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Iraq: Economists Fear War Could Deal Blow To World Economy

In the run-up to the Gulf War in the early 1990s, a sharp rise in oil prices pushed the economy in United States into a recession that ultimately also affected most of the world. Iraq this week sought to avert the threat of a new war by offering to readmit United Nations weapons inspectors. But military action is still not ruled out, especially given the skeptical U.S. and British response to Baghdad's offer. Analysts say another war could deal a blow to the world economy, though the impact is hard to predict.

Prague, 18 September 2002 (RFE/RL) -- When Iraq invaded Kuwait 12 years ago, the price of oil nearly doubled to around $40 a barrel. By the time the United States and its allies drove Iraqi forces out six months later, it had dropped back again. But the spike was enough to kill off the beginnings of an economic recovery in the U.S., tipping it into a recession that ultimately affected the rest of the world too.

This week, Iraq sought to avert the threat of a new war by offering to readmit United Nations weapons inspectors. That has taken much of the steam out of U.S. efforts to push the UN into taking tough action on Iraq.

Financial markets around the world reacted immediately with relief. The price of oil dropped, stocks rose -- briefly -- and the U.S. dollar increased in value against the euro. But military action is still a possibility, especially given the skeptical U.S. and British response to Baghdad's offer. The tough talk in recent weeks has led many to ponder what economic impact could be expected if there is another war.

Many analysts note the situation now shares many similarities with that of 12 years ago. Now, as then, there are signs the U.S. economy is recovering after a period of faltering growth. Oil prices, too, would be expected to spike, possibly to similar levels.

But observers say it's devilishly tricky to predict the impact a war might have this time around, not least because there are also important differences that muddy the picture.

On the up side, economists note that the U.S. is less reliant on oil than it was a decade ago. Other producers, Russia and Saudi Arabia, for example, could be persuaded to make up for any dip in Iraqi production. World oil reserves are also much bigger these days, suggesting that oil prices would not surge as sharply.

Professor Ron Smith is an expert on defense economics at London's Birkbeck College. He said a higher oil price could have longer-term benefits too. "It could well be that the long-term effects of the oil price, in terms of economizing, getting more fuel-efficient things -- a higher oil price may have benefits that way," Smith said.

Oil-exporting countries like Russia could also benefit from rising oil prices.

Some have suggested a war might even boost the U.S. economy due to increased defense spending.

Top U.S. officials have also downplayed the negative economic impact of a military campaign.

Lawrence Lindsey, a key economic adviser to the White House, suggested this week that the benefits of a short war that successfully removed Saddam Hussein might outweigh the costs to the U.S. economy, which he said could reach up to $200 billion. A war might also boost the economy by increasing oil supplies.

U.S. Treasury Secretary Paul O'Neill declined to put a price tag on a potential campaign, but added that the U.S. could afford it.

And Alan Greenspan, the chairman of the U.S. Federal Reserve, said the economic impact is "unlikely to be significant" if hostilities are not prolonged.

But that, say the pessimists, is too big an "if."

Gerd Hausler, a senior official at the International Monetary Fund, warned last week that a conflict with Iraq "would not be a very healthy development" for world markets. He said it could undermine the forces helping the global recovery.

Distinguished U.S. economist Paul Krugman also warned that a war is likely to be a bane, not a boost, for the U.S. economy. He noted this week that a recession followed every oil crisis of the 1970s and that a war could easily tip the U.S. into recession this time too.

Other things point to the economic downside of another campaign. In the Gulf War, the U.S. allies in the international coalition shared some of the cost of the military campaign itself. This time around, the U.S. is likely to have to pay the lion's share.

A decade ago, the U.S. Federal Reserve was able to ease the effects of higher oil prices on businesses and consumers by cutting interest rates. But with rates now at 1.75 percent, it has little if any room to maneuver.

And what of Europe and farther afield? Several European ministers warned in Salzburg this week that their economies could be too frail to withstand the combined consequences of higher oil prices and weaker consumer confidence.

The economies of Western Europe a decade ago were much more robust, fueled in part by German reunification. But growth is now sluggish, and constraints in the European Union's stability pact mean they can't spend their way out of a crisis either, as Smith explained. "The other way would be through expanding public expenditures, trying to offset [the impact of higher oil prices]. And again, the stability pact of the EU and particularly for the euro members would stop them doing that, particularly since some of the countries -- Portugal, Italy, Germany -- are very close already to the [pact's budget-deficit] limits," Smith said.

Other oil-importing countries, such as those in Central and Eastern Europe, would suffer a double impact from higher oil prices and lower demand for their exports from Western Europe, their most important trading partner.

Wike Groenenberg is a Central and Eastern European economist for Salomon Smith Barney in London. "We might see as much as a 0.5 percent of GDP knocked off growth in Western Europe and we would expect to see something similar in the Central and East European region," Groenenberg said.

Ironically, what makes these countries more vulnerable is their success in building up export industries during the economic transformation of the last decade.