SOCIAL TOPICS (Archive): INVESTMENT & ECONOMIC ANALYSIS  

Published, Summer 2003

Hindsight will soon afford us a better understanding of the impact the Iraq War has had on our economy and global political relationships. For now, it is a matter of conjecture, but let us look at some long-term trends.

In the early 1980s, the Federal Reserve’s restrictive monetary policy broke historically high interest rates (over 20 percent for short-term funds) and led to the most severe economic contraction since World War II. Though that recession was painful, it ended the inflationary spiral that began fifteen years earlier with the Vietnam War when LBJ chose guns and butter over guns or butter. Over the last twenty years, however, inflation and interest rates have declined, productivity has increased, and economic recessions have been less frequent and severe than those of earlier periods. This favorable era of gentler business cycles and strong growth has been reinforced by expanded world trade, the demise of communism, the emergence of market oriented economies, and shifts in production of goods to lower cost regions; in short, the zenith of capitalism.

The Iraq War may not necessarily have a lasting, material impact on these established trends. It is not in the self-interest of the industrialized world, especially the countries with newly emerging capitalist economies, to reduce ties to the United States. Nor is it in our interest to reduce ties with them. Furthermore, there is no reason to expect the pace of technological innovation will slow or key central banks will abandon non-inflationary policies that have thus far been a success.

Still, the risk that this long period of steady growth is now near an end seems higher today than at any time in two decades. First, the Bush Administration’s National Security Policy enunciated in September 2002 (required reading for the politically concerned at http://www.whitehouse.gov/nsc/nss.pdf) calls for a policy of action that is both "pre-emptive" and "unilateral" in advancing U.S. security interests—a policy we saw implemented in Iraq. Second, this policy has been accompanied by passage of the Patriot and Homeland Security Act and other responses to the heinous terrorism of September 11th, 2001 designed to ensure domestic security. Together these actions, while now not too costly, are bound to affect our way of life. They require a continuous flow of economic resources to activities that neither advance productivity nor political and economic freedom—the very incubators of a vibrant economic system. While one can argue about both the efficacy and social implications of such policies, the economic cost is almost certain to be high. In the long run this is likely to be measured in more inflation, higher interest rates and lower growth. Add to this the Bush Administration’s call for tax cuts that are unsustainable, and deficit spending to fund military budgets, and the notion of an end to the favorable environment of the past 20 years becomes more convincing.

Meanwhile, for the many non-Americans who lack confidence in our benign intentions, America becomes a state—with weapons of mass destruction—that must be contained or balanced. This also bodes ill for global productivity, as others also redirect investment from productive activity to security needs. Further, it undermines multilateral cooperation and thus world trade, whether out of legitimate security concerns or fear, military conflict, or most importantly, political or isolationist impulses. It also reduces security as terrorists, targeting U.S. imperiousness, find recruits more easily and hostile nations consider pre-empting the pre-emptor. All of these risks, however, are reversible with wise, post-Iraq War policies or more multilateral behavior by our government. So for the moment, we consider this pessimistic case to have a low probability. But we do not feel much more certain either of Thomas Friedman’s optimistic case; that the ousting of Saddam Hussein, if post-war reconstruction of Iraq is done well, could contribute to a stable, ademocratic renaissance in the Middle East. With that scenario would come a loss in legitimacy of terrorist activity and better behavior on the part of the other so-called "rogue" states.

What is the role of socially concerned investors and citizens in shaping the future of the U.S. economy and its global relationships? As investors, we must hold U.S. multinationals to the highest economic, social, and environmental standards wherever they do business. As purveyors of our culture and leadership, their actions are the determinant of world opinion about the United States. As citizens, our task is to exact constructive multilateral policies from our representatives, our leaders, and our institutions, and hold them to the best of our patriotic notions of liberty and justice for all and government "of the people, by the people, and for the people." --S. Moody