Will Iraq war kill globalization?

Brigitte Granville, International Economics, Royal Institute of International Affairs, London, Project Syndicate

The UN and NATO are widely perceived as damaged, if not broken, by their failure to agree on what to do about Iraq. Will these cracks in the international political system now wound the world's economic architecture, and with it globalization, as well?

International economic agreements have never been easy to make. Reaching consensus among the World Trade Organization's 145 members, where one dissent can cause utter disarray, was difficult even before the world's governments divided into pro- and anti-American camps. Indeed, multilateral trade agreements were being eclipsed by bilateral deals, such as between the EU and various developing countries, long before the divisions over Iraq appeared.

Of course, the problem goes deeper and not everything that touches globalization has turned dark. Immigration controls, for example, have been relaxed in several European countries (notably Germany) due to declining populations and educational shortcomings. But bad economic times are rarely moments when governments push bold international economic proposals.

Economic fragility among the world's leading economies is the biggest stumbling block. The U.S. and the EU have few fiscal and monetary levers left to combat weak performance. Short-term interest rates in the U.S., at 1.25 percent, are at a 40-year low. Congress has pared US$100 billion from the Bush administration's 10-year $726 billion tax cut plan, and the U.S.'s projected 10-year $2 trillion budget deficit will grow as the Iraq war's costs mount, with President Bush submitting a supplemental request for $80 billion (0.8 percent of gross domestic product) in extra military spending this year.

Such spending risks absorb productive resources that could be employed more efficiently elsewhere. This was demonstrated by the rapid growth of output and incomes that followed the arrival of the so-called "peace dividend" which came with the Cold War's end. Moreover, others (Arab countries, Germany, and Japan) will not cover America's military costs, as in the 1991 Gulf War. We are now back to the more usual situation where war is financed by government debt, which burdens future generations unless it is eroded by inflation.

In the Eurozone the scope for fiscal stimulus (lower taxes and/or higher public spending) was constrained until war blew a hole in the Stability Pact, which caps member budget deficits at 3 percent of GDP. The limit will now be relaxed due to the "exceptional" circumstances implied by the Iraq war-providing relief, ironically, to the war's main European opponents, France and Germany. But the European Central Bank remains reluctant to ease monetary policy.

In Japan, there seems little hope that the world's second- largest economy can extricate itself from its homemade deflation trap to generate the demand needed to offset economic weakness elsewhere in the world. Four years of deflation and a drawn-out banking crisis offer little prospect of economic stimulus. Higher oil prices and lower trade turnover aggravate the problem.

But high oil prices threaten the health of the entire $45 trillion world economy. Oil prices have flirted with their highest level since the Gulf War and will go higher if Iraq's oil infrastructure (or that of neighboring countries) is damaged.

The adverse effects on growth will be felt everywhere, but nowhere more, perhaps, than in the energy-dependent South Korea and China. Although China's official growth rate reached 8 percent in 2002, its high budget deficit and large stock of non- performing loans (about 40 percent of GDP) mean that it cannot afford any slowdown if it is to keep people employed, especially in rural areas.

Some poor economies will be directly damaged by the loss of the Iraq market, which accounts for roughly 40 percent of Vietnam's tea exports and 20 percent of its rice exports. For others, weakness in the world's big economies may be compounded by political risks.

Turkey has suffered from rising oil prices, falling tourism income (its second-largest source of foreign exchange), and declining foreign investment. Now the Erdogan government's lukewarm support for U.S. policy on Iraq exposes Turkey to doubts about America's commitment to its economic well being, and global markets may question its ability to service its $100 billion public-sector debt in 2003 and 2004.

The test of whether multilateral cooperation can be put back on track, and reconciled with America's war against terrorism and the spread of weapons of mass destruction, may come with Iraq's reconstruction.

With the costs of ousting Saddam Hussein and occupying Iraq likely to run at anywhere from $100 to $600 billion over the next decade, the U.S. will want to "internationalize" Iraq's reconstruction. Iraq's $20 billion annual oil revenues cannot meet such costs. Indeed, those revenues will scarcely cover the costs of rebuilding basic infrastructure, feeding and housing displaced populations, and paying for the country's civil administration.

After the ouster of the Taliban last year, the $4.5 billion of reconstruction aid pledged to Afghanistan's new government demonstrated that a multilateral approach to reconstruction is possible. ` But the poisoned atmosphere that followed the UN debates on Iraq may prevent the U.S. from getting its way here. Already, French President Jacques Chirac has promised to veto any Security Council resolution on reconstruction that seeks to justify the war. If the world economy is to recover, the diplomatic failures and name-calling must end.