Wednesday, Dec. 04, 2002

That Old Empty Feeling

By CHARLES P. WALLACE

The terrorists are hitting "soft targets" — holiday resorts in Bali and Mombasa — and they tried to take out an airliner with surface-to-air missiles. And Washington's preparations for a war against Iraq continue. What impact will terrorism and the looming conflict in the Middle East have on oil prices and the economic climate in 2003?

The global economy has displayed remarkable resilience in the face of terrorist attacks. Resort bombings have devastated local tourist economies but not world tourism. That won't change unless the bombings become far more frequent. Similarly, the effect of war in Iraq depends on whether the military action is brief and decisive or prolonged and inconclusive — and on whether the conflict spreads to Iraq's oil-producing neighbors. Recently, the Center for Strategic and International Studies in Washington, D.C. convened a conference of military, political and economic experts who formulated four scenarios and tried to assign probabilities to each. In most of the projections, the economic fallout was modest, but in the worst-case scenario — which is given a 5-10% probability — an invasion meets strong resistance, with chemical and biological weapons used; the conflict spreads to nearby countries and Iraq's oil fields are seriously damaged. Oil prices shoot to $80 a barrel — up from about $25 today — and remain at an average of $40 a barrel for two years.

Iraq produces 1.8 million barrels of oil a day, so a war will leave a large global shortfall. Saudi Arabia could bridge the gap, but not if the region erupts. "If oil prices go to $60 next year, there will be effects in every region and every country," says former Federal Reserve governor Laurence Meyer. "Nobody will be spared."

Most affected will be travel and tourism. Airlines will not only face higher fuel costs, but a falloff in passenger revenues similar to the one after Sept. 11. Gert Zonneveld, an airline analyst at WestLB Panmure in London, says British Airways expects passenger revenues to drop a devastating 25% in the first quarter if there is a war. In the second quarter, revenues would be down 15% and it could take another year to 18 months before they return to normal.

A short-term rise in oil prices will likely have a negligible economic effect. But a long-term spike, for a year or more, could trigger world recession. The good news: The economy is now in better shape to handle a crisis than it was at the time of the first Gulf War in 1991. Where the earlier Gulf War pushed an overheated economy into decline, now "we've already had a recession," says Robert DiClemente, U.S. economist at Salomon Smith Barney. "Companies have no inventory, they've slashed spending and have convalesced." If war comes in 2003, the global economy seems ready to fight back.