Predicting War’s Economic Effect Is an Oily Proposition
When Iraq invaded Kuwait 12 years ago, the shock caused oil prices to soar and consumer confidence to plunge, and helped tip the United States into recession.
If the U.S. invades Iraq anytime soon, don’t expect a replay of 1990.
No one can predict the repercussions of a military offensive in Iraq, but experts say the initial economic effects--if the war is short and successful, as they predict--could be much less disruptive than they were a decade ago.
Oil prices might jump, economists say, but probably not as much as they did then. Consumer spending might slow a bit, but not enough to stall the recovery. And the economic stimulus of more government spending might help ward off a double-dip recession.
“I think this has much, much less impact,” Wells Capital Management economist James Paulsen said. “We got a pretty good read a little over 10 years ago of the competitive deal between Iraq and America. It’s very one-sided. We can go have a war and watch it live on CNN, and it might hardly be a blip on the stock market screen.”
Of course, far more disruptive outcomes are possible. The economic damage could be substantial if the U.S. offensive goes awry, if Iraq deploys weapons of mass destruction or if the conflict spreads to countries where oil production is needed to avoid shortages.
And even if its impact on the nation’s economy turned out to be negligible, its effect on the federal budget could be more substantial, experts say.
But over the long haul, war with Iraq could leave a much bigger imprint on the federal budget. In contrast to the Persian Gulf War, when U.S. allies picked up most of the tab, many experts expect this country to bear the full cost of the next campaign, and most of the nation-building expenses that follow. That could limit Washington’s ability to tend to other priorities at a time of resurgent deficits.
“It’s not devastating,” said economist Dean Baker at the Center for Economic and Policy Research, a liberal think tank here. “But it’s something. It will make Congress reluctant to spend more money in other areas. They probably won’t be looking to lower taxes. There might be cuts in other programs, and we might see somewhat higher interest rates.”
The key variable in assessing the economic effect of an invasion is the price of oil.
After Iraqi President Saddam Hussein sent his forces into Kuwait in August 1990, oil prices nearly doubled. Benchmark crude rose to $41 a barrel as traders worried about the prospect of war and the security of Saudi Arabia’s reserves.
But other big exporters quickly increased production, and prices fell back to the low 20s by the time the United States and its allies launched their air campaign in January 1991.
“It’s almost as if the waiting for is worse than the doing,” Lehman Bros. economist Drew Matus said.
Still, the high prices lasted long enough to inflict significant damage on an economy already weakened by a commercial real estate bust and a big decline in defense spending. Some economists think the price spike pushed the nation into the 1990-91 recession and “jobless recovery” that bedeviled the administration of former President Bush, who stopped short of toppling Hussein’s regime.
If the current President Bush sends U.S. troops into Iraq to finish the job his father started, the effect on oil prices is likely to be less severe, economists say. Some believe the prospect of war and its potential to influence oil production already is reflected in today’s spot prices, which have risen to nearly $30 a barrel in recent weeks.
“The effect on oil prices has already been felt to a large degree,” said Bill Dudley, Goldman Sachs’ chief domestic economist. “Iraqi oil exports have already been cut significantly.”
Oil experts note that Hussein’s 1990 offensive took more than 4 million barrels a day of Iraqi and Kuwaiti oil off the market. Today, Iraq only produces about 1.5 million barrels a day, and other oil exporters have the ability to boost daily production by as much as 6 million barrels.
Iraqi production accounts for 2% of the world’s oil production and about 8% of the output from the Persian Gulf region. The United States gets about half its oil from overseas, none of it from Iraq.
“Naturally the price would go up somewhat because of nervousness,” said Ron Gold, vice president of the Petroleum Industry Research Foundation. “But if the risk is confined to Iraqi oil and others are willing to make it up, the markets would settle fairly quickly.”
Economists also say the element of surprise that accompanied Hussein’s invasion is unlikely to be a factor in a U.S. offensive. The Bush administration has telegraphed its intentions to the world, they say, giving global traders and U.S. consumers plenty of time to anticipate, assess and react.
“We should not assume that Saddam Hussein is just going to sit there and take what we have to dish out to him. He’s got some cards he can play,” said Harvard economist Richard N. Cooper, former chairman of the National Intelligence Council.
Cooper worries about what might happen if Hussein fired Scud missiles at oil collection and transport facilities in Kuwait, Saudi Arabia or Iran. Even a miss, Cooper said, “it would play havoc with the psychology of the market.”
Even a small, short-lived price spike could further slow an already halting recovery, said Stephen Roach, chief economist at Morgan Stanley Dean Witter & Co.
“I don’t think anybody is looking for oil prices to move up sharply and remain at elevated levels for a long time,” Roach said. “But we have a pretty vulnerable U.S. and global economy right now, and it wouldn’t take much of a shock to transform that vulnerability into recession.”
Yet economists say the government spending that would accompany a big military operation could have a beneficial impact on the economy, particularly if it arrived quickly. Every $1 increase in government spending adds about $2 to the nation’s gross domestic product, Merrill Lynch senior economist Gerald D. Cohen said.
But experts express concern about the longer-term implications for government finances.
Operation Desert Storm cost $61 billion, most of which was paid by other Persian Gulf nations and Japan. Current estimates of the cost of a U.S.-led invasion of Iraq range from less than $50 billion to $150 billion, and experts say it appears doubtful that other countries will kick in this time.
If a war costs $100 billion and is confined to the fiscal year that begins in October, Washington would post a deficit of about $245 billion in 2003, based on projections.
That amounts to about 2% of GDP; it was up to 6% at the height of the Reagan-era defense buildup.
Even if the additional deficit spending remains manageable, the cost of war and its aftermath would further tighten the squeeze on discretionary domestic spending. That, in turn, would make it less likely that Washington could find the money to finance expensive new initiatives such as prescription drug coverage under Medicare.
Ultimately, it may be a mistake to even attempt to judge a military campaign on its financial merits, said Richard Kogan, a budget expert at the liberal Center for Budget and Policy Priorities in Washington.
“I cannot, in honesty, say that one should even think about the economic arguments,” Kogan said. “One should think about the military, the geopolitical, the personal, the human, the dozen other factors that are more important than these very small economic effects.”
