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James David Spellman

As war in the Middle East escalates with Israel’s invasion of Lebanon and Iran’s counter-attack, the global economy faces fresh recession fears after a year of remarkable strength and investor complacency even as Israeli forces swept through Gaza.
The past week tells us the balance of power in the Middle East is fundamentally changing and long-held assumptions of geopolitical risks are being swept aside. The same holds true for the global economy as the severity of a pullback will depend on the scale and duration of the conflict.
An analysis by the International Monetary Fund shows that economies in the Middle East and Central Asia are more affected by hostilities. Even a decade after a major conflict, their income per capita remains about 10 per cent lower, whereas impacts elsewhere fade after five years.
One gauge of the potential menace ahead is the sudden spike in oil prices, which have climbed about 8 per cent in the wake of Iran’s missile attacks on Israel on October 1 and after President Joe Biden said the US was discussing possible strikes by Israel on Iran’s oil industry.
Disruptions in production and supply within the region could imperil already tepid global growth, which the World Bank projects at 2.6 per cent this year and 2.7 per cent in 2025. That is well below the 3.1 per cent average in the decade before the Covid-19 pandemic.
The Persian Gulf is by far the world’s most important energy-producing region. Seven countries in the region – Bahrain, Iran, Iraq, Kuwait, Qatar, Saudi Arabia and the United Arab Emirates – produced about a third of the world’s crude oil in 2022 and held about half of the world’s proved crude oil reserves. In 2018, more than a fifth of world oil shipments passed through the Strait of Hormuz between Iran and Oman.


Attacks by Iran-funded Houthi rebels on commercial vessels sailing through the Red Sea show the vulnerability of the region’s shipping routes if the war spills over to more countries. Oil shipments are an important source of income for Iran, and Tehran likely does not want to imperil relations with important customers.
However, while the level of its retaliation against Israel might suggest Iran does not want to engage in full-scale war, the ongoing hostilities could still reach a point where they obstruct traffic through the Strait of Hormuz and other important routes. The resulting cascade of problems, from longer and more costly deliveries of energy and commodities to paralysing disruptions in global supply chains, could shock the global economy into a recession.
Growth in world demand for oil is expected to slow in the years ahead as production continues to ramp up. Fast-growing economies in Asia and certain industrial sectors will need more oil, but that could be offset by a decline in oil uses as a consequence of rising sales of electric cars, advancements in fuel efficiency and shifts to more renewable energy sources for producing electricity. Meanwhile, oil production from the United States and the Americas is expected to outstrip global demand. In fact, the US currently produces more oil than any other country.
But those trends will upended by protracted war in the Middle East. Oil prices will be highly volatile, as recent trading has shown. “The economies that are net energy importers would be hardest hit, particularly those most reliant on oil supplies from the Middle East, including many in Europe and Asia-Pacific,” Ken Wattret, S&P’s vice-president of global economics, wrote in an April Global Market Intelligence report.
Volatility rattles investors, undermines consumer confidence and causes businesses to slow plans for expansion. Behavioural economics shows people can be irrational when making decisions, including by imitating others instead of acting on their own information, a phenomenon known as herding. “Herding is not necessarily something one does as the result of analysis,” Nobel Prize-winning psychologist Daniel Kahneman once said. “It is what one does when one’s confidence is impaired.” That could spark a sell-off, forcing the global economy into contraction.


The vulnerability of Israel’s offshore gas fields is another concern. Attacks on these targets would imperil Egypt, Jordan and Europe, as was shown when the Tamar gas field was temporarily shut down last October. Prolonged disruptions of natural gas would squeeze the global market as colder temperatures come to the northern hemisphere.
These events and more will test whether inflation will flare up again and bring about higher interest rates just as major central banks started cutting them, as the US Federal Reserve did last month for the first time since 2020. The groundwork for raising interest rates is in place given the high levels of sovereign debt that at some point could push investors into seeking higher risk premiums. War in the Middle East could force them to move abruptly from risk-off to risk-on strategies.
Alongside prices for natural gas and oil, the Shanghai Containerised Freight Index – a widely used index for sea freight rates for imports from China – will indicate how quickly and deeply a rise in inflation will occur.
These problems could affect China’s ability to wrestle itself free from difficulties rooted in the collapse of the country’s real estate sector, the rise of economic nationalism in the West, and a domestic economy where household consumption cannot keep up with what manufacturers are producing to prevent high unemployment. A slowdown in China would have tremendous ripple effects worldwide.
Prolonged war in the Middle East risks a sharp slowdown. With each round of incursions, the likelihood is greater and the timing nearer.


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Middle East

How a wider Middle East war could bring a world recession

Illustration: Craig Stephens

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Ruins at the site of the Israeli air strike that killed Lebanon’s Hezbollah leader Sayyed Hassan Nasrallah in Beirut’s southern suburbs. Photo: Reuters

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A gas flare on an oil production platform is seen alongside an Iranian flag in the Gulf in July 2005. Photo: Reuters

People look at the remains of an Iranian missile in the Negev desert near Arad on Thursday, after an Iranian attack on Israel. Photo: AFP

Multilateralism won’t work with US focused on competition

From left to right, Japanese Prime Minister Fumio Kishida, Canadian Prime Minister Justin Trudeau, European Commission President Ursula von der Leyen, French President Emmanuel Macron and US President Joe Biden observe a skydiving demonstration on the first day of the Group of Seven summit in Savelletri, Italy, on June 13. Photo: Reuters

UN Secretary General Antonio Guterres (front right) visits an area in Tonga on August 27 that was affected by a volcanic eruption and tsunami in 2022. On the same day, Guterres sent out a global climate “SOS” at a Pacific Islands summit. Photo: AFP

People walk past the damaged Gaza City headquarters of the United Nations Relief and Works Agency for Palestine Refugees, on February 15. Several countries, including the US, UK, Germany and Japan have suspended funding to the agency. Photo: AFP

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Volatile oil prices, shaky investor confidence and prospects of interest rate increases threaten a global slowdown if Israel’s war expands


Volatile oil prices, shaky investor confidence and prospects of interest rate increases threaten a global slowdown if Israel’s war expands.


Israel-Gaza war

Lebanon

War and conflict

Energy

Yemen

International Monetary Fund (IMF)

Israel

Saudi Arabia

Iran

US-Iran tensions

United States

Islamic militancy

Joe Biden

Iraq

Egypt

US Federal Reserve

Central Asia

Central banks

Expresses the views, ideas and conclusions of the author. (Eg. Enough of Crazy Rich Asians, think of crazy poor Hongkongers.)


How a wider Middle East war could bring a world recession

.css-1c6uqr6{color:inherit;font-weight:inherit;font-size:inherit;font-family:inherit;line-height:inherit;overflow-wrap:break-word;}Volatile oil prices, shaky investor confidence and prospects of interest rate increases threaten a global slowdown if Israel’s war expands

Volatile oil prices, shaky investor confidence and prospects of interest rate increases threaten a global slowdown if Israel’s war expands