Beyond war on Iraq

Last week, I predicted a global recession, exuding gloom about the future of the Indian economy and the IT industry in particular. I said the world typically went into recession when the price of the oil crossed $30 per barrel for any sustained period. Today it is $36 per barrel.

And if Saddam Hussein sets fire to his oilfields in the coming Iraq war, it might take a couple of years to rectify the damage. So, I suspect oil prices will remain above $30 per barrel long enough to cause a recession.

Too simplistic, say some some friends. Inflation has reduced the real value of $30 per barrel today to half its real value in 1980. Besides, the GDP of all countries has shifted towards services, and the oil-intensity of their GDP has fallen. Finally, the dollar itself has weakened by around 13 per cent in the last year. In sum, $30 per barrel oil is not reason enough to predict a global recession.

Very true. But let me add that there are several other reasons for fearing a recession: Oil may simply be the last straw that breaks the camel’s back. I did not go in detail into those other reasons last week for want space. So let me now recite the whole gloomy litany.

First, Germany is probably in recession already. lt achieved only 0.2 per cent GDP growth last year, unemployment is in double digits and rising, and stock markets are down to new lows.

Because of various rigidities, German labour is on average 17 per cent costlier than US labour, yet does not make up for this through higher productivity. The political consensus does not favour changing the system that produced the German economic miracle for three decades after World War 11. Rather than go for painful reforms, Germany prefers to slide into stagnation.

This mimics the other miracle economy after World War II, Japan. That country too is reluctant to reform its financial sector or labour laws, which helped it boom sensationally from 1950 to 1980. Japan and Germany, the two miracle workers of 1950-80, are now dragging down the global economy.

The political consensus in both countries favours stagnation without reform to growth after painful reform. France has just had its worst month of industrial production for six years. Italy is in trouble, with the once dominant Fiat empire crumbling. Britain is limping along, but its stock market has crashed to a seven-year low.

That leaves just one country, the USA, to try and rescue the whole world. It did so during the Asian financial crisis of 1997-99. Then, the USA kept growing fast on the back of a technology boom. It increased its imports phenomenally, enabling stricken Asian countries to convert their trade deficits into surpluses.

By 2000, the USA had triumphantly steered the world out of the Asian financial crisis, and its stock market rose to record heights.

Not for long. The technology boom went bust. The stock markets crashed. In 2001, the USA led the world into recession. Helping the downswing was the sharp rise in US oil price in 2000, which at one point touched $37 per barrel. It is almost at that level again today.

Pessimists predicted that the USA would suffer a double-dip recession in 2001. That did not happen. The US economy grew by a respectable 2.8 per cent in 2002, thanks in considerable measure to a housing boom. But by the last quarter, growth had slowed to just 0.7 per cent. Retail sales fell in January by 0.9 per cent.

A viciously cold winter has sent heating bills shooting up, leaving people with less to spend on other things. Panic over a possible Al Qaeda attack in the USA is the latest blow to consumer sentiment there. Uncertainties over war with Iraq have hit business investment. Technology companies like Microsoft and Intel have already warned that 2003 will be a tough year.

A booming housing market fuelled the economic recovery of 2002 in USA and Britain. British prices are up 25 per cent over the last year. Many more people own houses than shares, so rising house prices have shored up consumer sentiment.

However, many experts fear that the housing market in these two countries is a bubble about to burst. The US Fed has been slashing short-term interest rates for two years to just 1.25 per cent today, enabling home-owners to refinance their mortgages cheaply.

But interest rates are too close to zero to be cut much further, so this tool is reaching the end of its usefulness. That increases the chances of a housing bust, that will take down entire economies.

In sum, the world economy faces huge risks even without the Iraq war, and even without high oil prices. Throw those two factors into the pot, and you have a recipe for a global recession. I rest my case.

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