A War Economy Jude Wanniski July 26, 2002

Memo To: Supply Side Students
From: Jude Wanniski
Re: Invading Iraq

When I was a college student in the late 1950's, a “left-winger” at that, I was taught that the Great Depression was caused by a paucity of consumer spending and that the Depression ended when we went to war with the Axis powers in December 1941 – when the federal government spent on behalf of the consumers to win the war. I’ve since come to understand the problems of the U.S. and world economy at a much more elevated level, with hindsight my best teacher. The most influential economists of my youth were the followers of John Maynard Keynes, the men and women who not only identified U.S. war spending as a cure for economic depression, but who also believed that Adolf Hitler had paved the way in economic theory by lifting Germany out of economic stagnation with an economy on a war footing. No less an eminence than John Kenneth Galbraith made this argument. Of course he did so not to celebrate the Third Reich, but to point to the utility of having government step into a weak economy and make it stronger by spending, not on munitions, but on public works and poor people. If rich people were not going to spend to boost the economy along, so the theory went, it made sense for Washington to tax their surplus income and give it to the government to spend on good causes.

We were later to learn that the Depression was caused by grave mistakes in tariff and tax policies by the United States in 1929-32, and that World War II itself was the product of those grave mistakes. But until supply-side economics emerged in the 1970's with a better explanation, those earlier explanations of how useful a wartime footing could be to spur economic expansion held sway. One of the primary reasons President John F. Kennedy embraced “the space program,” with the goal of “putting a man on the moon,” was that if the economy needed government to spend, it would be better to spend on peaceful scientific purposes than on looking for an excuse for war. Because the American people want to be fully employed, the idea of plowshares instead of swords seemed an attractive one.

Those of you who follow this website during the week as well as during SSU lessons know that I do not believe it wise or necessary for the United States to “do” Iraq, as supporters of the idea put it. Let us, though, put aside those political arguments to address the economic questions posed. I do not argue, for example, that a War Economy is necessarily bad. Any military conflict means that resources which would otherwise be available to raise the standards of living of the nation at large would have to be diverted to winning the war. Imagine a nation that is enjoying a booming economy and rising standards of living but is pretending that its neighbor is NOT about to invade for the purpose of conquest, with a little rape and pillage thrown in for good measure. The international investment community would see through that wishful thinking, I believe, and begin withdrawing resources from the nation. In that instance, a decision by the government to tax and borrow to spend on military defense would be reassuring to the international investors. In other words, a bigger defense budget would be good for the economy.

In the past I have used the example of household insurance to make the idea understandable. A family that spends 2% of its annual income on fire insurance comes to that decision after thinking through the costs and benefits of the insurance. You can see how ridiculous it would be if the family would decide to spend 25% of its annual income on fire insurance, unless of course the insurance covered a collection of Great Masters hanging on the living-room wall. At the national level, it would be foolish for the United States to tell the masses of ordinary people that they will have to give up any chance of staying off the dole because Uncle Sam is going to spend 25% of national income on insurance policies.

The debate about a military intervention in Iraq in 1990, after it invaded Kuwait, included the economic issues. At the time, the Bush administration went all out to persuade the world that Iraq posed a threat far beyond the oilfields of Kuwait, that Saddam Hussein had plans to invade Saudi Arabia as well and eventually all the remaining monarchies of the Middle East. Uncle Sam then passed the hat around and collected $60 billion to pay for the war. Even Japan chipped in several billion dollars for the effort, bowing to the argument that the U.S. military has been covering Japan with a security umbrella since the end of WWII. This financial and political support from the rest of the world, including most Arab countries, clearly helped persuade Congress to vote support for the war effort. If the United States was prepared to put its young men and women at risk in “the mother of all battles,” as Saddam warned, the moral pressure was on the rest of the world to put up money. In this kind of arrangement, the financial markets had no trouble in deciding there would be no net reduction in the value of U.S. capital assets.

If Iraq were considered a serious threat to the United States at the moment, or in the near future, it would not matter that the cost of military intervention would subtract from the value of capital assets. This is a point made recently on NBC’s McLaughlin Group by Tony Blankley, editor of the editorial page of the Washington Times. This would be true even if no other nation would be willing to contribute to the cost of another war with Iraq. The fact that one Islamic nation invaded another Islamic nation in 1990 made it easier for the rest of the Islamic world to either support the U.S. financially and politically. It becomes far more difficult when the entire Islamic world refuses to support the U.S. in its assertion that Saddam will pose a future threat to its neighbors.

In evaluating the economics of intervention this time around, then, the government has to begin with the assumption that it would have to cover all the costs of the war out of its own Treasury. If the estimated cost would be in the range of $65 billion, there would be less of an argument to consider the diplomatic alternatives to war, as that amount is relatively small in a $10 trillion economy. The difference between expelling Iraq from Kuwait and expelling Saddam Hussein from Baghdad is a serious one. Those who are most intent on the war route argue that as soon as the U.S. bombs began falling, the Iraqi army will turn against the regime in Baghdad and take care of Saddam without any of the high costs associated with a worst-case scenario. In a worst-case scenario, the United States would have to send in ground troops to defeat an Iraqi army fighting to defend its own soil. In that scenario, the only country in the region that has indicated the possibility it would permit the U.S. to use its soil as a staging area is Turkey. The government there is secular, but the Islamic population may well resist use of its soil for a U.S. attack on Iraq, especially when such an attack would be universally seen as an attack on behalf of Israel – as Iraq could not possibly pose any kind of threat to the United States.

Even if Turkey manages to keep the population under control, the problem for the Pentagon military planners can quickly be seen when it comes to estimating the cost of the intervention. If U.S. ground troops are going to go into Iraq from Turkey, they will have to go through the mountains, a route that will sharply increase the likelihood of combat casualties. The minimum amount for such an intervention would be $100 billion, not including the amount of blood spilled. In a worst case scenario, should Iraq decide to include Israel as a combatant, the use of Israel’s nuclear weapons would have to be considered, which would mean the Pakistan government would come under pressure to bring its nukes into play against Israel. Costs would quickly escalate on all sides and the domestic U.S. economy would feel both the direct costs of the war but also the indirect costs of a much higher price of oil and a world of businessmen retreating from any business until the smoke cleared.

There are those who still argue the war economy would not damage the U.S. economy at all, but like World War II end any chance of recession. It is important to recall that the cost of WWII was more than $300 billion, when gold was $35 per ounce. The Dow Jones Industrial Average, which was at 370 at its peak in 1929 did not return to that level until the Eisenhower years, taking into account the devaluation of the dollar against gold in 1933-34.

The point of this summer lesson is that war is serious business. Those who want war with Iraq argue that it would be “a piece of cake” and all the downside risks should be ignored or minimized. We will see in August as the Senate Foreign Relations Committee opens hearings on the Iraq issue how these economic issues are treated. The warriors at the Pentagon and their civilian allies are already pressing for the removal of Secretary of State Colin Powell, who tends to look at the worst-case scenarios in order to prepare for the worst if it happens.