Government Returns to Front and Center

The long campaign against terrorism declared Thursday by President Bush represents a turning point for the U.S. economy. Government spending will account for a greater share of the economy than it did for most of the 1990s, when the U.S. enjoyed a “peace dividend” after the Cold War.

The peace dividend is no more. The war economy has begun. Since the Sept. 11 terrorist attacks, Congress has authorized an additional $40 billion in spending for defense, rebuilding and aid to the airline industry on top of a record federal budget of $2 trillion for fiscal 2002, which begins Oct. 1.

More will be spent, including $3 billion for federal reform of airport security. Administration and congressional leaders are discussing a package of spending programs and tax relief for business that could total more than $100 billion.

The spending is needed to spur a dangerously stalled economy, says economist James Galbraith of the University of Texas. “It is imperative at this time that the government maintain employment and morale, keep the economy going, keep people working,” Galbraith says.

Others concur. A government aid package “should not be capital gains tax reduction or long-term missile development, which can take years to have an impact. Everything should focus on boosting spending in the next year,” says economist Albert Wojnilower of Monitor Clipper Partners, a New York investment firm.

What will a sudden flood of government spending mean to the economy, to specific industries and investments?

The obvious hope is that business and consumer confidence can be bolstered and the economy can expand again by winter.

But world economies had been slowing for a year before Sept. 11. Since then, new fears about U.S. financial markets and even safety in the United States have caused the dollar to decline against the Swiss franc, the Japanese yen and the euro, notes economist William Rhodes of Rhodes Analytics, a Boston consulting firm.

Dollar declines, which raise the prices of imports, and war spending could spark inflation in a still-recessionary economy. That could be serious in wartime. “The government would have to take action to control prices,” Galbraith says, recalling that his economist father, John Kenneth Galbraith, worked in the Office of Price Controls during World War II.

Today the worry is deflation, tomorrow the concern could be inflation. Choosing bonds and stocks will be as tough a call as ever.

Industry will see changes in the new war economy. Industrial deregulation, a trend since the 1970s, when banks and airlines were deregulated, will be modified. The trend was already on the wane after California’s troubles with electricity deregulation.

The war economy, with more government guidance and control, will recall the 1950s more than the 1990s.

Airlines, which have become the nation’s long-distance mass transit system in the 23 years since deregulation, will come under more government guidance for several reasons. Some regulation will be a natural consequence of the $15 billion in aid and loans from taxpayers coming to the industry. The industry won’t return to routes being set by a Civil Aeronautics Board, but airlines may not have the option of abandoning service to small cities on grounds that it is unprofitable.

Also, if traffic does not recover quickly, airlines will want to collaborate and merge in hopes of surviving through size. The government will have to approve or arrange such transactions.

Other industries will come to the fore in the new war economy. Communications is getting renewed attention. Investors noted how essential telephone communications were in the week of the terrorist attacks. That’s why stocks of BellSouth, SBC Communications Inc. and Verizon Communications rose last week even as most stocks fell.

Experts predict that companies will rely even more than they now do on computer systems to run their affairs. Stocks of computer services companies, such as Electronic Data Systems and Computer Associates International Inc., fared better than most stocks in last week’s markets.

“Authentication will be a major new field,” says telecommunications expert Peter Bernstein of Infonautics Consulting, a Ramsey, N.J., firm. “Security of data will be paramount; companies will want to be sure who they’re dealing with and whom they’re employing.”

The security industry itself was already evolving from a fragmented collection of rent-a-guard firms to a business led by sophisticated companies with technological and international capabilities, says Enrique Hernandez Jr., president of Inter-Con Security Systems, a privately held firm in Pasadena.

Securitas of Sweden has acquired leading U.S. firms Pinkerton’s Agency (of Encino), Borg Warner Security and Globe Security in recent years.

Defense spending will take precedence during the long campaign outlined by President Bush on Thursday evening. The defense budget was already scheduled to rise to $325 billion for fiscal 2002, 21% above its 1998 recent low point. Now that budget will rise further, as spending is increased on domestic air defense systems and on technology for surveillance and military intelligence systems. Most defense stocks rose last week; Northrop Grumman Corp. shot up 25% when trading resumed Monday.

Some on Wall Street see a poorer economy ahead. William Seidman, former head of the Federal Deposit Insurance Corp., said on the CNBC cable channel last week that the economy would see “government intrusion increase and productivity decrease” in the next five years.

But Wall Street thinking as usual is like the proverbial “reed shaken by the wind”--much anxiety, little reflection.

The economy’s prosperity in the late 1990s wasn’t all due to the peace dividend. As Federal Reserve Chairman Alan Greenspan pointed out in congressional testimony last week, technological innovation has been the “driving force” behind gains in productivity in the last half-dozen years. And further technological innovation certainly would be possible as government spends on research in a war economy.

Also, one of the greatest periods of growth in economic productivity--loosely defined as rising output and living standards without inflation--occurred in the 1950s, when government guidance led the economy.

The point, of course, is that other factors influenced the economy in the Cold War, as they will in this “long campaign” period. The only certainty is that the war economy has begun.

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James Flanigan can be reached at jim.flanigan@latimes.com. For recent columns on the Web, go to https://www.latimes.com/flanigan.