The Interrupted Recovery
by Robert W. Bradford

2003 started out looking like a fine year of recovery from the 2001-2002 recession. In January, employment, productivity and retail sales pointed to 2003 being a much, much better year than 2002 for most businesses. Unfortunately, the specter of war arose, and uncertainty once again caused the businesses and consumers who were fueling the nascent recovery to pull back. We spent February and March in a "wait and see" mode, worried that we would go to war, and then worried that a protracted war could wreak serious havoc on the economy.

There is no question that the war in Iraq has had negative consequences for the US economy this year. We only have to look back to 1992 and the end of Desert Storm to see what this effect is likely to look like. There are, however a few differences, and you will want to be aware of these as you plan for this year and the years to come.

First, the economic effect of Desert Storm came from a number of sources. To begin with, 500,000 reservists were called away from their productive work in the US to duty in the Persian Gulf where their work — while extremely important - did almost nothing to produce goods and services in the US. Secondly, productivity took a big hit from the distractions provided by the heavy media coverage of the war. Thirdly — and finally — uncertainty about the war's outcome and costs caused consumers and businesses to hold back on their purchases.

At least superficially, Operation Iraqi Freedom had very similar economic effects. The first effect — of taking 200,000 reservists out of the productive workforce — should be distinctly smaller today than in 1992, because of both the smaller size and shorter duration of the conflict. The second effect — distraction reducing productivity — may be the same or slightly greater in this conflict, because, although the total operation was shorter, the engagement of ground forces was longer and more intensely covered in the media. The third effect — uncertainty and fear depressing spending — may be much, much greater. This effect is probably magnified because the Iraqi conflict in 2003 lies against a much more ominous backdrop of post-9/11 concern about terrorism, US relations with the Middle East, and an already weak economy.

The relative state of the economy is an important difference between 1992 and 2003. The economy in 1990-1991 was actually weaker than in 2001-2002. In the last quarters of 1990, before Desert Shield had started, the economy had already shown back-to-back declining quarters and a net real GDP growth rate for the year of —1.26%. By comparison, real GDP growth in 2002 was 2.91%, which is not too far below the 50 year average.

Another important difference between 1992 and 2003 is the prospect for further conflict. In 1992, the Desert Storm coalition had a simple mandate to eject the Iraqis from Kuwait, while in 2003, the coalition objective was to topple Saddam Hussein and ensure Iraqi compliance with previous treaties and UN resolutions — a much more ambitious and possibly open-ended mission. Other states in the region — Syria and Iran — as well as states outside the region, like North Korea, appear to fit the bill for further action, if the Bush administration wants to continue extending the use of US military might in pursuit of anti-terrorist policy.

Because of the uncertainties around these key points, we need to look for clues that the economic impact will be stronger or weaker than in 1991. First, do we have clues that extended commitment in Iraq will cause undue strain on the US economy? Second, will our actions in Iraq disrupt the world economy? Third, will the rebuilding of Iraq stimulate economic activity in the US or abroad? Finally — and perhaps most importantly — when will we see signs that US consumers and businesses have decided that it is time to get back to work, beginning the slow but steady move back to more normal levels of spending and investment?

A close look at the 4th quarter 2002 numbers shows that this move back to normalcy had already begun. Notably, consumer spending picked up considerably despite pervasive gloom in most media stories about the economy. In addition, investment picked up nicely in the last quarter, while inventories remained stable. US exports were given a boost by a weakened dollar, and unemployment — while higher than in the late 1990's, was still well within the range of the norm for the mid-1990's.

Low interest rates have created a boom for construction and bank refinancing — but we should not expect this to persist. Indeed, if your industry relies on construction as a driver for sales, you should prepare to weather a very tough reaction to increased rates, when and if they come along.

For manufacturers, the picture is less rosy. Capacity utilization, while up marginally, is still quite lackluster at 75.4%. This is likely to have a serious impact on pricing and margins for companies that do not have strong strategies to target specialty customers, as the siren song of commodity-driven volume is never so alluring as during a recession.

Prices will show some spiking in the first and second quarters, driven mostly by war-driven speculation and fear driving up prices on commodities like oil. Indeed, these fears had already hit the Crude Materials Price Index with a whopping 9.3% quarterly increase in the 4th quarter, and we can expect to see increases in Producer Prices following close behind. This is not all bad — a little inflation can stimulate economic activity — but we need to be careful of much higher inflation and — much more likely — higher interest rates that may come up as the Fed seeks to stave off that inflation.

While the Composite Leading Indicators do not indicate a recession in the coming year, it's pretty safe to say that you will likely notice a hiccup in 1st and 2nd quarter activity driven by the war. We recommend paying close attention to the impact the war will have on demand in your markets for the short term, and serious consideration to fundamental changes in strategy warranted by the shifting global situation in the long term.

Robert Bradford is President of Center for Simplified Strategic Planning, Inc. He can be reached via e-mail at

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