War With Iraq: What It Means for Small Business
As a U.S. invasion of Iraq likely looms in the near future, people in America, Europe and the Middle East have been fervently debating the subject. Massive antiwar protests have broken out in the United States and Europe, and in response, American officials and supporters of the war have mustered fiery rhetoric to justify an invasion. The U.S. and Britain have begun a furious round of diplomacy talks at the United Nations, wooing formerly ignored nations like Cameroon and Guinea in an attempt to obtain a second resolution authorizing force against Saddam Hussein's regime.
But largely lost amid the clamor over Iraq is the fact that a conflict, which Pentagon sources say probably will begin in late March, could have a major impact on the American economy, which appears to be slowing down once again. For small businesses, which generally operate with less of a margin for error and smaller reserves of capital and staff, a war could be devastating--or potentially empowering.
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Tightening the Purse
Some companies have expressed concerns about the potential impact of a conflict on shipping and supply lines, and many business executives have postponed plans to travel in late March and early April. Indeed, a recent survey of business leaders by the Association of Corporate Travel Executives showed that 82 percent of corporate travel managers said their firms would reduce travel in the event of war.
But overall, says John Satagaj, president of the Small Business Legislative Council, a Washington, DC-based trade organization, few small businesses fear that an Iraq war will make much difference to supplies. "Supply chains are affected by unforeseen events," Satagaj says. "The Iraq war is seen as basically predictable--when it's going to start and, probably, how it's going to go, so suppliers can incorporate it into their plans." In fact, Satagaj adds, the aftermath of the West Coast port lockout actually has had more of an impact on supply chain management, since these events were so much less predictable.
Although they are not overly concerned about their suppliers, small companies have other major worries about the ramifications of war. The last five American recessions have all been preceded by sharp rises in global oil prices, and the run-up to war has led to oil spikes. One year ago, oil cost less than $20 per barrel on the world market; today, it is at nearly $37 per barrel, its highest level in two years, and economists have begun to worry about another recession. (Economists normally estimate that every $10 rise in the price of a barrel of oil cuts U.S. economic growth by 0.5 percent.) "Rising oil prices increase costs for basically any small company that has vans or needs to make deliveries, which is mostly everyone in the service industry," says Satagaj. Indeed, truckers are now adding fuel surcharges of up to 80 percent for shipments.
Worse, higher oil prices, combined with government spending on the war, could lead to massive federal deficits, boosting higher interest rates and raising the cost of borrowing for small businesses, which are often the first to find their loan conditions trimmed by banks. William D. Nordhaus, a prominent Yale economist, has estimated that a war with Iraq and a post-war reconstruction of the country could cost the U.S. government as much as $1 trillion. Unlike in the Gulf War, America is unlikely to be able to turn to allies after the war to foot much of the bill, since many European and Asian countries oppose an invasion of Iraq.
The federal deficit, which has reached its highest level in decades, thus probably will rise even more in 2003 and 2004. Already, banks have begun to cut back on lending to entrepreneurs. In the Federal Reserve's most recent survey of loan officers, the net percentage of banks tightening loan standards for small companies rose to 20 percent, from 6 percent in the previous period. "I had always been a good customer with the local bank," says Walter T. Towner, president of Thorsen Inc., a 26-person metal works company in Avon, Massachusetts. "I was cash-positive up to the 2002 Christmas season, but they kept tightening the loan requirements, eventually even asking me to put my house up as collateral for my business loans." In late December, Thorsen filed for Chapter 11 bankruptcy, and since then, Towner has been negotiating with a court over the future of his business.
Even more than the impact of higher fuel prices, however, the uncertainty surrounding war, combined with the oil price shock, has depressed consumer spending and devastated small companies. "There is this general mood of pervasive anxiety in the public that they don't want to buy any big items while the economy is still overshadowed by the threat of conflict. They feel insecure and threatened by war, and this filters down and impacts small companies," says Joel Marks, executive director of the American Small Business Alliance, a trade group in Washington, DC. "No one wants to buy anything until they know what will happen in Iraq, so small retailers and other businesses are hurting, not hiring people, not making investments. ...Everybody is just freaking out." Indeed, last month the Conference Board's closely watched index of American consumer confidence fell to its lowest level since October 1993.
Some entrepreneurs also have lost high-quality employees who are military reservists--roughly 150,000 National Guard and Reserve members have been activated in the buildup to a war. Among these reserves are employees whom entrepreneurs can't replace because they know they will return from war, but whose jobs have to be filled in the short term. "Five or six months ago, I wasn't hearing much about reservists leaving hurting small businesses, but over the past month, I have started to hear complaints about lost reservists from many small companies," says Satagaj.
Higher fuel prices also cut into consumer spending, as Americans have to pay more to pump gas into their cars and heat their homes through an unusually cold winter in the Northeast and Midwest. What's more, rising oil prices have staggered investors' optimism and depressed the U.S. stock market, still a major repository of many Americans' wealth. The Dow Jones has plummeted in recent weeks. (In a strange turn of events, the Baghdad stock market actually has soared in the past month, though as yet no one has figured out why.)
Entrepreneurs, in turn, have felt the impact of depressed consumer spending. "Last spring, we were doing tons of traffic," says Magda Halgash, owner of Angels in the Attic, an antiques store in Leesburg, Virginia. "We would clear as much as several thousand dollars on one weekend day, but in recent months, it's just dead. No one has any money to spend because of layoffs in this area and their fear of the future. . Some days now we only get one person coming into the store." The effects have been so devastating, in fact, that Angels in the Attic will close on March 31. "I'm not even breaking even anymore," says Halgash. "I am spending my savings and taking out huge credit card debt, and only taking in $100 or $200 on some weekend days--I just can't afford to stay open."
The looming war is not causing gloom for all small companies, however. Some firms in the military-industrial sector stand to benefit from war-related orders. In San Diego County, for instance, where military spending accounts for nearly 10 percent of the area's domestic product, an Iraq conflict could goose a languishing regional economy. Similarly, many of the smaller military contractors--such as Florida-based Talla-Tech, which builds handheld computers used by Special Forces scouts to coordinate air strikes--that design the latest generation of high-tech weaponry, which will be showcased in Iraq, could receive heightened Pentagon interest in their latest products.
Still, notes Warren Bailey, associate professor of finance at Cornell's Johnson School of Management, the impact of defense spending on the economy is far less than it used to be. "In previous wars, like Vietnam or World War II, spending on the war could be a considerable percentage of U.S. gross domestic product. Spending on Iraq, even at the high-end estimates, would be nothing more than a fraction of that," Bailey says. "We're not going to be revving up Rosie the Riveter and sending millions of men to war, like we did in the 1940s."
What's more, some small companies believe a quick victory could end the uncertainty that is plaguing consumer confidence, curtailing consumer spending, and accordingly forcing small companies to be extremely cautious about new hires and capital investments. "The benefit of a conflict would be that, once it has begun, and as long as it goes OK, much of this pessimism and uncertainty probably will disappear," says Satagaj. "Right now, the economy is in first gear, with the anxiety keeping it from shifting into second or third." Indeed, during the Gulf War, on the first day that the United States started bombing Baghdad, the Dow Jones rose by 5 percent, and the S&P 500 gained more than 50 percent in the three years after the Gulf War.
And as Grant Aldonas, Undersecretary of State at the U.S. Commerce Department, has noted, a short war, lasting four to six weeks, leading to a collapse of Saddam's regime and not seriously damaging Iraq's oil fields, could sharply lower oil prices, helping small companies. "The effect may actually be positive economically . because it will open up the spigot on Iraqi oil," Aldonas told reporters.
A study by the Institute of Directors, a prominent London-based economic think tank, backs Aldonas' assertion: It showed that a brief war would lead oil prices to fall to at least $20 per barrel. Such a prediction is not fanciful. On the first day of U.S. air strikes during the Gulf War, global oil prices plummeted 33 percent.
Joshua Kurlantzick is foreign editor of The New Republic and a frequent contributor to Entreprenuer.com.