Thu, Nov 22, 2001 page19

• After the 1990s boom, the competition's dwindling

  Added costs of doing business in wartime are a ball and chain and the economy can't run as fast as it did before

  • By Caroline Baum / BLOOMBERG
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  The day-to-day developments of the war in Afghanistan and the preoccupation with whether the markets know something we don't know (recovery ahead) have deflected attention from the big macroeconomic question of the day.

  To what extent will the changed landscape, post-Sept. 11, affect the US economy's rate of growth? Potential growth is circumscribed by the growth rates of productivity and the labor force. The labor force grows on average 1 percent a year. And productivity growth -- well, that's the big question mark for the US economy going forward.

  

  Marion Legare, 39, left, Joseph Franklin, 54, center, and Charmaine Burin, 33, are shown on Monday at the main office of Coalition for the Homeless where they receive assistance. A lack of affordable housing and the economic downturn that worsened after Sept. 11 have resulted in an all-time high of nearly 30,000 homeless adults and children in New York shelters.

  PHOTO: AP

  To the extent that the 1990s benefited from the end of the cold war, globalization, deregulation and restructuring, the next decade may see a reversal of those trends, according to Neal Soss, chief economist at Credit Suisse First Boston.

  "Globalization was about taking politics out of international commerce, and deregulation was about taking politics out of domestic commerce," Soss says. "These forces will be blunted, if not reversed, to deal with the collective enterprise called war."

  In a recent report, Soss discusses four key forces "that helped suppress business cycles in the last two decades," which saw a nine-month mild recession of 1990-1991: globalization, deregulation, just-in-time inventory management and geography agglomeration.

  The benefits of globalization are obvious, except to those who trashed storefronts at the World Trade Organization meeting in Seattle two years ago. Global competition and the proliferation of free-trade zones restrained inflation and boosted productivity, providing consumers a wide array of quality goods at the lowest possible price. The events of Sept. 11 reversed the trend in open-door policies.

  "Immigration policy is already under review, and flows of merchandise across our borders will, at the very least, be subject to great scrutiny and episodic delays," Soss says.

  That has implications for inventories. If just-in-time inventory management allowed companies to hold smaller stocks of raw, processed and finished materials, just-in-case means more bloated inventories and higher costs for corporations. For the same output, businesses will now need to hold higher stocks than they did before to ensure smooth business operations, now that border delays and time-consuming, stepped-up screening procedures are part of everyday life.

  Working capital tied up in inventories is unavailable for more productive uses. And while the added cost of doing business is currently coming at the expense of profits, not inflation, that's not likely to be the case when the pace of economic activity improves.

  The terrorist attacks have sent the process of deregulation into reverse. The federal government is now intervening in the airline, insurance and banking industries, Soss says. "The new Office of Homeland Security is as likely to have at least as profound an effect on the structure of our society in the decade ahead as the Environmental Protection Agency did a few decades back."

  Security versus freedom: the eternal trade-off. War tips the balance in favor of security, which may be good for our personal well-being (fewer of us will die), but not our economic well-being (the US will be poorer as a nation).

  Before Sept. 11, homeland security was free. Now it costs money. That's the antithesis of productivity, which is getting more for less (or something for nothing).

  Soss's final point has to do with geography. The Internet was supposed to make physical location -- working at the company's headquarters -- passe. Instead, "the economy chose to agglomerate, with two-thirds of Americans living within 160km of our three salt-water coasts,'' he says.

  If the terrorist attacks prove not to be a solitary event, it will require greater geographic dispersal of economic activity, complete with added costs, he says.

  Okay, you're asking, so what does it all mean? It means about a trillion dollars over 10 years, that's what.

  Soss outlines three scenarios for productivity and potential growth over a 10-year horizon. The difference between the pre-Sept. 11 scenario and the worst-case scenario, wherein productivity growth is permanently reduced due to the allocation of capital to unproductive uses (security and war), is about US$1 trillion, according to his projections.

  Think of the added costs of doing business as a permanent ball and chain. The economy can't run as fast as it did before.

  There's a middle course as well, the one advocated by Federal Reserve Chairman Alan Greenspan. In this model, productivity growth suffers a one-time hit to the level. After the higher costs are absorbed, the rate of growth of productivity resumes its pre-attack pace.

  In other words, the level of productivity dips, but the slope remains the same.

  "That's the party-line view," Soss says. "I'm always suspicious of the party line." In both the pre-Sept. 11 and Greenspan scenario, potential GDP growth is 3.6 percent. In the worst-case scenario, it's 2.8 percent. That 1.2 percentage point difference is significant and has serious implications for stock prices, interest rates, the federal budget -- in other words, just about everything traders and investors care about.

  It's a big question. The answer is largely unknowable.
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