FRANKFURT, 29 March 2003 — War in Iraq has hurt the alliance that underpins the global economy and could injure the institutions designed to keep world growth from harm.

Iraq pitted ‘old’ Europe of France and Germany against America and Britain in the United Nations Security Council, straining the already tattered consensus on economic policy management.

If this ill-will spreads from foreign policy into the realm of real business, trade and investment could end up as casualties of the war. It is also bad news for the work of the Group of Seven, World Bank and International Monetary Fund, at a time when their crisis-fighting abilities may be needed.

“At stake is the question of how much you can insulate this general bad feeling from the day-to-day issues,” said Adam Posen, a senior fellow at the Institute for International Economics in Washington.

The United States, due to its massive current account deficit, is highly dependent on foreign investment to finance borrowing, while the rest of the world needs US consumers to keep buying their exports to stimulate economic recovery.

“Capital flows do not like uncertainty and worry about changes in the rules, say on corporate governance or taxes, which are things affecting how to get your money out,” he said.

Tip-toeing through the maze of daily business that could affect confidence among foreign investors requires patience and diplomacy — commodities currently in short supply in Washington, Paris and London.

Trade, the cornerstone of greater global prosperity, could be where tensions in the global economy show up first.

Doha, better known now as the headquarters of US military command in the Gulf, was also the location of the World Trade Organization’s last round of trade liberalization talks. Unfortunately, these are currently deadlocked over tariffs for agricultural imports, a dispute which once again places the United States on one side of the argument and France on the other.

With politicians in Washington preoccupied by who is with and who is against the United States, the prospect of this spilling over into wider trade is all to easy to imagine.

“The world cannot afford to reverse course on globalization,” Morgan Stanley Chief Economist Stephen Roach warned clients in a note this week.

“That would heighten the risk of trade frictions and protectionism, repeating the painful mistakes that have derailed the world at critical junctures in the past,” he said.

Morgan Stanley calculates world trade growth has already slowed to an average of five percent a year between 1998 and 2003.

“To the extent that war in Iraq creates new fault lines in an already shaky world order, the economics of globalization will be even harder to execute,” he warned.

It is also hard to see how the International Monetary Fund or World Bank can flourish in this chilly climate.

This is a problem because the emerging economies which they are supposed to help are the ones most in the firing line if there is another dip in world growth — not a remote possibility in today’s uncertain times.

Both institutions are under pressure to improve how they work through reform. But if European members of their executive boards are at logger-heads with the United States and cannot even agree amongst themselves, this will not produce the best results.

“I worry that the kind of tensions we saw at the UN Security Council could be reflected in the deliberations of the Fund and the Bank,” said Barry Eichengreen, an economics professor and adviser to policymakers in the United States and Europe.

“There is a risk that politics gets in the way of sound economic decision making... It is right to worry that tensions over the war will slow the process and the lack of reforms will make these institutions less effective,” he said. The same goes for the Group of Seven club of rich nations, due to meet alongside the IMF in Washington on April 12.

America, Britain, Japan and Italy backed the war whilst France, Germany and Canada were against fighting without Security Council approval. Some economists advocate the G-7 conspiring to manage the dollar lower to re-distribute demand from the United States to Europe.

They hope the European Central Bank will be inspired by the stronger euro to slash interest rates and boost sluggish activity in the euro zone. To others, the idea of the G-7 agreeing to do anything in a coordinated fashion just sounds far-fetched.