How war would hit US wallets

Gripped by war jitters, Wall Street fell to a three-month low Friday.

The last time the United States went to war with Iraq, the economy plunged into a recession. Should the US fight a second war with Iraq, would that history repeat itself?

It depends on how long the war would last, economists say, and how much the US commits to reconstruction efforts.

A rout of Saddam Hussein's forces, followed by a minimal peacekeeping effort, would likely improve the US economy. The war-or-peace uncertainty weighing on markets and oil prices would be lifted.

But if weapons of mass destruction are deployed or oil fields damaged, sky-rocketing oil prices and investor jitters could hinder any economic recovery for several years.

"You'll know in 10 days whether it will be one of these routs, or whether there [are] nasty things going on," says Yale economist William Nordhaus, who recently published a study on the costs of war. Until then, he cautions, the economic impact is "fundamentally unpredictable."

Wars have gotten cheaper

While the fog of war confounds economic predictions, the trend since World War II has been toward cheaper conflicts. War costs as a percentage of GDP have been falling dramatically since World War II, according to Mr. Nordhaus.

But that trend hasn't necessarily been a boon for the economy. Rather, the declining cost of war has accentuated the role of oil and investor psychology in how the US economy reacts to war.

The first US war on Iraq shattered a long-standing truism that American wars brought economic booms spurred by government spending, says Nordhaus. Any benefit from increased military spending was outweighed by high oil prices and depressed consumer confidence in the wake of Iraq's unexpected invasion of Kuwait.

Unlike Gulf War I, there have been no big shocks like the Kuwait invasion, just a slow march toward war. The possibility of a new war has already slowed new investment and inflated oil prices.

"The atmosphere of lack of decision is holding up a lot of investment decisions," says Ariel Cohen, an economist at the conservative Heritage Foundation. A quick victory would spur wary Wall Street investors and discount the so-called war premium, says Mr. Cohen.

The danger of shocks

But if Saddam Hussein succeeds in making the war ugly, the economic picture isn't so rosy.

In order to help economists envision the full range of military scenarios, military analyst Anthony Cordesman with The Center for Strategic and International Studies (CSIS) in Washington outlined in late November three possible courses for the war.

Mr. Cordesman figured that the most likely scenario was the benign case, where the regime crumbles with minimal urban warfare, weapons of mass destruction (WMD) are not used, and Saudi Arabia helps stabilize oil production. An intermediate scenario that's almost as likely according to Cordesman, would see stiffer Iraqi resistance and little help from allies.

Both these scenarios would result in a mild spike in oil prices during the first quarter of the war, estimated a CSIS panel of economists. Neither scenario would push the economy back into recession, however.

But Cordesman figures there is a chance - 10 percent or less - that the war will take a significant turn for the worse. Damage to oil fields, high casualties, or effective use of WMD would send the price of oil surging to $80 per barrel, according to CSIS economists.

Motorists would pay $3 per gallon at the pump. Further, it would take two years for the price of oil to return to pre-war levels.

High oil prices mean consumers and businesses around the world pay more for transportation and heat.

Inflated oil prices have been partly to blame for the last three recessions. And this spike would be no different, according to the CSIS panel. This worst-case scenario would trigger a double-dip recession lasting two or three quarters with higher unemployment for at least two years.

Trying to gauge the exact price of oil and length of recession in the worst-case scenario is a bit like "throwing darts," cautions Peter Navarro, an economist with the University of California-Irvine.

"If we go to even $40 or $50 a barrel of oil, we'll have a recession," Mr. Navarro says. "And it would be a global recession."

That said, the price of inaction would be worse, says Navarro.

"It's not the price spike of $80 that bothers me over a two-week period, it's the one year of $30 a barrel of oil plus because the situation isn't resolved. That's much more pernicious."

Cost vs. impact on economy

The debate over war with Iraq has focused more on its cost than on the impact on the economy.

Several estimates fall in the ballpark of $50 billion for a month-long war, followed by several months of mop-up. So found two separate analyses, one by Democratic staff members on the House Budget Committee and another by the Congressional Budget Office.

The first US war against Iraq, by comparison, cost roughly $76 billion in today's dollars.

Larry Lindsey, a former Bush economic adviser, turned heads in Washington when he predicted a price ceiling of $100 to $200 billion. The White House distanced itself from the estimate, and followed up later with figures from the Office of Management and Budget that echoed Congressional estimates.

A high price tag would give opponents of the war ammunition and force fiscal sacrifices to offset budget deficits.

For this reason, Nordhaus created a further stir when his study predicted a much higher worst-case cost of the war than even Lindsey.

His "favorable" war estimate, $99 billion, was not much higher than government figures. But for a war gone wrong, Nordhaus estimated a cost of $1.9 trillion, which includes projected economic losses. Dividing that sum equally, each American household's portion of the bill would be $20,000 spread over a decade, he notes.

Take out the projected losses from a souring economy and the direct government costs would top out at $755 billion.

Nordhaus's worst-case figures dwarf the government estimates because he factors in the cost of winning the peace as well as the war.

Peacekeeping doesn't come cheap. After all, peacekeepers are still in Bosnia. Nordhaus estimates a cost of $75 billion to $500 billion depending on the hostility in post-Hussein Iraq. That's compared to a worst-case military spending of $140 billion.

Add to that the cost of reconstruction and humanitarian assistance, which he estimates to be between $31 billion and $115 billion based on historical comparisons.

This high price tag could spell economic peril down the road.

"The real problem is not the money we spend but the deficit we incur, which leads to higher interest rates down the line. That chokes off private investment," Navarro says.

However, war expenditures are not be without some economic benefit. Cohen says that after Gulf War I, many of the reconstruction purchase orders were given to US companies, thereby boosting American business. Allies also contributed substantially to the conflict costs in what was dubbed Operation Tin Cup by the first Bush administration. Similar generosity would alleviate some of the budget pressure.

The attitude of allies, the deepening oil crisis in Venezuela, and the ultimate course of war or peace will all factor into whether better days lie ahead for the economy.

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