Outlook: Stock markets start to lose their complacency over war risk

Airline trouble; Supermarket blues

Stock markets look set to become a barometer of allied success or otherwise in the war against Iraq. If this seems like poor taste, as if every blow against Saddam is worth so many points on the index while every additional allied bodybag sent home is so many points off, it is not entirely without reason. The war needs to be short and sweet from a Western perspective to avoid economic calamity. If it is long, tortuous, and results in American humiliation, the macro economic impact could be very serious indeed.

The impact would be felt in three ways. First of all there's the cost. Bad enough for Britain, it would be much higher for the US, even taking account of the enormous size of the US economy. The US Senate has already trimmed $100bn from President George Bush's tax cutting plans, and if it is true that he is about to go cap in hand to Congress for an extra £70bn to fund the war, then the whole package would be in jeopardy, dampening prospects for economic recovery. Even assuming a relatively early victory against Baghdad, it now seems possible that sporadic fighting could continue for a long time afterwards, necessitating a substantial military presence in the region for possibly years to come.

The second effect is through the oil price, which last week sank to a level which indicated the war had already been won. The setbacks of the last few days are a sharp reminder it has not. The threat to oil supplies is still very real. High oil prices have the effect of deepening recessionary and inflationary pressures at the same time.

The most important macro-economic impact is on confidence. Business confidence in America, Britain and in Europe is already rock bottom. Few business leaders are prepared to sign off on new investment until the fog of war has cleared and even then many are doubtful about the long term outlook. Consumer confidence, especially in the US, will crumble if the war proves prolonged.

If the allies are still fighting after a month with no end in sight, things will look start to look very rocky indeed. The Federal Reserve will presumably react with further sharp cuts in interest rates, but with rates already so low, there's a limit to what can be done. These are uncharted waters, and the stock market is as lost in them as everyone else.

Airline trouble

It is not only the markets and General Tommy Franks who are praying for a quick victory. The world's airlines always do badly at times of conflict but on this occasion they have even more to lose than in the last Gulf War. Then, the global aviation industry had completely recovered within a year. Iraq's invasion of Kuwait showed up as a mere blip on the ever upwards graph of passenger traffic.

This time around the situation is more dangerous. Europe's carriers are, in the main, better placed to withstand the worst that Saddam can throw at them having learned how to trim their cost bases. British Airways, for example, has a war chest of some £2.3bn which ought to see it through any conceivable conflict.

But America's carriers have never really recovered from the impact of 11 September and their collective position looks grave. Estimates from the US suggest that, one week into the conflict, domestic bookings are already down by a fifth and international bookings by perhaps a third. In the event of a protracted war, which for the airlines means anything which lasts more than a month, the US airline industry could be looking at a quarterly combined loss of $4bn.

With United Airlines teetering on the brink of insolvency and American Airlines perilously close to following United into Chapter 11 bankruptcy protection, this would be more than enough to tip one or both of them over the edge.

There is, then, a real prospect of at least one major US airline falling out of sky permanently. There are those who believe the Bush administration would never permit this, regarding it as a victory for Saddam and international terrorism. The same thing was said about Pan Am, which was finished off by Lockerbie and is now but a dim memory. Moreover, it is only 18 months since the US injected $15bn into its airlines in a failed attempt to get them airborne again. A fresh rescue package could be more expensive still. For George Bush, allowing his Texan friends over at American go to the wall would surely be too much to countenance. But the future looks grim indeed for United.

Supermarket blues

Competition regulators have got themselves into the most terrible muddle over the five competing bids for Safeway. I don't want to apologise for the Office of Fair Trading, which has done the public a disservice by referring all four trade buyers while giving the retail tycoon Philip Green a free pass. On the other hand, the OFT didn't create the underlying problem with supermarkets, which is that they never have been and probably never will be a properly competitive industry.

This is because there is a limit to the amount of competition local planning authorities are prepared to allow, making the British supermarket scene quite unlike that of the US and many areas of Continental Europe. Land in Britain is generally expensive and planning consents hard to achieve.

In the US, or even France, no one would bat an eye-lid about Safeway being acquired by one of its main competitors because barriers to entry are so low. There would always be scope for someone to move in alongside and prevent the new behemoth from abusing the consumer. Real competition can flourish in such an environment, to the benefit of all. Of course, the damage that the out of town warehouses is doing to town centre retailers and local suppliers is as much a concern in France and the US as it is here, but that's a different issue.

According to recent research at Northwestern University, Illinois, more than half the difference between productivity growth in the US and Britain is accounted for by retail. A large part of the American productivity miracle is simply that older, inefficient retailers are being forced out of business by the hyper efficiency of Wal-Mart and the shopping malls.

That makes the relative lack of competition in the UK market a headache not just for competition regulators, but also for economic policy makers. In a report to the Chancellor some years back, McKinsey, the management consultants, cited planning constraints as one of the biggest factors in Britain's poor productivity record. It wasn't what the Chancellor wanted to hear and very little policy action has been taken since to address the issues raised McKinsey's report.

All of which explains why the OFT has got its knickers in such a twist over Safeway, a company which is only attracting so much interest because it represents one of the last great land grab opportunities in British retailing. Unfortunately, persuading the OFT it should allow the trade bids has proved as difficult as getting planners to sanction the development of new supermarkets.

In its deliberations over the various bids, the OFT couldn't decide what constituted a local monopoly. Did it mean no other competing supermarkets within fifteen minutes driving time or twenty minutes? And what speed of travel should be used to calculate the driving time? Both parameters make a big difference to the number of supermarkets each player would have to dispose of to satisfy local competition concerns.

In a country as small and densely populated as Britain, planners couldn't allow a free for all in new development. Because of that, the OFT has felt obliged to rule that there can be no free for all of trade bidding for Safeway either, or at least not without a Competition Commission investigation. In the meantime Safeway's competitive position continues to deteriorate, with suppliers tightening their terms and consumers voting with their feet. Under the control of a financial buyer like Philip Green, Safeway's competitive position could only get worse still. What a mess.

jeremy.warner@independent.co.uk