Economic Challenges Continue to Loom

I can’t recall witnessing such all-pervasive gloom as pervades Washington and New York. Washingtonians are focused on the coming war, and were jolted by the disintegration of the space shuttle Columbia into a realization that risks taken can result in deaths realized. New York businessmen, surrounded as they are by laid-off investment bankers, on-going investigations of CSFB technology banker Frank Quattrone and some of the city’s once-superstar analysts, and a city budget that suggests that massive tax increases and service cuts cannot be far behind, watch share prices and convert their board rooms into bunkers from which edicts of “hold the line on hiring and investing” are issued.

One source of discontent is the hard numbers being produced by the White House and other analysts as war with Iraq comes closer. The effect on oil prices has long been known, or at least guessed at. If the war proves to be a quick, surgical excision of the Saddam regime, analysts expect the oil price to surge at its outset, and then quickly retreat to something like $20 per barrel as the “war premium”, now estimated to account for some $10 of the current $35 price, is eliminated, and as Venezuelan production continues to recover. Under this scenario, an investment estimated by the Council on Foreign Relations (CFR) and the James A. Baker III Institute for Public Policy at $5 billion will be needed over the next two years to modernize Iraq’s oil fields and maintain capacity at something close to three million barrels per day. Adam Sieminski, London-based oil analyst at Deutsche Bank, is a bit more optimistic: he thinks that in two-to-three years Iraq can increase its ability to produce by 1-2 million barrels a day.

Since only 15 of Iraq’s 74 known fields have been developed, international oil companies should be willing to fund the investment of $40 billion estimated to be needed over the next decade to double current output from the nation’s low-cost reserves. If that proves to be the case, the prospect is for an increased flow of oil that, along with other new sources, will exert a restraining influence on oil prices in the long term.

That’s the scenario believed the most likely by defense planners in Washington. But the crash of the Columbia shows that bad things happen to good scenarios. Should it all go wrong—the war become prolonged, Saddam sabotage Iraq’s wells—prices might soar to as much as $80 per barrel, and fall back to $40 rather than $20, according to CFR-Baker.

Moreover, even if all goes well, it is not certain that a new Iraqi government will put out the welcome mat for foreign investors. Daniel Yergin, author of the Pulitzer Prize-winning The Prize: The Epic Quest for Oil, Money, and Power, points out that Kuwait promised to be host to foreign companies when America, Britain and their allies drove Saddam out. “Eleven years later that has yet to happen—because of nationalistic opposition in Kuwait’s parliament.” That nationalistic pattern is not peculiar to Kuwait: Saudi Arabia has yet to allow foreign oil companies to enter the country, and Mexico has chosen to become a net importer of oil rather than allow American companies to invest in the development of its cash-starved oil industry.

So the era of peace and low prices might elude us. Add to that a realization that this war will not have the same demand-boosting impact as have others. There is no massive ordering of hardware by the military, and much of the cost will be incurred to support personnel stationed overseas. It is true that stepped-up military spending accounted for nearly two-thirds of the slight 0.7 percent growth recorded by the economy in the fourth quarter of last year. But the president has asked for only a $16 billion increase in the defense budget he submitted to congress last week, an increase of less than 5 percent. Throw in the guess that the war in Iraq, not included in the budget, will cost some $100 billion, and the added defense outlays still come to a trivial percentage of the $10 trillion U.S. economy.

When matched against the unnerving effect the prospect of war is having on investors, businessmen, and consumers, the stimulus provided by defense spending pales into insignificance. Franklin D. Roosevelt may have seen the onset of World War II lead to massive spending and an economic recovery, but George W. Bush won’t get any such cheering byproduct from the grim process of putting American troops in harm’s way.

Nor is he likely to find the going easy for his domestic programs. A British chancellor of the exchequer both proposes and disposes; an American president may propose, but it is Congress that disposes. Despite having a majority in both houses of Congress, the president is unlikely to get all or even most of the spending cuts he has called for in several social programs, or anything resembling the tax cuts he is pressing Congress to enact. Some critics on both sides of the aisle say that the 2,866 page, $2.23 billion budget he delivered to Congress last week projects deficits so high and so enduring as to threaten the nation’s economic health. The $300 billion-plus deficit projected for this fiscal year is a manageable 2.7 percent of GDP. But the administration is projecting deficits that do seem to persist as far ahead as a forecaster’s eye can reasonably see.

Bush supporters here in Washington agree that the president faces a host of problems. But in a play on his sometimes obscure syntax, they point out that Bush has often come out the winner because his enemies “misunderestimate” him. Even that joke is wearing thin: his eloquent State of the Union speech, and his spare and moving addresses to the nation after the ill-fated Columbia flight, are making it more difficult for critics to argue that Bush is a serial language-mangler.

This article appeared in London’s Sunday Times on February 10, 2003, and is reprinted with permission.