Friday, May 04, 2007

War Spending Harms The Economy

I've been writing for some time on the dangers of increased government spending, while at Peak and during the decline. The argument seems simple enough. A fixed quantity of energy, will get you a fixed quantity of production. A declining quantity of energy will reduce production.

More government spending will divert resources away from the civilian economy and drive prices of everything upwards. To compensate, civilian industries will need to keep wages stagnant or even lay off workers in order to continue to do business, while profit margins decline.

In the old days, we could keep increasing energy production and grow both the military sector and the civilian sector. But those days are over. Now we have to pick one. Logically we might choose to reduce military spending to stabilize the civilian economy, but I doubt we will. We'll keep increasing the military until we have a serious problem with the home economy. Then we'll increase government spending to help those that are being destroyed by the economy. The government will keep growing like a parasite that doesn't know to stop feeding when its killing the host.

Now someone has spent a little money to see if this is true, in an article entitled, "The Economic Impact of the Iraq War and Higher Military Spending".

Here's the Executive Summary from the article.

There has been relatively little attention paid to the Iraq War's impact on the U.S. economy. It is often believed that wars and military spending increases are good for the economy. This is not generally true in most standard economic models. In fact, most models show that military spending diverts resources from productive uses, such as consumption and investment, and ultimately slows economic growth and reduces employment.

In order to get an approximation of the economic impact of the recent increase in military spending associated with the wars in Iraq and Afghanistan, the Center for Economic and Policy Research commissioned Global Insight to run a simulation with its macroeconomic model. It produced a simulation of the impact of an increase in annual U.S. military spending equal to 1 percent of GDP, approximately the actual increase in spending compared with the pre-war budget (see appendix). We selected the Global Insight model for this analysis because it is a commonly used and widely respected model. Global Insight produced a set of projections that compared a scenario with an increase in annual military spending equal to 1.0 percent of GDP (current about $135 billion) relative to its baseline scenario. This is approximately equal to the increase in defense spending that has taken place compared with the pre-September 11th baseline.

The projections show that:

• After an initial demand stimulus, the effect of higher defense spending turns negative around the sixth year. After 10 years of higher defense spending, payroll employment would be 464,000 less than in the baseline scenario. After 20 years the job loss in the scenario with higher military spending rises to 668,100 compared to the baseline scenario.

• Inflation and interest rates would be considerably higher in the scenario with higher military spending. In the first five years, the annual inflation rate would be on average 0.3 percentage points higher in the scenario with higher military spending. Over the full twenty year period, inflation averages approximately 0.5 percentage points more in the high defense spending scenario. After five years, the interest rate on 10-Year Treasury notes is projected to be 0.7 percentage points higher than in the baseline scenario. After ten years, this gap is projected to rise to 0.9 percentage points, and after twenty years to 1.1 percentage points.

• Higher interest rates are projected to lead to reduced demand in the interest sensitive sectors of the economy. After five years, annual car and truck sales are projected to go down by 192,200 in the high military spending scenario. After ten years, the drop is projected to be 323,300 and after twenty years annual sales are projected to be down 731,400.

• Annual housing starts are projected to be 17,900 lower in the high military spending scenario after five years, 46,200 lower after ten years, and 38,500 lower after twenty years. The cumulative projected drop in housing starts over the twenty year period is 530,000. The drop in annual existing home sales is projected to be 128,400 after five years, 247,900 after ten years and 286,500 after twenty years.

• Higher interest rates are projected to raise the value of the dollar relative to foreign currencies. This makes imports cheaper, causing people in the United States to buy more imports and makes U.S. exports more expensive for people living in other countries, leading to a drop in exports. The model projects that in the high military spending scenario, high imports and weak exports causes the current account deficit to increase (become more negative) by $90.2 billion (2000 dollars) after five years, compared to the baseline scenario. The current account deficit is projected to be $72.5 billion higher after ten years and $112.8 billion higher (both in 2000 dollars) after twenty years. The cumulative effect of higher imports and weaker exports over twenty years is projected to add approximately $1.8 trillion (in 2000 dollars) to the country’s foreign debt.

• Construction and manufacturing are the sectors that are projected to experience the largest shares of the job loss. While construction is projected to have a net gain of 8,500 jobs after five years, it is projected to lose 144,200 jobs after ten years and 211,400 jobs after twenty years in the high military spending scenario. Manufacturing is projected to lose 44,200 after five years, 95,200 jobs after ten years, and 91,500 jobs after twenty years in the high military spending scenario. Two-thirds of the projected job loss is in the durable goods sector.

The paper notes that military spending is not generally perceived to cost jobs, however, in standard economic models, its impact can be thought of in the same way as spending on the environment, which is generally believed to cost jobs. While tax and emission restrictions are often used to achieve environmental ends, it is also possible to reach environmental targets by paying people to do things that will reduce pollution. For example, it is possible to reduce greenhouse gas emissions by paying people to buy more fuel efficient cars and appliances, or paying them to install insulation and other energy saving devices.

In the case of both increased military spending and paying people to take steps to reduce greenhouse gas emissions, resources would be pulled away from their market directed uses. In standard economic models, this redirection of resources will cause the economy to operate less efficiently and therefore lead to slower growth and fewer jobs. In the scenario modeled in this exercise, higher interest rates are the mechanism that slows the economy and leads to fewer jobs.

In policy debates, it is important to recognize the potential job loss from military spending. The potential economic costs are often a factor in debates over environmental policy. Economic costs should also be recognized in debates over military policy. It would be useful to have the Congressional Budget Office produce its own projections of the economic impact of a sustained increase in defense spending.

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