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PRICE OF WAR

War begets uncertainty. Financial markets have reacted favourably since the war in Iraq began. Speculative elements that drove global oil prices up to almost $ 35 per barrel have also disappeared, and oil prices have dropped to slightly over $ 30. While developed countries are much less sensitive to increases in oil prices than in the Seventies, thanks to substitution in production and a switch away from manufacturing to services, an oil-price hike does spike world economic growth. For example, the International Monetary Fund estimates suggest that a $ 5 increase in global oil prices shaves off 0.3 per cent from world gross domestic product growth. However, Iraq produces only 2 per cent of global crude. Even the Persian Gulf region produces only 40 per cent, alternative sources of supply having been found, despite strikes in Venezuela having crippled supplies from that source. Not only is the Organization of Oil Exporting Countries less of a cartel, unlike past instances, but Saudi Arabia has also indicated that it will increase supplies to make up for any shortfall in supplies out of Iraq. The direct impact of the Iraq war on the global economy through oil price increases is thus limited.

Uncertainty also surrounds post-war reconstruction. Clearly, American motives for the war have a lot to do with controlling Iraq’s oil supplies. Squabbling has already broken out between the expected victors about post-war reconstruction spoils, and there are suggestions that non-American firms be excluded, especially French ones. Once post-war reconstruction is over, there is every reason to expect oil prices to drop to $ 20 per barrel. However, the longer the war takes (and Mr George W. Bush has now admitted it is unlikely to be that short), the more the market’s initial euphoria will disappear. While estimates are not precise, there is a range of between 30 billion and 90 billion floating around for the war alone. This will have to be borne singly by the US. Coupled with Mr Bush’s tax-cuts, this will drive deficits to dizzying heights, unless the even more unpopular option of rolling back the proposed tax-cuts is adopted. Not surprisingly, the US has not stuck out its neck on its own contribution to post-war reconstruction. Collateral damage to the world economy is therefore likely to be much more than Mr Bush or his advisers appreciate, and shock to the economy of the United States of America will be no less severe. In international diplomacy, the US may think that other countries ride free on its initiatives. But as the current account deficit shows, the US economy has been free-riding on savings from other countries. That uni-polarity will certainly change.

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