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Assessing Geopolitical Risk in the Global Economy

Speakers: Fareed Zakaria, editor, Newsweek International, and Richard N. Haass, president, Council on Foreign Relations
Presider: Alan Murray, assistant managing editor and columnist, Wall Street Journal
March 10, 2005
Council on Foreign Relations

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Council on Foreign Relations
Corporate Conference
New York, N.Y.

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ALAN MURRAY: Please. Everybody, please. I'm sure you've already done this: turn off your cell phones, turn off your Blackberries. No unusual rings during the session. I'd just take a moment to remind all of you that this is a completely on-the-record session. You can take anything these gentlemen say and do anything you wish with it.

RICHARD HAASS: Except take it seriously. [Laughter]

MURRAY: I'd take it seriously. I don't think we need to do much in the way of introductions. You know both of these people: Richard Haass, who is the president of the Council on Foreign Relations, and Fareed Zakaria, who is the editor of Newsweek International, authors of— between them probably have more than a dozen books and they're certainly the perfect people to address the topic this morning, which is assessing global risks.

Last night we got a fairly sanguine view of the global economy; now comes the tough stuff. We're going to talk for about 30 minutes among ourselves, then we'll open it up to questions. And I'm going to start by asking the two of you— you can flip a coin to see who goes first— to name what you think are the top three global risks that we face right now.

HAASS: Let the guest speak first. [Laughter]

FAREED ZAKARIA: Well, thank you. It's a pleasure to be here as always. Look, I think what I would focus on is political events and political risks because my general feeling is that markets are pretty good at factoring economic information; that markets discount various economic data pretty well. Not perfectly always, but, you know, if interest rates are going to rise, that has been taken into account in some way or the other. What markets are not good at doing is factoring political risks in and factoring political events in, and that's when you tend to see the sharp drops and rises.

Along those lines, I'd say the single biggest political risk remains, I think, the threat of a major terrorist event in some major capital or place like that around the world. I think it's in some way strange that it hasn't been— [Berkshire Hathaway Chairman] Warren Buffet has often said that he finds it rather strange that it doesn't get factored in more often. But even though I am generally more sanguine about the state of this problem of radical Islam and its violent offshoots, I think the reality of terrorism today is that the math— is that small numbers of people can do very bad things, and you don't need a large number.

Now, the specific problem I'm actually worried about is that even though the Iraqi elections went well, Iraq still remains a very significant security problem, and the most dangerous part of that is that you have a small group of radical Islamists— [terrorist leader Abu Musab al-] Zarqawi running the operation— that are based in Iraq and that are training people. The— increasingly, we learn that many of these people come from Europe. There have been people in Fallujah arrested with French passports. There have been people arrested in France who are about to go to Iraq. So to my mind, the great danger here is these people go into Iraq, get trained, infused with extra-special ideology, if you will, and come back and are very difficult to detect on the radar screen because they have EU [European Union] passports. They can move freely. They do not have a background. Many of these people are very young. They do not have a background of radicalism or terrorism. So I'd say that's No. 1.

The second one— and I think I'm going to stop at two— is the China-Taiwan [issue]. I think that it has always been considered a problem that will be solved rationally in due course, will be kicked down the road. And I don't know about that. I just get the sense that China is rising in every sense of the word. With economic power comes political confidence and desire to assert itself. And when I go to China, what I'm struck by is how dazzling the economic progress is and how intensely nationalistic the people are increasingly becoming. You go to Shanghai and talk to Shanghai yuppies at Starbucks, and they sound exactly like yuppies in Seattle and New York, until you get them talking about Taiwan or Japan or sometimes the United States, and on those three issues, they are intensely nationalistic, often virulently so.

And it does remind one of what one read about Germany in the early part of the last century: rising power, infusing people with a great deal of nationalism, and that nationalism being directed toward the neighbors and border disputes it has. So if you noticed recently, even though Taiwan has been more accommodating than ever before on the China-Taiwan issue, the Chinese are now passing a law which in effect says, "Even if you think about seceding, we reserve the right to take all necessary means," et cetera, et cetera. They've recently told Australia that it should rethink its security ties with the United States, because this might lead to a confrontation with China. There's a strange kind of saber-rattling going on, which doesn't make a lot of sense unless as simply a kind of raw assertion of Chinese power.

MURRAY: Well, we're definitely going to want to get back to the China issue, but, Richard, your— you want to accept, amend, add to?

HAASS: All of the above. Basically agree with both of those; the idea of a catastrophic version or repeat of 9/11 with a weapon of mass destruction quite possible at some point.

China-Taiwan for sure. It's— what's so frightening about it— I would say it's the one scenario where one can imagine it leading to a conflict between the world's existing great power and the rising power. Or to put it another way, what's so interesting about the answer I think to the question Alan posed is that with the exception of a Taiwan scenario, what's missing from any prediction of geopolitical risk on a massive scale is great power conflict, which I would suggest is perhaps the great differentiator between the century we're entering and the century we just left behind. So what— the dog that's not barking in the night is to me the chance of a major power clash.

The one set of problems I'd add— and I think Fareed would have gotten to it obviously if he'd had his third— is the chance in lesser countries, quote, unquote, for radical, quick change. One scenario is assassination. The two assassination possibilities that scare me most are [President Pervez] Musharraf in Pakistan and [President Hamid] Karzai in Afghanistan. They are probably the two irreplaceable men in those two countries. And, particularly, Pakistan scares me, because here you've got a country of nearly now 150 million people with dozens of nuclear weapons, thousands of terrorists and so forth, and a border with nuclear India. Right now, the Indo-Pakistani relationship is somewhat improved, but it's in no way on a firm or secure footing, and a Musharraf assassination could make that all too interesting, so there are the assassinations scenarios.

The only other thing I'd add to the list— and not so much with confidence, it's just I throw out there— is change in the Middle East. The Middle East is becoming interesting, and that's both good news and not so good news. And the potential there for serious change in certain places is not inherently or inevitably welcome. Whatever our frustrations with the status quo in places like Egypt and Saudi Arabia, one can imagine scenarios and alternatives that are worse. And the Iran experience of several decades ago ought to be something of a warning that one can have very unattractive authoritarian regimes, which are ultimately replaced by very unattractive radical authoritarian regimes of a coloration of behavior which is even less to our liking.

MURRAY: Fareed, no Iran, no North Korea, no Russia on either of your hit lists. How come?

ZAKARIA: The Iranian and North Korean problems I think are actually— I would put them to medium-term to longer-term problems in this sense. Iran is actually not developing nuclear weapons, as far as we can tell. What it is developing is the capacity to make nuclear weapons. It is actually very cleverly playing right under the NPT [Nuclear Non-Proliferation Treaty] guidelines, which allow it to— if— everything Iran is doing right now is legal. There is a loophole in the NPT which allows you— the Nuclear Proliferation Treaty— which allows you to do what it's doing, and we're trying to close that loophole. But the reality is, my guess is they're trying to achieve a kind of capacity very much like Japan, which is that in two or three months, or six months, they could go nuclear, but they are not nuclear right now, so it's a— it doesn't suggest a kind of sharp crisis.

The North Korean one, I think— at the end of the day I assume the regime is deterred from using them. The danger there is slightly different, which is that they will sell them. They have pretty much sold everything they have ever made previously, and what worries me about it, and that's why I perhaps should have added it to the list, is simply this, that once you make this stuff, once you make enriched plutonium— you know, I don't know about diamonds, but plutonium is forever. I forget the half-life, but it's, you know, some 25,000 years or something like that. So this stuff is going to be around. It's the size of a grapefruit, you know, enough to make a nuclear weapon, and we know there are buyers. We know from intelligence sources that al Qaeda has actively sought buying this material, and that is the missing ingredient in Richard's scenario of terrorist groups with weapons of mass destruction.

The capacity is no longer very difficult in the sense that know-how— I mean, nuclear technology is now 50 or 60 years old. This is, you know— nuclear weapons were developed in the age of black-and-white television and AM radio. This— you know, this stuff is not that difficult. It's the fissile material that's difficult to obtain, and that's why we should be much more actively trying to shut down the North Korean plutonium factory, if you will.

MURRAY: And how about Russia?

HAASS: Russia again is a medium-term problem, and, you know, we've been talking about China, which is the challenge of dealing with a rising power. Russia essentially represents the escalator going in the other direction. It's the challenge of dealing with declining power. And Russia has its seat on the [United Nations] Security Council and has rusting nuclear weapons, but other than that, it's not a great power. But the problem is, it does have thousands of nuclear weapons and it does have mountains of nuclear material, not all of which is secured to anything near the extent we would like.

We've also got a country that is failing in some ways. If you look at the population of Russia, it is declining now five [hundred thousand], six [hundred thousand], 700,000 a year. The gap in life expectancy in Russia between men and women is 15 years and growing. You have vast tracts of Russia which are essentially under-populated or unpopulated, and because they've become depopulated, particularly in the eastern reaches of Asiatic Russia, you've got a political process there where you have a— I guess you could describe it as de-democratization under way under [Russia's president,] Mr. [Vladimir] Putin.

And the question is, how is all of this going to play out, particularly as we get towards the 2008 election, which is supposed to— by which point Mr. Putin is supposed to step down, and whether he will or not, your guess is as good as mine. So you could have a political crisis in Russia around 2008, and it could work out well like Ukraine's or it could work out not so well.

But I think the real challenge of Russia is longer than the next couple of years. And to me, it's the question of whether ultimately it is a viable concern, particularly once you scrape away the veneer of energy wealth. Other than that, it is not a terribly well-functioning economy. And I'd just simply say, when you marry it with China's rise and with China's resource thirst [inaudible], the combination of this large, heavily populated, resource-poor country called China next to this large under-populated resource-rich country called Russia with the world's— you know, one of the longest, if not the longest borders— I simply say it's not assured to me as the 21st century plays out that all this plays out nicely.

MURRAY: And weapons of mass— Russia and weapons of mass destruction, is that something you worry about?

HAASS: Sure. Again, you've got not so much for the weapons, but it's the stockpiles of nuclear material. Plus, the most recent nuclear agreement between the United States and Russia has some unfortunate characteristics. One of them is that at the insistence of the United States the last— if my memory serves me right— the two countries only had to take weapons out of operational status. They did not actually have to destroy the material. They didn't do to them what they did with the gates from Central Park. Nothing got pulverized.

As a result, you have hundreds, if not thousands of nuclear weapons, which, while taken out of the active operational inventory, could be made quickly— or operational in very short order. So the [2002] Moscow Treaty [U.S.-Russia Strategic Offensive Reductions Treaty], so-called, did not do the degree of denuclearization that they should have, and that's why this whole question of security of nuclear facilities, security of stockpiles of fissile material— again, what Fareed said is exactly right. The key missing ingredient is either enriched uranium or plutonium. That's the hard stuff. And the fact that you've got mountains of it, in some cases with terrible security arrangements— alcoholic soldiers, poorly paid, very primitive security systems, you know, alarms that don't work and the rest— that is something— given particularly the ongoing, say, civil war in places like Chechnya, that's a dangerous brew.

MURRAY: Yeah. Let's— the China situation is so fascinating. Let's spend a little bit of time on it. Richard talks about it as a rising power; clearly not a great power now. How far away are we from the possibility of a world of two great powers?

ZAKARIA: Quite far away in this, if you mean militarily. China is not even trying to build a military that would rival the United States. You know, the United States in that respect is in a league of its own in historical terms. The British, when they were the sort of superpower of the day, had a rule they called the two-navy rule, which was that the British Navy had to be larger than the next two navies put together, which were, generally speaking, the American and the German. The United States military this year will be larger than the next 25 countries put together.

MURRAY: Wow.

ZAKARIA: So, you know, essentially if spending patterns hold, which is to say European defense spending is declining, American is rising, in about five years, the United States will be spending more money than the rest of the world put together on defense. Now, that just places it in a— you know, and that doesn't even take into account what you buy. The United States has technologies that place it leaps ahead of China. So not just militarily, the United States is a world power. China is essentially trying to be a regional power, and it will have sufficient military capacity to kind of express that probably in the next five to seven years.

The more important issue: China is trying to build its great-power status essentially on economic interdependence. It is becoming the crucial link in supply chains around the world, whether it is in commodities, in energy, of course in manufactured goods, increasingly in services. And so what it is trying to do is to make it impossible for anyone to be doing something that is not in China's interests, because there are simply too many economic repercussions. That's the part that we're not paying as much attention to, and that may be China's sort of new way of expressing. They've taken Joe Nye's admonition to heart and are trying to become a soft super power with a vengeance.

MURRAY: Richard?

HAASS: Well, I would just add a few things to the consideration of China. And I agree with everything, as usual, that Fareed said. One is, what are some of the weaknesses or some of the offsetting things to think about?

One is the fact that the United States has good and improving relations with India on one side of China, that the U.S.-Japanese relationship is very strong, and Japan is essentially in the process of unwinding some of its special post-World War II status. And one of the quiet, but interesting, strategic evolutions of our time is to— you might call it the normalization of Japan. You've got over 1,000 Japanese self-defense forces operating on the ground in Iraq. Japan is essentially stretching the political space in the country that allows it to take on a larger regional and global role militarily. So, China has to contend with the fact that its rise to some extent— indeed, there's this whole doctrine in China called the peaceful-rise doctrine— is in some ways, almost in a Newtonian fashion, beginning to stimulate a little bit of a geopolitical response, because people take note of it and they adjust. And you can adjust by accommodating, or you can adjust by in some ways pushing back, and we're seeing some elements of quiet push-back from the United States, from Japan, and from India.

Secondly, the other thing I'd point out with China is the gap between the economic dynamism and the political situation in China. And the whole with China— the so-called China or Asia model of development is essentially unleash the economic side but try to maintain as much political control as you can. And the gap— obviously, though, a gap has grown up between those two horses. And the question is, can the Chinese leadership manage that gap? And they're not going to slow down the economic side of the camp, so the question is whether you catch up on the political side, which means a degree of political opening, which obviously we hope they do.

The danger, and Fareed pointed it out, is that communism is essentially dead in China and the danger is that nationalism fills the intellectual and political void. And it's one of the reasons that it's important that we have— we don't lose sight of— you might call a reformist foreign-policy dimension vis-a-vis China. It goes beyond human rights. It's almost what we're talking about in the Middle East. You want to see the Chinese political side of the coin evolve, because we don't want nationalism to be the only thing that gets people excited politically in that country.

MURRAY: But you know, Fareed, if we had been sitting in this room 25 years ago— talking about the rising economic dynamism of China, if we'd been sitting in this room 25 years ago, somebody would have been talking about Japan— straight-lining all the trends, talking about where this is going to lead us in 15 or 20 years. What reason is there to think that our experience with China will be any different than our experience— obviously, it's a bigger country— but that it won't— at some point, the clash between the political culture, which is still totalitarian and closed, and the economic culture won't cause the economy to halt?

ZAKARIA: It's a very good question, and Richard's point is very well taken. The political side of the Chinese model doesn't— here's a country that has been run for 30 years by a committee effectively, or 20 years by a committee, that has produced 10 percent growth every year. First of all, it's mind-boggling. How exactly does that work? We've always assumed these kinds of strange committee structures don't work well. They've managed it. Every five years, people have said what Richard and I would both say, which is, you know, you can't keep this up forever, but they've kept it up for a long time. But I still think you can't keep it up forever because you're unleashing elements within society that are increasingly difficult to control, and you're already beginning to see it with big Chinese businesses that are a little uncomfortable with, you know, with the way the things are set up.

But the reason I wouldn't count on a dramatic slowdown in Chinese growth, and at some point the law of numbers suggest you can't keep going at 10 percent but, you know, maybe you'll drop to seven or something, but it's not Japan, and I'll tell you why. In Japan, you had— what you are dealing with in the '80s was the question of whether or not an economy that was somewhat strange, had some important pluses, but other minuses, was going to be able to become the richest and most sophisticated economy in the world. You remember, Japanese per capita GDP [gross domestic product] was about that of the United States, actually surpassing it at points. That's a very difficult thing to do, and if you don't have a sophisticated and modernized legal system, banking system, distribution here, every part of your economy has to be modernized. In the case of China, they're still at, you know, $3,000 per capita GDP. They can double that—

MURRAY: All they have to do is go halfway there.

ZAKARIA: --pretty easily. Yeah. They just have to make a few more— you know, more cars or more toys. In other words, when they get to $15 [thousand] or $20,000 GDP, we— they will face the very interesting question of, is this system capable of producing the kind of sophisticated political and economic results that the U.S. does, but they're 20 years away from that.

MURRAY: Yeah. Richard, a story in my favorite newspaper this morning about—

HAASS: And what might that be?

MURRAY: I'm glad you asked.

HAASS: Glad you liked the [inaudible], so do I.

MURRAY: Copies of which are on sale outside [Laughter]--about the Quadrennial Defense Review going on at the Defense Department, talking about what the U.S. defense looks like in the future to deal with this world. It's very different than what the U.S. defense looks like now; much more proactive, multiple engagements, teaming up with local military. Is that something— I mean, to me it sounds a little frightening, frankly.

HAASS: Well, I'm just going to assume that all of you have read your Wall Street Journal, which as a matter of course, we all do after we finish the Financial Times, I think, but the— it is an interesting story and it basically suggests that the Pentagon, which is mandated by law every four years to come up with a— basically, a pro-strategy that's meant to guide the budget. And what you see here— what's interesting is what it doesn't include, because what it— it's an emphasis on terrorism, counterterrorism, homeland security, dealing with the threat of the proliferation of weapons of mass destruction. I think it talks about influencing China and Russia. Those are the four things.

Well, again, what's interesting about it is the one thing it's not focusing on is fighting a major conventional war, which during the Cold War was obviously the driver of the defense budget. The challenge then for the Department of Defense is going to be to take a military which still has heavy dimensions of being this Cold War military— all these advanced fighter aircraft, all these ships, and a fairly heavy Army— and match it up to this new set of priorities, and there's a bit of a disconnect.

So the challenge for [Defense Secretary] Mr. [Donald] Rumsfeld will be to get the individual services to come up with a budget that in some way is consistent with this new set of strategic priorities, and the bigger challenge will be to get the Congress to ultimately pass the budget that reflects that set of priorities, and it's never perfect. There's always inconsistencies or disconnects, but I do think it's fair to say that the military is changing in some big ways.

We spent a few hours the other morning, myself and some other people from the Council, meeting with the Joint Chiefs [of Staff]. What came through, the most interesting thing— and it wasn't so much in the article— is that you've got this very different strategic environment which you're operating in, and the one thing that is killing the defense budget, even though it's reached these rather astronomical heights of roughly $500 billion a year now, is manpower costs. What is eating up the budget is the cost of recruiting and retaining people, both salary but also benefits, including health care. Half of our conversation over lunch with the chairman of the Joint Chiefs and the other service people was about health care. And what's happening is it's eating up the procurement— the money that would normally go for investment and procurement.

One of the interesting phenomena is you're going to see the gradual reduction in manpower in the U.S. military in every single service. We are moving towards an increasingly depopulated armed forces, and the idea is to have more and more weapons systems that require fewer and fewer people to operate them; whether it's no people at all, like drones and things like that, or ships that used to take over a 1,000 sailors will now take 100, and will be far more capable. And what's driving it is technology, and again this relentless pursuit of reducing the personnel costs of the military.

So what we're going to see over the— I think are tremendous battles about manpower levels, and how much of the traditional military we keep— things like planes and ships and the rest— at a time the Pentagon is basically trying to adjust through a fundamentally different strategic situation. Very interesting how it's going to play out, and again, it's going to have to play out within the five-sided building, but then the more interesting debates might ultimately be on [Capitol] Hill, because it will require— in order for this to happen, there would have to be far-reaching changes to the American industrial base and also to things like our base structure and both our active service, reserve, and National Guard forces. So I think we're just really on the cusp of a major set of debates here.

ZAKARIA: I will agree with everything Richard said, and I think that this might be one of the reasons why [President] Bush has not let Rumsfeld go. My gut is that Bush knows Rumsfeld served him badly on Iraq, but that on this broader issue of the transformation of the American military, Rumsfeld is really alone in pushing the Pentagon to do this. The Pentagon does not want to do it. Congress does not want to do it. The services do not want to do it because it's the old story: the lobbies exist for existing industries and existing technologies that do not exist for this new military, and so you have a tenacious struggle to maintain the old military and not move to the new.

MURRAY: Yeah.

ZAKARIA: And Rumsfeld on that issue, I think, is completely right.

MURRAY: It's interesting. I want to open it up for questions in just a minute. Let me just throw one curve ball into this, though. You mentioned health care. When I was at [the World Economic Forum in] Davos last month, I did a close— I moderated a closed session with a group of health care executives. There were maybe 20 of them, different industries, and we did the same sort of exercise. What are the top risks facing your businesses? And of course, there were— a lot of it was predictable. They were talking about, you know, price controls. But then the one that— one person mentioned and then starting moving very rapidly up the priority chain and it ended up being No. 3 was the possibility of some sort of outbreak—

HAASS: Flu pandemic.

MURRAY: Flu pandemic; something that in a globalized world can spread like that, and we don't have the public health infrastructure to deal with it.

HAASS: Entirely right. One of the things— the first new position I created when I got here was a senior fellow in international health. In part, it's because of the connection between issues like health and national security and economic performance around the world. But if there's an Avian flu pandemic or something like that, this conversation, or next year's corporate conference, would have a very different conversation, quite possibly. I mean, that's one of the risks we didn't get to, and it's true. What you're lacking are the national health capacities you'd want and also the international.

One of the interesting debates after the SARS outbreak in China is the following: What ought to be the responsibilities of a sovereign country, not just to its own people, but to everyone else in this area? Because what we learned is, when people in China came down with SARS, given the global travel realities, people in Canada and others suddenly became vulnerable. And so what are the— what ought to be the obligations of a sovereign country in terms of how it deals with its own health problems?

Second of all, what ought to be its reporting requirements? And you end up— and the WHO [World Health Organization]is tapping this question of what ought to be, if you will, an international , CDC, Centers for Disease Control [and Prevention] sort of network? What sorts of reporting responsibilities and so forth? Again, it's part of a larger debate about obligations of sovereignty in an increasingly global world where what goes inside country X affects everybody else. So I would add that very clearly to the list.

The only other risk, Alan, at the risk of— I'd throw out, which we— is the one that connects everything we've been talking about in the economics, and it's everything from a major problem with the dollar and what would be the strategic consequences there, because of some of the things that [Federal Reserve Board Chairman] Alan Greenspanwas talking about what if the world essentially gets tired of American fiscal or current-account deficits, or given the oil situation, some instability in any one of the producing areas. And just given the tightness of the market, one could imagine stunningly high price spikes, which again would have not just strategic, but all sorts of economic consequences, and I think we probably have to factor those in.

ZAKARIA: On the biological issue, which is what essentially we mean by disease, I'm actually— when I say a major terrorist event with a weapon of mass destruction, that's what I worry about. I still think at the end of the day producing nuclear weapons is more difficult than most terrorist organizations can do, but the stuff that it takes to produce a strain of anthrax or smallpox is actually not that complicated. The technology is widely available, and it's much easier to do. You just need a human carrier.

And if you think of it— I mean, you know, part of the business of this breakfast is I'm supposed to scare people, but if you think about what biological weapons can do, there's literally no limit to the number of people you can kill. A nuclear weapon, you, you know, it detonates somewhere. There's a limited radius of effect. With a biological weapon, with smallpox, one carrier in the New York subways and, you know, there literally is no limit. There could be 10, 15, 20, 30, 40 million people. Depends on when you are able to somehow medically arrest the phenomenon.

With nuclear weapons, all the work you can do is basically on the side of before it detonates. You try to prevent people from getting access to it, prevent people from building it, prevent people from detonating. Once you've detonated a nuclear weapon, there's nothing you can do. You can't take aspirin, right? With biological weapons, it's exactly the opposite. There's almost nothing you can do on the prevention side, because the technology is so trivial. Everything is consequence management. It is— once it happens, do we have in place a set of health care,you know, health, public-health procedures that make it less likely that this will become a 10, 15 million, you know—

MURRAY: And all that infrastructure is dual-use, so that if you do have a bird flu that mutates and starts to spread, it's useful for that as it is for biological.

ZAKARIA: Exactly.

HAASS: But as we've seen this winter with the flu vaccine, we are woefully, woefully under-capacity, if there's such a phrase, in that area.

ZAKARIA: I would just say one thing before closing on the dollar. I am actually one of the, I'm somewhat Pollyanna-ish on the current account deficit, by which I mean, I think this is a consequence of the increasing wealth of countries around the world. You have a situation where Asians over-save, Americans over-consume, and part of globalization is you don't have to do everything in every country. Why should Americans save at 30 percent if somebody else is willing to save for them and those people need to do something with their money?

In other words, the scenario under which something happens, there is so much more punitive to the Asian economy than to the American economy, that you'd have to think that the Chinese Central Bank would be incredibly foolish to do it. It's not just that their portfolio of dollars would fall in value. That's actually a trivial cost. It's that they would— it would slow down growth in China. And we've all discussed how you can't slow down growth in China. The Japanese are certainly not going to do something that's anti-growth. The Indians are not going to do any, and once you take Japan, Taiwan, China, and India into account, that's 80 percent of the, you know, of the holdings.

So the danger, I think, is slightly different, which it's the fiscal imbalance, because at the end of the day, the dollar is also generically a sign of American, you know, stability, good management. There's a psychological value there. And I think the degree to— we are now trying to run a global empire on the cheap and we're trying to do it in the face of these incredible, rising entitlement costs. I mean, this year for the first time, more cars were manufactured in Canada than in the United States because car manufacturers find that American health care costs are too high.

So you're beginning to see— you know, the Social Security is a side issue. The prescription drug benefit is actually going to add more to the American insolvency than the entire Social Security problem. If we can't solve this and want to run this global empire and want to have these massive tax cuts, we have a situation which is just unsustainable, and my fear is just a psychological one. There's a rational deal for the Asians to save and for us to consume, but psychologically at some point, this is just the, you know, the underlying shadow that will make somebody say, "You know what, I've got to get to the exit first on the dollar."

MURRAY: Which, by the way, Fareed, you weren't there, is pretty much what Alan Greenspan said last night, but he said it many more words than you did. [Laughter] Any questions?

HAASS: Ouch.

QUESTIONER: Hi. I'm Karim Pakravan of J. P. Morgan. My question addresses something you haven't talked about, is Iraq. And what are the consequences of a failure of the United States to stabilize Iraq over, let's say, the next three to five years down the road on the whole region and on the— and on the sort of U.S. position?

HAASS: Consequences of failure in Iraq?

QUESTIONER: Yeah. In the sense, you know—

HAASS: Yeah.

QUESTIONER: --chaos, civil war, partition.

HAASS: You can describe what failure is, but to just— assume we'll know it when we see it. But I would say that somewhat more seriously, the worst scenario in Iraq is one where the United States gets driven out by terrorism. That would be the single-worst scenario, because that would then— you know, the word— you know, the domino theory may not have worked in Asia, but it could conceivably come to the Middle East if the U.S. is seen to be driven out by terrorists. I don't think there's a big chance of that. I think the staying power of this country is considerable. At some point, we may be asked to leave by an Iraqi government. That's a very different thing, which I think has much less repercussions. And then if Iraq doesn't—

MURRAY: Well, are you sure you'll be able to tell the difference when it happens? Whether we're being driven out by terrorists or asked to leave by the Iraqi government?

HAASS: Yeah, I think you will because I think one is, you'd have a big debate in this country which would put forth the president's hand, as opposed to having a big debate in Iraq, which forth— which pushes the new government to essentially—

ZAKARIA: Also, let me just— we're not going to be asked to leave by any Iraq government. What Iraqi government will ensure that it will fall the day after American troops leave? We are the only thing keeping that government in place. I mean, you know, what government— what prime minister is going to say, "Yes, I want all the troops that are protecting me to leave?" It's highly unlikely.

HAASS: And so I would think— and so, ultimately, if Iraq doesn't work, just say we're there for a number more years, and it ends up being somehow messy or even a civil thing, I don't think it has the kind of domino effects of what I was just describing. But it does have tremendous effects just given the fact of where Iraq is, the oil resources, what that would mean over time: losing a couple millions of barrels a day or just not being able to add several million barrels a day— either way.

And then obviously the— potentially if Iraq did become a place of a civil war what— how that would potentially drag in Turkey or Iran or Syria. It could be a version of Lebanon from 15 years ago on steroids, and that would obviously be destabilizing.

I think you've got, if you will, potentially symbolic repercussions, as well as actual repercussions of failure and, yeah, we can debate the odds of it, but I still think— instead of thinking of— let me just make one other point— instead of thinking of failures and either/or situations for Iraq, you might think of Iraq's future as something more of a spectrum where on one side you have a Jeffersonian democracy, on the other side you have utter chaos, but you have a lot in between. And you— my own hunch is Iraq will fall somewhere in the in-between area, in which case the repercussions may not be, you know, quite as dramatic as some would suggest.

MURRAY: Who has the microphone? And please identify yourself before you ask your question.

QUESTIONER: My name is Fred Broda of Oxford Analytica. And my question again is relating to something that hasn't come up this morning. It has to do with our military space program and its effectiveness in maintaining us as a superpower. What are your comments about that, including the GPS [global positioning system]?

MURRAY: And so where does—

ZAKARIA: I yield to Richard. I don't know enough.

MURRAY: Where does that fit into the defense outlook, the defense of the future?

HAASS: Oh, it's critical, and I'd very quickly turn to [inaudible] here, who knows more about it than probably any of us in this room. But the real advantages, or one of the principal advantages of the American military right now, is the ability to collect information— battlefield awareness— and essentially get it increasingly to the individual soldier. And one of the— it's one of the things that made the individual soldier now so much more potent a fighting force. And the ability to use space in that is critical to both gain information about the battlefield and then to get information, and increasingly individual soldiers are able to synthesize it— that information— given the laptops that they take with them.

Space is obviously essential to all that. It came up the other day at the Pentagon. People seem pretty confident that our ability to protect our assets in space right now is pretty high. I didn't get the sense that this was high on the concerns for the foreseeable future about, in terms of our ability to maintain dominance there.

MURRAY: Do you want to add anything on that?

ZAKARIA: I'd agree, except that I don't think the Pentagon's budget reflects what you just said.

HAASS: Oh, OK.

MURRAY: Did everyone hear that? There was a question over here. Yeah, David?

QUESTIONER: Hi.

MURRAY: So let's get up— [inaudible]. Wait. We'll get another microphone. Hopefully one will work.

QUESTIONER: Hi. I'm David Malpass with Bear Stearns. My question is on something you did discuss some, but I'll try to pull it together. The U.S. government is very important in so many areas. We heard one on the defense budget. Ours is going to be bigger than all the other countries combined. This is true on wealth. And so it's the inertia of the U.S. government. We've got a very fast-changing world and a pretty slow-changing process in the U.S., whether it's on Medicare and U.S. health costs, on the education system, on dealing with the uranium in the Soviet Union, where for maybe a little money we could have helped them secure all of that, and yet we moved slowly.

And so, how can we break that? We've got a situation where so many of these issues rest on— specifically on U.S. federal government, and yet in each case we're probably going to move slower than the times allot for. Don't we have a big specific problem right there in terms of whether you want to think of it as procedural issues in Congress or personnel difficulties in the administration, or wherever it is? What's the problem and how could it be fixed?

ZAKARIA: OK. Gosh. I mean, that's a big question. Look, I think to a certain extent a lot of this— a lot of these problems are— they become American problems because, as you say, the United States is the leader, but they are not exclusively American problems. One of the reasons, for example, on the Soviet nuclear issue that we have not been able to make the kind of progress we'd like to make is that if you think we're slow, try Russia. You know, I mean, there's a great problem of Russian capacity, and that's why while it sounds nice in my— you know, and I probably said it myself, that we should increase funding for Nunn-Lugar [Cooperative Threat Reduction Program], which is the program that does it, I think at some point, you actually face the reality that the Russians are not able to do more or don't want to do more. It's not entirely clear, but the mixture of intentions and capabilities— I think that your broader question, though, is really about the degree to which you can have efficient "executive action," in the words of Alexander Hamilton, in today's world.

It's very difficult. It's very difficult because of the structure of American democracy which, you know, empowers factions and empowers lobbies and empowers that process of special interests, which I think has completely run amok in Washington, so that you have— everybody has a veto on everything, because anyone who is going to be de-funded has a lobby. And as a result, every government program is eternal. You know, we are still, we still have a mohair subsidy. The mohair subsidy was created in World War II because you needed mohair as a synthetic, you know, as a fabric to make Army uniforms. That was the only reason it was put into place in 1942. Right? It should have been sunset in 1945. We still subsidize mohair. And that's, you know, just one example.

So how do you change the structure so that you're thinking about the problems of the future? The only examples I can think of where it's worked, it's tax reform in '82, it's base closings— is you have to do that thing that, you know, that nowadays in today's polarized world is considered terrible, which is bipartisanship, but some kind of a bipartisan committee/panel that says, "Look, let's put aside the, you know, we both have legitimate interests and claims here. What is in the national interest?" and try to come up with a set of proposals.

I think we need to do that desperately on medical costs, because that is, to my mind, that is the whale that's going to swallow us all, but I think we need to do it on a number of these other small issues, because Washington has become so polarized that right now, there is really no incentive for anyone to make a deal. You— what happens if you make a deal is you get pilloried on your side for having made a deal with [Senator] Ted Kennedy [D-Mass.] and, you know, you will face a Republican primary opponent. You will lose funding. [Conservative radio personality] Rush Limbaugh will scream at you. And on the other side, the same thing happens.

In the old days, those were the people who were honored, the people who could actually make deals with the other party. Today, it is a recipe for political suicide, so it's much better to have gridlock and say, you know, "I stood firm. I didn't give in to [House Majority Leader Tom] DeLay and his bunch of Nazis." Or you say, "I stood firm. I didn't give in to Ted Kennedy and the communists," you know. As a result, nothing gets done.

MURRAY: And it goes beyond just the willingness of the participants. The whole institutional framework—

ZAKARIA: Yeah.

MURRAY: --that made these things possible 15 or 20 years ago has been destroyed.

ZAKARIA: Exactly.

MURRAY: Do you want to add to that?

HAASS: No, I'm depressed enough. [Laughter]

MURRAY: OK. Chris and then Jacob, and then I'll— I see you, Bob. OK.

QUESTIONER: Chris Wall, Pillsbury Winthrop. I agree the prospects for great power confrontations are not likely on the horizon, but certainly there's lots of room for frictions and even dislocations. The U.S. and Europe obviously have very different views towards China and I'm wondering if both of you could comment on the U.S. proposal to sell arms to China, to lift the embargo. What do you think the likelihood of that happening might be, and if it does happen, the dislocations that would occur in the U.S.-European relationship in terms of the trend towards force integration, interoperability, even NATO, and the negative consequences that could follow from that?

HAASS: It's one of the two issues right now that could set back what seems to be a general pattern of improving U.S.-European relations. One being Iran, although that— there might be a greater degree of overlap between the U.S. and European positions now that the administration seems prepared to entertain incentives, and the Europeans seem prepared to entertain penalties. But if the Europeans go ahead with arms sales to China, that could become a major issue, particularly with Congress. I think less so for the administration. A big, big issue on the Hill, given the salience of this issue on— I think the Europeans would be unwise to go ahead, based upon a certain principle I have, [which] is that, in the management of the transatlantic relationship, each side ought to defer to which side has the greater equities. And in the case of Asia and the whole China-Taiwan situation, the United States has far greater equities than Europe.

And when I've made that argument to Europeans they agree in principle, but they say this is going to be impossible to stop in practice. I'm still not persuaded— well, to put it a bit more in the present, I think there's a chance you could still compromise. From what I gather— and by the way, it's not only a European issue. It came up with Israel several years ago, when the Israelis wanted to sell China essentially their version of an AWACS [airborne warning and control system], and the States leaned on the Israelis and they didn't, is to— for the United States and Europe to have a conversation, which has barely begun now, about what sorts of weapons systems or technology transfers would matter.

And what I think matters is technology. It's not weapons systems. It's dual-use technology, which would— what, among other things, would give the Chinese either greater accuracy for certain systems or greater battlefield or space awareness, essentially AWACS-like capabilities, and it's obviously what China wants.

And so whether, I still get the sense there's some chance for a U.S.-European conversation about this in compromise, but if that doesn't work out, there will be something of a train wreck on the Hill because I think the Europeans are committed to selling things to China, and the administration— well, the Congress doesn't want them to. But this has been, there's not been the degree of consultation about this issue, from what I am told, that there needs to be.

ZAKARIA: I'd just say, I think there's a 100 percent chance that the Europeans will, you know, lift the embargo. They are absolutely committed to getting in on the China market. They feel that they have been latecomers in this game. American companies have gotten there too fast. When [Chinese President] Hu Jintao came to Paris [in January2004], [French President Jacques] Chirac made— turned— literally turned Paris red. He painted the Eiffel Tower red at the cost of several million euros, welcomed him, had a week-long series of celebrations. When Bush came to Paris, it was a markedly more low-key celebration. The Eiffel Tower was not painted in stars and stripes. So, I mean, I think that for the Europeans they regard this as a crucial strategic issue. It's not really about the defense stuff. It's about wanting to sell them Airbuses, and their wanting to sell them everything that and in an entirely unencumbered way, and the Chinese will accept nothing less than a total lifting of the embargo.

I agree with what Richard said. There will be a spat on the Hill. I think the administration is aware of this reality and recognizes it's going to happen, and it's not as a result going to be enormously surprised or shocked by it. In Congress you will have something, but, you know, I think that this is part of the rise of China. The European— it's reshaping the world and it's important for us not to have this split [in] the Western alliance, but there is the great danger it will do so, not simply because of actions of the Chinese, but the Europeans. The French are, you know, committed to this, as are the Germans.

MURRAY: Jacob and then over here.

QUESTIONER: Thank you. Jacob Frenkel of AIG. An observation and a question. Observation, I noticed that in the opening remarks the dangers were all focused in one way or another emanating from Asia. It's Taiwan, it's China, it's Afghanistan, it's Pakistan, India was mentioned, and the like. A few years ago, probably one would have spoken about the Middle East. One would have spoken about oil. My observation is that probably we have on this stage— on that stage quite a few chairs, and we have the musical chairs. We are now focusing on those occupied chairs, but let's remember the other chairs are still on the stage, because the issues have not been fully defused yet, and I think that this was hinted.

The question that I have is, the operation— given that we identify these as the pressure points, what's the operational action that should be recommended to do about it? For example, if you believe that Taiwan and China may get into a big problem or something or other, what is the single or two [inaudible] to be made?

I feel much more comfortable when it comes to the other risks that you mentioned. If you speak about a dollar, and you believe the budget is the issue, well, at least we know who should do what, and likewise with the Chinese. If you believe that the sharp change in the currency value of China may do disruptions, then don't push them to do it, and don't push them to liberalize the capital markets, or that's the way they can control the things without being subject to the discipline of the markets, et cetera, et cetera. But on those other issues, I still don't know the operational move.

ZAKARIA: Well, I mean, Jacob, you asked the most difficult question, which it is— it has always been very difficult to figure out how to accommodate a rising power on the world stage. You know, if you think about the last 100 years, when Germany rose to great power status, it produced, shall we say, a little bit of a problem in Europe. When Japan rose to great power status in Asia, it produced a problem. Generally speaking, these are— these kinds of entries onto the world stage are accompanied with a great deal of tumult.

I don't think there's an easy answer to what to do about China. I think you have to do two things. One is to give the Chinese a sense that they will be a real player, and they are a real player on the world stage to reassure them to try to allay any sense of nervousness or insecurity about that. But the second, I would argue, is also to deter them quite firmly, that is, to enhance our ties with Japan, with India, with Australia. I think Richard put it exactly right: some countries will jump on the bandwagon; some will balance. Traditionally, the small countries jump on the bandwagon; the big countries balance. And so what you will likely see, is the Singapores and South Koreas of the world being very wary of doing anything that suggests confronting China, but that Japan, India, and Australia will probably be more comfortable with something like that.

And I think that Taiwan remains a uniquely sensitive issue because we are trying to deter China from doing something where we hope to God our bluff is not called, which is a very awkward situation. You know, in international affairs, there are two things that are very expensive: threats when they fail and promises when they succeed. And this is one of those cases where we have to be very careful about what kind of threat we make, because it is quite likely to fail, and then we confront that reality.

MURRAY: We've got a lot of questions and a little bit of time, so let's see if we can get through some very quickly. Here, then Bob, then Peggy.

QUESTIONER: Thank you. I'm Tim Goodman from Pfizer. We talked briefly about health issues earlier. One important health challenge that we haven't talked about is HIV/AIDS, which has already, as we know, undone most of what's been achieved in many countries of sub-Saharan Africa over the past 40 years. HIV/AIDS is also now poised to break out in much more geopolitically significant parts of the world, specifically India and China.

I'd like to ask the panelists how you assess this threat, and what you would suggest that governments, the private sector, and multilateral organizations do to anticipate it and hopefully prevent it. Thank you.

HAASS: Let me take a quick stab at it. You're right. I mean, the African reality of HIV/AIDS is familiar. It doesn't make it any less awful, but it's familiar. The CIA and others have been saying that the three great possibilities, though, for the future— you mentioned two of them, China, India, the third being Russia. From what I can tell, the Chinese are basically doing OK on it in terms of their public health reaction, the Indians less so, and the Russians worst of all, which reflects in general the decrepit state of the public health care system, so it's not— and it's one of the factors that's contributing to the depopulation of Russia, particularly given drug use, needle reuse, and so forth.

But we know a lot of the things you need to do. This is not brain surgery in terms of how do you protect people, things like— you know, whether it's condoms, whether it's one-time use needles so no one can— and so forth, how it protects blood, so it's basically resources, and, in many cases, also building up the local healthcare facilities because it— everything— and the more I learn about the healthcare system is that you just can't— how do I put it— parachute in the pill or the equipment, whatever [inaudible]. You've got to develop a local capacity to service people, to check up on people, and so forth. And so it takes building healthcare infrastructure in a lot of these countries.

And again, in places like China, you're going to be the most successful; in places like Russia, you're going to have the biggest problem. But, you know, the resources are large going there. They obviously need to be larger. But I actually think because we know pretty much what to do, which is not— so absent— and with retrovirals and the rest to treat people of it, I think this is a manageable problem. Again, it's a question of resource availability and then host-country willingness to do the right things. And in some cases, you just don't have that.

MURRAY: Another thing that came up at this conference I was mentioning about is that some of the good things that are beginning to happen right now in terms of building up the infrastructure to deal with AIDS will help— will be— you know, could be the beginnings of a public health system that would help if you had some other sort of an outbreak, so that was actually viewed in a— I mean, it's hard to be— you know, to be positive or optimistic about HIV/AIDS, but that was viewed as a positive development, and obviously Pfizer is very much involved in it. Bob?

QUESTIONER: Hi. Bob Hormats, Goldman Sachs. I'd like to return to the conversation that you were having a little while ago about these entrenched bureaucracies and entrenched lobbyists in Washington that you've written about, Fareed. And Richard mentioned these, particularly in the context of the Quadrennial Review, as limiting the willingness or the ability to change. One thing that strikes me as you go back in American history, when we faced wars, wars have broken bureaucratic inertia. They've changed things dramatically. All the big changes in the American tax system have resulted from the fact that war has created a sense of urgency and people coalesce around new ways of raising revenue, changes in the way the defense system works, a whole range of things. We haven't had that after 9/11, and I'd like to probe this a little bit more.

There's a notion of a great sense of urgency about addressing terrorism, yet we have not reallocated resources in a way that rises to that threat; for instance, the mohair subsidy. In a world where you have other demands, you should get rid of the— we still allocate money for port security on the basis of some political formula. It has nothing to do with urgency or need or threat. What does it take, or is there anything that can be done to underscore, as we have in past wars, the greater sense of urgency, and not just the sense of urgency, but the need to overcome—

HAASS: The sacrifice.

QUESTIONER: --these bureaucratic constraints and the lobbyists who distort resources on the basis of old power relationships, and don't have them correspond to the new sense of urgency and threat?

MURRAY: And you have 15 seconds to answer that question.

ZAKARIA: Well, I think in a way, Bob, you answered it yourself, which is America deals very well with real crisis. I mean, this is a country that can adapt; that can take pain. If you look at all— the way the United States dealt with the '70s compared with Japan dealing with the '80s, this is a country that can inflict pain on itself, but there has to be a sense of real crisis. Unfortunately, the wars that we are engaged in right now are essentially colonial wars, that is to say, imperial expeditions that do not produce that sense of national crisis. And as a result, what you're seeing is these trends that are slowly eating away. We're not that good at dealing with those kinds of things.

MURRAY: Yeah.

HAASS: Can I say one thing that— I mean, the one structural response we had—

MURRAY: Go ahead.

HAASS: --was homeland security, and there was some changes in that, but I actually would say two things. One is, one or two more terrorist attacks that are successful on a large scale will get you what you want, Bob. Indeed, it may get you more than you want. [Inaudible] I know. But it may get you more than you want, because I think one of the questions then is whether— is how the pendulum works in certain ways about martial law, rights, and so forth. I think there's some very interesting question there. The other is whether the administration sends a mixed message. If we are at war, how could you argue for things like lowering taxes and some of the entitlement increases?

Transcript ends.

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