Once the organized fighting in Iraq ended—sooner than most dared to hope and without weapons of mass destruction being used—the relief many managers felt gave way to anxiety. Would anger over the U.S. decision to prosecute the war without broader international agreement lead to economic reprisals against American companies? And with the recent SARS outbreak underscoring the vulnerability that comes with the increased connectedness in a global economy, could such reprisals depress world markets still mired in a slowdown?
"At a recent conference in Europe, I heard anecdotal evidence that negative feelings toward the U.S. are costing American companies, particularly consumer goods companies, business," says Robert Hormats, a vice chair of Goldman Sachs (International) who has held important trade and diplomatic posts in Republican and Democratic administrations. "In the Middle East, anger against the U.S. has been in evidence for a while," but, despite doubts about several aspects of U.S. policy, little hostility toward the U.S. exists in Asia or Latin America. Overall, damage to American business has not been significant. "Still, in a downturn, you don't want to lose any potential revenue."
| Countries will do what's in their interest whether they are angry at the U.S. over Iraq or not. |
| — Robert Hormats, Goldman Sachs |
Hormats is more worried about the long-term, macroeconomic consequences of U.S. fiscal policy than any near-term, microeconomic impact of the war or political friction on specific industries or companies. Unlike some analysts, he doesn't find a federal budget deficit of $300 billion to $400 billion—a result of economic weakness, increased defense and homeland security spending, and tax cuts—particularly troubling this year. When considered as a percentage of GDP, a deficit of this magnitude is manageable for a year or two, he says. Besides, with few companies looking to add inventory or build capacity, there's little competition for capital from the private sector.
But "down the road, assuming we begin to enjoy more growth, will we want the federal government to accrue big deficits in 2005, 2006, 2007, and 2008?" Hormats asks. "Good Keynesian economics says that when an economy is healthy, the government should run surpluses, not deficits, so that it has the flexibility to spend more money or cut taxes to stimulate the economy to revive growth in the event of a future downturn. Had we been running large deficits in the late 1990s, this administration would have had a lot less fiscal flexibility to cut taxes to stimulate the economy and spend more money for defense."
Among his concerns is a possible retreat from multilateralism. "The administration's general view during the war was that it could accomplish U.S. goals with a small coalition. And it did so with great success. However, such an approach doesn't work as well for other challenges. On most issues relevant to business—negotiating trade issues, combating the laundering of drug money, trying to catch terrorists, or dealing with SARS—you need broader coalitions."
Through an economic lens
In general, "countries will do what's in their interest whether they are angry at the U.S. over Iraq or not," Hormats continues. "The gray area, where geopolitical tensions could spill over, is trade." In the current trade negotiations, tensions between the U.S. and Europe on agricultural issues in general, and particularly on those involving genetically modified food, have been at the center of broader trade disagreements. "The strained relations caused by the war make the resolution of such issues that much harder."
Hormats believes that businesses should be working in Washington to actively encourage the administration and Congress to build broad coalitions. "This is not multilateralism for multilateralism's sake," he emphasizes. "It's not ideological—it's pragmatic. You need broad coalitions for international trade and commerce to work smoothly. You also need to have the framework provided by multilateral institutions such as the World Trade Organization, the International Monetary Fund, and the World Bank. If you don't support the work of those organizations, they won't be around to help you when you need them most. "There are also times when you need to threaten to do things unilaterally or in small groups in order to get broader cooperation. For example, to induce the European Union to be more flexible in trade negotiations, the U.S. has, on occasion, threatened to negotiate regional arrangements with Asia or within the Western Hemisphere that would put Europe at a disadvantage."
Despite some signs of increased economic nationalism in various parts of the world in the aftermath of the war in Iraq, "the American consumer is generally the consumer of first and last resort to much of the rest of the world," says Hormats. "That gives the U.S. a lot of leverage. But by making too many demands on other countries, we could end up making them less willing to accommodate us." A negative attitude toward global economic cooperation could also make it more difficult to solve the problems of slow growth and overcapacity that have plagued world markets since the technology bubble burst.
| You need broad coalitions for international trade and commerce to work smoothly. |
| — Robert Hormats |
In late 19th-century America, Hormats says, a frenzy of railway construction created an investment-led boom. When the railway infrastructure became overbuilt—there was too much capacity and too little traffic—an investment bust followed: Many of the original investors in the railways lost their money, and for several years there was little new investment, even though interest rates declined sharply. But time, consolidation, and acquisition of stocks and bonds of railway companies by new investors ultimately revived the sector. The current situation is very similar, says Hormats: "Booms in the information technology and telecommunications sectors, followed by a collapse. There's been little new investment in those sectors, or many others, despite low interest rates. There's still a lot of overcapacity, and still a lot of debt on the books of the firms that built the overcapacity; both will take some time to work off."
But Hormats sees things improving slowly over the next eighteen to twenty-four months, as a "second-mover phenomenon" occurs in the tech sector: "There'll be better values; the people who buy companies at these bargain prices will have more cash and, in many instances, will be better managers than the original owners. And because of industry consolidation, many of the surviving companies will be much more efficient. So you'll gradually see much of this excess capacity get used up. The tech boom is far from over; science, technology innovation, biotech research, and the use of the Internet continue to surge ahead."
How can companies prepare for the medium-term future? Hormats's recommendations:
- Strengthen your balance sheet.
- Enhance productivity, especially by investing more in advanced technologies and in people. The better trained your employees are, the better off your firm will be when the economy comes back.
- Continue to develop opportunities. "Many of the CEOs with whom I talk take the view that the best time to get business and increase market share is when things are sluggish," says Hormats. "That's when you can spend more quality time with clients and customers, and develop a better understanding of their needs. When things do pick up, you're in a far better position to do more business with them."
"I'm not saying bet the farm with new capital spending," Hormats cautions, "nor am I arguing for new capital investment for its own sake." It's still a very risky environment, and you've got to be very agile if things don't go well. But there are examples to take heart from, he says. "In Japan, which has been in deflation for some time, firms like Toyota and DoCoMo have done very well in the past five years, employing advanced technology and investing a great deal in research."