Costs of War...

October 24, 2004
ECONOMIC VIEW
Counting the Hidden Costs of War
By ANNA BERNASEK

IT'S often said that truth is the first casualty of war. During a presidential campaign, that may be more apt than ever. Consider a seemingly simple question: What is the cost of the Iraq war to the United States? President Bush and Senator John Kerry have given different answers, but both candidates have ignored what may be the biggest cost item: the war's impact on the overall economy.

After all, the real cost of war is not only the money spent but also the economic effects, good or bad. For example, World War II led to huge levels of production and employment in the United States, while the Vietnam War dragged down economic growth as it wore on.

So, after 19 months of conflict in Iraq, how has the war affected America's economy, and what about the future?

Of course, calculating the net effect of a continuing war is neither easy nor exact. That's why many analysts are reluctant to try. But a few knowledgeable economists have made reasoned estimates, and the results are surprising.

The economic cost incurred so far may be as large as - or larger than - what has actually been spent directly on the war. (While estimates vary, the official figure for spending stands at around $120 billion since the conflict began.) And there are likely to be major economic costs as long as the war continues.

But start with the economic impact to date. Two economists, Warwick J. McKibbin of the Brookings Institution and Andrew Stoeckel of the Center for International Economics in Australia, have calculated that the war may have already cost the United States $150 billion in lost gross domestic product since fighting began in March 2003. That is close to one percentage point of growth lost over the past year and a half. If that figure is correct, the nation's annual economic growth rate, which has been 3.7 percent during this period, could have been nearly 4.7 percent without the war.

Where does that $150 billion figure come from? The study took into account factors like higher oil prices, increased budget deficits and greater uncertainty. When analyzing the effects of uncertainty, the authors estimated the impact of the war on financial markets, business investment and consumer spending.

Of course, the results of any economic model are open to debate, and the $150 billion estimate is no exception. Some economists, like David Gold at the New School University, argue that the figure may be too low while others, like Mark Zandi of

Economy.com, contend that it's on the high side.

But if Mr. McKibbin and Mr. Stoeckel are correct in their estimate, the real cost of the war to date, including direct spending and lost economic growth, is in the neighborhood of $270 billion.

Most economists would agree that the war has hurt the economy, mainly through higher oil prices and continuing uncertainty. The war's effect on oil prices is hard to disentangle from factors like higher global demand and supply disruptions, but it is commonly thought that the war's role has been significant.

"It isn't a coincidence that we have oil prices breaching the key $50-a-barrel threshold one and a half years into this war," said Stephen S. Roach, Morgan Stanley's chief global economist.

Mr. Zandi says the war has clearly "had a very large impact on our economy and on the psyches of business and consumers." He explained it this way: First, in the period before the war, fear and uncertainty held back the economic recovery. Then, as the initial invasion succeeded, the economy recovered strongly and found its footing again. Now, as the war drags on, higher oil prices and shaky confidence are dampening the pace of growth and job creation.

What really worries economists, though, is the future economic impact. "The longer this war runs, the weaker our long-run growth will be," Mr. Zandi said. That is because spending on things like the occupation and peacekeeping in Iraq does not do anything to bolster the American economy's productive capacity.

And it adds to the growing budget shortfall. "With a budget deficit already at 3.5 percent of G.D.P.," Mr. Roach said, "that's a really big deal."

To see how big the future economic costs could be, consider a study prepared by William D. Nordhaus, a Yale economist. Back in 2002, when the merits of going to war with Iraq were being debated, Professor Nordhaus published a thorough analysis of the potential economic costs. It has become the most influential study on the topic. (Mr. McKibbin and Mr. Stoeckel collaborated with Professor Nordhaus, and they relied on many of his assumptions to build their

model.)

Professor Nordhaus calculated how much output the economy would lose, based on two possibilities: a quick victory or a long conflict. Although he has not updated his results, the long-conflict version has turned out to be pretty accurate so far. He estimated that such a conflict would result in $140 billion in direct government spending, a figure that we are already near. He also predicted that oil prices would spike and that heightened uncertainty would hurt the economy. In addition, he expected large additional costs associated with the occupation and peacekeeping operations as well as with reconstruction and nation-building efforts.

Adding it all together, he came up with a whopping figure of $1.9 trillion in costs during the decade after the invasion.

OF course, any analysis of the war's economic impact over time is not complete without considering the potential future benefits to the United States and the rest of the world. Increased political stability in the Middle East, stable energy markets and diminished global terrorism could pay major dividends. In fact, many people in Washington hope that the benefits will ultimately outweigh the costs, however large.

So far, though, 19 months into the conflict, those kinds of benefits remain beyond the horizon. And until more time passes, estimating the likelihood and magnitude of those benefits lies in the realm of politics, not economics.



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