Are We Headed for Another Recession?

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

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

The signs are not good. A well-known index of economicindicators, the Conference Board report, fell in March; meanwhile,March's index by the Institute of Supply Management, thenation's leading forecaster of manufacturing activity, droppedbelow 50, signifying that the manufacturing sector is contracting,and employers eliminated more than 100,000 jobs in March, afterslashing nearly 300,000 the month before. Overall, companies arehiring at their slowest pace in more than a year. "It doesappear increasingly likely that we're headed for anotherrecession," says Robert E. Scott, an economist at the Economic PolicyInstitute, a Washington, DC, think tank.

"It's one of the most difficult periods I've everseen," concurs Al T. Lubrano, president of TechnicalMaterials Inc., a Lincoln, Rhode Island, company thatmanufactures specialty metal products. "Where's the hopeon the other end?"

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

What's more, the end of the war in Iraq has notsignificantly reduced the uncertainty felt by many Americans--anuncertainty that keeps consumers from spending as much as possibleand prevents businesses from making long-term plans. Although theprice of oil has dropped, America still remains dependent onpotentially unstable nations--Nigeria, Venezuela--for aconsiderable percentage of its petroleum.

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

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

Meanwhile, housing construction fell in March, suggesting thatAmerican consumers, who are carrying higher levels of personal debtthan they did during the 1991 Gulf War, also are becoming morecautious. In the past, the government was able to stimulatespending and growth by slashing interest rates, but the FederalReserve has cut rates 12 times since 2000, to its current rate of1.25 percent.

The arrival of SARS in North America has further heighteneduncertainty. Already, Stephen Roach, chief economist at MorganStanley, has predicted that the world will fall into recession thisyear, in part because of SARS. "Right now, SARS is in Toronto,and we've seen how it's decimated the economy of thateconomically powerful city," says Marks. "Tomorrow itcould be in Des Moines."

SARS, the possibility of future conflict and the continuingthreat of terrorism also are complicating shipping logistics,cutting into companies' profits. For example, over the past sixmonths, freight rates have risen by more than 30 percent forcompanies shipping through the Middle East, as marine insurancecompanies raised rates on shippers since the Iraq war by as much as50 percent. In fact, according to marine insurance companies,shipping rates have been pushed to their highest level inyears.

More expensive logistics, along with increased tension betweenEurope and the United States due to friction over the Iraq war, isputting a damper on global trade. "The pace of free tradeexpansion has slowed drastically," says Scott. "If weengage in more conflicts in the Middle East, that could furtheralienate Europe, which is already hurting economically, and damagetrade." Indeed, unlike in the wake of the 1991 Gulf War, whenEurope and Asia were growing and helped pull the American economyout of recession, today Europe and Japan are struggling on theverge of their own recessions.

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

Small Companies Bracing Themselves

As all these signs of economic weakness build, small companieshave the most to lose. Thus far, small firms have largely been shutout of contracts forpost-war reconstruction in Iraq, though the Bush administration haspromised to share the wealth. And according to Marks, many smallcompanies do not possess the kind of cash reserves to deal withanother prolonged period of economic downturn, since banks havebecome more willing to turn away small clients than they havelarger companies. "Small companies have spent down much oftheir cash already, in the previous recession, and they didn'thave time to build it up again," Marks says. "There'snumbness out there in the small-business community, wonderingwhether they can hold on to the cash they have and numbed by eacheconomic shock."

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

Meanwhile, small companies rarely have the capital needed tocreate the redundant, alternative supply chain networks that canallow goods to bypass world hotspots and generally avoid logisticalproblems. And owners of small companies often are ill-prepared todeal with the effects of continued anxiety and uncertainty on theirworkers, since few have the kind of dedicated in-house counselingservices large companies employ.

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

Always a SilverLining
But not all signs of the economic future are negative. In theimmediate aftermath of American troops arriving in Baghdad, stockmarkets, which can be leading indicators of economic expansion,posted stronger gains than they had since September 11. What'smore, since the beginning of the Iraq war, the price of oil hasfallen by more than 25 percent. A decrease in the value of thedollar actually could help American entrepreneurs, as it would makethem more competitive with companies from the developing world.

And despite high levels of debt, American consumers often provewilling to keep shopping. Corporate credit became slightly easierto obtain in March. The fact that companies have spent so littleover the past three years ultimately will leave them with no optionother than to increase business spending. Last week, FederalReserve Board Chairman Alan Greenspan told Congress the economy ispoised for growth even without further tax cuts--though the Bushadministration continues to push for a $550 billion, 10-yeartax-cut plan that may or may not stimulate the economy. (InFebruary, a group of 10 Nobel Prize-winning economists concludedthat the tax cuts would not have a significant short-term stimuluseffect--some leading economists worry that further tax cuts couldexacerbate federal and state deficits.)

Perhaps most important, small companies have internalizedlessons from the 2000-2001 recession to prepare themselves for moreeconomic turbulence. "Small companies that are around now areleaner than they were two years ago, and they've learned how tocut fat oradjust in other ways--merging with competitors, going into nichemarkets, renegotiating their contracts, conserving cash," saysMarks. "Three years ago, two guys and an idea could raisecapital; today those guys are living in their parents'basements."

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