The diplomatic rift over war with Iraq has reverberated throughout the United States, the United Kingdom, France, Germany and the rest of what only recently has come to be known as Old and New Europe. Policy makers and citizens are wondering what will happen in the coming months and years as familiar alliances founder, new alliances emerge, and structures like NATO and the European Union face new pressures.

But more is at stake than politics and diplomacy. At issue, too, are business and trade relations between the United States and Europe, according to faculty members at Wharton and INSEAD, the French business school. Just how far the disagreement over Iraq may affect business remains to be seen. No one is predicting anything like an out-and-out trade war or a rash of Americans pouring bottles of Bordeaux into Boston Harbor. But faculty members say the impact of the Iraq issue on commerce may nonetheless be serious as ordinary consumers and corporate strategic planners alike begin to make decisions based on the friction that has affected the political climate in Berlin, Brussels, London, Paris and Washington.

“Nobody knows how this is going to play out,” says Howard Pack, professor of business and public policy at Wharton. “I think the likelihood of a consumer backlash is not huge. But Germany has a very high unemployment rate. It also exports about $30 billion more a year to the U.S. than it imports. So, even if sales of German consumer products went down by $20 billion, this would have a very serious impact on the German economy. In that sense, the Europeans may run into some unanticipated problems. Given the weakness of the European economies, this dispute might have some effect.”

Bruce Kogut, professor of strategy at INSEAD, attended the recent annual conference of corporate leaders, government officials and other well-connected people at Davos, Switzerland, where he found the atmosphere “devastatingly against the U.S.” At Davos, he noted, “Europeans and many expatriate Americans were angry over the United States acting as a bully” toward those countries that oppose military action against Baghdad. Those same people also expressed disappointment over previous U.S.-European conflicts regarding trade and environmental policies.

After the Davos sessions, Kogut and his family went skiing in France where he heard people express fears about a possible decline in U.S. imports from Europe, which is a net exporter to America. “Europe is very dependent on the American market and has invested heavily in the U.S. in the last 10 to 15 years,” says Kogut.

Reports of a Backlash

News articles concerning the effects of the diplomatic rift on business have surfaced in the last few weeks. According to the International Herald Tribune, the president of a German wholesalers group reported that an executive of a consumer-goods company lost a contract with a longtime U.S. customer who was unhappy over German Chancellor Gerhard Schroeder’s opposition to a war with Iraq. The newspaper also quoted the president of the French-American Chamber of Commerce in Paris as saying that, while French-U.S. crises usually “blow over” in a few weeks, “I don’t expect U.S. airlines to be buying Airbus over the next few months.”

The Associated Press, meanwhile, ran a story that an official in Palm Beach County, Fla., would try to block a subsidiary of the French company Vivendi Environmental from getting a $25 million government contract to build a sludge-treatment plant.

But faculty members say the potential ramifications of the European-U.S. dispute go beyond anecdotal evidence of consumer dissatisfaction and the French-bashing comments of tabloid columnists and late-night comedians. They say that animosity and distrust on both sides of the Atlantic could affect where U.S. firms decide to invest in Europe and how effectively trade disputes between the EU and the United States are handled. In addition, EU antitrust officials may look at proposed U.S. corporate mergers with a more critical eye. What is more, they say, the chasm between Old European countries like Belgium, France and Germany and the New Europe of Poland, the Czech Republic, Hungary and other central and east European nations will affect how enlargement of the EU proceeds. The 15-member EU is expected to expand to 25 countries by 2004.

“The less obvious, but perhaps more damaging, effects won’t be from consumer boycotts and companies walking way from deals,” says Wharton management professor Witold Henisz. Instead, bigger risks will arise when a company, say, enters into talks with blinders on or a chip on its shoulder.

“When companies deal in an international context, they need to appreciate the situation on the ground in other countries,” says Henisz. “If you’re not listening, you may miss the importance of what someone else is saying. There’s a danger that if you are entering into a negotiation, you won’t hear the piece of information you need for a deal to work.”

He adds: “Are people going to walk away from deals out of spite? I don’t think so. I think it’s more important to understand … what makes a deal successful. A continued process of discussion, of developing a better understanding of what politics, culture and societies are like in other countries, helps businesses succeed abroad. If a firm writes off the other side as antagonistic, that will impede further progress.”

Henisz also fears that the disagreement over Iraq will spill over into other areas, such as the longstanding controversy over the importation of genetically modified organisms into EU countries. 

The value of the dollar has fallen against the euro since the rift opened. But Richard J. Herring, professor of international banking and director of the Joseph H. Lauder Institute of Management and International Studies, says it is difficult to discern how much of the dollar’s decline is attributable to the diplomatic flap over Iraq.

“A lot of things have happened at once,” Herring explains. “There are structural reasons to believe the dollar would be devalued anyhow because the U.S. has a huge current account deficit and the euro has, by some measures, been undervalued for some time. But we haven’t seen what we often see when there are huge international uncertainties, such as a flight to the safety of the dollar. It’s possible the current threat to international stability won’t have that result. After 9/11, the U.S. no longer seems invulnerable to attack. Also, terrorists seem to be hostile only toward the U.S.”

Herring notes that the costs of the 1991 Gulf War were borne jointly by the United States and its allies, so there was little impact on America’s balance of payments position. “But it’s clear if we go ahead with a war on Iraq, it will be ours alone to pay for. This could cause an adjustment in the dollar,” he adds.

According to Wharton management professor Gerald A. McDermott, U.S.-European tensions may affect the evolution of EU enlargement and the drafting of a European constitution, which is currently underway. Many of the countries that have announced support for the U.S. position on Iraq are candidates for entry into the EU and into the North Atlantic Treaty Organization. It was these countries that in mid-February were on the receiving end of criticism from Jacques Chirac. The French president said that the countries should have kept their opinions about Iraq to themselves and indicated that their outspokenness could affect their entry into the common market.

Trade Issues

What this all means for business is that fundamental decisions are being made about the future of political and economic institutions in Europe at a time of strained relations, McDermott suggests. “The French say President Bush is screwing around with the EU [by welcoming support for a war with Iraq from Central and Eastern European countries]. Historically, the EU has been a French-German affair. The French view Bush’s actions as a willingness to play around with what they view as domestic politics. There are huge divisions within the EU over things like subsidies [to new EU entrants] and to agriculture. Now the French and Germans are really angry at the countries that support Bush, which exacerbates the difficulty in dealing with critical policies and institutions.”

McDermott says the disagreement over Iraq also may affect the current Doha round of World Trade Organization negotiations on contentious issues that include EU subsidies to farmers. (The deliberations are known as the Doha round because the talks began in 2001 in the capital of Qatar.) He also predicts “foot dragging” on U.S. antitrust cases that come before EU officials. In addition, tensions related to Iraq will affect whether Britain decides to give up the pound and adopt the euro as its currency, an issue that bitterly divides British officials.

British Prime Minister Tony Blair is “at no threat of losing his job at this point,” McDermott says, “but what is at issue is the political capital and power he would need to get voters to adopt the euro. I think you have to evaluate the impact of the Iraq war and the postwar situation on Blair’s ability to carry out other parts of his agenda. All of these issues affect the integration of Europe and the international political economy.” With regard to trade between the United States and the EU, Herring says it is hard to predict what may happen as a result of the current diplomatic tensions since trade friction already exists. “There have been longstanding tensions over the EU’s agricultural policy, its mergers policy and U.S. steel tariffs,” according to Herring. “But at the end of the day I don’t see the Iraq issue rupturing the WTO. I think the last round of tit-for-tat retaliation for tariff moves shows that neither side may be eager to resort to them at this point.”

When the U.S. placed temporary tariffs on imported steel last year, the Europeans were clever to retaliate not in an across-the-board way but by targeting steel products in congressional districts where they thought President Bush was weak. “The Republicans ended up winning the mid-term elections, but the impression was left that the Europeans would be almost surgical in retaliation, which makes tariffs less appealing,” says Herring.

The Lure of Eastern Europe

INSEAD’s Kogut believes that French and German opposition to a war with Iraq may lead more U.S. firms to seek to set up operations in Central and Eastern Europe, where labor is cheaper, the business climate is entrepreneurial and there is access to the EU market. But Kogut notes that American companies were looking to this region as a place for investment long before the Iraq issue caused U.S-European tensions.

The extent of the attraction that New Europe holds for investors in the United States – as well as Old European countries – was spelled out in a recent article written by William Drozdiak, a former Washington Post reporter and now executive director of the German Marshall Fund’s Transatlantic Center.

“Over the next decade, Europe’s fastest growth rate and highest income surge are projected to occur in the eastern swath, stretching from the Baltic states to Bulgaria,” Drozdiak wrote in the Post. He added: “Western insurance companies, supermarkets, banks and automobile and machinery firms are flocking east to establish themselves in what is seen as the new mother lode of consumer markets.” For instance, Citigroup and General Motors are among the firms that have heavily invested in Poland, a staunch U.S. ally that was particularly unhappy with the way Chirac chastised European supporters of the United States in the Iraq controversy.

Wharton’s Pack points out that if any U.S. firms are reluctant about investing in Germany or France, it may simply be because they see good opportunities elsewhere and have little to do with the squabble over Iraq. “American businesses are concerned with investments in China and, increasingly, with India in the area of software,” says Pack. “There is rapid per-capita growth in both countries. This highlights a long-term trend. Economies in India, China and even Russia may do much better than Europe in the next 10 or 15 years.” France, Germany and other European countries “have to figure out how to keep their economies growing when their birth rates are so low.”

Herring points out that many U.S. companies “are already not investing in Germany and France. Even the Germans are no longer investing in Germany, which is part of their problem. The same is true of France, but to a lesser degree.”

An Optimistic View

Looking ahead, Kogut is largely optimistic about the ability of the United States and Europe to settle their differences. “I’m not predicting the U.S. will withdraw economically from Europe,” Kogut stresses. “The U.S. is a unified market and it is still the country that has been the engine of world growth in the past few years and it will continue to remain attractive to Europeans.”

By the same token, Western Europe will continue to remain attractive to many U.S. firms, and vice versa. “In deciding where to invest, American companies look to see whether there is support for their presence and activities in foreign countries,” according to Kogut. “Every investment depends on favorable political climate. My sense is U.S. firms are going to find support in France and Germany. These economies still have high unemployment rates and are thankful for investment. And, in the end, Europe and the U.S. have great common interests.

“Things do look a bit worse than they really are,” Kogut continues. “It’s difficult to know what French policy is – and that’s a major factor in how all of this will play out. But, in the end, I’m fairly optimistic. Both Europe and the U.S. are so deeply involved with each other they’re going to work to maintain favorable business environments. Their destinies are common destinies.”