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Forecast is for Slow, Steady Growth in U.S. Economy - 2003-04-21


There’s some question as to whether the Iraq war will give a limited boost to the U.S. economy. Government defense spending to replenish equipment and materiel used during the war along with the rebuilding of Iraq’s infrastructure will likely mean more business for American companies in the near term. But there can also be a down side to such spending. According to Gary Becker, a Nobel prize-winning economist at the University of Chicago, the war could affect the U.S. economy in two ways.

“On the one hand, we spent resources on the war, assuming that the alternative would have been peace and no problems with Iraq. These are resources taken out of the economy. So that’s a cost,” he says. “On the other hand, the price of oil: if we get increased production from Iraq after we rebuild production facilities, the price of oil will come down. So overall, unless the post-war reconstruction period is very expensive, I think the net effect of the Iraq war on the U.S. economy will be pretty small.”

Others think the war will benefit the U.S. economy. Marc Miles, Director of the Center for International Trade and Economics at The Heritage Foundation in Washington, is one. “Right now it’s having a positive affect on the U.S. economy,” he says.

“There was a question of whether there would be a war, what the outcome of the war would be and how long it would take to conclude the war. But now that uncertainty is gone.” Mr. Miles says. “Uncertainty causes people to hesitate in moving forward with their plans. And now that that uncertainty has been eliminated, people will tend to go forward. When I talk about ‘people,’ I’m not just talking about consumers, I’m talking about producers as well. I think that this is good news that is likely to jump-start the [financial] markets.”

Early estimates of the cost of rebuilding Iraq exceed $100 billion. And there’s the question of who will pay. Will the war and reconstruction put a long-term financial drag on the U.S. economy?

According to economist Ken Goldstein of the Conference Board in New York, the price tag for Iraq is only part of the United States’ economic concerns.

“You can’t just put that in isolation. In fact, even the IMF and the World Bank have downgraded economic prospects for the United States based precisely on growing deficits because: a) we’re proposing to cut taxes and b) because of the cost -- and nobody knows what the real cost will be -- in Iraq,” Mr. Goldstein says. “And finally, the idea that later on in this decade, the ‘Baby Boom’ generation is going to start to retire. So the budget deficits already are large and are piling up for all of these reasons, not just because of Iraq, and will inexorably and cumulatively continue to weigh like a millstone around the U.S. economy.”

But economist Marc Miles of the Heritage Foundation says by rebuilding Iraq’s infrastructure and economy the U.S. will actually be creating more wealth.

“I’m not one who sees this as being a zero-sum game, that if you take capital away from place you have less capital to put somewhere else,” he says.

“By creating an economy in Iraq that is stronger, you actually create more capital. And on top of that, we already have here in the United States some proposals that are likely to increase the efficiency of capital allocation,” Mr. Miles says. “President Bush’s plan to reduce the tax rate on stock dividends and to include retained earnings as part of the cost basis for stocks [i.e., stock holders are not taxed on shares they are awarded in lieu of dividends, thus lowering their cost basis when they redeem their stocks] is likely to cause capital to be better allocated and therefore free-up a lot of capital to move around the world.”

And that, according to Marc Miles, will help grow America’s economy. Government borrowing and budget deficits will be offset by tax cuts that will stimulate business development, broaden the tax base and ultimately increase federal revenues. But not all experts agree that tax cuts in the face of deficits will work.

The pre-war posturing in the United Nations Security Council and tensions between much of Western Europe and the United States led to public boycotts of goods on both sides of the Atlantic. Some economists fear that strained U.S. diplomatic relations with Europe and other parts of the world could spill over into the economic sphere.

Edward Leamer is an economist at the University of California at Los Angeles and Director of the Anderson Forecast, which provides economic and business projections for the United States.

“We have more than $400 billion a year flowing into the United States from foreign sources. That’s more than 4% of GDP. That’s a very, very large external imbalance,” Mr. Leamer says. “If global investors lose interest in U.S. equities and U.S. bonds, that will cause very severe adjustment problems here in the United States. I think that’s really the biggest risk. If global investors, because of political difficulties between the United States and other parts of the world, start to lose faith or interest in U.S. equities and bonds, that will be a very, very difficult problem in the short run.”

Conference Board economist Ken Goldstein says there’s already a slow down in economic globalization that predates the Iraq war and the war on terrorism.

“We look at something called ‘foreign direct investment’ -- how much money companies in Europe, for example, invest in the United States; how much money the United States invests in companies in Europe and elsewhere around the globe,” he says. “These foreign direct investments began to slow down in the late 1990s, long before we ever got into the Iraq situation. So in some sense the globalization process was already slowing down or maturing.”

“Then we get into this situation [i.e., the international political tensions over Iraq] where clearly there has been damage to multilateralism, to multilateral institutions such as the WTO, the UN and so forth,” Mr. Goldstein says. “And so the way all of this played out and is going to play out in terms of the looming fight over who will pay for the reconstruction of Iraq certainly is not going to add to a process that has already seen a slowing down in this march toward globalization. This is going to be one of the big stories over the next few years as it continues to play itself out.”

Other economists aren’t so sure. William Reinsch, President of the National Foreign Trade Council in Washington, downplays the impact of political tensions between the U.S. and Europe. “I don’t think it’s going to have that big an impact,” he says.

“The trade talks had problems before the war. Agriculture always has a problem; it’s not news,” Mr. Reinsch says. “These talks generally crash and burn once, if not twice, before they reach conclusion. I think it’s way too soon to decide that they’re in deep trouble. And it’s certainly too soon to blame it on the war. Clearly, the war has people grumpy and disgruntled. It makes some of our European friends less inclined to bring some of these trade issues to resolution. But the reality is that it’s a little early to bring them to resolution anyway. I’m not concerned, but it means that we have to work extra hard to get back to where we were and to overcome some of those humps. But I don’t think it’s fatal by any means.”

There’s widespread disagreement among economists over the impact the Iraq war and the war on terrorism ultimately will have on the U.S. economy and globalization. But most observers do agree that the transfer of human capital and ideas could be most affected.

Already, the war on terrorism has led to new travel and immigration restrictions in the U.S. and elsewhere, and that worries William Reinsch of the National Foreign Trade Council.

“One of the reasons this country has prospered so much for so long is because we have taken in so much from elsewhere. We get a lot of the best people, and frankly, the best ideas, from all over the world,” he says. “Sometimes they come here to go to college and then they go back. But they make us stronger while they’re here, and they also make us stronger when they go back because they take a lot of our values and our way of thinking back with them. And we’re in the process of cutting a lot of that off. Over a generation, it’s going to make a huge difference in the way our country is perceived abroad, in the willingness of people to do business with us, to deal with us and understand us, and to come here and add to our strength.”

In the aftermath of the Iraq war and as the war on terrorism continues, most analysts agree that the face of international economic growth and interdependence will change. Should political uncertainty and the threat of terrorism increase, the major casualties will be the U.S. and global economies. But for now, most observers say, slow but steady growth is on the horizon.