Global Policy Forum

By Daniel Altman

The nation's first military foray under its new doctrine of pre-emption ended in victory, but the war and the uncertainty it created still cost the economy dearly. Those consequences, along with the potential for more diplomatic and military conflicts, are giving some international investors pause as they decide where in the world to put their capital.

"The American administration has made it clear that they wish to take that battle to more than just Iraq," said Martin M. Gagen, chief executive of the 3i Corporation for the United States and Asia. 3i is Europe's biggest venture capital firm.

"My working assumption is that there will be other events," he said. "It may not be as significant as invading another country, but you could see very high-level diplomatic initiatives against these countries overseas. You'd be foolish to think it would have no impact on the economics."

In the eyes of many investors, the United States' fundamental economic strength continues to justify its place as a favored target for capital. They still see the flexibility of the nation's markets and its prospects for growth as superior to those of Europe and Japan, and they cite these factors as the most important for investment. But by influencing the economy, the federal budget and international relations, American foreign policy has begun to creep into the picture.

"America is more dependent on the rest of the world for capital than at any time in the past 50 years," said David P. Bowers, chief global investment strategist of Merrill Lynch. "What the rest of the world is being asked to fund is very different from what they were being asked to fund three years ago. Three years ago they were being asked to fund a private sector miracle. Now they're being asked to fund Bush's tax cuts and the war on Iraq."

Mr. Bowers, speaking from London, asserted that America's foreign policy had created tension and vulnerability in its economic situation. "At the end of the day, the U.S. is prepared to act unilaterally," he said. "The bottom line is that if you are a net debtor to the rest of the world, ultimately you have to be multilateral."

In an article he wrote two weeks ago, Mr. Bowers cited "a geopolitical change under way that could spell trouble for the funding of the U.S. economy" as the "most disturbing" risk threatening a strong recovery. For some other strategists, the nation's nascent unilateralism has become part of a bigger discussion of how investors perceive the American investment environment.

"The current differences of opinion over first the necessity of a war in Iraq, secondly the conduct of the peace in Iraq, and the postwar environment — they're important yet incidental to the larger question of whether the United States is headed in some longer-term sense on the right course," said Stuart A. Schweitzer, a strategist at J. P. Morgan Fleming Asset Management.

Mr. Schweitzer expressed confidence in the nation's potential for growth, but he said that "heightened tensions with traditional allies" were affecting international investors' confidence in the United States. Mr. Gagen said bad blood had already made it harder to seal big transactions between French and American companies. He said he also worried that the nation's foreign policy could make settlement of trade disputes more difficult. "The next time there's a major trade negotiation between any of these parties," he said, "we just don't know what sort of impact these things will cause."

Though these frictions are hard to measure, the White House's foreign policy choices have had some tangible effects in the short term. Economists generally agree that the war in Iraq exacted a heavy toll on the economy, even before the fighting began. According to some Wall Street experts, the uncertainty preceding the conflict may have cost the economy $50 billion or more in lost spending by consumers and businesses. Some investors have also worried that the nation's activist foreign policy could hurt businesses that rely on exports.

The direct costs of the war in Iraq to the government are also easily measured. Congress allotted $79 billion to pay for the war and related expenses this year. In addition, the reduction in economic activity that preceded the fighting is likely to have lowered federal tax receipts.

That weakening of the government's fiscal balance is contributing to the concerns of investors here and abroad, Mr. Schweitzer said. "Foreign investors care not only about whether the U.S. is fundamentally right or not about what it's doing in other countries. Foreign investors also attach a great deal of significance to the budget position — to whether the U.S. is being fiscally prudent or not."

Steve Alexander, a managing director at BNP Paribas who heads the private capital group for North America, explained that geopolitical risks were implicitly "baked into" most indexes of economic activity that investors would watch routinely. "The geopolitical elements probably add some flavor, but I don't think they drive it," he said.

Indeed, some investors consider themselves virtually immune to geopolitical risks. "Our companies are going to come to market in years, not months, so we don't tend to have a short-term economic horizon," said Peter Schwartz, a venture partner at Alta Partners in San Francisco. "You would say that about the people investing with us as well."

But Mr. Bowers contended that if the rest of the world changed its view of the United States, it would cut to the core of the economy. The nation's gross saving rate — including all sources of saving, from households to governments to corporate accounts — is at its lowest level since 1945. So increases in investment are likely to depend on foreign funds. "There are some really fundamental issues here which really do matter," Mr. Bowers said.

Not everyone is convinced, however, that a more unilateralist foreign policy is a bad thing for the United States, from an economic perspective. Joseph R. Schmuckler, president and chief operating officer of Nomura Securities International, suggested that the war in Iraq might actually help the United States to attract investment.

"Lack of United States and allied resolve in combating the war on terrorism, and allowing the uncertainties and risks to continue to weigh on investors' minds, is not only a negative for the United States but for other free-market economies around the world," he said. "Without question, doing nothing is not an answer. We can't survive in the long term without fighting back this enemy."

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