War with Iran and the Economy

Should America Do Wrong Things for the Right Reasons?

Share/Save/Bookmark

War with Iran and the Economy
by varjavand
10-Oct-2012
 

With the rise in conservatism and the likely success of Mitt Romney in the upcoming presidential election, there will be a renewed effort to beat the war drum in regard to Iran. Given the disappointing economic conditions here in the U.S., there might be popular support for war, especially among some politicians and economists who believe that war will jump start our stalled economy. In a September 5, 2010 article in The New York Times, renowned economist Paul Krugman stated: “From an economic point of view, World War II was, above all, a burst of deficit-financed government spending” [that he believes was responsible for a long lasting economic boom]. He then concluded: “The economic moral is clear: when the economy is deeply depressed, the usual rules don’t apply.” Such a view is rooted in the belief that consumption is the main impetus for economic activity. Its effectiveness in modern time, however, may be open to speculation. To the extent that war necessitates a huge increase in government spending, it may have an expansionary effect on the economy. Workers would be able to find employment and earn income in war-related industries, and factories would produce more output to support a war. Additionally, the rebuilding efforts after a war could also help the economy.

Historically, the trend of U.S. economic performance reveals persistent ups and downs that are clearly more intense before and after major wars. Most notably, severe fluctuations occurred right after WWII. Such historical evidence has led many economists, such as Paul Krugman, to support war as a remedy for the country’s anemic economic recession. (See: Military Keynesianism Gone Haywire: Paul Krugman Pines For World War ... Based On Ginned-Up Reasons)

We should notice, however, that while this was true in the past, this may no longer be the case because the current recession is not on par with the Great Depression in terms of causation, intensity, duration, and consequences. Those who draw a parallel between the two may be scantly right at best. Unemployment was 25% at the height of the Great Depression while it was less than 9% at the trough of the great recession of 2007. Many economists believe that the Great Depression was not basically triggered by lack of or insufficient spending, but rather by the tremendous loss of wealth due to the stock market crash, the increase in taxes on imports following the enactment of the Smoot-Healy Act, and the tight monetary policy of the Federal Reserve. Accordingly, massive investment in public works projects, which was beyond the will and ability of the private sector, was needed and was in fact instrumental in moving the economy out of the Great Depression and into a healthy recovery phase that lasted for more than three decades.

The Great Depression was primarily caused by years of reckless mortgage lending and risky asset-backed securities that were created and sold to investors worldwide. The resulting financial crisis then infected the real economy and brought it its knees, ultimately causing its meltdown. Furthermore, the nature of business fluctuations has changed over the past 50 years, thanks to more prudent formulation and implementation of fiscal and monetary policies that were lacking prior to the Great Depression, and the installment of safety nets such as the Social Security system that automatically kick in to counter the business cycles. Finally, the nature of war has changed in modern time. Wars are now more high-tech, like the popular drone war, and they are less expensive and less labor intensive. Since most expenses in the recent wars in Iraq and in Afghanistan are related to moving heavy equipment and personnel, this is not going to help the production sector of the U.S. economy as much as in WWII. In fact, war will likely be more economically helpful to those countries the U.S. attacks or invades rather than the U.S. itself.

It is illusionary to rely on war to stimulate economic growth. This is what economists call the fallacy of the broken window. If you spend $500 to replace a window in your house that was broken by the obnoxious kids in your neighborhood, your action surely creates jobs and incomes for those who replace the window. However, spending $500 on that window would prevent you from buying other things with that money, for example buying a new suit for yourself or a dress for your wife, thus creating an offsetting effect to begin with. In other words, some activities that look productive do nothing but divert resources from alternative and perhaps more efficient options. Just as you do not ask the neighborhood kids to break your windows so you can create jobs and incomes for others, government should not start a war for the same purpose. In a broader sense, should we resort to doing wrong things for right reasons, such as stealing food and money from some people for the sake of helping others or incentivizing poor people to sell their organs to help patients in need?

There is no phrase more famous in the English language than “there is no free lunch.” Well, at least there is none from an economics point of view. Even if something appears to be free monetarily, it is not economically. Every choice we make involves trade-offs or opportunity costs. That is, resources that are used to repair that broken window, or to produce armaments, could have been used for more valuable purposes. In other words, if a nation spends billions of dollars on war, it has to forgo the other things that could have been purchased with that sum of money.

Even if we ignore its colossal non-monetary costs, war is not going to generate real economic growth; its effects are only nominal at best and economically unimportant. To begin with, war mostly wastes the resources needed to rebuild the things that have been destroyed. Money that is spent on war could be used for something more productive such as education and public health, or saved for investment purposes. The crucial point is that the economy is not going to be better off as a result of war or repairing war-related destruction. War or no war, the economy will remain the same.

You may ask, what if the economy was in recession and war helped to utilize the idle workforce? Critics may claim many workers go back to work, thanks to jobs created as a result of war. This argument may be fictitious as well. Why do some workers always remain unemployed to begin with? In modern economies, some people remain unemployed for a variety of reasons regardless of the condition of the economy. They may lack the skills or the education needed to perform modern jobs; the economy may be in a recessionary cycle; or some big companies may move jobs overseas. War does not solve or alleviate any of these or other causes of unemployment. Under normal conditions, some unemployed workers will return to work shortly after the economy starts recovering. Today, unemployment is mostly rooted in structures that involve the permanent loss of jobs. Under such circumstances, either new jobs must be created by the private sector, or structural bottlenecks must be dealt with, often through well-designed government policies. This requires the collaborative efforts of both government and the private sector, and not an ineffective band-aid type solution that may be achieved through war.

The idea of stimulating the economy through an increase in government spending was first proposed by a British economist named John Maynard Keynes. The reason for its immense popularity was due to the reality that his theory came at the right time, when the U.S. economy was suffering from the deepest recorded economic downturn in its history known as the Great Depression. Keynesian prescription did in fact help the United States to successfully come out of this depression victoriously. But Keynes never meant that government should promote economic growth through war.

Since the Great Depression, Keynesian ideology has remained in the mainstream of American economics and politics. The key reason behind its effectiveness was the concept of multiplier, proposed by Keynes himself, in which he suggested that, over time, every dollar of additional government spending will create much more than one dollar worth of additional income and spending for the economy. In other words, the effect of government spending on the overall economy will be magnified over the long term. However, when it comes to the effect of multiplier, there are some serious considerations. First, it seems that multiplier has worked more effectively in the past, especially during a highly aberrant time like the Great Depression, but its effects in recent recessions has been feeble. That is, the streams of additional incomes and spending that are supposed to follow the government policy no longer have fully materialized, especially following the recent use of the so-called government stimulus package to contain the 2007 recession. People no longer respond strongly to policies such as spending more money due to tax cut unless other factors are also encouraging, including their own feeling about the economic outlook and their job/income security. If expectations are not optimistic, consumers are not going to spend enough and the multiplier will fail to fully function. I would argue also that at some point in time, especially in later stages of life, consumers develop a sense of aloofness to government policies because they have seen no useful results from them. They will no longer be avid spenders as they used to be once they reach a stage of life where their demand is mostly saturated, as evidenced by every room in their homes filled with stuff they wish to be rid of. This is true with perhaps the caveat that older people (retirees) might still harbor “pent-up” demand for dining out, visits to Mount Rushmore, Yosemite National Park, travel—generating jobs for cruise ships, resort hotels; plus failing health provides work for doctors, nurses, nursing homes, hospices, among other things.

More importantly, there is the “crowding out” effect which suggests that additional government spending eventually leaves a smaller amount of resources, including investible funds, for the private sector because of competition between government and private investors. Increase in government spending will also necessitate additional borrowing that causes interest rates to surge, making private investment more expensive. Also, government spending intensifies the already excessive budget deficit and national debt, forcing people to save more money instead of spending it because they expect that they will have to pay higher taxes in the future. Robert Barrow, a noted economist, seems to believe that the effect of government spending is weak and temporary otherwise there is no reason for government to stop spending if its effects on the economy are so robust. In the January 22, 2009 issue of The Wall Street Journal, Barrow states: “I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943–44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943–44. Thus, the multiplier was 0.8 (430/540).”

While there is no consensus among economists, or concrete proof concerning the efficacy of government spending, it seems most economists agree that government cannot remain completely neutral to economic slumps. In an extreme case, spending money, even on infertile but job creating projects, is better than a do-nothing approach. That is the main message of Keynesian economics. This does not, however, justify war to boost government spending. It seems many economists, regardless of their political persuasion, believe that government has an obligation to promote economic prosperity, especially when economic conditions are bleak. One can argue that war-related expenditures helped in the post-depression era not because of additional spending per se, but because the system was also suitable for the trickle down to happen. The evidence indicates that the U.S. economy was in fact on its path toward recovery even before WWII. Government spending simply reinforced that recovery; plus, the potential demand was already strong. People had earned a good deal of money during the long and expensive war and were waiting for a chance to spend their income. The opportunity to unleash their pent-up demand was provided once the war had ended. Some may still credit the war for pulling the economy out of the Great Depression; however, it was the proper government policy that paved the way toward economic expansion. The great prosperity of 1947–1975 did not happen because of the war, but because of prudent and meticulously crafted government policies complemented by favorable institutional settings and the changing of American culture in favor of mass production and mass consumption. Because of these things, war-related spending soon spilled over to the production sector of the economy.

The key concern is whether economic progress can be fostered through military spending. There is no question about the enormity of the U.S. military budget; currently it is $711.0, 4.7% of its GDP and 41% of the world’s total, and Mr. Romney has promised to raise it by $2 trillion over the next ten years if elected. There is no doubt that such spending contributes effectively to the coffers of some industries and to the advancement of some technologies that may also have commercial applications. However, such spending will also choke off the private sector’s investment by diverting resources and the labor force away from this sector and into military activity.

This whole discussion reminds me of an old television commercial. A man buys a Remington electric shaver and he likes it so much that he buys the whole company. Although the commercial was designed to promote a product, the underlying idea is really foolish if you think about. It brings to mind an old expression: you do not buy a cow just for a cup of milk!

This article is published simultaneously in Op Ed News.

Share/Save/Bookmark

Recently by varjavandCommentsDate
The Rise of Secular America
6
Oct 29, 2012
Why Do We Believe? II
-
Aug 25, 2012
Why Do We Believe?
5
Aug 12, 2012
more from varjavand
 
Esfand Aashena

Saturated markets

by Esfand Aashena on

Varjavand you may be taking the economic prosperity of 1947 - 1974 in a vaccum.  The manufacturing and production of those decades were due to the demand.  Everything was pretty much being built new.

Not so now or in the past decade or so.  I mean how many cars were there in 1974 and how many are there now?  How many millions of cars can you produce per year and expect every one of them to be sold?  How many cars can one person buy at a time?!  

Same thing with housing.  Nixon bought his house from Sears for $4000 or $5000 right?!  Now they're talking about micro homes on trailers for about the same price with adjusted inflation.  Except there was a lot more room in a Sears house than these micro units!

You also mentioned good paying jobs with benefits.  Well those were the times that the companies could afford it.  Now there is just not enough room to share!  I agree with you that less greed was a factor and wealth was being shared more frequently than now but since then greed has become an industry all it's own in Wall Street!  Other than the greed industry there just isn't enough to be left to keep a company afloat if everyone gets the good paying jobs and full benefits with annual raises.

In parallel to reduction in manufacturing and production of goods and services, the population has also increased along with the immigration explosion and the increase in elderly and expansion of medicare and medicaid and all that good stuff.

So we really may be at new point in history where the old rules and expectations don't apply anymore.  We may be at a dead end and are screwed!

I don't know but the optimist in me want to believe there are better days ahead.  I agree with your points about costs of wars and that a new war with Iran or any other regional war, will make things worse.  I just wished we could see more articles and views about the realities at hand and how and if we really can dig ourselves out of it. 

Everything is sacred


varjavand

Dear Commentators;

by varjavand on

Dear commentators,
My purpose in this article is in no way to hope for a victory for Mr. Romney nor do I believe he will win the election. As an educator, I should be a Democrat by default, and I am, and a supporter of President Obama. If Romney is elected the first things he is going to do, as he promised, is to repeal the Affordable Care Act thus the removal my youngest son who is now covered under my policy from my insurance plan, his other proposals also do not help to strengthen the ordinary Americans causing a further shrinkage of the middle class.
The American prosperity during 1947 – 1975 was not totally the outcome of World War II. It was mostly due to other factors including: flourishing factories through utilization of mass production technology as well the popularity of mass consumption, the pent-up demand resulting from increased government spending, and more importantly a fair system of taxation and contribution that favored the middle-class not just the rich. In other words the prosperity was shared, income and wealth were trickling down not up. Workers income doubled during this period. It was not war per se but the fair distribution of income that contributed to prosperity. Employers were required to pay a decent wages and provide benefits to their workers and were supported by strong unions. American entrepreneurs understood when workers do better so do the companies.
America prospered despite high tax rates during this time. Government provided essential safety nets including low-cost mortgages for people so that they can achieve the American Dream, government invested heavily in infrastructures highway systems and communications systems through Public Work Projects that benefited companies as well as consumers. The system was fair, the bargain was symmetrical. We were all in this together. When the tide of economic progress came, it raised all the boats.
Having experienced two costly wars in Iraq and Afghanistan for more than 10 years, it would be so imprudent for America to start another war with Iran. And I do believe it will not due to the following reasons. First, it is too costly both monetarily and human toll. Second, it will trigger a regional war and possibly World War III. Third, the United States knows if it starts such a war it will be based on false premise as was the Iraq war, it is, therefore, difficult to sway the public opinion in favor of war. Forth, war with Iran will result in massive disruption of oil supply to the United States and to the west which can trigger escalation of energy prices. Having experienced a colossal shack in 1973, following the oil embargo, the United States should be foolish to expose the world to the same quandary again. War with Iran will also result in wide-spread retaliation of the government of Iran and its allies in the region. Such retaliation will especially be destructive to Israel.


bushtheliberator

much eonomic analysis and some pure political nonsense

by bushtheliberator on

  ?? ""here in the US there might be popular support for war, :

dear varjavand,

               You may capture the Yeti. and some Little Green Martians,But you'll be hard-pressed to find much  "popular support for war" in the US. I'm here in pistol-packing, George Bush loving Texas, and the only applause line here is : "Bring our boys home"


Esfand Aashena

A crisis of time?

by Esfand Aashena on

I think part of not being able to see the solution or the way out is the increase in population and a saturated market.  During the depression the market sank and had to start all over again.  That gave a fresh start for a lot of people and new businesses. 

People suffered a lot more than they did during this great recession.  So much so that the 30s generation always carried the scars of depression and talked about it for as long as they lived.  In Iran we had a similar situation when our grand fathers used to talk about famine.  Though we ourselves could hardly relate to it.  There is a big difference in being there and reading or hearing about it.

This time around the banks were given a second chance and bailed out, markets didn't collapse and the saturated housing market wasn't part of the bailout.  So it's hard for individuals (read middle class) to adjust and fight back.  It's simply out of their means.  

As the population ages the caring for them will be more and more expensive and that's what we're hearing in these debates about deficits and cuts to medicare and such.  Even after the election the debate and issues will be there just like they were before the election and that sequestration deal.  They probably won't do anything until there is another major crisis that have to respond to by the seat of their pants!  Who'd have thought W would bail out banks to the tune of Trillion(s)?

I agree with your assessments of wars not having the impacts that many think can bring to improving the economy.  However, the defense industry as it is even with the war(s) is providing a lot of jobs and it's a big sector of the economy.  I suspect as part of trying to build jobs the Govt will try to sell more military hardware to foreign allies.  They put a hold on foreign military sales but they're trying to ease those restrictions.

Look at Dubai and UAE and the oil money their spending on skyscrapers or man made lakes and islands!  They can sure spend a lot of money on military hardware and provide jobs here, right?

Having said that I believe a world with less war tensions is better off and better for the economy.  People live better when they're not tense and worried.  They're more content and can live better with less but when you jack them up to belittle others to insert yourself as being "better" then you're never content and always tense and worried and lost.  

Everything is sacred


varjavand

Esfand Aashena

by varjavand on

I wish I could. This crisis is lot more complicated and deep-rooted that the previous recessions the US economy has experience, especially considering its root cause, the crisis in financial market, which then spread into real sector of the economy. It is also of global nature due to openness of the US economy. Many external factors, like crisis in Euro Zone, can now influence the US economy and such influences render the government economic policies ineffective or less potent.


varjavand

Good points elmcoint

by varjavand on

The monetary system without backing is very fragile and subject to misuse. Without gold standard, government can print and issue money unlimitedly and exchange it with assets including goods and service supplied domestically and/or by other countries especially crude oil or Chinese products. The US can play this game successfully as long as these dollars remain overseas. However, if they return to US economy and be converted into demand for goods and service, they create inflation.
I don’t think quantitative easing is going to strengthen economic capability of a country in the long run. The Federal Reserve System uses them on as needed or emergency basis to inject liquidity to the market and they are supposed to be revered once they are no longer needed. They have been more successful in the past but they are becoming neutral and impotent these days.
You have made good point in second and third paragraph. I hope the Iranian intellectuals use their talent and the freedom of expression, that is guaranteed in the US, to clarify the misunderstanding people have about Iran and its culture.


Esfand Aashena

Nice article.

by Esfand Aashena on

Though you still don't provide any new outlook or way out of these economic crisis.  At least I didn't see it, maybe I missed it.

Govt spending does create jobs but it also depends where you spend it.  Building or maintaining roads and infrastructure is an example.  Some buyback programs or tax credit programs, like turning in old cars for scrap or new ones, or other household appliances and renovations another example, which is not happening much though. 

Everything is sacred


elmcoint

This is exactly what US is doing now..QE1,QE2, QE3 &more

by elmcoint on

in Keynesian ideology, one Dollar may bring extra extra Dollar with one catalyst involved, depleting other people's accets in other countries. AffterWII, this is what USA did to others; starting regional wars by depleting their natural resources as well as human resources. The era has changed now, Iran is one good example of that. No more shove and push.. BUT surely it would be costly for players who want to be independent. Do you believe QEs can have a long term solution for USA without any catalyst involved? This is why people like Paul Krugman is referring to; USA and its allies will not survive with its electronic money unless they have some type of back ups. It could be oil, land, or human resources. We all know that it is not gold standard any more. To create money in any economy, the players involved need some type of CATALYST.

I believe Iran has paid its dues for past 33 years. the Iranian all over the world with their vast financial resources should follow suit and push for independent Iran. They should push the world system specially WEST to keep its hands off Iran at any means. Jews did, Why not Iranians? How can a person breath when others have their hands on his throat and his balls? This is the problem that the current Iranian system has; There has never been a peaceful moment for them for past 33 years, the war, unrealistic comments, and now the unsubstantiated nuclear issues . We Iranian abroad should create this for the country that we have connections with. We should tell the USA and its allies that enough is ENOUGH. Iran can not go towards democracy through revolt, it has to go through so many gradual modifications. We change the system today, another system will start with a different type of corruptions. The modification has to start at the people's level not at the government or system level. The 200 years of neglected mentality can not be changed or modified by means of war or revolution. The WEST knows this, but as I said before; the West is not ready to let Iran go loose. This is the problem.

The only way to cure this, is through constant push from all over the world by strong Iranian scholars and businessmen to change the current mentality towards Iran that has been establishes for past 33 years by the WEST and its allies.


Anonymous Observer

" likely success of Mitt Romney in the upcoming...elections"

by Anonymous Observer on

Don't think so.  I suggest you keep up with the following:

http://fivethirtyeight.blogs.nytimes.com/


vildemose

Excellent job. You nailed

by vildemose on

Excellent job. You nailed it. Hope to see more. 

 

 

All Oppression Creates a State of War--Simone De Beauvoir


FACEBOOK