The $800bn conflict and a world left licking its wounds

When the First World War started, the saying was "It'll be over by Christmas". With the potential conflict in Iraq, the timeframe is even shorter. Some are talking about it being over before Gordon Brown stands up to present the Budget at lunchtime on 9 April.

Even if these optimists are right, though, this conflict will end up as one of the most expensive in history. Last year Larry Lindsey, George Bush's chief economic adviser, estimated that it would cost America $140bn (£87.5bn). But this figure has already been exceeded and the bill is getting larger by the day.

First there is the direct cost of the build- up of troops in and around Iraq, along with the ships and planes carrying them, their supplies and logistics, the potential cost of the weapons and fuel they will use up, and the potential loss of expensive machinery and soldiers' lives. Last week the Bush administration gave an indication of how much extra it would need from the Federal budget to cover all this, quoting between $60bn and $95bn. Few people think the final bill will come at the lower end of this range.

This doesn't include the UK's expenditure. Last week the Chancellor said he would need to allocate more than the £1.75bn he has put aside so far for the war, but could not say how much. This could take the total allied bill past $100bn.

To put this in context, this is about 50 per cent of the cost (in today's money) of America's late involvement in the First World War, just under a third of the cost of the Korean War and a fifth of the expenditure on the conflict in Vietnam.

It is also a third more than the last Gulf War in 1991. This is not because it is any more expensive to wage this conflict, just that the UK and the US have to pay for all of it. "The allies have to foot their own bill this time," explains Mark Cliffe, chief economist at ING Barings. "In 1991 the Gulf states, Japan and Germany all paid out to help cover the costs."

This $100bn assumes a short conflict. The Congressional Budget Office has priced war at between $6bn and $9bn a month just for the cost of munitions and supplies, while deploying troops would cost another $9bn-$13bn a month, and occupation would come in at between $1bn and $4bn a month. A month-long war with a year-long occupation would cost up to $70bn, but a three-month war and two years of occupation could cost $200bn.

The $95bn estimate includes some of the compensation the US government is going to offer Turkey for letting US troops use its bases. But as the Turkish parliament has thrown out the US plans and intense negotiations are under way, there could be substantially more aid for Turkey. The total bill could exceed $30bn and it is not clear how much of this is included in the war funding being put before Congress.

And Turkey isn't the only country looking for compensation. Israel has asked for $12bn in a mix of aid and loan guarantees, Egypt is pressing for up to $8bn and Jordan is likely to seek up to $2bn. Others may also look for help, leaving a total bill for assistance to "friendly" countries of over $50bn. This means that in the case of a long but successful war, the total direct cost could be at least $250bn.

All this ignores the impact on the world economy, which is much harder to quantify. The most obvious effect is on the oil price. On Friday it closed at $33.60 a barrel, over $10 higher than it was before this crisis started. But economists and oil traders cannot agree on how much of this rise is due to the Iraq situation and how much to problems in Venezuela.

However, assuming the price would be around $25 without the crisis, then it is making oil some $8 a barrel more expen- sive. The world consumes 75 million barrels a day, which makes the daily increased cost $600m. Even given a short war, the crisis will have lasted about six months, for a total extra cost to the world of $36bn.

Optimistic economists believe the oil price will drop once the war is over, as it did in 1991. But others have changed their view. "We thought the price would fall back to $20, but we now think it will only be to around $27 or $28," says Keith Wade, chief economist at Schroders Investment Management. "This is because inventories are so low and it will take some time before Iraqi oil comes on stream."

HSBC estimates that each $5 rise in the price of oil would cut world economic growth by 0.1 per cent, or $32bn. So if the oil price stays $8 higher for the year, this would cost the global economy $51bn.

The knock-on effect could be even more marked. Already the world's economies are suffering as investment decisions are put off and people are thrown out of work. "Early estimates of US GDP growth for the first quarter ranged around 3 per cent, but these seem wide of the mark," says Stephen Lewis at Monument Research. "There must be some doubt about whether there will be any growth at all." In effect, this means the crisis has cost the US economy $300m in the first three months of this year alone.

And what happens after the war? Mr Cliffe at ING Barings was initially derided as too bearish when he said world economic growth could be cut by up to 1.7 per cent because of the conflict. However, many are coming round to his view. If Mr Cliffe is right, this would mean a bill for the world of $530bn this year – and he was assuming a sharp recovery in global activity after the war. But now he is not so sure, pointing out that recovery could be slow or even negligible until the political uncertainty is sorted out.

Mr Wade agrees: "The cost of the war and of occupation is pretty open-ended. And if Bush then goes after Iran or North Korea, the uncertainty will continue. Even an ideal, short war will not put the world economy back on a recovery path."