While the world frets over the potential global economic impact of a spike in oil prices caused by a war in Iraq, Washington ignores a much more serious economic challenge: the continued underperformance of both the Japanese and the European economies-a sluggishness that threatens to drag the world economy down, war or no war.
The assertiveness demonstrated in recent months by the White House in cajoling allies regarding terrorism and the Middle East turns dangerously into passivity when the topic is those nations' economies, undoubtedly because of the administration's fear of undermining allied support for its war efforts.
But, said Adam Posen, a senior fellow at the Institute for International Economics in Washington, "it's time for the Bush administration to realize that allies who let them down economically can do as much damage to the U.S. economy as enemies who attack militarily. This is a foreign-policy issue."
So, befitting the president's new pre-emptive approach to international threats, it's time for a more aggressive White House posture toward European and Japanese economic mismanagement.
The International Monetary Fund predicts that world economic growth will be an anemic 2.8 percent this year. "The engineless global economy is simply lacking any real source of growth," writes Stephen Roach, chief economist for the New York investment house Morgan Stanley, in a recent assessment of the international economy. "It's starting to feel like a global double-dip" recession. And that listless economy could bring with it what economists euphemistically call "downside risks."
The threat of a jump in oil prices to $40 a barrel, which would tank everything from auto sales to airline travel all over the world, is the most immediate danger. But, notes Lael Brainard, a senior fellow at the Brookings Institution, "under any foreseeable scenario, oil is not more than a one-year problem."
The graver challenge is the potential failure of Japan's current efforts to finally end its decade-long economic stagnation. The IMF predicts that Japan's economy will shrink by 0.5 percent this year. Japanese banks' bad-loan problems continue to mount. And corporate bankruptcies-which can help bloated industries become more efficient and are a prerequisite for economic restructuring-were down slightly in the first half of this fiscal year.
Japan's new economic czar, Heizo Takanaka, has ambitious plans for the government to inject billions of taxpayer dollars into the banks. "But there is a big question about whether they can pull it off," Brainard said.
Success will ultimately depend on more-truthful accounting, argues Robert Alan Feldman, chief economist at Morgan Stanley Japan. When the interest rate is effectively zero, as it now is in Japan, nonpayment of interest can no longer be the measure of a borrower's nonperformance. Loans have to be reclassified based on the borrowers' ability to repay. And tax laws have to be changed to make it easier to assess banks' capital adequacy. The government has to be ready to acquire and sell off bad assets at a fraction of their book value, even to foreigners. And Tokyo needs to boost unemployment insurance.
After initially foreswearing any "lecturing" of an ally, the Bush administration has periodically admonished Tokyo to get on with its economic restructuring. But more than words are now needed. In 1991, Japan wrote a large check to help pay for the Persian Gulf War. This time it can't afford such largesse. But President Bush should suggest to Japan that its best contribution to the Iraq war effort would be to restructure its economy fast enough to ensure that it beats the current IMF projection of 1.1 percent growth for next year. Nothing could do more to help stabilize the world economy.
Europe faces a less dire but still troubling economic slowdown. The IMF has cut growth projections for the European Union to 0.9 percent for this year. That rate is about 3.5 percent slower than what economists think is Europe's economic potential. In the face of this dismal performance, the European Central Bank steadfastly refuses to cut interest rates-in the name of inflation-fighting. And European governments refuse to increase government spending-in the interest of fiscal discipline.
"If we are going to be [in conflict] with Europe about hormones in beef and the International Criminal Court, which are second-tier issues," Posen said, "we have to be willing to take on Europe for growing so slowly."
That includes jawboning the European Central Bank to share the global stimulus burden with the U.S. Federal Reserve. A half-point cut in interest rates could add a full point to Europe's growth rate. Taking on this challenge also means the United States should lean on the German overnment to implement its new blueprint for making its economy more flexible by promoting temporary and low-wage jobs, encouraging self-employment, and acting as a job-placement bureau. Most broadly, it means convincing Europe that it has global economic responsibilities.
None of this would be easy. And it would certainly complicate building the Iraq war coalition. But global economic leadership is no less an obligation of a hegemon than is military leadership.