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ArchiveJanuary 2 2002

Storm or stability?

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Karina Robinson examines the international geopolitical and economic aftermath of the September 11 attacks on the US.

"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity..." Charles Dickens' immortal introduction to A Tale of Two Cities applies to a time of startling transformation following the September 11 attacks on the World Trade Center.

This is a new world where Russia has become part of the west, where the unexpected launch of a new trade round is a fait accompli, where China has joined the global trading community, where the US is now involved in global affairs, and there is a new emphasis on development.

It is also a world where the economic reality of recession is biting, where the biggest sovereign default in history seems likely, and the biggest company bankruptcy has taken place, while much of Africa continues to be mired in dire poverty.

The conspiracy of optimism on the economic front, with the majority of forecasters predicting an upturn in growth come the spring, appears unwarranted. Admittedly, many of the predictions are moderate. JP Morgan, for example, sees global growth of only 2.1% in 2002 - less than in 2000 when it was 3.1% - with a spring recovery in Europe and the US on the back of a stimulative monetary stance and the US fiscal push. It also says the bottom has not been reached yet with US consumer spending still to fall.

The problem with this scenario is that consumer behaviour is the least predictable of all economic variables. After all, more than 1 million people in the US have lost their jobs, yet consumer spending remains inexplicably buoyant. Also, with such a worldwide slowdown, it is not obvious where external demand is going to come from.

On the downside, disinflation is a spectre, with all central banks reaching the goal of price stability.

What this might mean for the business cycle of the past 20 years - one in which inflation rose, followed by interest rates, leading to a collapse in consumption - is a major change. If inflation stabilises at lower rates, then business cycles will have less peaks and troughs, argues John Lipsky, chief economist at JP Morgan.

"What will cause business cycle shifts are technological achievements and geopolitical events, more like the late-1800s, when you had the gold standard and price stability but acute boom and bust [because of those two factors]," he says.

In terms of geopolitical risk, the world looks both less secure and more secure than four months ago. On the one hand, the ability of Islamic militants to orchestrate an attack on the heart of capitalism is staggering and its proponents' willingness to die makes defence close to unattainable. On the other hand, "the west" as a concept of shared values has expanded to include Russia and, on certain issues, even China.

"It will be difficult for historians in a couple of centuries to know whether to start their 21st century histories with the fall of the Berlin Wall or September 11," says Martin Taylor, an international adviser at Goldman Sachs. "What is most important is the change in the geopolitical world but we don't know whether it is durable or not."

Changes for emerging markets

A number of countries with emerging market economies have seen big changes, namely Russia, Turkey, Pakistan and arguably China. Russian President Vladimir Putin's decision to ally himself with the US marks a watershed in the transformation of the formerly communist state.

"What is particularly interesting is that Mr Putin was ahead of the rest of the political cabinet. In record time, he was firmly on the side of the US. It is a sign of his underlying strength that he feels unconcerned about opposition from people lower down the scale," says Augusto Lopez-Claros, chief Russia economist at Lehman Brothers and a former IMF representative in Moscow.

Russia will get some dividends from the west, including a say of some sort in Nato decisions, increased foreign investment as perceptions of political risk diminish and influence as an emerging oil power by presenting itself to the West as a reliable, alternative supplier to Opec, says Mr Lopez-Claros. It is the world's number two oil exporter after Saudi Arabia, a crucial position when the continuity of the current Saudi regime is not assured.

Meanwhile, Russia is in talks to join the World Trade Organization (WTO) and the concept of "a common European economic space" is starting to be fleshed out. The latter is the idea of a free trade area between the EU and Russia, which was given impetus by the events of September 11, and the perception that Russia is part of the West, as opposed to the East - something that Tsar Peter the Great visualised a few centuries ago.

Turkey's position has also been strengthened as a result of September 11. Its key position as the only Muslim member of Nato has been reinforced. The US sees it as key in fighting terrorism, for example in leading peacekeeping troops in Afghanistan as a Muslim - albeit officially secular - state. In August 2001, the chances of Turkey receiving a fourth bail-out in four years were not good. "Now Turkey is the IMF's largest borrower, an impressive achievement for a small country," says Mr Lopez-Claros, ironically.

As for Pakistan, it has seen the clearest reversal of fortune of any state bar Afghanistan, going from pariah to best friend of the US. General Parvez Musharaff's illegal accession to power and the exploding of a nuclear device lie forgotten. Instead, at the end of 2001, the IMF gave Pakistan a $600m loan, even though the country has never completed any previous IMF agreement, while the Paris Club rescheduled $12.5bn in debt.

China's involvement in the world, as epitomised by its joining the WTO, was given a political push by the attack on New York. There has been an upturn in relations formerly marred by the US bombing of the Chinese embassy in Belgrade and China's forcing down of a US spy plane. Not only has China tied its economic fortunes more closely to the developed world, it has also tied its political fortunes - with its own fears of homegrown Islamic militancy one of the undoubted impetuses behind the move.

Argentina, which looks as though it may be the biggest sovereign default in history, was affected by September 11 events only in what might be termed a more collegiate atmosphere among top policy makers. This means a new way of working out crises seems likely but will come too late for the Latin American country. "The disorderly process in Argentina means we are starting to see the international community come to alternative proposals for debt resolution," says Mohamed El-Erian, manager of the PIMCO Emerging Markets Bond Fund and a former IMF official.

The World Bank, the IMF and the US administration are studying possible formulae.

Relations across the Atlantic

As important as the September 11 effect has been on most of the countries above, what has happened to the EU and the US is even more so.

"Osama Bin Laden has done us a big favour as he put into reverse what was developing into a serious rift between the US and Europe over a number of issues like Kyoto, Qatar and US disengagement," says one former European politician who asks not to be named.

Whether the shrinking of the Atlantic Ocean will continue is one of the major incognita looking forward. As the sense of shock and comradeship from September 11 fades and the Taliban regime collapses, the many stumbling blocks in the relationship are beginning to resurface.

The US, after all, has not said it will now sign the Kyoto Protocol on climate change, while the same protectionist instincts may prevail in the EU and the US as negotiations progress on a new trade round. But, assuming these can be dealt with, much more detrimental for the relationship would be a US decision to carry its anti-terrorism campaign into Iraq or other countries. That, for its allies, would be taking its new engagement in world politics too far. Although pundits argue the incursion into Afghanistan marks the end of the Vietnam syndrome - the US public now accepts casualties in distant wars - it is doubtful the Europeans would be in agreement with this extension of the war. Let alone the Chinese or the Russians.

Another "benefit" of the terrorist attacks was that central banks pulled together to loosen monetary policy, and the US government put together a hefty stimulus plan. At the time of going to press, the plan was still stuck in Congress amid political manoeuvrings, but its very existence was already having an effect.

The negative scenario is if forecasters are right and the economy turns up in the spring, then a fiscal hand-out will provide an excessive cyclical boost.

Euro contribution

The outlook for Europe, despite squabbling at the Laeken summit last December, looks better on the back of the physical launch of the euro. For the first time in decades, member states cannot use competitive devaluation and beggar-thy-neighbour policies to get out of a slowdown.

"If you can pull off a single currency, you can pull off anything" says former Member of the European Parliament John Stevens. "It was a comedy of errors to get there."

Nor is the currency's weakness, the subject of much breast-beating since its launch, a worry. "The problem the euro will have is when it is strong, not when it is weak," says Goldman's Mr Taylor, noting that Germany suffered when the Deutschmark was strong, making exports less competitive.

Europeans also have to tackle the issues of labour market reform, creating a truly single market and dealing with the common agricultural policy. The latter looks impossible in a French election year. There may also be a relatively public battle over whether European Central Bank (ECB) president Wim Duisenberg steps down to allow Jean-Claude Trichet, head of the Bank of France, to take over. The Dutchman has shown little willingness to stick to the agreement that was reached when he was nominated.

There will be increased tensions between European finance ministers and the ECB on the back of slower growth. In theory, if governments stick too strictly to the Maastricht targets on budget deficits and public debt, deflation is a possibility. In practice, this should not be a worry because "unlike the Bank of Japan, the Europeans [central banks] haven't forgotten how to inflate", says Mr Taylor.

Recession in the east

Japan, the world's second largest economy, continues to be caught in a long recession. A recent poll by Japan's cabinet office revealed public confidence at lows only comparable with those seen at the end of the US occupation.

"Japan will never grow again. Any 10-year forecast is 0.5% GDP growth but it is not clear where that is coming from," says Rudi Dornbusch, Ford professor of economics and international management at MIT, the US university.

Even assuming a slightly more optimistic scenario, this means the prolongation of Asia's slump. There is a concern that if Japan persists in trying to send the yen lower - it was at a three-year low to the dollar in mid-December - this might antagonise and harm its neighbours.

On a political front, though, Japan's decision to dispatch logistics support for the Afghan war was a major step forward. "It is becoming a normal state," says Terry Taylor, president of the International Institute of Strategic Studies (IISS) in Washington.

New plans to tackle poverty

On the development front, September 11 may be seen as a watershed. As former Mexican president Ernesto Zedillo prophetically said in a United Nations-sponsored report on financing development before September: "In the global village, someone else's poverty very soon becomes one's own problem: lack of markets for one's products, illegal immigration, pollution, contagious disease, insecurity, fanaticism, terrorism."

The report also noted that the challenge was to persuade industrial countries that aid expenditures were a vital investment in building a more secure world. A UN conference on development in the spring, to be held in Monterrey, Mexico, may prove more productive than anticipated, despite Mr Dornbusch arguing the UN is useless at development. "It will say you have to distribute more money but it has no money. One would have to have the equivalent of a Marshall Plan from Europe, Japan and the US," he says.

In December, UK chancellor Gordon Brown called on the industrialised world to deliver a Marshall Plan for the developing world. Finding the will to deliver the equivalent of $300bn in today's money, as the US did for post-war Europe in 1947, is not easy. But the mere fact that it is a serious policy initiative proves the world is a different place.

It stems partly from the acknowledgement, brought forth with murderous impact, that poverty is an impetus to further terrorism. "One of the lessons from Afghanistan is that you ignore these festering sores at your peril," says the IISS's Mr Taylor.

"The opportunity to boost international solidarity and multilateralism is there. Just look at Gordon Brown's recent speeches about the need to put together a Marshall Plan to aid poor countries," says Mr Zedillo.

He is, however, fearful that momentum cannot last. "I am afraid, however, that this train can leave us behind too soon, certainly in less than two years, if relevant decisions are not undertaken rather quickly. Bold commitments will be needed in the Financing for Development conference. The big question is who will lead the way towards the needed agreements?" he says.

World trade

What will have a larger and more immediate impact on the developing nations is what happens to global commerce. World trade grew 12% in 2000, the best in at least 20 years. But 2001 estimates are assuming at most 2% and, with the slowdown, 2002 will be even worse.

However, the launch of the Doha Development Round brings hope. Admittedly, to get fast-track negotiating authority from the House of Representatives, the US government was forced to make potentially damaging concessions to a host of industries. Nonetheless, it is worth remembering when focusing on what can go wrong, that before September 11 the chances of even launching a trade round looked scarce.

"The US is more international and it understands it needs partners. But the US is not the opponent to rout [in trade talks]. It is agriculture and that is Europe and France and [EU[ enlargement," says Mr Dornbusch.

Unquestionably, the geopolitical balance has changed. The question is whether this new world will last or whether old patterns will reassert themselves; will we have storms or stability?

If nothing else, the resilience of the liberal economies and the way they recovered from September 11 is a lesson to people who think a terrorist attack will deal a mortal wound to the industrialised world.

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