Global recovery fights new costs of terrorism

Vincent Lingga, Senior Editor, The Jakarta Post, Hong Kong

The United States was pushed decisively into recession when the Sept. 11 terrorist attacks on that country undermined consumer confidence, disrupted trade and destroyed assets, most economists at the East Asian Economic Summit in Hong Kong agree.

East Asian economies, particularly Japan, which has been in trouble over the past decade due to a long delayed reform of its financial system, is feeling the fallout of dwindling demand as consumer confidence wanes.

Further down the line, South Korea, Taiwan, Hong Kong, Singapore which are usually the star performers in the East Asian economy, are suffering the crunch too as they depend largely on the two biggest locomotives. Only China seems to continue enjoying robust growth.

That is how most economists meeting in Hong Kong at the East Asian Economic Summit, organized by the Geneva-based World Economic Forum, see the economic landscape after Sept. 11.

Before the tragedy, U.S. consumers spent more than they earned, hence their confidence was sustained by regular gains on the stock market.

But with share prices falling fast and unemployment rising, there is a strong indication that self-confidence at the heart of the U.S. growth is being punctured.

Could the doomsday scenario happen?

It depends on the fragile flower of confidence. If consumers carry on spending and holding on to their shares (50 percent of Americans own shares), the U.S could muddle through with minimal damage.

But if they stop spending in order to replenish their savings or sell shares on a big scale, then demand will collapse and companies will lay off workers, who in turn will cut their spendings, leading to a downward spiral recession.

Under this circumstance, the other engine of the private sector -- business confidence -- will decline as well, as companies refrain from investing when the consumer demand needed to justify it is in free fall.

Nobody will know what will happen. The outcome will depend on the decisions of millions of people interacting with each other and reacting to what they read in newspapers and see on television.

Fiscal pump priming has worked so far, but if the U.S. economy goes into a tailspin, that will not be enough, especially since the American government has now to allocate a much bigger budget for security.

"The post Cold War era has ended," noted analyst Jusuf Wanandi, chairman of the Jakarta-based Centre for Strategic and International Studies, at one of the plenary sessions of the summit.

That means that the U.S. has lost its peace dividend coming after the end of the Cold War in the late 1980s which helped transform budget deficits into surpluses and freeing more resources to flow into private-sector investment and generate more than a decade of steady gains in productivity.

As the U.S. now has to devote more of its resources to defense outlay for restoring national security, fewer resources are now available for fueling economic expansion.

Investors are now painstakingly trying to fathom how long the U.S. will take to win the war against terrorism and how much it will cost.

But since the war has just begun, the risk for significantly faster growth in defense spending over a longer period of time is very real.

Despite the buildup in defense spending -- 13 percent expansion for 2002 alone -- it will raise the share of the economy devoted to military only to an estimated 4.4 percent from 3.9 percent now, U.S. analysts said.

"That is why the root causes of terrorism cannot simply be ignored; the scourge of terrorism has to be dealt with because you need the sense of security to get the economy back on track," added Jusuf.

A noted economist from Britain, John Kay, observed that the strongest message of Sept. 11 is that globalization and the market economy can no longer ignore the complex set of economic, social and cultural context.

"There must now be a greater sensitivity to the gap between the rich and poor nations and a self-contemplation of the excesses of greedy capitalism," Kay told the meeting.

Many economists who initially saw the shocks as a temporary phenomenon, are now suggesting that a recovery would be much more difficult, especially after the recent release of more weaker economic indicators.

"The bounce back could be a very long time and a bumpy one," observed Vernon J. Ellis, international chairman of Britain's Accenture management cosultancy company.

Terrorism is also causing a more persistent kind of damage as it forces what analysts describe as lasting changes in the way Americans do business and lead their lives.

But some analysts suggest that this recession, like others, will be followed by a vigorous recovery as consumers and businesses hold back on discretionary spending during the cyclical downturns, creating pent-up demand which at some point will rebound like a tide when the flood gates open.

Merril Lynch economists are predicting that the recession will be followed by a recovery sometime next year. They point out that the Federal Reserve has already eased interest rates seven times this year. These lower rates could save consumers up to US$70 billion in interest payments next year.

But analysts of the "less optimistic" camp, including those of Morgan Stanley investment bank, argue that in the long term, terrorism is imposing new costs that are unlikely to go away.

For every business, insurance and security costs will be higher. For many industries, the benefits of just-in-time production will be sacrificed as companies will hold more inventory to guard against disruptions in the global supply chain.

Together, those costs could represent a new form of supply shock that will hurt growth and could boost inflation. This would be a toxic combination for global financial markets.