will be considerable.

But all this assumes military and nation-building success. It would be naive to take for granted that events will turn out at the most favourable end of the scale. Were things to go pear-shaped, uncertainties would mount.

The two areas of particular concern are oil and consumer confidence. The world is an oil economy and will remain so for at least another generation, maybe longer. Iraq is not a particularly large producer (in 2001 it pumped less than Britain), but the Middle East is, supplying 30 per cent of the world total and it has 65 per cent of proven reserves.

In today's money, the oil price went to some US$50 a barrel, well above the present level, after Iraq's invasion of Kuwait, though it fell back after the allied liberation began. This compares with roughly US$90 a barrel after the second oil shock in 1979, but that rise led to a global recession.

The horror scenario would be for there to be such damage to Iraqi and other Middle Eastern oilfields as to cut the ability of the region to pump the oil.

The world is not as dependent on the Middle East as it was two decades ago, for those high prices stimulated exploration elsewhere. But at an extreme, one could envisage the oil price at around US$60 a barrel for several months. That would be high enough to make another world recession inevitable.

The other concern is consumer confidence.

The world economy recovered relatively swiftly from the recession that struck several large countries a year ago because of the strength of consumer demand in the US, with a little help from consumers in Britain.

But in both countries, people have borrowed to maintain their standard of living, and the scale of that debt is causing concern among monetary officials and consumers.

At some stage, consumers are likely to cut back. There is evidence that they are doing so already. Suddenly, anyone pondering whether it is a good time to splash out on a new car, or some other big-ticket item, has a good excuse to hold off.

Further, business confidence is already fragile. Investment in the US has failed to recover and it has fallen recently in Britain. If business investment is to take over the baton of demand as consumers fall back, a recovery in business confidence will be required.

Were the conflict to be swift and successful, consumption would be likely to rebound. That is what happened during the Gulf War and after the September 11 attacks.

Were it neither swift nor successful, expect the confidence of consumers and business to be damaged gravely.

That would trigger a second leg to the world recession. It is perfectly plausible that this second dip would be deeper than the first and might encompass countries that escaped recession first time round. But we cannot know.

One final point. All the above is based on the assumption of another war in the next few weeks.

But suppose, for whatever reason, an invasion of Iraq is postponed. Uncertainty will continue and that is bad for confidence.

Only in the event of Saddam Hussein going into exile peacefully, and a stable regime being set up in Iraq, would US confidence return. That does not seem likely.

Starting from where we are now, to have no war would be almost as unsettling as to have one. Whether we ought to be in that position is another matter but, whatever happens in the Middle East, difficult months lie ahead for the world economy.

- INDEPENDENT