Wars and economic depressions

Published : Nov 08, 2002 00:00 IST

The U.S. administration's obsession with war against Iraq may have as much to do with a desire to control Iraq's vast oil reserves as with its need to combat domestic deflation.

FEW analysts today would argue with the proposition that the world economy is weak and getting weaker in terms of immediate growth prospects. The United States economy, which was the engine of growth for the rest of the world economy for most of the past decade, continues to falter, despite the tax cuts as well as expenditure increases related to the so-called "war on terrorism". The European Union economies remain largely sluggish, while Japan's downward spiral appears to be unabated.

So systematic is the downslide in the major capitalist economies that there is now serious discussion in the international financial press over whether the global economy is entering an era of deflation of a kind not seen since the Great Depression. In fact it is true that the risk of falling prices is now greater than at any time since the 1930s. World trade prices in most important primary and even manufactured commodities have been low and are still falling. (The only exception is oil, the price of which varies daily with expectations of the likelihood of imminent war.)

In the U. S., deflation in goods prices has been evident since April this year. But even services - which have traditionally been seen as being immune to the problem of deflation since the prices of most services tend to be downward sticky - have shown much weaker price increases, which have not been sufficient to counteract the overall deflationary trend. Similar tendencies are evident for Europe, while of course in Japan deflation has been raging for several years now with no signs of recovery.

The facile perception that falling prices are "good for consumers", is still being voiced by some official policy spokesmen. But more and more economists, even those untouched by the insights of Kalecki and Keynes, recognise the basic problem with deflation in capitalism: that it reflects a slump in effective demand, substantial underutilisation of existing capacity, unemployment of labour and also depressed expectations that adversely affect investment decisions.

Deflation indicates downward pressure on profit rates, forcing firms to try continually to cut costs if they are selling in a market where prices are falling. This in turn has negative multiplier effects on the rest of the economy, pushing it into a downward spiral. As early as 1933, the economist Irving Fisher had pointed out the paradox that when individual firms attempt to reduce their debt burdens by cutting costs, this could unleash a vicious cycle of falling incomes and asset prices, and therefore rising real debt burdens!

In addition, falling prices tend to play havoc with financial markets as well, with banks and other financial institutions facing growing problems of liquidity and even solvency as their investments fail to make good as anticipated. The World Depression from 1929 onwards had its origin in output imbalances and falling prices, but it was most dramatically expressed in the bank failures and stock market crashes that made it public knowledge.

There are signs that a similar (if not so extreme) process of sluggish real economic growth accompanied by major problems in the financial sector, is already under way in Europe's largest economy, Germany. The major German banks are on the threshold of a financial crisis. In terms of share values in dollar terms, German banks in the past year have performed worse than those of any country except Argentina and Brazil. Central bankers in the rest of Europe are becoming concerned about the state of German banks and the risks their weakness poses to the whole financial system.

Even the U.S. economy is not immune to such pressures, especially as investors' expectations are already depressed and consumer confidence seems to be brittle and easily shaken, adversely affecting sales and therefore profits.

IN such a relatively worrying economic context, some observers have found it strange that the Bush administration is using up so much of its time, energy and machismo in fighting its most recently created bogey, Saddam Hussein, and not addressing itself to the problems in the U.S. economy which have international ramifications. But it could well be that the very moves towards war against Iraq are in fact the U.S. government's way of trying to deal with the economic problem as well.

Consider what history tells us. Wars have been - and remain - a classic way of diverting public attention from domestic problems and issues that governments are unable or unwilling to address effectively. But also, wars have typically been seen as powerful positive stimuli for economies that are suffering from unutilised capacity and unemployment. They create employment, increase aggregate demand because of enhanced public expenditure, and have positive multiplier effects. More recently, defence expenditure has been seen as playing a key role in productivity increases because of its impact on new technologies and their wider application.

With such experience to learn from, perhaps George Bush (or his advisers) would not be mistaken to believe that a dose of war, especially a war fought conveniently far away from U.S. borders and involving the latest technology with minimum U.S. human involvement, would be a positive economic stimulus that could guide the economy out of the recession and divert the threat of deflation.

But history may be an imperfect teacher in the current context. The economic realities of today are more complex and less susceptible to easy manipulation of the sort that allowed earlier wars to be so economically effective. To start with, the type of war that the Bush administration is clearly anticipating is one that will involve the minimum of use of troops, and therefore will certainly create less direct employment.

Secondly, the giant military-industrial complexes that power the U.S. economy and form an important part of George Bush's constituency, no longer have need for actual wars to keep them going and make them highly profitable; sufficient levels of public expenditure in these areas is adequate. This might explain why the Pentagon's bosses apparently have little enthusiasm for this planned war, with all its uncertainties.

Finally, then the immediate economic effect of such a war would depend upon how it impacts upon expectations. Of course, if the U.S. is able to defeat the Saddam Hussein regime in a relatively short time, install a client regime in its place and thereby acquire effective control over Iraq's oil reserves, this would clearly make investors happy. It would not matter then how much damage the war would wreak upon the Iraqi economy or how much devastation and slaughter would be inflicted on its people. If expectations turn buoyant in such a context, then the U.S. economy, and with it the international capitalist system, might well experience a recovery of sorts, however short-lived.

But if the war turns out to be longer and messier than anticipated, if it creates widespread unrest and possible instability in other parts of West Asia, if it involves snapping of trade routes or wide fluctuations in financial markets, then the outcome in terms of expectations is much less predictable and more likely to be negative. Such a war may then contribute to the wider economic downslide, rather than prevent it, much the same way the First World War indirectly contributed to the forces that eventually culminated in the Great Depression.

Ironically, the two World Wars also provide some idea of how the closures of wars can change the world economy. The First World War ended in triumphalism and revenge as expressed in the Versailles Treaty, imposing penalties upon losers and effectively denying the world economy the possibility of growth for the next two decades.

The end of the Second World War, by contrast, saw the Marshall Plan and U.S. involvement in the reconstruction and rebuilding of the economies of the defeated countries, which played an important role in the subsequent growth of the world economy over two decades.

To judge by its vituperative language over Iraq, and its callous attitude in Afghanistan after that recent war, the model for the current U.S. administration seems to be Versailles. This attitude of vengeance, bereft of any concern about the havoc being wrecked by globalisation on the poor all over the world, may more than anything else cause more serious instability and lack of growth for international capitalism in the near future.

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