THE United Nations (UN) and the North Atlantic Treat Organisation (Nato) are widely perceived as damaged, if not broken, by their failure to agree on what to do about Iraq. Will these cracks in the international political system now wound the world's economic architecture, and with it globalisation, as well? (U.S. Air Force )...

THE United Nations (UN) and the North Atlantic Treat Organisation (Nato) are widely perceived as damaged, if not broken, by their failure to agree on what to do about Iraq.

Will these cracks in the international political system now wound the world's economic architecture, and with it globalisation, as well?

International economic agreements have never been easy to make. Reaching consensus among the World Trade Organisation's 145 members, where one dissent can cause utter disarray, was difficult even before the world's governments divided into pro- and anti-American camps. Indeed, multilateral trade agreements were being eclipsed by bilateral deals, such as between the European Union (EU) and various developing countries, long before the divisions over Iraq appeared.

Of course, the problem goes deeper and not everything that touches globalisation has turned dark. Immigration controls, for example, have been relaxed in several European countries (notably Germany) due to declining populations and educational shortcomings. But bad economic times are rarely moments when governments push bold international economic proposals.

Economic fragility among the world's leading economies is the biggest stumbling block. The US and EU have few fiscal and monetary levers left to combat weak performance. Short-term interest rates in the US, at 1,25%, are at a 40-year low. Congress has pared $100bn from the Bush administration's 10-year $726bn tax cut plan, and the US's projected 10-year $2-trillion budget deficit will grow as the Iraq war's costs mount, with President George Bush submitting a supplemental request for $80bn (0,8% of gross domestic product) in extra military spending this year.

Such spending risks absorb productive resources that could be employed more efficiently elsewhere. This was demonstrated by the rapid growth of output and incomes that followed the arrival of the so-called peace dividend, which came with the Cold War's end. Moreover, others (Arab countries, Germany, and Japan) will not cover US military costs, as in the 1991 Gulf War. We are now back to the more usual situation where war is financed by government debt, which burdens future generations unless it is eroded by inflation.

In the Eurozone the scope for fiscal stimulus (lower taxes and/or higher public spending) was constrained until war blew a hole in the stability pact, which caps member budget deficits at 3% of GDP. The limit will now be relaxed due to the "exceptional" circumstances implied by the Iraq war providing relief, ironically, to the war's main European opponents, France and Germany. But the European Central Bank remains reluctant to ease monetary policy.

In Japan, there seems little hope that the world's second-largest economy can extricate itself from its home-made deflation trap to generate the demand needed to offset economic weakness elsewhere in the world. Four years of deflation and a drawnout banking crisis offer little prospect of economic stimulus. Higher oil prices and lower trade turnover aggravate the problem.

But high oil prices threaten the health of the entire $45-trillion world economy. Oil prices have flirted with their highest level since the Gulf War and will go higher if Iraq's oil infrastructure (or that of neighbouring countries) is damaged. The adverse effects on growth will be felt everywhere, but nowhere more, perhaps, than in the energy-dependent South Korea and China. Although China's official growth rate reached 8% last year, its high budget deficit and large stock of nonperforming loans (about 40% of GDP) mean it cannot afford any slowdown if it is to keep people employed, especially in rural areas.

Some poor economies will be directly damaged by the loss of the Iraq market. Weakness in the world's big economies may be compounded by political risks.

Turkey has suffered from rising oil prices, falling tourism income (its second-largest source of foreign exchange), and declining foreign investment. The Turkish government's lukewarm support for US policy on Iraq exposes Turkey to doubts about US commitment to its economic well- being, and global markets may question its ability to service its $100bn public-sector debt this year and next.

The test of whether multilateral co-operation can be put back on track, and reconciled with the US war against terrorism and the spread of weapons of mass destruction, may come with Iraq's reconstruction. With the costs of ousting Saddam Hussein and occupying Iraq likely to run at anywhere from $100bn to $600bn over the next decade, the US will want to "internationalise" Iraq's reconstruction. Iraq's $20bn annual oil revenues cannot meet such costs. Indeed, those revenues will scarcely cover the costs of rebuilding basic infrastructure, feeding and housing displaced populations, and paying for the country's civil administration.

After the ousting of the Taliban last year, the $4,5bn of reconstruction aid pledged to Afghanistan's new government demonstrated that a multilateral approach to reconstruction is possible. But the poisoned atmosphere that followed the UN debates on Iraq may prevent the US from getting its way here. Already, French President Jacques Chirac has promised to veto any security council resolution on reconstruction that seeks to justify the war. If the world economy is to recover, the diplomatic failures and namecalling must end. Project Syndicate

Granville is the head of the International Economics Programme at the Royal Institute for International Affairs, London. Patekile Holomisa's column will resume in a fortnight.

Apr 09 2003 07:04:01:000AM Brigitte Granville Business Day 1st Edition

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