Foreign Policy and the Recession

Source: The Wall Street Journal
WrittenBy RICHARD N. HAASS
It now is highly likely that the United States will face several quarters of negative growth to be followed by several years of low growth. Less and less are we hearing of V- or U-shaped economic recoveries. The immediate future looks like an L: sharp contraction followed by not much in the way of a quick rebound.

Most of the current conversation is about the economic consequences of such a future, and what can and should be done domestically and internationally to soften the blows and speed recovery. But the world is not a series of silos. What happens in the economic realm will spill over into the political and strategic ones. Some of what results will add to the challenges confronting President Barack Obama.

Pressures to rein in federal spending are sure to grow. There is little that is easy to cut given the need to meet entitlement obligations, pay interest on the $10 trillion debt, and bail out states and cities unable to balance their budgets. What's more, there is an emerging consensus on the need for yet another stimulus package. Down the road, ballooning deficits will bring inflation and cause problems for the dollar. It is highly likely then that Congress will want to cut the defense and foreign-aid budgets simply because there are so few other targets available to reduce federal spending. This will limit the availability of tools central to asserting U.S. power and influence abroad.

There will be other policy consequences of recession. It will be more difficult to negotiate an accord on climate change as countries such as China and India will resist anything that could be an impediment to growth. High unemployment will make it even tougher to build a majority here at home for immigration reform. We will likely see new outbreaks of resistance to the ability of foreigners to buy U.S. assets despite a clear need for their dollars.

The recession is sure to strengthen trade protectionism. This is a big setback, as trade offers the ideal noninflationary stimulus. It is also a boon to developing countries, and one way to link countries in a web of dependencies that restrains nationalist impulses.

The combination of recession and no global trade accord will reduce U.S. imports, which in turn will slow growth around the world, increasing poverty and straining political stability in many countries. Many countries are already suffering from slower growth, much lower stock values, scarce credit and reduced exports. Others are reeling from lower commodity prices. We should not be surprised when governments fail and societies suffer from violence.

One other adverse consequence merits mention. The appeal of free markets is much diminished. The ability of U.S. officials to preach persuasively on the virtues of market reform is all but gone. The backlash against markets will almost certainly go too far, with adverse results for economic recovery and democracy around the world.

We are already seeing increased anti-Americanism, the result of perceptions that the global economic slowdown had its roots in the U.S. mortgage market. Globalization itself is further tarnished. What we can expect is heightened state intervention, protectionism and mercantilism as governments look to enter into arrangements that guarantee preferential outcomes.

Still, most clouds have silver linings, and this one is no exception. Recession has caused a major decline in the world price of oil, to roughly $70 a barrel from over $140. This is bad news for Iran, Venezuela and Russia -- the so-called axis of diesel.

The most encouraging consequence of this change involves Iran. Iran has been closing in on the ability to enrich uranium on a large scale. The last thing the new administration wants is to choose between living with a nuclear Iran and attacking Iran so it does not reach that point. Either path promises to be extraordinarily costly.

Up to now, diplomacy has produced little. The question is whether this could change. The reason it might is economic pressure. Financial sanctions, relatively easy for the mullahs to shrug off when oil was $140 per barrel, are having real effect now that oil is only half that price. Adding to the pressure is an Iranian budget that is based on oil fetching some $90-$95 per barrel. Inflation, unemployment and deficits are rising as dollar reserves are falling.

All of this could well make the Iranians more open to diplomacy that would limit or better yet end their independent uranium enrichment effort in exchange for economic relief. It might even lead the Iranians to examine some of their expensive support for Hamas, Hezbollah and Shiite militias in Iraq.

The slowdown also may bring good news closer to home. Venezuela under Hugo Chávez has been carrying out an imperial foreign policy, supporting governments such as Cuba's, Bolivia's and Nicaragua's. Mr. Chávez has also been systematically subverting Venezuelan democracy. But like Iran, Venezuela will have to scale back. A $4 billion oil refinery for Nicaragua is on hold. Given an inflation rate of 35%, mounting debt and declining financial reserves, the question is whether Mr. Chávez will be able to keep his hold on power if the price of oil remains where it now is for several years.

Developments in Russia may constitute another silver lining. A Russia resentful over its loss of status and territory has become a resurgent power. Oil and gas have become a source of wealth and influence. But Russia is feeling the pain -- not just of falling energy prices but of a plummeting stock market that has come down two-thirds from its high and was closed by authorities more than a dozen times. Many Russians see what has happened as the result of the world's negative reaction to their actions in Georgia. This has the potential to make Russia's leaders think twice before intervening in Ukraine on behalf of ethnic Russians living in the Crimea.

Falling energy prices have one other benefit: They reduce the burden to importers everywhere, from the U.S. (by reducing some pressure on the dollar) to poor countries that did not have the good luck to find oil or gas in their territory. It would be unfortunate, though, if the reduction in energy prices took the wind out of the sails (so to speak) of the effort to reduce American energy consumption. Current levels of use leave the U.S. vulnerable to supply interruptions and price hikes, fuel the economies of some of the world's least savory regimes, and add to climate change. The temporary respite provided by lower energy prices should not be squandered so that we continue policies and behaviors that made us vulnerable in the first place.

This all raises a larger point. To say there will be a recession followed by years of depressed growth leaves vague the questions of how deep and how prolonged. Little is inevitable. The Treasury and the Federal Reserve have demonstrated that the U.S. is not Japan; policy innovation is part of our political culture. The new president and Congress will have the opportunity to shape the dimensions of the "L" and to both offset and exploit its strategic consequences. Let's hope they use it wisely.

Mr. Haass is president of the Council on Foreign Relations.