Terror times eight: TIE asked an important international strategist to list, beyond terrorism, the major looming threats to the international economy - International Economy

International Economy, The, Nov-Dec, 2001 by Daniel K. Tarullo

Some consequences of the September 11th terrorist attacks are near certainties: The multi-front campaign against terrorism will be the centerpiece of U.S. foreign policy in the foreseeable future. An already shaky economy has been tipped into recession. The American psyche has been traumatized. Beyond these basics, little is yet clear. Will the campaign against terrorism provoke a fundamental change in how key nations assess their interests and formulate their policies, or will it simply accelerate trends and tendencies that were already in evidence? Will the United States and global economies bounce back after some period of uncertainty, or will a significant "security premium" be effectively imposed on most economic transactions, resulting in sizeable cost increases that retard growth indefinitely? Will Americans respond by trying to close the country's doors, or will they commit to greater international cooperation against common threats?

With all these unknowns, it is exceedingly premature to predict whether the events of September 11th will, a half century from now, appear as a watershed in American history, much less the nature of such a watershed. In the midst of our grief over the loss of life and our sense of everyday security, we do well to remember that the United States continues to have a range of global interests. Though they may have receded from the consciousness of top policymakers and mass-market commentators, they are still important. They will move front and center again someday. Even as the nation responds to the fact and threat of terrorist attacks, we must pay heed to these risks and opportunities, lest they too catch us unawares.

The aftermath of the terrorist attacks has been a grim reminder that security developments can dramatically affect economic performance. But causation can move in the other direction as well. That is, long-term economic trends, both favorable and unfavorable, can themselves create foreign policy challenges and security crises. What follows is a list, in no particular order of likelihood, of eight latent foreign policy problems arising from economic developments. Because most of these longer-term concerns are more likely to materialize in a prolonged period of sub-par economic performance, they are very much related to the immediate question of how the world will change in reaction to the terrorist attacks.

Deterioration of South American Economies. This is perhaps the most obvious item on my list, but no less important for all its obviousness. Argentine and Brazilian economic difficulties of the last year or two have already revealed how conditional the embrace of market-oriented economic policies has been in much of South America. The admirable resolve of those countries to overcome rampant inflation in the early 1990's does not necessarily convert to a commitment to maintain austerity policies in the face of disappointing growth. To the contrary, if the policies preached by the United States and the IMF are not seen as promoting equitable growth, they may be abandoned. Further, there is a risk that some members of the middle and working classes may associate liberal democratic values with the market-oriented values of the "Washington consensus" and reject both.

A Collapse of World Energy Prices. Possibilities that the Afghan war may spread westward or that a revolution may occur in an oil-producing nation suggest that the biggest short-term oil risk may be that of vastly higher prices. But if these unwelcome political contingencies are avoided, oil prices are as likely to collapse as rise. At first glance this may seem like cause for celebration, rather than a harbinger of problems. But there is a difference between prices that are low within the range of prices that has prevailed in recent years, and a collapse of prices below that range. Depressed prices would, of course, most likely occur against the backdrop of a recession that severely limited demand for oil and natural gas. Thus the good news for consumers would be more than offset by unemployment and falling incomes. At the same time, the revenue declines for Middle Eastern energy-producing states would seriously threaten the stability of the already vulnerable regimes of Saudi Arabia and some of the Gulf states. By spreading their oil wealth around their countries (and, to some degree, the region) those states have thus far held at bay both fundamentalists and democracy advocates. Without the wealth to do so, this fragile situation may come unglued, with potentially severe consequences for regional stability and oil supplies.

Financial Collapse in Japan. Japan has drifted in and out of recession for a decade. Several times during the Asia crisis, the Japanese financial system seemed in danger of collapse, but was held together with some patchwork policy measures and a dose of luck. We have now lived with these risks for so long that there is a tendency to downplay them. Yet the banking system is still burdened with so many trillions of yen in bad and questionable loans that it is not clear the system as a whole is solvent. The high levels of Japanese government debt constrain its ability to bail out the banking system. In the event of an extended worldwide recession, a collapse could not be ruled out. The economic consequences of the period before and after a collapse could themselves be serious, as Japanese banks and companies repatriated assets held abroad in order to meet their liquidity needs. The security repercussions could be equally severe if, as seems likely, Japan turned further inward, leaving a regional vacuum once occupied by a strong American ally and the world's second largest economy.