Consequences of War with Iraq could be disastrous for fragile economy Predictions of economic effects range from a slowdown to a double-dip recession, in light of uncertainties
Estimates of Economic Costs A comprehensive analysis by a group of experts convened by the Center for Strategic and International Studies (CSIS) predicts that a war with Iraq could send stock prices careening downward by as much as 25 percent. An economic assessment completed last year by Yale economist William Nordhaus underscores the tremendous uncertainties involved: he concludes that the costs of a war could range from roughly $99 billion to as much as $1.9 trillion over the next decade. Most economists agree that even if the war goes "well", the economic shock is likely to dwarf the impact of the administration's economic stimulus plan. Many analysts fear it will tip the economy back into a prolonged recession. War with Iraq involves numerous uncertainties that will affect costs, including the duration and character of the conflict, the potential for unconventional warfare, the scale of post-war reconstruction, the difficulty of occupation and peacekeeping, the magnitude of humanitarian needs, and the reaction of world oil markets. To deal with these uncertainties, analysts have produced a range of possible costs based on scenarios intended to capture worst and best cases. Using this methodology, the CSIS and Nordhaus studies -- the most comprehensive and current estimates available -- paint a sobering picture of a threatened economy and possible return to recession. Where are the Administration's cost estimates? The Bush Administration has declined to provide detailed cost projections of US intervention. The President's former top economic advisor, Lawrence Lindsey, was chastised by the White House for telling the Wall Street Journal last September that a war with Iraq could cost $100 to $200 billion. In late December, the new White House budget chief Mitch Daniels countered that a war could cost $50 to $60 billion, but he did not provide any data or explanation to support this claim. The administration's fiscal year 2004 budget request, which calls for $399 billion in military spending and a record deficit of $307 billion, does not include any funds to cover the costs of a war and subsequent occupation and rebuilding of Iraq. Congress will be presented with the bill after the fact, in a supplemental appropriation request. Since there has been little discussion of how to finance the war prior to the outbreak of conflict, the US may be "well prepared militarily, but not so economically," observed Robert Hormats, a senior economic official for Republican and Democratic Presidents. The Administration's failure to disclose costs -- and Congress's failure to demand them -- represent a failure of democracy. "Leaders of great powers," argues Hormats, have an obligation to "discuss candidly with their people the costs of defending their freedoms and to obtain their informed consent." Study from the Center for Strategic and International Studies The CSIS study, conducted by a panel of prestigious economists and foreign policy experts chaired by former Federal Reserve Board Governor Lawrence Meyer, analyzed three scenarios. + In the "best case" scenario of "a quick war without any major problems" lasting four to six weeks, the effect of war on the economy is limited. + In the "intermediate" case of a war that lasts six to twelve weeks without serious problems in the flow of energy or any major political catastrophes, stock prices would continue to fall, interest rates would rise and economic growth would slow by another 1 + percent. This in turn will push unemployment up to about 6.3% by the end of 2003. + In the "worst case" scenario, in which a war would last for 90 to 180 days, oil supplies were significantly disrupted and terrorist attacks ensued, the economic would fall back into recession regardless of economic policymaking. Growth would slow by 4 + percent and unemployment would hit 7.5 percent. William Nordhaus Study William Nordhaus's comprehensive study, a preview of which appeared in the December 5 New York Review of Books, concludes that the costs of war range from roughly $99 billion for a ôshort and favorableö war to $1.9 trillion for a "protracted and unfavorable" conflict. + Nordhaus's analysis underscores the point that the largest costs resulting from a war with Iraq may occur after the war is over, to pay for occupation, reconstruction and humanitarian assistance. His "low cost" analysis minimizes these costs because the history of four decades of US interventions in other countries suggests that the US will leave Iraq half-built," despite current talk of ambitious rebuilding plans. But even Nordhaus's low-end estimate is roughly twice as much as any figure the White House or the Pentagon is willing to acknowledge. + Nordhaus's worst case scenario omits a number of truly worst case conditions, such as the use of chemical or biological weapons, spread of the conflict to other areas, possible backlash against U.S. exports in Europe and the Middle East, and terrorist attacks in this country prompted by a US attack on a Muslim country. In the event of any of these developments, the already astronomical costs will climb higher. Other states unlikely to share the financial burden In the 1991 Gulf War, allies such as Japan, Germany, Kuwait and Saudi Arabia financed the war. The US was left with a small proportion of the costs. This time, the expected "coalition of the willing" is composed mostly of smaller states and reluctant partners under pressure who are highly unlikely to assume financial costs. The US is more likely to experience what William Nordhaus has described as "negative allied contributions" -- demands for US aid to help allies shoulder the burdens on war. One of the biggest payouts will go to Turkey, which reportedly has demanded up to $28 billion in aid and loans in exchange for allowing US troops to launch ground operations from its territory. Press reports suggest that Ankara will receive at least $14 billion of the requested aid. The Oil Wildcard War with Iraq might cause major upheaval in global oil markets because of physical damage to Iraqi and possibly to other Middle Eastern states' oil facilities, or because political events lead producers to restrict production after the war. We cannot know now, but destruction of facilities by a vengeful regime on its way down is certainly a possibility. A boycott against the US, such as the one that followed the 1973 Arab-Israeli war, is also not out of the question. A significant decline in production would result in sharp increases in oil prices and high inflation. Some economists have suggested that war with Iraq would mean only a brief "spike" in oil prices. Jim O'Neill, an oil industry expert at Goldman Sachs, disagrees. He recently observed that "The combined effect of the Venezuelan and Iraqi disruptions has the potential to be the biggest shock in oil market history, even allowing for offsetting increases by other players." Nordhaus concludes that "Economists fear that the shock of a steep hike in oil prices along with its inflationary impetus would be more enough to set off a recession." Wartime spending is no longer a stimulus Historically major wars have produced economic booms by fueling large increases in government spending. This is no longer true, as was demonstrated by the sharp recession that followed the first Gulf War. The increase in defense spending for that war was only 0.3 percent of GDP. As Joel Prakken of Macroeconomic Advisors has noted, "The big story of an Iraqi war will be all the negative consequences that arise, such as slumping confidence, an undermining of real equity wealth . . . and increased risk premiums. The negatives are the things that are going to shine through, because the positive boosts to GDP growth coming from a relatively modest defense buildup are not enough to make much of a difference in a $9/10 trillion nominal economy." Spending on the war means less for other priorities and a growing deficit According to a recent report by the National Governors Association, "States face the most dire fiscal situation since World War II." Despite this, the current Administration budget request offers no significant relief to states. Spending on war with Iraq may also undercut the ability of willingness of the federal government to fund a wide range of programs related to homeland security, ranging from airline safety and port security to protection of nuclear power facilities. This result strikes many analysts as ironic since a war with Iraq is likely to increase the threat of terrorist attacks. Despite rhetorical emphasis on homeland security, the administration's budget is "a status quo budget, providing maintenance capabilities for these agencies to do what they've always done," says Stephen Flynn a budget analyst at the Council on Foreign Relations. As noted earlier, the projected budget deficit of $307 billion for fiscal year 2004 does not account for the costs of war in Iraq. The same is true for the $1.3 trillion in deficit spending the administration projects between now and 2008. If deficits continue to widen as the administration ignores the contribution of military spending increasing and tax cuts to the problem, the perception that the federal budget is spinning out of control is likely to grow, provoking higher interest rates, slower rates of investment, and declines in major consumer purchases. One way or another, Americans will pay for the war. William Nordhaus: "The Bush administration has not prepared the public for the cost or the financing of what could prove to be an expensive venture. Perhaps the administration is fearful that a candid discussion of wartime economics will give ammunition to skeptics of the war; perhaps it worries that acknowledging the costs will endanger the large future tax cuts, which are the centerpiece of its domestic policy. Nonetheless, the price must be paid-by raising taxes, by cutting expenditures, or by forcing the Federal Reserve do the job by raising interest rates, thereby curbing investment and especially housing. One way or another, Americans will pay for the war." This briefing paper draws on material contained in a forthcoming report on the "Hidden Costs of War" written by William D. Hartung for the Fourth Freedom Forum (www.fourthfreedom.org). For further expert commentary contact: William Hartung, World Policy Institute, 212 229-5808 ext. 106, or 917-932-3202 (cell) William Nordhaus, Professor of Economics, Yale University, 203-432-3598 Dean Baker, Center for Economic and Policy Research, 202-293-5380 Trevor S. FitzGibbon Sr. Account Executive FENTON | Communications 1320 18th St. NW Washington, DC 20036 202.822.5200 ext. 255 - (v) 202.246.5303 - (c)
