The Honorable C. Fred Bergsten has been Director of the Institute for International Economics since its creation in 1981. He also served in the Carter Administration as Assistant Secretary of the Treasury for International Affairs. His latest book is No More Bashing: Building a New Japan-United States Economic Relationship (2001). He spoke with In the National Interest editor Nikolas K. Gvosdev about a number of issues facing the global economy.

Q: What sort of an impact did 9/11 have on the global economy? Did the terrorist attacks cause any serious damage to the international economic system, or has it been a "blip", a momentary shock that has had no real lasting consequences?

A: I think that, so far, it has been a blip. There are, however, two potential costs.

The first concerns trade. If the outcome leads to substantial increases in the barriers erected at borders for security reasons, then, of course, you could have some negative effects on trade. There have already been a series of efforts undertaken by the G-7 and by APEC to put in place cooperative programs to reduce the risks of terrorists or terrorist devices being transported internationally. (1) Such efforts will lead to some increase in border security costs on international transactions, and so that could, over time, have some modest dampening effect on trade. A few countries--Hong Kong, quite notably--have publicly raised this question. While they have pledged their support to minimizing security risks, they are concerned about the impact on trade. So there is some degree of tension between increased security and the free flow of goods. I suspect that as the United States leads the international effort to tighten up on borders, there will be some modest increase in costs, and some modest diminution of trade flows.

The second and more indirect effect is whether steps taken in the aftermath of 9/11 have slowed down economic growth. All countries, starting with the United States, will have to pay a security premium to reduce the risk of further terrorist attacks. This premium encompasses things such as more expensive and time-consuming airport security procedures, the costs of hiring more police, developing and implementing more comprehensive programs for homeland security, and so on. All of this diverts resources from presumably more economically productive uses. This could have a modest yet negative effect upon economic growth. That, in turn, would also reduce international transactions.

It is, however, going to take a while for all of this to show up in the economic data, and even then it will be hard to separate which effects spring from 9/11 and which are caused by other, ongoing developments. I would suspect that these two outcomes arising out of 9/11--increased security at the borders and the diversion of resources into homeland security--could to some modest extent dampen the continued pace of globalization and the internationalization of the world economy.

We can also mention a third, psychological effect of 9/11, which is, to some extent, affecting equity markets and other financial markets. It is, however, hard to quantify.

Q: Could you comment on the impact that a potential American strike on Iraq may have on energy prices? Linked to that, what is your opinion of the statements made by some economists that, in the event that Saddam Hussein is overthrown rapidly and a friendly, pro-American regime comes to power in Baghdad, that it is not in American interests to promote a drastic decline in world oil prices?

A: With regard to the first question, I think that a sharp distinction needs to be drawn between the current period of uncertainty prior to any action in Iraq, and what would actually occur in the energy markets were action to take place. In this period of uncertainty, the market places an extra premium on the price of oil, what can be termed an "uncertainty effect." There are different estimates as to how much the premium actually is, but I would think that at it at least a few dollars more per barrel of oil. So, I suspect you now have an oil price than is higher than would otherwise be the case because of uncertainty as to what might happen in the region. Assuming that action takes place--and that any military action we undertook would be successful and fairly short in its duration--I think it would prove to be quite positive for the world oil market. First, it would eliminate the current climate of uncertainty, and I think it would also lead to a decline in the price of oil, on its merits. This, after all, is the lesson of the Gulf War. When Operation Desert Shield was converted into Desert Storm, when the first air attacks proved to be quite successful, and--crucially--when the United States announced it would release oil from the Strategic Petroleum Reserve to offset any instability or interruption of supply in the world markets, the oil price dropped by a third. In fact, the decline in the oil price as a result of the Gulf War helped to trigger the economic boom in the United States that lasted for nearly a decade. So, assuming that military action would be quick and fairly successful, and assuming that the United States and other OECD countries would be prepared to release oil from their stockpiles to counter any short-term interruptions, the end result of action could prove to be very bullish for the oil markets and that, in turn, would stimulate growth all around the world.

On the second question--I do agree that the United States has an interest in maintaining a stable oil price, within a reasonable range. I think that the range that OPEC has in mind--between $22 and $25 per barrel--is not bad, although I would say that as a consuming country, we would tilt toward the lower end of that range. I myself would be happy with an oil price in the range of $18 to $20 per barrel. This price would still be enough to stimulate new investment and new production. I agree that a very sharp decline in the price, such as occurred in 1986 as well as a few years ago, is destabilizing in terms encouraging new investment and diversifying long-term supply. So I think that view is right. The extent that the price can be held at that range--averaging at about $20 per barrel--would be the best outcome for us.

Q: I was wondering whether you might be able to comment on developments in Japan, and the impact of either the success or failure of reform in Japan might have for the region's economies as a whole.

A: First, Japan is, I think, the single greatest threat to the world economy right now. The very fragile state of their financial system does create the possibility, at almost any time, that a major financial crisis could erupt, triggering large-scale bankruptcy, capital flight and a sharp fall in the currency. This has to be a major worry for us; Japan is the second largest national economy in the world and the prospect of any of this occurring could be very disruptive for the rest of the world.

Having said that, I do not think Japan's weakness reflects the prospects for Asia as a whole. Keep in mind that Japan has been in the tank for a decade in terms of stagnation. It has undergone four recessions in ten years. For the last decade, it has had zero average growth, during which time, certainly for the first half of that period, the rest of Asia continued to boom ahead. Certainly, the rest of Asia had its crisis, but most countries in the region have bounced back pretty smartly--even with Japan still in the tank. So this demonstrates that, even with Japan's economy remaining basically stagnant, East Asia as a whole, and the world economy in general, can continue to move ahead. As I mentioned earlier, there is a risk that a major crisis in Japan could have negative ramifications for the rest of Asia and for the world as a whole. However, if Japan continues to muddle through, with another decade of stagnation (essentially, zero growth) but with no major crisis, I do not think that this precludes Asia from moving ahead.

Part of the reason is simply that China has become such a dynamo. China is growing at a rate of 7 or 8 percent a year, and I think it will continue to do so for another ten or twenty years. It has already surpassed Japan as the major market for many of the other Asian countries. Since China is the real locomotive for growth, I do not think that continuing Japanese stagnation--even if it continues for another decade--will obviate a very dynamic economic performance in the rest of Asia.

Can Japan successfully reform itself? I would have to say that this week, I am pretty pessimistic. Even a week ago, I was still hopeful that the plan put forward by Financial Services and Economics Minister Heizo Takenaka, especially if it enjoyed the full support of Prime Minister Junichiro Koizumi, could succeed and really produce a major breakthrough. (2) I think that there is still a chance. But the obvious comedown, particularly by the prime minister, suggests that even he may not have realized the limitations on his power, that he simply could not overcome resistance of the LDP [Liberal Democratic Party] political leadership, the entrenched bureaucracy and the vested business and labor interests in the country. It may prove that even a popular Prime Minister in the Japanese system may not be able to turn things around. I hope that assessment turns out to be wrong. I think that the plan that has been announced, along with some further augmentation, may give Takenaka's strategy--which I think is the right one--a real chance to succeed. At the moment, however, the traditional constraints of the Japanese political system have prevailed again and condemned them, at a minimum, to continued stagnation.