Political uncertainties add to economic risks

Economics:  The theory of a 'short, successful war' followed by a rapid return to buoyant markets and stronger growth is prevalent…

Economics: The theory of a 'short, successful war' followed by a rapid return to buoyant markets and stronger growth is prevalent, but threats to this outlook are now substantial.

Today Hans Blix returns to the UN Security Council to file his latest report on Iraq. It comes at the end of a week of high political drama, with all the indications still that war is in the offing.

The focus has, understandably, been on political and military issues. However, it is clearer by the day that the economic stakes are also very high. Up to recently the theory of a "short, successful war" held much sway. This led many economists to predict a rapid return to buoyant markets and stronger economic growth following a brief and successful campaign. The risks to this outlook are substantial.

There are, of course, the military risks, principally of a long-drawn out conflict. However, for the economic outlook, these risks may be dwarfed by the dangers of the wider fall-out, much of it political.

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Militarily, the arguments are well rehearsed. The US clearly anticipates a relatively rapid toppling of Saddam's regime. The majority view of military analysts is that this can be achieved, but that there are risks: that the conflict may be prolonged; that Saddam may target Israel; that he may damage Iraqi oilfields and so on.

There are two transmission mechanisms for this military risk to world economic conditions. The first is through business and consumer confidence. Business confidence is already poor and the threat of war, added to the poor conditions in many economies, has led many companies to put investment plans "on hold". Consumer confidence has been reasonably strong - in the US and Britain at least - but is also likely to be affected. Warnings of renewed terrorist threats to the West will add to the prevailing uncertainty.

The second, and related, transmission mechanism is the price of oil. It has already risen to more than $30 a barrel and forecasters have a range of complicated formulae for what might happen in the light of various war scenarios (most of which are of the "guesstimate" variety.)

However, with the Venezuelan strike continuing, the oil market is obviously vulnerable to a short-term price rise as (presumably) tensions increase in the weeks ahead. Again, the short and successful war scenario sees prices falling later in the year but there is a considerable leap of faith in predicting this.

The wider fall-out from the crisis may have even more profound economic implications.

First comes the reaction in the region itself, the location of 65 per cent of the world's proven oil reserves. What happens after the war in Iraq, which itself contains the second largest proven reserves or proven oil? The US says Iraqi oil revenues will be used to rebuild the country, while the French and Russians claim some existing interests in the Iraqi oilfields. First, however, political stability will have to be attained, which will be no easy task.

As for the implications for the wider Middle East, political analysts have so many perspectives they put even the "two-handed" economists to shame. Suffice to say that the fall-out from war will be considerable - and unpredictable.

A report presented recently to the US Congress quoted UN estimates that a conflict in Iraq could displace two million people, create 900,000 refugees and leave some 10 million Iraqi civilians (about 40 per cent of the population) seeking emergency help. This has obvious implications for Iraq's neighbours.

There are also wider political uncertainties. The report to Congress points to the Bush administration's professed wish that a democratic regime in Iraq leads to the advancement of a democratic order for the region. But as the document, written by US foreign affairs experts, makes clear the background in the region is "demographic pressures, stagnant economic growth, questions over political succession and festering regional disputes \ already raise many uncertainties regarding the future of the Middle East".

No wonder there is so much uncertainty as to the likely geo-political impact of US-led action, not only on the Arab-Israeli conflict but on the political balance of the entire region.Even if the war is short, the political implications are thus very uncertain, adding considerably to the economic risk.

This week, another factor became crystal clear. The relationship between the US and parts of Europe - France and Germany, in particular - is coming under a strain unprecedented in recent years.

There are questions of long-term political influence at play here, both within Europe and between Europe and the US. But there are also economic implications. It is noticeable that the countries which came out in support of the US included the applicant countries of Eastern Europe.

Many of these, particularly the Baltic states, have strong political ties to the US which supported their independence in 1991 and is seen as a key guarantor of defence, through NATO.

However, there is also an economic dimension. These states, particularly Poland, Hungary and the Czech Republic, will be fierce competitors for US foreign direct investment. Offering low costs - and with US-friendly politics - the attraction to US investors of eastern Europe is obvious.

The Republic has, of course, been winning a disproportionately large share of such investment. US companies have invested over $34 billion here and employ 90,000 people in 570 companies. Also, the US is our second largest export market. Meanwhile much of our economic governance is tied up with Brussels and Frankfurt and we also have substantial trade in European markets. No wonder Bertie Ahern and his colleagues have been trying to ride both the Boston and Berlin horses.

This means the strategic economic interests at play for Ireland are substantial. Interestingly German industry is planning moves to try to limit the impact on their US business of the Schröder government's stance. What chance now for BMW sales in the US?

One final thought. World trade talks under the Doha round are due to enter a crucial phase in the months ahead, with a key meeting this autumn in Mexico. What chance of the US and the EU - with France a key force, particularly on agriculture - striking a deal in a spirit of friendly co-operation? Already more hawkish Republicans in Washington are calling for sanctions on French and German exports. If the move to free trade breaks down, the we will really have to look out.