Centre for Research on Globalisation
Centre de recherche sur la mondialisation

War and "Terror" and the World Economy

by C. P. Chandrasekhar & Jayati Ghosh

Global News Wire - Asia Africa Intelligence Wire, 23 September 2003
www.globalresearch.ca   24 September 2003

The URL of this article is: http://globalresearch.ca/articles/CHA309B.html

An examination of certain paradoxical trends in the US' economic performance over the last three decades suggests that political and military hegemony rather than economic competitiveness has helped sustain its global economic dominance. But domestic political developments and differences with its erstwhile allies are posing new challenges, argue C. P. Chandrasekhar and Jayati Ghosh.

IN EARLY September, the Bush administration put out its demand for $ 87 billion of emergency spending next year to finance its post-war, anti-terror operations in Iraq and Afghanistan. The request for emergency funding provides for $ 51 billion to fund military operations in Iraq next year and $ 11 billion for US forces in Afghanistan. The request also includes another $ 21 billion for "reconstruction" in Iraq, of which, $ 5 billion would go to train a new Iraqi army and police force. Thus the bulk of the new demand, if approved by Congress, would be allocated to sustaining the Iraq misadventure.

That it is a misadventure in economic terms and that earlier administration efforts to underestimate the economic cost is now well established. According to the Financial Times, the total estimated cost of the US intervention in Iraq so far is, at $ 138 billion, precisely where the former White House economic adviser, Mr Lawrence Lindsey, declared it was heading. Among other reasons, Lindsey was fired at the end of last year for forecasting that the Iraq war would cost $ 100-200 billion. The actual figure is likely to be much higher. Currently, with the US finding little support in terms of men, materials and money from countries other than Britain, it is estimated to be spending $ 3.9 billion a month to finance its occupation. With the occupation unlikely to be short-lived, estimates suggest that the cost of the occupation alone for the US alone could amount to around $ 4 billion a month for the next three to four years, or a total of around $ 150-200 billion.

To this must be added the cost of the ongoing, even if limited, process of reconstruction. That process is to be financed partly with US funds approved by Congress and substantially with revenues from Iraqi oil, the production and export of which is still to reach its full potential. Lael Brainard and Michael O'Hanlon of the Brookings Institution quote estimates, based on the presumption that Iraqi oil production is unlikely to be restored to potential in the near future, which place spending for reconstruction at anywhere between $ 5 billion and $ 120 billion a year over the next several years.

The full financial implications of the war have not sunk in because much of the expenditure relating to the Iraq war is funded outside the normal appropriations process, in so-called 'supplemental' or emergency spending bills. The recent $ 87 billion demand, comes on top of $ 62 billion appropriated for military operations in Iraq and Afghanistan in April this year and an overall total of $ 79 billion approved by Congress to cover the immediate costs of the Iraq war.

As a result of these piecemeal, off-budget spending requests, both the actual costs of the war on terror and it budgetary implications are not clear, leading to varying estimates.

Whatever the actual figure, however, it is clear that deficit-financed spending, justified by the war, is touching and would continue at high levels. Estimates are that with tax cuts amounting to revenue losses of around $ 3 trillion announced over the last two years and $ 41.3 billion planned to be spent on homeland security, the federal deficit next year would exceed $ 550 billion. Clearly, the "war on terror" that has replaced the communist "threat to freedom" as the principal strategic preoccupation of the US is not just costing the US dear. It is also leading to a ballooning deficit in a country whose government has for more than two decades now backed an ideology that treats deficit financing as anathema, especially in developing countries seeking balance of payments financing.

It is not just that the war on terror is proving costly in economic terms. It is now some time since the Pentagon announced that the number of American soldiers killed after combat operations were declared as over in Iraq exceeded the number lost during the war itself. Yet there are no signs of any halt to American and British casualties in Iraq. This has spurred movement in two directions: on the one hand, hawks in the administration are lobbying for an increase in the number of US troops in Iraq, with estimates of required numbers varying from 20-50,000 or more; on the other, there is growing domestic resentment over the decision to go to war in the first place, since no weapons of mass destruction have been discovered in the process, while the cost in American lives is rising along a trajectory with no end in sight.

With the war proving politically and economically expensive, why does the US still persist with the strategy of keeping the occupation going, even if with the expectation that other countries would join the effort under its leadership? Could the answer lie in the fact that what appears almost suicidal is in actual fact the only policy option available to the US?

There are three paradoxical features of US hegemony over the last three decades that need to be noted here.

First, we must recall that after the US lost its competitiveness as a trading power in the late 1960s, it could not handle the consequences of the huge dollar surpluses in the world economy. Those surpluses were built because in the 1950s and 1960s the US had exploited the fact that the dollar was the world's reserve currency and spent huge sums on, among other things, policing the world and legitimising its hegemonic position. Unable to redeem its promise to convert dollars to gold on demand at a pre-specified price it had, in the early 1970s, to break the formal link between the dollar and gold which was presumed to underlie its position as the reserve currency. Yet, to this day, the dollar remains the principal reserve currency and the preferred destination for investment by wealth-holders the world over. This suggests that political and military hegemony rather than economic hegemony underlies the strength of the dollar and its role as reserve. Political hegemony in turn is ensured by the fact that in the "division of labour" between the world's leading capitalist powers, the US was given the role of policing the system - whether against the earlier communist threat or the more recently discovered terrorist threat.

Second, this persistence of the dollar as the reserve currency has served the US well in recent years. Despite the inflationary effects of the oil shocks and the contractionary responses it forced on the US in the 1980s and early 1990s, starting in the mid-1990s the US experienced a period of prolonged buoyancy and relatively low unemployment (Chart 1 and 2). During this period, other than for the UK, most other OECD countries were recording poor or indifferent economic performances. Interestingly, this was a period in which US federal deficits were declining and eventually the US recorded a surplus on its budget, providing the background for the Bush tax cuts.

If despite this loss of the fiscal deficit, the US was able to ensure a prolonged period of relatively high growth, low inflation (Chart 7) and low unemployment, it was not because it had regained its lost international competitiveness. Higher growth in incomes meant larger trade and current account deficits for the US. As Chart 9 makes clear the US current account deficit has been rising continuously, even while other leading capitalist nations recorded much smaller current deficits and even surpluses on their balance of payments. Small current account deficit or even surpluses are increasingly the rule in most countries outside the US, including developing countries. This reflects the deflationary tendencies that rule in those environments, partly because of a self-adopted or externally imposed deflationary fiscal stance.

The net result has been a build up of record levels of foreign exchange reserves in all these countries. Since those reserves are invested in dollar denominated assets in ostensibly "safe" US financial markets, these reserves help finance the US current account deficit.

Among the factors that explained this paradoxical US strength was: i) its ability to keep commodity prices, including oil prices, down so as to keep inflation in control, facilitated in part by its "diplomacy"; and ii) a huge increase in capital inflows into the US, which resulted in a stock and bond market boom, increased the wealth of savers investing in pension and mutual funds, and triggered a "wealth-effect" induced spending splurge. Not surprisingly, during the years of declining fiscal deficits and fiscal surpluses in the US, private consumption expenditures (Chart 4) rose sharply and savings rates fell (Chart 6), helping trigger growth in output and investment (Chart 5). The fact that military and political hegemony ensured that the dollar was the world's reserve currency and the US the safest financial market had served the US well during those years.

Growth in the US did impact on world trade growth (Chart 8) as well. But the benefit was partly concentrated in a few countries, such as China, which registered high export growth rates and large current account surpluses. Further, in most cases the benefit of whatever increase in exports occurred seems to have been neutralised by the deflationary effects of government fiscal stringency and the consequent fallout in the form of reduced spending and higher saving by consumers fearing possible unemployment. The net result was that increases in export growth were not accompanied by parallel increases in import demand, leading to trade and current account surpluses, higher foreign exchange reserves and larger investments in dollar denominated securities in the US. The system worked perfectly for the US, even if not for many others.

Finally, at the end of the 1990s the US stock market bubble gave way to a slump that was aggravated by news of accounting scandals and other kinds of corporate fraud, which in turn dampened consumer sentiment resulting in the recession of 2001. But this was precisely the time when the war against terror was ensuring a return to high fiscal deficits in the US. This then provided the stimulus for recovery, making the growth downturn short-lived and revived hopes that, but for the blip, the long period of prosperity would continue.

While still considered hasty by many, that expectation is grounded in recent figures. The last day of July 2003 brought news of unexpected vigour in US economic growth. Commerce Department figures showed that in the second quarter of 2003, the US economy grew by 2.4 per cent, which was well above the 1.5 per cent predicted by many analysts. Interestingly, there is consensus on the cause of this buoyancy. Analysts point their finger at the substantial rise in government spending fuelled by the occupation of Iraq, which has been assessed by the Financial Times, London, as being the "largest run-up in government spending since the Vietnam War". As a result, defence spending in the recent past has been rising at a 44 per cent annualised rate. Not surprisingly, overall government spending rose by an annualised 22 per cent in the second quarter of 2003, contributing according to some estimates as much as 1.5 percentage points to the 2.4 per cent second-quarter growth rate. Once again, even if not through the same mechanism, the US's military activity seems to be working to keep its economy afloat and growing. The only difficulty is, of course, the ballooning trade deficit, resulting in a current account deficit of close to half a trillion dollars in 2002. But so long as the world's foreign exchange reserves continue to be invested in US government securities, despite low interest rates, this would not be a problem. According to one estimate some two-thirds of capital flows into the US in recent times is accounted for by investments of foreign reserves in US securities, especially by central banks in the Asian region.

These developments suggest that the Bush administration may choose to stay in Iraq because the indirect economic effects of the misadventure provide the only means by which it could stall or reverse its declining popularity. The second-quarter growth figure must be giving cause for celebration to a government that is fast loosing domestic support for its Iraq misadventure that is proving much more prolonged than expected, more unilateral than multilateral and more costly in terms of US lives that are being lost virtually every day.

But these very factors make the task of sustaining the spending that yields that growth rate difficult. The view that the direct financial cost of the occupation is proving too heavy for the US Government, even if it is proving to be good for American business and the American economy, is gaining ground. If growth is to be sustained, therefore, the US must ensure that other international governments contribute to the reconstruction effort and that the "external" benefits of that effort must flow to the US.

However, while a solely US occupation and reconstruction effort is increasing proving infeasible, support from the international community has been virtually absent, not just in terms of sending troops but also in terms of finance for reconstruction.

In April this year, the Congress approved $ 3.6 billion towards the reconstruction effort. According to White House Budget Director, Mr Joshua Bolten, funds from various sources such as frozen Iraqi assets, revenues from oil and $ 800 million in cash found inside Iraq, had helped add to the congressional appropriation and secure $ 7.7 billion for rebuilding efforts during 2003. But the Iraqi administration is likely to run through this money relatively fast. Mr Paul Bremer, US administrator in Iraq recently informed the Bush administration that he expected to spend $ 7.3 billion by the end of the year. Speaking to CNBC's Capital Report regarding the cost of rehabilitating and reconstructing Iraq, Mr Bremer said: "It's probably well above $ 50 billion, $ 60 billion, maybe $ 100 billion. It's a lot of money." He clearly intends to return to Washington with a large request for funds.

Thus, even if the actual spending on reconstruction is a small fraction of the Brookings estimate, deficit financed spending by the US is bound to increase substantially if outside help is not forthcoming. Though current trends indicate that this could convert the recent buoyancy of the US economy into a robust recovery, there are ideological and congressional limits to that process. However, if the US manages to restore Iraqi oil production to potential in the near future, the gains it gets from financing the costs of occupation would be strengthened by the benefits derived by US business from the reconstruction spending financed with oil revenues. Even if the occupation alone can be sustained, the purely economic gain for the US from the occupation could be substantial. But if governments outside the war coalition could be persuaded to contribute to the reconstruction effort, then a US recovery is a real prospect.

Iraq, the victim, is meanwhile less fortunate. It is still left devastated by the war, with little benefit as yet from reconstruction. Electricity and water facilities are still to be restored to pre-war levels and hospitals are short of supplies. This shows that the level of spending and its allocation were inadequate from the point of view of quick-impact reconstruction. In late July, White House officials provided the US Senate foreign relations committee senators with a report on the extent and pattern of spending, as of June 30, out of the $ 7.7 billion funds that was available for reconstruction. Till that date, allocations totalled slightly more than $ 2.7 billion. Of this, $ 2 billion came from the funds approved by Congress and $ 750 million from seized and vested Iraqi state assets. Of the $ 5 billion that remained, $ 2.2 billion was from funds appropriated by Congress, $ 1.8 billion from seized and vested Iraqi state assets and approximately $ 1 billion from the Development Fund for Iraq.

A significant share of the $ 2.7 billion spending till June 30 had gone towards emergency payments and salaries for Iraqi civil servants and pensioners ($ 400 million) and to support the operations of the Coalition Provisional Authority (CPA) in Baghdad ($ 200 million).

The US administration in Iraq had spent about $ 730 million on humanitarian initiatives such as restoring food distribution and augmenting medical supplies leaving $ 1.37 billion for reconstruction, including restoring basic services and oil production. This compares with the US civil administration's own estimates that it would cost $ 13 billion to rebuild the electricity infrastructure and the United Nations' forecast that it would take $ 16 billion over four years to restore water supplies.

With the reconstruction effort proving inadequate, three months after the end of the war, Mr Paul Bremer announced at the end of July a "detailed timetable and clear benchmarks" to restore crucial services to pre-war levels in 60 days. Experts are sceptical. In the case of electricity supply, for example, this would require increasing generation from 3,000 MW at present to 4,000 MW.

But security problems, ageing equipment, lack of spare parts and the effects of the looting of high-voltage power lines imply that such an increase, even if achieved, would not be sustainable.

Even though reconstruction has been slow, policies to ensure that the gains from occupation would accrue to corporate America and the US economy are being rapidly put in place. In particular, the Coalition Provisional Authority has initiated moves that would open up the Iraqi economy for foreign operators. In July, the CPA, while announcing a competition for mobile phone licences in Iraq, promised to waive Iraqi legislation requiring foreign investors to allocate a 51 per cent equity share in projects in Iraq to Iraqi entities.

Another example is the call for proposals from international banks and consulting firms to help restructure Iraq's two biggest state-owned banks - the Rafidain Bank, with deposits of over $ 1 billion, and the smaller Rasheed bank - with 150 branches each. This restructuring process is seen as a prelude to allowing the contractor who undertakes the process to buy into the banks' equity.

The " privatisation" in favour of foreign investors is problematic because of evidence that it is primarily US firms that are benefiting and are likely to benefit from the still limited reconstruction effort.

On July 31, Halliburton, the second biggest oilfield service company in the world and one of the largest private contractors in Iraq, reported that work in Iraq had boosted its revenue and helped it swing from a loss to record second-quarter net income of $ 26 million. Mr Dick Cheney was the chief executive of Halliburton from 1995 to 2000 before he became US vice-president and its activities have been controversial because its German subsidiary Halliburton Company Germany GmBH has contracts with Libya even though the Iran-Libya Sanctions Act passed in 1996 by the US Congress has kept US companies out of Libya.

On May 30 Halliburton had announced that it had finalised a $ 6 million agreement to settle 20 lawsuits alleging that the company used deceptive accounting practices when Mr Dick Cheney ran the company. Halliburton's role in Iraq has been controversial since the US Army's Corps of Engineers awarded it a contract worth $ 7 billion to extinguish oil-well fires and undertake emergency repairs without calling for bids from competitors. The lead the company got appears to be favouring it subsequently as well. Recently, its rival Bechtel announced that it would not participate in two calls for bids totalling $ 1 billion for repairs in Iraq's oil sector.

These trends explain in part the unwillingness of other OECD countries to contribute substantially to the reconstruction effort.

As pressure builds on the US to seek financial support from other countries to accelerate the reconstruction effort, and Mr Bush has put out an appeal for such support, France and Germany have called for the creation of an independent fund as an alternative to the US-controlled Iraq Development Fund to which contributions likely to be pledged at a proposed donor conference in October can be made.

Mr Gunter Pleuger, Germany's ambassador to the UN, has announced that "Germany stands ready to contribute its share", but that "international support to the necessary extent will only be forthcoming if full transparency and international participation in the decision-making process will be assured."

In Germany's view, "the creation of a separate international fund could dispel some concerns, expressed by some members of the United Nations, with regard to the Development Fund for Iraq. " France's UN ambassador, Mr Jean-Marc de La Sabliere, supported the suggestion when he said: "We favour creating a special multilateral fund, managed collectively by the United Nations Development Programme and the international financial institutions."

Others have suggested that even the Iraq Development Fund, through which oil revenues are to be channelled into reconstruction, should be subject to scrutiny by an international board created for the purpose.

If the US is forced to accept these conditions to legitimise its occupation with accelerated reconstruction and a return to normalcy and if the growing domestic opposition forces it to cut back on its defence spending and, therefore, its own military presence in Iraq, then the hope of recovery spurred by the second quarter growth figure would definitely remain unrealised.

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