Iraq, Afghanistan, and the U.S. Economy

Following 9/11, the United States launched new military endeavors on a number of fronts, including in Iraq. Estimates for the total costs of these efforts remain sharply politicized. Costs have consistently outpaced government predictions. In September 2002, White House economic adviser Lawrence B. Lindsey estimated the cost of invading Iraq could amount to between $100 billion and $200 billion. Mitch Daniels, who at the time headed the White House budget office, called Lindsey’s estimates “very, very high” (MSNBC) and said the war would cost $50 billion to $60 billion; shortly thereafter, Lindsey left the White House. In January 2004, a report from the Congressional Budget Office (CBO) estimated the total costs of Iraq’s reconstruction would land between $50 billion and $100 billion. But in October 2007, the CBO said in a new report that the United States had already spent $368 billion on its military operations in Iraq, $45 billion more in related services (veterans care, diplomatic services, training), and nearly $200 billion on top of that in Afghanistan. The CBO now estimates the costs of the Iraq war, projected out through 2017, might top $1 trillion, plus an extra $705 billion in interest payments, and says the total cost of Iraq and Afghanistan combined could reach $2.4 trillion.

Some experts say even those figures underestimate the true price tag. Joseph E. Stiglitz, the Nobel Prize-winning economist and former economic adviser to President Bill Clinton, projected in a 2006 paper (PDF) with another economist, Linda Bilmes, that the total macroeconomic costs of the Iraq war itself would surpass $2 trillion. This analysis differs from that of the CBO, which measured only the war’s budgetary impact. Stiglitz and Bilmes also predict a somewhat higher budgetary impact than the CBO did, though the CBO responds at the end of its 2007 report that some of the difference may be accounted for by factors like inflation and standard pay increases that have little to do with the Iraq war itself.

More recently, a group of Democrats on the U.S. congressional Joint Economic Committee released a report estimating the total long-term cost of operations in Iraq and Afghanistan would range between $2.6 trillion and $4.5 trillion, depending on how quickly forces are drawn down. These figures drew pointed criticisms from congressional Republicans, who released a statement (PDF) citing dozens of errors in the report’s findings, some of which were subsequently changed.

Comparing the Defense Budget to the Total Economy

The U.S. defense budget has risen over the past decade but remains substantially lower than historical levels when considered as a percentage of U.S. GDP. President Bush requested $481.4 billion in discretional spending for the Department of Defense’s 2008 budget. That figure does not include any of the spending for the wars in Iraq and Afghanistan, which have been paid for primarily through “emergency supplemental requests” that are not included in the federal budget’s accounting. War spending is expected to tally to roughly $193 billion in 2008, an increase of $22 billion, or roughly 13 percent, over 2007 expenditures. Other aspects of military-related spending also fall outside the defense budget, including nuclear-weapons research, veterans affairs programs, State Department activities in war zones, and operations covered by the budgets of the various intelligence agencies. Allocations toward the “Global War on Terrorism,” which exceed $145 billion for 2008, also fall outside the U.S. defense budget, and do not include the war-budget supplements.

Even considering the military budget and war spending together, however, total U.S. expenditures remain modest compared to historical levels in wartime. Shortly before the Vietnam War, in 1962, defense spending alone tallied 9.3 percent of GDP. During World War II expenditures were higher still; in 1944 the defense budget peaked at 37.8 percent of GDP. Even after recent increases, defense spending today comes to about 3.7 percent of GDP — and the combined total, even after including both war-spending supplements and “Global War on Terror” expenditures, comes to 6.2 percent of GDP. Still, today’s spending represents an increase since before the wars in Iraq and Afghanistan, when defense spending tallied roughly 3 percent of GDP.

In a global context, U.S. spending on military-related endeavors ranks high. According to 2005 data from SIPRI (PDF), the Stockholm International Peace Research Institute, the United States spends substantially more on military endeavors than any country in the world. If war spending and allocations to the “Global War on Terror” are excluded, the U.S. military budget is still more than seven times that of its next closest competitor, China. If you include those other expenditures, U.S. military spending surpasses that of all other countries in the world combined. The U.S. Central Intelligence Agency notes on its website, however, that when you look at military expenditures as a percentage of GDP, the United States ranks lower, at twenty-eighth in the world.

Does War Spending Help or Hurt the Economy?

There is an ongoing debate about the extent to which war spending affects a country’s economy. Experts disagree on the most fundamental point — whether war helps or hurts national economic prospects. Massive U.S. national defense spending during World War II is sometimes credited with rejuvenating U.S. economic prospects following the Great Depression. The journalist Robert J. Samuelson, in a primer on the topic, says there can be little doubt that military spending and mobilization during World War II reduced U.S. unemployment rates and revitalized the economy. A recent paper from the National Bureau of Economic Research concludes that countries with high military expenditures during World War II showed strong economic growth following the war, but says this growth can be credited more to population growth than war spending. The paper finds that war spending had only minimal effects on per-capita economic activity.

The effects of more recent wars are equally disputed. A historical survey of the U.S. economy from the U.S. State Department reports the Vietnam War had a mixed economic impact. The first Gulf War typically meets criticism for having pushed the United States toward a 1991 recession. In a 2003 op-ed in the Guardian, economist Stiglitz wrote that the aftermath of the Gulf War exposes the “myth of the war economy.” Indeed, he argues that increased military spending is “unambiguously bad” for the living standards of normal citizens. Other economists argue the opposite. Harvard economist Martin Feldstein, who served as an economic adviser for President Ronald Reagan, wrote recently in Foreign Affairs that the United States could moderately increase the Pentagon’s budget without negatively affecting the economy.

Direct Economic Impact of the War

Apart from abstract questions about whether war spending is helpful or hurtful, economists also debate the specific economic impact of the current wars in Iraq and Afghanistan. Whether one estimates the total long-term cost of the wars at $2.4 trillion or $3.5 trillion — the estimates of the CBO and the congressional Democrats on the Joint Economic Committee — experts debate precisely what direct impact this expenditure would have on the U.S. economy. The analysis differs starkly depending whose numbers you use. If the CBO’s prediction is correct that the wars will cost roughly $2.4 trillion through 2017, assuming current U.S. population levels, that would average out to a total cost of $7,973 per U.S. citizen, or $570 per citizen per year.

By contrast, the Democrats on the Joint Economic Committee, which estimated a $3.5 trillion cost through 2017, say the war will cost the average U.S. family $46,400. Per person, the total cost, given these estimates, would be $11,627, or $830 per year. Both estimates factor in interest payments on foreign debt, which the United States has sold in order to help finance the war. These debt payments account for a significant percentage of total costs. For instance, examining long-term costs just for Iraq, the CBO says actual costs through 2017 will amount to roughly $1 trillion, but interest payments on debt will add over $700 billion to that price tag.

Collateral Economic Impact

The wars in Iraq and Afghanistan touch the U.S. economy in a variety of ways beyond the impact of direct spending. First, Iraq has a lot of oil, and swings in the country’s production levels have an effect on global oil pricing. By some estimates, Iraq has the second-highest amount of oil in the world, behind Saudi Arabia. The Wall Street Journal reported in December 2007 that improving security conditions had allowed Iraqi oil production to return to pre-war levels. But the former Iraqi oil minister said in an interview with the Journal that maintaining current production levels would be a challenge. Whether Iraq is able to sustain — or possibly increase — its oil production, the fighting of the Iraq war ground production nearly to a halt in 2003. In the years since, production gains have proved choppy, as noted in a recent Backgrounder on Iraq’s infrastructure.

Geopolitical turmoil can also affect oil prices. Crude prices have spiked since the inception of the Iraq war, though experts say turmoil in Iraq is only one of several factors influencing this increase. Still, Iraqi production currently accounts for 3 percent of global oil production, and thus turmoil in Iraq can have a substantial effect on oil prices. This, in turn, bears heavily on the U.S. economy. Douglas Holtz-Eakin, a former director of the CBO who currently serves as a campaign adviser to Republican presidential candidate Sen. John McCain (R-AZ), notes the impact in a 2006 Financial Times op-ed, saying it could have significant “business cycle effects” by bringing higher oil prices and lower U.S. growth rates.

Market analysts say rising energy prices combined with a falling dollar have already strained the budgets of U.S. companies and consumers, pushing the United States toward a possible recession. Rising oil prices also fan inflation, which remains at low levels in the United States but which experts say could emerge as a major economic issue, particularly if the U.S. Federal Reserve feels the need to make substantial additional interest rate cuts. Experts add, however, that should Iraq’s security situation continue to improve, future gains from increased oil production could help mitigate some of these economic pressures.

Geopolitical Risk and Market Psychology

Experts say some of the gravest economic effects of the wars in Iraq and Afghanistan are also among the hardest to define quantitatively. Markets build assessments of financial and geopolitical risk into their pricing of just about everything. To the extent that political unrest in Iraq threatens the stability of Middle Eastern and global markets more generally, it also has a broad, though somewhat ambiguous, dampening effect on asset prices. Yale economist William D. Nordhaus outlined the plethora of ways different fallout scenarios from the Iraq war could weigh on the global economy in a December 2002 article in the New York Review of Books. Though Nordhaus quotes cost estimates that have now been surpassed, his general outline of fallout scenarios remains viable. They include “prolonged conflict [in Iraq]; adverse impacts on oil markets; escalation of war by Israel; terrorist acts around the world; heavy occupation and peacekeeping costs; burdensome reconstruction costs and nation-building; costly humanitarian assistance; shocks to the overall U.S. economy; and the use of weapons of mass destruction.” Add to that list the possibility of conflict with Iran, which many experts say has been exacerbated by U.S. involvement in Iraq; the possibility of conflict between Turkey and Iraqi Kurdistan, which would threaten lucrative oil production in northern Iraq; and the opportunity cost that an overwhelming U.S. foreign policy focus on Iraq could spell if it delays the resolution of conflicts in other regions.

In addition, experts comment on the psychological toll involvement in Iraq has taken on the United States, and specifically the U.S. economy. In a recent essay in Newsweek International, Fareed Zakaria notes that worries spawned in part from U.S. involvement in Iraq have undermined what was previously an “open and expansive” U.S. attitude toward foreign policy and economics. Zakaria says the United States has become a nation consumed by fear and pessimism. He says this fear has led to protectionist policies on trade, immigration, and markets, which in turn threaten the future of the U.S. economy.

Assistant Editor, Council on Foreign Relations
Monday, February 4, 2008; 3:58 PM