Are We Headed for Another Recession?

In March, as the U.S. military began its invasion of Iraq, many American businesses feared the impact of the battle on commerce. Yet they hoped a quick victory would provide a post-war boost to the economy. An end to the war, they hoped, would prompt exuberant and relieved consumers to open their wallets, depress the price of oil, lead to increased spending on domestic travel, and allow companies to more easily make plans for capital spending.

Unfortunately, it does not appear that a post-war boom is likely. In fact, many economists and businesspeople now worry that America actually is headed for another recession--one that could prove the final blow to many small companies already struggling from more than two years of economic weakness.

The signs are not good. A well-known index of economic indicators, the Conference Board report, fell in March; meanwhile, March's index by the Institute of Supply Management, the nation's leading forecaster of manufacturing activity, dropped below 50, signifying that the manufacturing sector is contracting, and employers eliminated more than 100,000 jobs in March, after slashing nearly 300,000 the month before. Overall, companies are hiring at their slowest pace in more than a year. "It does appear increasingly likely that we're headed for another recession," says Robert E. Scott, an economist at the Economic Policy Institute, a Washington, DC, think tank.

"It's one of the most difficult periods I've ever seen," concurs Al T. Lubrano, president of Technical Materials Inc., a Lincoln, Rhode Island, company that manufactures specialty metal products. "Where's the hope on the other end?"

Unlike in the past, economists say, this war has not--and will not--provide much stimulus for U.S. economic growth. "Despite the defense spending for the Iraq war, the amount of spending this time is still quite small, proportionally, compared to previous conflicts," says John Nye, an associate professor of economic history at Washington University in St. Louis, Missouri.

What's more, the end of the war in Iraq has not significantly reduced the uncertainty felt by many Americans--an uncertainty that keeps consumers from spending as much as possible and prevents businesses from making long-term plans. Although the price of oil has dropped, America still remains dependent on potentially unstable nations--Nigeria, Venezuela--for a considerable percentage of its petroleum.

Many U.S. businesses and consumers remain unconvinced that another war is not on the horizon. "The victory in Iraq hasn't resolved this uncertainty, because we don't know it will be the last conflict," says Joel Marks, executive director of the American Small Business Alliance, a Washington, DC, trade group. "Given the fact that we're continuing to fight against terrorism, we don't know that we won't have a conflict soon with Syria, or Iran, or North Korea."

Numbers Don't Lie
Indeed, the Federal Reserve's weekly assessment of lending to businesses dropped throughout April, suggesting that most companies are holding off on new investments. As Craig Thomas, an economist at West Chester, Pennsylvania, forecasting organization Economy.com, notes: "Why would anyone want to invest in equipment [right now]? I just don't see it."

Meanwhile, housing construction fell in March, suggesting that American consumers, who are carrying higher levels of personal debt than they did during the 1991 Gulf War, also are becoming more cautious. In the past, the government was able to stimulate spending and growth by slashing interest rates, but the Federal Reserve has cut rates 12 times since 2000, to its current rate of 1.25 percent.

The arrival of SARS in North America has further heightened uncertainty. Already, Stephen Roach, chief economist at Morgan Stanley, has predicted that the world will fall into recession this year, in part because of SARS. "Right now, SARS is in Toronto, and we've seen how it's decimated the economy of that economically powerful city," says Marks. "Tomorrow it could be in Des Moines."

SARS, the possibility of future conflict and the continuing threat of terrorism also are complicating shipping logistics, cutting into companies' profits. For example, over the past six months, freight rates have risen by more than 30 percent for companies shipping through the Middle East, as marine insurance companies raised rates on shippers since the Iraq war by as much as 50 percent. In fact, according to marine insurance companies, shipping rates have been pushed to their highest level in years.

More expensive logistics, along with increased tension between Europe and the United States due to friction over the Iraq war, is putting a damper on global trade. "The pace of free trade expansion has slowed drastically," says Scott. "If we engage in more conflicts in the Middle East, that could further alienate Europe, which is already hurting economically, and damage trade." Indeed, unlike in the wake of the 1991 Gulf War, when Europe and Asia were growing and helped pull the American economy out of recession, today Europe and Japan are struggling on the verge of their own recessions.

America's burgeoning deficits--its national deficit and trade deficit with other nations--also are constraining the economy. The federal government will run a 2003 deficit of at least $200 billion, and states also are facing their biggest deficits in ages. Many states are taking almost laughably drastic measures: In Missouri, the governor has ordered every third lightbulb unscrewed in state buildings. At the same time, as the American trade deficit has grown, the U.S. has become increasingly dependent on foreign capital to finance growth. If that capital pulls out, it could shave as much as 10 percent of U.S. growth and drastically weaken the dollar, Scott says.

As all these signs of economic weakness build, small companies have the most to lose. Thus far, small firms have largely been shut out of contracts for post-war reconstruction in Iraq, though the Bush administration has promised to share the wealth. And according to Marks, many small companies do not possess the kind of cash reserves to deal with another prolonged period of economic downturn, since banks have become more willing to turn away small clients than they have larger companies. "Small companies have spent down much of their cash already, in the previous recession, and they didn't have time to build it up again," Marks says. "There's numbness out there in the small-business community, wondering whether they can hold on to the cash they have and numbed by each economic shock."

Lubrano agrees. "I look at competitors in the field, and I see many of them are going bankrupt," he says.

Meanwhile, small companies rarely have the capital needed to create the redundant, alternative supply chain networks that can allow goods to bypass world hotspots and generally avoid logistical problems. And owners of small companies often are ill-prepared to deal with the effects of continued anxiety and uncertainty on their workers, since few have the kind of dedicated in-house counseling services large companies employ.

Small companies also usually are more reliant on obtaining business from other entrepreneurs. "Unlike bigger companies, small firms usually depend on getting paid by a large number of small clients, many of whom can't pay now," says Marks. "Small companies can't extend them the kind of credit they need to last until an upturn that big corporations could."

Always a Silver Lining
But not all signs of the economic future are negative. In the immediate aftermath of American troops arriving in Baghdad, stock markets, which can be leading indicators of economic expansion, posted stronger gains than they had since September 11. What's more, since the beginning of the Iraq war, the price of oil has fallen by more than 25 percent. A decrease in the value of the dollar actually could help American entrepreneurs, as it would make them more competitive with companies from the developing world.

And despite high levels of debt, American consumers often prove willing to keep shopping. Corporate credit became slightly easier to obtain in March. The fact that companies have spent so little over the past three years ultimately will leave them with no option other than to increase business spending. Last week, Federal Reserve Board Chairman Alan Greenspan told Congress the economy is poised for growth even without further tax cuts--though the Bush administration continues to push for a $550 billion, 10-year tax-cut plan that may or may not stimulate the economy. (In February, a group of 10 Nobel Prize-winning economists concluded that the tax cuts would not have a significant short-term stimulus effect--some leading economists worry that further tax cuts could exacerbate federal and state deficits.)

Perhaps most important, small companies have internalized lessons from the 2000-2001 recession to prepare themselves for more economic turbulence. "Small companies that are around now are leaner than they were two years ago, and they've learned how to cut fat or adjust in other ways--merging with competitors, going into niche markets, renegotiating their contracts, conserving cash," says Marks. "Three years ago, two guys and an idea could raise capital; today those guys are living in their parents' basements."

"If you haven't already prepared for economic tough times, either by cutting all extraneous things or moving into niche markets where you can survive a downturn," says Lubrano, "after all we've been through the last few years, you have yourself to blame."