There is considerable speculation on the likely economic impact of the conflict in Iraq. Consumers and companies alike are under close scrutiny, and many are discouraged by what they see.
The problem is, the situation is just too uncertain to make such an assessment. How long will the conflict last? Will oil infrastructure be damaged? Will the fiscal costs spiral out of control? No one knows, which means that it would be just as wrong to assume the worst as to assume the best.
Consider the situation with consumers. U.S. consumer confidence has declined to its lowest level since October 1993. That sounds grave, but consumer confidence has never been the greatest predictor of consumer behaviour – U.S. consumer spending was growing strongly during 1993-94 despite weak consumer confidence.
Consumer disposable income is growing by more than three per cent per year in Canada and the U.S., after adjusting for inflation. High oil prices were sapping spending power during the winter, but the first tangible effect of the war has been to put that gas money back into consumer pockets.
Gloomy forecasts assume consumers will save their income until the economic outlook improves. Many economists said the same thing in the wake of 9/11, believing that cutbacks in travel spending would lead to a recession.
Consumers cut back on travel, true enough, but spent the money on other things instead. This time, in addition to travel, the concern is with soft car sales.
Perhaps U.S. consumers will buy fewer cars this year, but past experience shows that we should be open to the possibility that they will spend on other things instead – especially when their weak confidence reflects fear of war and terrorism, which tends to boost spending on the home.
Consider the situation with companies. Profits have begun to recover, and evidence began to accumulate in the second half of 2002 that investment spending in equipment and software had turned around in response. In the U.S., we saw six quarters of declines in investment spending on equipment and software, starting in late 2000. But for the past three quarters positive growth has returned, and non-defence capital goods orders have stabilized.
Nevertheless, it seems natural to postpone major investment decisions in the current situation. Investment decisions are meant to prevail for several years, so postponing them for a month or two will make little difference to the big picture. When we see the economic data for March-April, there is likely to be evidence of such a pause in spending. But the corollary to this analysis is that those investments are likely to be made later this year, after the war.
The bottom line? The uncertainty associated with war is undoubtedly putting a dent in economic growth. The longer the war persists, the more this uncertainty will weigh on economic decisions and the deeper – and more lasting – will be its effect on the outlook. So far, however, it appears that the underlying situation remains positive, suggesting a return to strength after the war.
(Poloz is vice-president and chief economist for Export Development Canada. He can be reached at spoloz@edc.ca)
