NOT TO BE QUOTED WITHOUT THE PERMISSION OF THE
AUTHORS
THE ECONOMIC COSTS
OF THE IRAQ WAR:
AN APPRAISAL THREE YEARS AFTER THE BEGINNING OF THE CONFLICT
Linda Bilmes
Kennedy School, Harvard University
And
Joseph E. Stiglitz
University Professor, Columbia University
Three years ago, as America was preparing
to go to war in Iraq, there were few discussions of the likely
costs. When Larry Lindsey, President Bush’s economic adviser,
suggested that they might reach $200 billion, there was a quick
response from the White House: that number was a gross
overestimation.
Deputy Defense Secretary Paul Wolfowitz claimed that Iraq could
“really finance its own reconstruction,” apparently both
underestimating what was required and the debt burden facing the
country. Lindsey went on to say that “The successful
prosecution of the war would be good for the economy.”
Many aspects of the Iraq venture have
turned out differently from what was purported before the war:
there were no weapons of mass destruction, no clear link between
Al Qaeda and Iraq, no imminent danger that would warrant a
pre-emptive war. Whether Americans were greeted as liberators
or not, there is evidence that they are now viewed as
occupiers. Stability has not been established. Clearly, the
benefits of the War have been markedly different from those
claimed.
So too for the costs. It now appears that
Lindsey was indeed wrong—by grossly underestimating the costs.
Congress has already appropriated approximately $357 billion for
military operations, reconstruction, embassy costs, enhanced
security at US bases and foreign aid programs in Iraq and
Afghanistan. This total, which covers costs through the end of
November 2005, includes $251bn for military operations in Iraq,
$82bn for Afghanistan and $24bn for related foreign operations,
such as reconstruction, embassy safety and base security.
These costs have been rising throughout
the war. Since FY 2003, the monthly average cost of operations
has risen from $4.4bn to $7.1 bn – the costs of operations in
Iraq have grown by nearly 20% since last year (whereas
Afghanistan was 8% lower than last year).
The Congressional Budget Office has now estimated that in their
central, mid-range scenario, the Iraq war will cost over $266
billion more in the next decade, putting the direct costs of the
war in the range of $500 billion.
These estimates, however, underestimate the
War’s true costs to America by a wide margin. In this paper, we
attempt to provide a range of estimates for what those costs
have been, and are likely to be. Even taking a conservative
approach, we have been surprised at how large they are. We can
state, with some degree of confidence, that they exceed a
trillion dollars.
Providing even rough order of magnitude
estimates of the costs turns out to be very difficult, for a
number of reasons. There are standard problems in cost
allocation; there are future costs associated with the Iraq war
that are not included in the current calculations; there are
marked differences between social costs and prices paid by the
government (and it is only the latter which traditionally get
reflected in the cost estimates); and there are macro-economic
costs, associated both with the increase in the price of oil and
the Iraq war expenditures.
Consider, as an example, accounting for the
value of the more than two thousand American soldiers who have
died since the beginning of the war, and the more than sixteen
thousand who have been wounded. The military may quantify the
value of a life lost as the amount it pays in death benefits and
life insurance to survivors – which has recently been increased
from $12,240 to $100,000 (death benefit) and from $250,000 to
$500,000 (life insurance). But in other areas, such as safety
and environmental regulation, the government values a life of a
prime age male at around $6 million, so that the cost of the
American soldiers who have already lost their lives adds up to
around $12 billion.
The standard estimates of the death costs
also omit the cost of the nearly one hundred American civilian
contractors
and the four American journalists that have been killed in Iraq,
as well as the cost of coalition soldiers, and non-American
contractors working for US firms.
The military values the cost of those
injured by what their medical treatment costs and disability
pay; and current accounting only reflects current payments in
disability, not the present discounted value of (expected)
future payments; a full cost analysis includes both the present
discounted value of all future payments, as well as the
difference between the disability pay and what the individual
might have earned—and even this ignores the enormous
compensation that would have been paid for pain and suffering
had this been a private injury.
Costs of recruiting have increased
enormously—and even after the war ends, there is reason to
believe that compensation will have to be increased, including
for Reserves and National Guard. Many Reservists, particularly
those who are older, supporting families and established in
their careers, underestimated the risks of being called to fight
a war abroad and the ability of the government to force them to
extend their tours of duty and even to serve second and third
tours. The majority of these Reservists have suffered a
significant loss in wages due to serving in Iraq. By the same
token, wages currently paid the military almost surely represent
an underestimation of a fair market wage, given what individuals
would have needed to make them willingly undertake the job in
Iraq. In fact, we know from the wages being paid by contractors
performing similar work what the free market wage for such
services are, and they are a multiple of what the American
military get paid.
Even determining the current “direct”
expenditures turns out to be a difficult task.
The Administration has provided a number, based on the current
costs of operations in Iraq. We are interested here in finding
the total economic cost, the value of the resources used,
and it is not always clear that standard accounting and
budgetary figures reflect that. For instance, the faster
depreciation or destruction of equipment already owned by the
government is clearly part of the cost of the war. Standard
cost allocation procedures would attribute a substantial
fraction of the overhead in the Pentagon to the War; by devoting
its attention to Iraq, it has less time to work on other issues,
to prepare for other problems.
A true costing of the war would focus, of
course, on the incremental cost; to the extent that the actual
War substitutes for expensive “war games,” the incremental cost
is less than the actual money spent. In our analysis we have
subtracted the direct savings, such as policing the “no-fly”
zone in Iraq, from the cost of the war.
This paper attempts to provide a more
complete reckoning of the costs of the Iraq War than have
previously been provided, using standard economic and
accounting/budgetary frameworks. Of course, a final tally
will have to wait the end, and even the President has made it
clear that there is no clear end in sight. And even then, it
will be years before we can be sure about whether our estimates
of future costs—increased costs of recruiting or payments for
disability or the health care costs of the injured veterans—were
accurate.
Of necessity, the numbers, especially of
future expenditures, are estimates, and we have tried to avoid a
false sense of accuracy by rounding our numbers from the more
precise estimates provided by econometric and statistical
studies, when those are employed. We provide several sets of
numbers. A “conservative” estimate that we think is
excessively conservative. We realize that the numbers
provided here may be controversial. They provide a picture of
costs that is much larger than that which has been provided by
the Administration, especially before the War. We also provide
a second estimate, which, while still conservative, is more
reasonable. We refer to this as our “moderate” estimate.
Our estimates, for instance, assume that we
have 136,000 troops stationed in Iraq in 2006. The
Administration has recently announced a troop reduction, from
160,000 due to the pre-election build-up, to 140,000, a number
which is still larger than the numbers employed in our
analysis.
We have not been able to quantify many of
what may turn out to be the most important costs of the Iraq
venture. There is a value in military preparedness, and it is
the reason for investing so heavily in defense. By most
accounts, America’s ability to engage in a second front at the
current time is greatly diminished. At the beginning of the
War, there was a great deal of talk about winning the hearts and
minds of those in the Middle East. Recent opinion polls
reflecting public opinion in the Arab world show that exactly
the opposite has happened. Some American businesses have even
claimed that anti-Americanism spawned by the Iraq War has had an
effect on their sales and profits. America’s credibility has
been diminished: if some time in the future another American
President were to claim that he had solid evidence based on
intelligence that there was a threat, that evidence is more
likely to be treated with skepticism. America has always prided
itself in fighting for human rights; but America’s credentials
have been tarnished by Abu Ghraib and Guantanamo. These are
among the many costs of the Iraq War that we do not attempt to
quantify, but which should clearly be counted in any assessment
of the Iraq War.
Nor have we included in this paper any of
the costs borne directly by other countries, either directly (as
a result of military expenditures) or indirectly (as a result of
the increase in the price of oil.) Most importantly, we have
not included the costs of the war to Iraq, either in terms of
destruction of property (infrastructure, housing) or the loss of
lives.
Clearly, including these would increase the cost of the war
substantially—perhaps by an order of magnitude.
The paper is divided into two parts. In
the first, we provide an estimate of the “direct” expenditures,
and provide adjustments to reflect the true social costs of the
resources deployed. The second provides an estimate of the
macro-economic costs; the effects of the War on the overall
performance of the economy, taking into account both the effects
of the expenditures themselves and of the increased price of
oil, some of which at least should be attributed to the War.
I. Budgetary Costs to the US
Government
The budgetary costs of the war reflect the
huge scale of operations that are being undertaken. For the
first half of 2005, there were over 200,000 US military
personnel stationed in Iraq and Kuwait (which serves as a
staging ground for Iraq). To date, over 550,000 troops have
served in Iraq in a combined total of approximately one million
tours of duty.
The costs of the war in Iraq that have been
reported in the media have almost exclusively focused on one
type of cost – the $251bn in cash that the government has spent
on combat operations since the invasion of Iraq in March 2003.
This is an important element of the financial cost but it is
only the tip of a very deep iceberg.
Currently the US is spending about $6bn per
month on operations in Iraq. However, there are additional costs
to the government – over and above this number. These include
disability payments to veterans over the course of their
lifetimes, the cost of replacing military equipment and
munitions which are being consumed at a faster-than-normal rate,
the cost of medical treatment for returning Iraqi war veterans,
particularly the more than 7000 servicemen with brain, spinal,
amputation and other serious injuries, and the cost of
transporting returning troops back to their home bases. The
Defense Department, for which expenditures not directly
appropriated for Iraq have grown by more than 5% (CAGR) since
the war began, has also spent a portion of this increase on
support for the war in Iraq, including significantly higher
recruitment costs, such as nearly doubling the number of
recruiters, paying recruitment bonuses of up to $40,000 for new
enlistees and paying special bonuses and other benefits, up to
$150,000 for current troops that re-enlist. Another cost to the
government is the interest on the money that it has borrowed to
finance the war.
Although it is difficult to estimate these
costs precisely, we can use current and expected troop
deployment to make a reasonable projection of the likely costs.
Looking purely at direct budgetary costs to the taxpayer, we
estimate that the total cost of the Iraq war is in the range of
$750 billion to $1.1 trillion, assuming that the US begins to
withdraw troops in 2006 and maintains a diminishing presence in
Iraq for the next five years. We have looked at the budgetary
cost both including and excluding the cost of interest on the
debt. We have also adjusted this cost for economic factors, as
outlined in section two. Under any reasonable set of
assumptions, the cost of the war even without considering
the macroeconomic costs – is more than double the current number
provided by the Administration.
We have estimated the budgetary costs using
two scenarios. Both scenarios are based on the troop deployment
projected by the Congressional Budget Office.
Our “Conservative” scenario assumes that all troops will be
withdrawn from Iraq by 2010, and that all interest on the debt
borrowed to finance the war will be repaid within five years.
Under this scenario we count the long-term costs of disability
pay and health care for veterans over a twenty-year period, even
though most of the troops in Iraq are between ages 21-28 and are
likely to live far longer. We have taken the present value of
all cash flows at a 4% discount rate. Even under this
conservative scenario, the direct costs to the government are
likely to exceed $700 bn. (See figure 1).
Under a second, “Moderate” scenario, we
have used CBO’s assumption that a small but continuous US
presence in Iraq continues through 2015. This has implications
for the projected number of casualties and the length of
involvement by the Defense Department. This scenario also
assumes that the US budget will remain in deficit for the next
20 years. This would raise the cost of the war to over $1.0
trillion. Both scenarios exclude the cost of operations in
Afghanistan – estimated to be approximately $82 bn to date and
consuming $1bn per month. ,
Assumptions for Figure 1 “Total Cost of War in
Iraq to the US Government”.
1.
Spending to date on combat and support operations:
The total spending to date, as of December
30, 2005 is $251 billion. This includes funds appropriated
specifically for Iraq in Emergency supplemental appropriations
in April 2002, November 2003, August 2004, April 2005, and the
Continuing Resolution of September 2005, which covers the first
6 weeks of FY 2006. This money includes funding for
combat operations, basic troop
deployments and logistics, deployment of National Guard and
Reserves,
food and supplies, training of Iraqi forces, weapons, munitions,
supplementary combat pay, reconstruction,
and payments to countries such as Jordan, Pakistan and Turkey.
This also includes the payment of $500,000 in “death gratuity
payment” and life insurance to the survivors of the 2156
fatalities in Iraq during this period. We have not
included the costs to the Defense Department for planning the
invasion in the months prior to the invasion, which the
Congressional Research Service has estimated at $2.5 bn
2.
Future spending on combat and support operations.
We have estimated the cost of future
operations to be proportional to the number of troops scheduled
to be deployed in Iraq from 2006-2010. We have estimated the
current number of troops stationed in Iraq as 160,000,
using the number cited by the Pentagon. Future troop deployment
figures are based on recent forecasts by the Congressional
Budget Office, which predicts that troop levels in 2006 will be
reduced to 136,000. The CBO has forecast troop levels through
2015, but in the conservative scenario we are assuming that all
troops are out of Iraq by 2010. However, this approach almost
certainly underestimates the actual cost of military operations,
because the Pentagon will hire contractors to replace some
portion of the activities performed by troops who are withdrawn.
In our moderate scenario, we have assumed that the US maintains
a small troop presence until 2015, that we increase the number
of contractors as troops decline, and that casualties continue,
proportional to troop deployment...
3.
Additional Veterans
Administration medical care costs for returning veterans.
As of December 2005, over 16,000 military
personnel have been wounded in Iraq since March 2003, of whom
96% were injured after the official combat operations ceased
(since May 1st, 2003). Due to improvements in body
armor that protect the core body, there has been an unusually
high number of soldiers who have survived with major injuries,
such as brain damage, spinal injuries, and amputations.
According to the Pentagon and other sources,
about 20% of those injured have suffered major head or spinal
injury and an additional 6% are amputees. Another 21% suffered
serious wounds that prevented them from returning to the
military, including blindness, deafness, partial vision and
hearing impairments, nerve damage and burns. In addition, more
than half of the 550,000 US troops who have served in Iraq have
served two or three tours of continuous duty under stressful,
grueling conditions. Some 20,000 soldiers have been prevented
from leaving the service by the government’s “stop-loss” policy,
which requires troops to extend their tours in case of
emergency. It is perhaps not surprising that the surgeon
general of the Army reported, in July 2005, that 30% of US
troops have developed mental health problems within 3-4 months
of returning from Iraq. To date, more than one-third of
returning veterans have used the VA system for health ailments.
The number we include here represents a
conservative estimate of the additional costs to the Veterans
Administration due to providing medical care and other benefits
(such as rehabilitation, retraining, purchase, fitting and
replacement of prosthetic devices, and counseling -- but not
including disability, housing, educational or loan payments) to
returning Iraqi War veterans (other than those with brain
injuries). The costs of treatment could be substantial. The VA
had originally projected that 23,553 veterans returning from
Iraq would seek medical care last year, but in June 2005, the VA
revised this number to 103,000. The VA also is now responsible
for providing care to an estimated 90,000 National Guards, who
previously were not eligible for VA services. To meet these
unforeseen demands, the VA appealed to Congress for an emergency
$1.5bn in funding for FY 2005. The VA is likely face a shortfall
of $2.6 billion in 2006While
not all the additional health care expenditures may in fact be
directly linked to the Iraq war, it will be difficult not to
provide the requested medical care. We assume that this need
will continue and increase to $3bn as the veterans return home,
and that the VA will require this additional level of funding
added to its base budget.
(We expect that this figure is significantly understated,
considering that The Veterans Administration is already facing a
shortfall in funding to meet its existing obligations.)
The additional cost of providing benefits
to Iraqi war veterans will become a major challenge for the VA.
In our conservative scenario we have estimated that all troops
are withdrawn by 2010 and these costs for 20 years; in the
moderate scenario we have assumed that troops continue to be
deployed through 2015 and these costs continue throughout the
lifetime of the veterans (40 years).
4.
Medical treatment for brain
injuries.
There is a special category of health care
expenditures that go beyond those included in the above
calculation—for those with brain injuries. To date, 3213 people
-- 20% of those injured in Iraq -- have suffered head/brain
injuries that require lifetime continual care at a cost range of
$600,000 to $5 million.
The government will be required to commit resources through
intensive care facilities, round-the-clock home or institutional
care, rehabilitation and assisted living for these veterans.
For the conservative estimate, we have used
a midpoint estimate of a net present value of $2.7 million over
a 20 year expected survival rate for this group, which is about
$135,000 per year, yielding a cost of $14 billion. This amount
seems low for brain-injured individuals who will require
round-the-clock care in feeding, dressing and daily functioning.
For the moderate estimate, we use a higher cost estimate ($4m)
and assume longer life duration for a total cost of $35 billion.
In both cases we assume that the number injured will rise in a
manner consistent with the duration of the conflict.
5.
Disability pay for veterans
Veterans of the Iraq war are eligible to
claim disability pay and benefits, ranging up to a maximum of
about $44,000 per year, under a complex formula administered by
the Veterans Administration. It is important to note that that
Congressional intent for disability payments is to “compensate
for a reduction in quality of life due to service-connected
disability payment of this disability”. The benefit is intended
to “provide compensation for average impairment in earnings
capacity” – but it does not require the veteran to actively seek
employment nor is it offset against post-military civilian
earning. The principle dates back to the Bible at Exodus 21:25,
which authorizes financial compensation for pain inflicted by
another.
Veterans are awarded claims based on the
percentage of disability they can demonstrate; in gradations
(0-100%) though it is possible to have a 0% disability
percentage across multiple conditions and still qualify a
veteran for some disability pay. The presumption for disability
compensation is tied to symptoms that appear within a period of
time after service. There are numerous programs that provide
benefits depending on the situation, including disability
compensation, specially adapted housing grants, medical benefits
with higher priorities, vocational rehabilitation,
service-disabled veterans life insurance, dependency and
indemnity compensation (paid to surviving spouse and children if
a veteran dies of an illness or injury contracted while on
active duty, or dies of such after retirement).).
We have estimated the amount of claims that
the government will need to pay based on a projection of the
rate of claims based on the Persian Gulf War. The government
currently pays $2 billion annually in support of 169,000 claims,
or an average of $11,834 per claimant. (Hartung, 2004) The total
number of claims for that war exceeded 200,000, or more than
one-third of the troops deployed, despite the fact that the war
lasted 4 weeks with 148 dead and 467 wounded. Many of those
claims were related to the exposure to depleted uranium during
the Persian Gulf conflict, and included ailments such as memory
loss, sleep problems, Lour Gehrig’s disease, poor concentration,
and joint problems. Congress has established a “presumption of
service-connection” for any health problems linked to “exposure
to possible nerve agents and other toxins present in the Persian
Gulf conflict and vaccinations against biological war hazards in
preparation for the Persian Gulf.”
In the Iraq conflict, more depleted uranium
was used in the bombing of Baghdad than in the Persian Gulf
conflict;
therefore the Iraq war veterans will be easily eligible for
disability claims for any health problems that they can link to
exposure. As we noted earlier, more than one-third of returning
veterans have used the VA system for health ailments. We have
estimated that those with serious injuries would receive the
maximum disability benefits from the VA, those with
medium-serious injuries would receive half those benefits
($22,000), and one-third of the remaining forces would receive
the average benefit awarded to the Gulf War veterans, or
$11,834. This sums to an annual payment of $2.3 billion. In the
conservative scenario we have estimated this payment over 20
years; in the moderate scenario we have assumed that these
payments continue over the lifetime of the veteran, so until
2045.
6. Cost of demobilization.
The Pentagon has announced plans to reduce
troop levels from their current force of over 160,000 to around
140,000 in the next year, and we have assumed that this
withdrawal will continual gradually as outlined by the CBO. This
will in itself require direct payments of $6-10bn for the
transportation and demobilization of troops, returning them to
their home bases, or civilian roles (in the case of Reserves).
7. Increased defense spending
Since 2002, the total appropriations for
the Defense Department have increased from $310 bn to $420bn,
representing a total cumulative increase of $325bn. Portions of
the FY 2002, 2003, 2004 and 2005 appropriations bills, as well
as FY 2003 and FY 2004 transfers, have been appropriated for
Iraq. In total we estimate that 30% of the $325 increase has
been devoted to Iraq. This figure covers increased military pay,
research and development, recruitment, operations and
maintenance and replacement of equipment. According to Pentagon
estimates, the military is wearing out equipment at a rate that
is 4-5 times the rate of usage in non-combat situations.
Additionally, CBO has estimated that the military will require
some $100bn in replacements over the next five to ten years.
(Much of this funding has not yet been requested)
and GAO has referred to the shortfall in funding for repairs,
replacements and procurements
and the confusion between determining emergency supplemental and
ordinary funding needs...
In our estimates, we have attributed
one-third of the increase in Defense spending to Iraq, minus the
savings from no longer policing the no-fly zone to the
Pentagon. Savings from the no-fly zone have been estimated to
be from $11 to $15bn per year.
Given that the Department is highly focused on the outcome of
the war in Iraq, we estimate that up to one-half of the increase
in the defense spending may be related to Iraq, but we have used
only 30% of the spending in our conservative and moderate
scenarios.
In addition, this increase reflects the
military’s increasing difficulty in recruiting troops and
officers at all levels since the beginning of the Iraq
conflict. During 2005, the Army was below target for most of
the year, and actually lowered its targets in order to achieve
them.
There were shortfalls in the Army National Guard, Army Reserves,
and Marine Reserves. Applications to West Point and the US Naval
Academy also fell between 10-25% from previous years. The
military has responded to this challenge by hiring thousands of
additional recruiters, increasing its national advertising
campaigns, offering sign-up bonuses of up to $40,000 for new
recruits, offering higher retirement and disability benefits,
increasing the “death gratuity” to $100,000, and providing
re-enlistment bonuses of up to $150,000 for experienced troops
(who might otherwise leave the military to join private
contractors who would pay even higher amounts). In further
efforts to boost recruitment, the Pentagon increased the maximum
enlistment age from 35 to 42 and relaxed standards for
appearance and behavior, making it more difficult to be fired.
The cost to the military per recruit has increased from $14,500
in 2003 to $17,500 in 2005. (Pentagon). Hardship pay has been
increased from $300 to $750 per month. We assume that the
military will need to make these changes permanent, adding at
least$1bn-$2bn per year into the permanent budget base.
Additional increases include military pay raises, and the
purchase of more expensive body armor for combat.
8. Interest Payments on Debt
Given that at the onset of the War, the
country was already running a deficit, and no new taxes have
been levied, it is not unreasonable to assume, for purposes of
budgeting,
that all of the funding for the war to date has been
borrowed, adding to the already existing federal budget
deficit. In the conservative scenario we assume that these
funds are borrowed at 4% and repaid in full within five years.
The moderate scenario assumes that the country continues to have
a deficit over the next 20 years and therefore interest
continues to accrue.
II. Costs of the War to the US Economy: Adjustments to
the budgetary estimates
A second way to measure the cost of the war
is to examine its economic cost. Economic costs differ
from budgetary costs in three ways: (a) costs are borne by
others (than the federal government and those fighting in the
war), and these are obviously excluded from the budgetary costs
to the federal government; (b) the prices paid by the
government do not reflect full market value; and (c) economic
costs do not include interest payments (which can be viewed just
as transfer payments), but do include long run impacts on the
growth of the economy. For instance, in the days of the draft,
pay provided soldiers were a vast underestimate of their
opportunity costs. Health care costs borne by soldiers and
their families are examples of costs borne by others.
Here, we focus on the loss of productive
capacity of the young Americans who have been killed or
seriously wounded in Iraq, and the loss of civilian wages that
would have been earned by those called back to duty in the
Reserve forces.
There are some “problematic” items within
the budgetary costs, most notably expenditures on veterans
not linked with the Iraq war. The best way to think of this
is as part of deferred compensation, and therefore, while the
“categorization”—repairing human damage as a result of the
war—is incorrect, it is still part of the cost of the war.
Once again we have estimated the costs
under two scenarios. In the conservative case, the adjustments
add $187 bn onto to budgetary cost – raising the cost to $839
bn, even when subtracting the entire cost of interest payments.
In the moderate case, the economic adjustments increase costs by
$305 bn. Even if we deduct the cost of interest, the cost of
the war under this scenario exceeds $1 trillion. But these
calculations ignore the fact that some of the resources deployed
in the war could have been used to promote economic growth, and
that there are a broad range of macro-economic costs, the effect
of which, as we shall show in the next section, is to increase
the economic costs of the war by a significant amount.
Figure 3: Projected Cost of the Iraq War ($US bn) without
macroeconomic costs
Scenario
|
Budgetary cost (without interest) |
Budgetary Cost (inc. interest) |
Cost with Economic Adjustments |
|
Conservative |
652 |
750 |
839 |
|
Moderate |
799 |
1,184 |
1104 |
Differences between assumptions for
economic and budgetary models.
1. Economic
Cost of Reserves.
As we noted earlier, the US force in Iraq
is composed of 40% the National Guard and Reserve forces. Many
of these men and women normally work in critical “first
responder” jobs in their local communities, such as firemen,
policemen and emergency medical personnel. More than 210,000 of
the National Guard’s 330,000 soldiers have served in Iraq or
Afghanistan, and the average length of Guard mobilization is 480
days
It is difficult to measure the cost of this deployment in purely
economic terms because there is a large unquantifiable cost in
terms of the loss of these “first responders” to emergencies,
including the value of the “insurance” of having these people
ready to respond to emergencies. This was clearly seen in the
Hurricane Katrina debacle, where 3000 Louisiana National
Guardsmen and 4000 Mississippi Guardsmen were stationed in Iraq
when the hurricane hit. According to the Institute for Policy
Studies, some 44% of US police forces have some of their ranks
deployed in Iraq. The loss of these services in Katrina and
elsewhere clearly has had large budgetary and economic costs.
We do not directly measure either the economic costs of the loss
of “insurance” or the economic and budgetary costs arising from
reduction in first responder capabilities (which may have been
considerable.)
Still, there are some quantifiable economic
costs that go beyond those noted earlier in our budgetary
analysis. In the budgetary model, we included (as part of
operating costs) the additional cost to the government of hiring
replacements for those sent to Iraq, which is around $3bn per
year. In this model, we have subtracted that sum from the total
cost of operations but added in the economic cost of the
difference between the civilian wages that these individuals
would earn in their regular occupations and the lower wages they
typically earn in the Reserves. Scott Wallsten and Katrina Kosec
(AEI/Brookings, 2005) have calculated that Reserve soldiers earn
about $33,000 per year as civilians. They estimate that the
opportunity cost of using Reserve troops at current levels is
$3.9 billion to date. We have adopted that figure into our
conservative assumptions. In our moderate model, we have
increased the pay per Reservist slightly to $46,000, taking into
account the fully loaded cost of benefits, particularly for
those reservists who are in police and fire departments and
receiving 60-100% benefits.
2.
Economic Cost of Military Fatalities.
The budgetary model only incorporates the
payments made to individuals as a result of death. Had these
individuals been killed in a car accident or a work related
accident (other than military) there would have been much larger
payments, reflecting the economic costs of the losses.
Although it is impossible to translate the
value of a life into purely monetary terms, the government
commonly uses this approach and determines the “Value of
statistical life” or “VSL”, based to some extent on the value of
foregone earnings and contributions to the economy. This method
is also widely used by insurance companies and other private
sector concerns. In this study, we have estimated the VSL of
each US military and contractor fatality as of December 2005.
According to the Pentagon casualty reports, this is 2156
military fatalities and approximately 100 contractors.
We have projected these forward according to the two different
scenarios described earlier.
We have not taken into account number of
Iraqis who have been killed in the conflict, estimates of which
range from 30,000 (the number estimated by President Bush in
December 2005), to a 100,000 estimated by the British Lancet. We
have also not counted the several hundred casualties among
coalition countries, of which about 100 were British soldiers.
There are
a wide range of VSL values in use. In our conservative scenario,
we have adopted the standard set by the U.S. Environmental
Protection Agency, $6.1 million per life. However this is only
an approximation. The value of a young life may be determined
to be higher than average, based on an estimate of foregone
earnings (Viscusi and Aldy, 2005).
Juries frequently award much higher amounts in wrongful death
lawsuits, and some have reached as high as $269 million.
We have used the number $6.5 million in
our moderate scenario. In projecting the number of fatalities
and casualties forward, we have assumed that these would be
proportional to the number of troops deployed in Iraq, based on
the average number of casualties per month to date. However,
even this is a conservative estimate, since the number of
casualties has been increasing.
3.
Economic cost of contractor fatalities.
There have been about 100 US contractors
killed in Iraq since March 2003 (as well as some non-US
contractors, mostly working for western companies.) In this
model we have only included the US contractors, and extrapolated
the numbers according to the two different war scenarios. We
have used the VSL of 6.1 million and 6.5 million, respectively,
for the conservative and moderate models. However it should be
noted that in many cases, the contractors were highly skilled,
highly paid specialists, working on reconstruction projects such
as fixing the electricity grid and oil facilities. We have not
counted their true loss to the success of the project in Iraq,
or the fact that their high casualty rate has made it more
difficult and more expensive for western contractors to higher
replacements to perform these jobs.
4.
Economic cost of the seriously injured.
Earlier, we described the budgetary costs
of health care and disability for the seriously injured. The
wounded contribute significantly to the cost of the war – both
in a budgetary sense (in the form of lifetime disability
payments, housing assistance, living assistance and other
benefits from the Veterans Administration), and in an economic
sense. The budgetary expenditures discussed earlier
underestimate the true economic costs for three reasons: (a)
they do not include adequate compensation for “pain and
suffering,” of the kind that would have been provided, for
instance, had those suffering injuries been hurt in an
automobile accident; (b) they do not include additional health
care expenditures by the parties themselves, their families, or
other government agencies; and (c) perhaps most importantly,
they do not include the loss of economic services. On the other
hand, they do include health care expenditures that may not be
directly a consequence of the war. However, as we noted
earlier, we are treating this as part of the deferred
compensation, and therefore it is both a budgetary and an
economic cost.
In their recent study of the economic costs
of the war, Wallsten and Kosec used a “value of statistical
injury” to estimate the cost of the wounded. This value
represents what people are willing to pay in order to avoid
being injured. They applied this value to the number of injured
personnel, according to the severity of their injuries and the
average cost of treatment over its lifetime. They calculated
total net present value of injuries at $18.2bn to date, and
$48bn through 2015, using a 5% discount rate.
The Wallsten and Kosec study is quite
thorough and we have used their estimates of the number and type
of wounds, and lifetime treatment costs. However, they probably
underestimated the total cost of the wounded because they only
assigned an amount to the 26% with brain injuries and/or
amputations. We have included additionally the cost of the 21%
of personnel (5545 people, as of December 2005) with other
serious wounds. Such injuries would include wounds from shells,
explosions, gunfire, mortar, landmines, grenades, firearms and
infections, resulting in conditions such as blindness, partial
blindness, deafness, partial deafness, cardiac injury, facial
deformation, burns, multiple broken bones, nerve damage and
mental breakdown. We have deducted the veterans’ disability
payments from all these individuals.
We have estimated that personnel with
serious injuries (including brain injuries) receiving full
disability payments will essentially be lost to the economy and
therefore we should assign them a VSL similar to the deceased,
of $6.1m. In the Conservative case, we have estimated that those
who were wounded during the conflict, but returned to the
military will suffer some impairment beyond the small amount of
disability pay they may receive. We have very conservatively
estimated that 20% of the total VSL would be an approximation of
this impairment. Taken together, this adds approximately $70bn.
Under our moderate scenario, we have used a
similar formula, but using an estimate of $6.5m for the VSL and
assuming that there are more casualties, due to the longer
duration of the conflict. Less disability payments this adds
another approximately $110 bn.
There is another significant cost that we
have not included, simply because we did not have the data to
prepare a robust estimate. This is the degree of impairment
that will be suffered by the other veterans – numbering some
160,000, or approximately one-third of the 550,000 veterans from
the Iraq war – who will be eligible to claim some disability
benefits. We believe that a significant number of these
individuals will suffer substantial mental and physical ailments
that will significantly reduce their earning potential and
quality of life. If even 15% of these veterans were fall into
this category, this alone would add another $30-35 bn to the
economic cost of the war.
A conservative estimate of the risk premium
individuals would require to be compensated for the injuries
(beyond the loss of economic functionality and health care
costs) could (with reasonable estimates of risk premia) double
the total.
We have, however, omitted those numbers from the analysis.
5.
Accelerated depreciation of military hardware.
There is only a slight difference in the
estimate of the budgetary and economic costs associated with
military hardware. The budgetary costs focus on replacement
expenditures, the economic costs on the more rapid depreciation
of hardware (than otherwise would have been the case.) In our
conservative scenario, we have simply estimated straight-line
5-year depreciation for the $100m in military replacements
estimated by the House Armed Services Committee and CBO, over
the next five years. This is in line with the DOD’s assessment
that equipment is being used up at 5 times the normal rate of
utilization in peacetime. We are assuming that the Pentagon will
incur at least an additional $25bn in replacements through 2015,
in the moderate scenario.
III. The Macro-economic effects of the War in Iraq
As large as the direct costs—current and
future—are, the macro-economic consequences may even be several
times larger.
There are at least three major sources of macro-economic
consequences: (a) the increase in the price of oil; (b) the
increase in defense expenditures; and (c) the increased
insecurity that has followed from the way that the war has been
pursued.
In ascertaining the magnitude of these
macro-economic effects, there is a standard problem: the
counterfactual, what would the world have looked like, but for
the war in Iraq.
Security
Consider the issue of security. The
bombings in Madrid and London have only exacerbated a growing
sense of insecurity. Would matters have been even worse had
there been no war? One of the stated objectives of the war was
to enhance the sense of security (to make sure that the war on
terrorism was fought there, not here.) It is conceivable
that the Middle East would have been even more unstable than it
is today. But especially on the basis of what we know
today—Iraq did not have weapons of mass destruction, and it did
not have the capacities to develop them quickly – this seems
unlikely, Contrary to the assertions before the War by the
Administration, Iraq (with its highly secular regime) was not
working with Al Qaeda, and was not a training ground for
insurgency. Unfortunately, the disorder that has followed the
war has provided a place where such training is going on today.
The costs of this insecurity are
potentially huge.
(a)
Individuals are risk averse, and there is thus a direct
quantifiable cost associated with the increase in risk.
(b) The response to security
threats has been to create significant barriers to the free flow
of people, goods, and services. The Administration champions
the virtues of free trade and the benefits from lowering trade
barriers, even when those barriers are already low. But
increased border security (including airport security, the
reporting and registration requirements of the bioterrorism act,
etc) are trade barriers; not only are there direct costs
associated with administering these security measures, there can
be significant macro-economic effects of the reduced flow of
goods and services. A special category of costs is associated
with the significantly reduced flow of students to the U.S.,
especially in areas of science and technology, where we have
become very dependent on these “imports.” (Many have stayed and
made large contributions to the economy.)
(c.) Increased risk is bad for
business; it lowers investment, and over the long run thus has
supply side as well as demand side effects.
Calculating these costs—and particular, the
incremental costs associated with the Iraq War (beyond
the costs which would otherwise be associated with the War on
Terrorism)—is sufficiently difficult and problematic that we do
not provide any estimates here. But it means that the numbers
reported below almost surely underestimate the total
macro-economic effects.
Oil
The price of oil is significantly higher
today than it was before the War in Iraq. Even as the country
went to war, it was recognized that it might have effects on the
global oil market. Some of the remarks of those in the
Administration seem to suggest that it may have even been a
factor driving the country to war. Larry Lindsey is reported to
have said, “the best way to keep oil prices in check is a short,
successful war on Iraq…”
The higher price of oil brings costs and
benefits. Profits of the oil companies have increased
enormously.
It is the one group (besides certain defense contractors) that
has clearly benefited from the war. (Though popular discussions
of the still not-clear motives for going to war often focused on
oil, there is so far no reason to suppose that these benefits to
one of the President’s “constituencies” played an important
motivation.) Here, we are concerned with the costs to the
overall economy of these high oil prices.
First, however, we have to ascertain to
what extent has the increased price (from $25 a barrel before
the War to around $50 today—ignoring the spike associated with
Katrina when prices rose to $60) been a result of the war
itself.
Again, the question is, what is the counterfactual? What would
the price have been had there been no war? To what extent is
the rise in price due to the war, and to what extent is it due
to other factors?
Future markets provide some insight.
Before the war, they were forecasting that oil prices remain in
the range that they had been, $20 to $30.
Futures markets take into account growth in demands in China
and elsewhere as well as changes in supply. They do so on the
basis of “business as usual,” that is, on the basis that nothing
out of the ordinary happens. The war in Iraq was the most
notable event, and it is hard to identify any other which can be
given as much credit for significant change in demand or supply
(apart from Katrina). Some might blame the high demand for oil
from China. But China has had two decades of robust growth, and
its growth in 2004 was stronger than many market analysts had
anticipated earlier; but global growth in 2005 (of around 4%) is
clearly not particularly unusual. Markets are supposed to
anticipate and respond to changes in demand by increasing
supply. Errors in one year are quickly corrected in the next.
What is striking is that present prices are
significantly higher than what most analysts believe is the long
run price, and futures markets expect that such prices will
persist for at least another two years.
That is, costs of extraction in Iraq
(apart from the security concerns), Saudi Arabia, and elsewhere
in the Middle East are much lower than $40, and at $40 there are
many alternative sources (shale, tar sands) with a large supply
elasticity. The question is, why has there not been this
normal supply response. We suggest that the War in Iraq
provides the critical explanation.
Had there been no war, and had price
increased, the international community could have allowed Iraq
to expand production, and this would have brought down the
price. But it is more likely that production elsewhere,
including and especially elsewhere in the Middle East, would
have increased. The instability in the Middle East which has
been brought about by the Iraq War has increased the risk of
investing in that region; but because costs of extraction are so
much lower than elsewhere, it has not provided a commensurate
supply response elsewhere. If stability is restored, then
prices will fall, and these investments elsewhere would turn a
loss.
In addition, there is the fact that oil
production in Iraq has plummeted since the war. Even though Iraq
is not an oil producer on the scale of Saudi Arabia and Russia,
Iraq did produce around 2.6m barrels per day (a similar level to
Kuwait, Nigeria and the UK) on the eve of the war. Now
production has dropped to 1.1million barrels per day. The
insurgency has sabotaged refining capacity and truck drivers
have refused to transport oil from the north, due to the threat
of insurgents.
Though we believe, accordingly, that the
best estimate of the cost of Iraq on oil prices is a very large
proportion of the $25 a barrel or more increase in the price of
oil (and looking forward, we can extrapolate this cost for the
next two years), we provide a conservative calculation based on
the assumption that only 20% of that amount--$5—is due to Iraq.
In our moderate estimate, we assume $10 is due to Iraq.
Figure 4: Impact of Oil Prices
|
Year |
Total Crude Oil Import (Thousand Barrels Per Day) |
Total Import Per Year (Billion barrels) |
Refiner Acquisition Cost of Crude Oil, Imported
($/Barrel) |
Total Cost of Oil Import (Billion US$) |
|
|
|
|
|
|
2000 |
11459.3 |
4.19 |
27.7 |
116.2 |
|
|
2001 |
11871.3 |
4.34 |
22.0 |
95.3 |
|
|
2002 |
11530.2 |
4.22 |
23.7 |
99.8 |
|
|
2003 |
12264.4 |
4.49 |
27.7 |
124.0 |
|
|
2004 |
13145.1 |
4.81 |
35.9 |
172.7 |
|
|
2005* |
13415.5 |
4.91 |
47.9 |
234.7 |
|
|
2006** |
13952.1 |
5.11 |
57.4 |
292.3 |
|
|
2007** |
14510.2 |
5.31 |
65.0 |
344.3 |
|
*Average for
the first 9 months of 2005. The total import cost is for the
12-month period using the 9-month average
**Assuming 4%
growth in 2006 and 2007
Given U.S. imports of roughly 4.75 to 5.0
billion barrels a year, a $5 per barrel increase translates into
an extra expenditure of approximately $25 billion ($10 would be
$50 billion). Americans are, in a sense, poorer by that
amount.
In a neoclassical model that assumes full
employment of all resources, this would be the principle effect
on national income. If the economy continues to use all of its
resources fully, gross output remains unchanged; only what is
paid for inputs of oil has increased, so that value added (GDP)
is reduced commensurately.
Assuming that a $5 price increase persists
for 5 years, this generates a conservative estimate of $125
billion. For our moderate estimate, we use a $10 price
increase, but more plausibly, assume it extends (as future
markets believe) for at least 6 years. That generates a cost of
$300 billion.
This supply side approach assumes that if
the price increase is reversed, the damage is over. To put it
another way, this simple model implies that if first the price
goes up by $10 for one year, and then down by $10 by one year
(from its baseline), and then is restored to its previous level,
there is no cost. This is wrong. There is a cost to this
volatility. The technology, for instance, that is best adapted
to one set of prices will not be that appropriate for another.
And the costs can be significant. This is consistent with macro
economic studies that show large asymmetries between the impacts
of increases and decreases in oil prices.
Thus this analysis of a five-year period of high prices, which
assumes that the only cost is the increased transfer abroad,
provides a significant underestimate of the true economic
costs. We have not, however, provided an estimate of this
additional cost.
Global Income and Price Effects
The value of national income is affected by
the prices of other goods the country imports or exports, and
these too can indirectly be affected by the increase in
the price of oil. If, for instance, a global increase in the
price of oil leads to a decrease in the price of other
commodities (because of a global slowdown), then America is
thereby better off. These effects are complex and likely in any
case to be small.
There may be some commodities that the
United States exports in which it has market power. In that
case, we take firms as setting the price of exports to maximize
profits. An oil price shock lowers income of buyers of American
products, shifting the demand curve over to the left. The
income effect (at least for a small perturbation) is just the
change in profits at the old price. If markets are fairly
competitive, the effect is small, but especially in areas of the
New Economy where mark-ups are large, the losses in income can
be significant. We have not, however, directly tried to
estimate the magnitude of these effects.
Most macro-economic analyses, however,
assume that there are more than just these (neoclassical or)
supply side effects. This is especially important when the
economy is operating below full employment. We noted that with
the increase in oil prices, Americans are poorer; they have that
much less to spend on other goods—including goods made in the
United States. There will be a reduction in aggregate demand,
and the reduction in aggregate demand caused by an increase in
oil prices is likely to result in a lower level equilibrium
output.
The macro-economic counterfactuals
The net effect depends on the
macro-economic state of the world and how policy makers
respond. If the economy is already in a world in which there is
excess supply (demand constrained), then we need to focus on how
monetary and fiscal authorities respond to stimulate demand. If
the economy were in a state of excess demand, then the dampening
of demand would lower inflationary pressure, but would leave
output largely unaffected. Unfortunately, the post Iraq war
world is one in which there has been excess supply (demand
constrained output) in all of the major economies.
Monetary policy response is determined by
two offsetting factors. The oil price increase generates some
inflationary pressures, and especially among central banks
focusing on inflation, this leads to higher interest rates,
exacerbating the slowdown of the economy. On the other hand,
if central banks focus on aggregate demand and unemployment,
it is conceivable that monetary policy could offset the adverse
effects of oil price increases. If they fully offset the
effect, then the only effect would be the transfer effect
described earlier.
Fiscal policy typically does not adjust
quickly enough to stabilize the economy (and the effect of
built-in automatic stabilizers is reflected in the multipliers
discussed below). Again, there are two effects. For countries
with fixed expenditures, then the increase in the oil price
means that there is less to be spent on domestic goods, and that
exerts a downward effect on the economy. On the other hand, for
countries running active countercyclical fiscal policies, the
slowdown in the economy could be offset by such policies.
With Europe’s Central Bank focusing on
inflation, the higher inflation resulting from higher energy
prices most likely contributed to higher interest rates than
they otherwise would have been, and thus a further weakening
of the economy. Fiscal constraints (the growth and stability
pact) has also meant that fiscal policy could not respond; on
the contrary, increased government expenditures on energy meant
there was less to spend on domestically produced goods and
services, again contributing to the weakening of aggregate
demand. In short, for Europe, the contractionary effects
including policy responses are greater than without them.
In Japan, with interest rates close to zero
in any case and fiscal policy stretched to its limits, probably
little policy response can be attributed to the oil price
increase.
The United States is the most problematic.
It appears that fiscal policy has not been closely related to
the short run cyclical state of the economy. (The worsening of
the fiscal position of the United States may have contributed to
the resolve by some moderate Republicans not to cut taxes or
expand expenditures as much as they otherwise would have done.
In this sense, the oil price increase has probably had a
negative effect on cyclical fiscal policy, i.e. the multipliers
are larger than they would be if fiscal authorities took a
“neutral” stance.) So too for monetary policy: the increased
inflationary pressure from the high oil prices would, if
anything, led to a tightening of monetary policy in response to
the high oil price, leading to a larger multiplier.
We have not carried out a full global
general equilibrium analysis, but rely instead on results of
standard macro-economic models. These suggest an “oil
multiplier” of around 1.5 (achieved over two years).
Thus, assuming that the economy remains
below its potential over the period of analysis, and focusing on
the total impact (not the timing), our conservative estimate is
increased to $187 billion, and our more reasonable estimate to
$450 billion. These models too have no feedback from exports.
Global effects
There are some studies, however, which
obtain much larger results. The IMF’s models yield results with
longer lags, but with full effects that are almost 4 times as
large.
One of the standard studies, that of
Hamilton, estimates that in the past a 10% increase in
the price of oil has been associated with a 1.4% decrease in
GDP. A $5 increase in the price of oil thus implies a lowering
of GDP by 2.8%, or approximately ($300 billion) per year that
oil prices remain at that level. A five-year price rise
would generate costs of $1.5 trillion. Hamilton’s analysis is
consistent with an oil price multiplier that is much larger than
the earlier studies.
There are two possible explanations of the
large discrepancies in results. The first has to do with the
analysis of global general equilibrium results, and can be seen
most sharply in the context of a “counterfactual” which has
governments maintaining a fixed level (or percentage of GDP)
deficit. In the standard model, what limits the multiplier are
leakages, income which is not spent “domestically,” but is taken
out of the system, and spent abroad, or by government. In both
cases, the feedback of income into further expenditures stops.
But if we take a global equilibrium approach, then the money
spent abroad is part of the system. If we include government
endogenous expenditures as part of the system, then as taxes are
taken out of disposable income, government spends the increased
revenues, just as if the individual himself had spent them.
(There can be even “negative” leakages; if the government
maintains a fixed deficit to GDP ratio, a stimulus—such as a
fall in oil prices—leads to a higher GDP, and so an increase in
government expenditures. Thus, for a global closed economy, the
multiplier increases from 1/s(1-t) + t, in which taxation
reduces the multiplier, to 1/(s(1-t) – d, where taxation
increases the multiplier (where s is the savings rate, t the tax
rate on income, and d the allowable deficit to GDP ratio) Thus,
if d = 0, s = .2 t = .25, the multiplier increases from 1/.4 to
1/.15, i.e. it increases by a factor of almost 3.
(Of course, we need to model the oil
exporting countries as separate from the oil importing
countries, and spending a substantially smaller fraction of the
income on American goods than Americans would. If Saudi
expenditure and savings patterns were identical to those of
Americans, then the change in the price of oil would simply be a
change in the distribution of income, but have no affect on
aggregates, besides the supply side effects originating from the
higher price of oil. We have slightly overestimated the
negative effects on American GDP by assuming that there is no
feedback from increased Saudi income back to the United States.)
If we further include future consumption
generated by extra savings, then even savings does not
constitute a leakage, so long as over the prevailing time
horizon, the economy remains in a demand constrained situation.
In short, leakages are much, much smaller, when multiyear
aggregate incomes are calculated. These dynamic feedbacks are
even present in first year income. Thus, increased savings this
year leads to increased wealth next year, and that increased
wealth leads to increased output (if output is sensitive to
demand). But rational consumers will realize this;
their lifetime income has gone up, and so too will there current
consumption. In calculating the cost of the War, we are
concerned not just with the impact today, but the impact in all
future years. Calculating the total multipliers requires
assessing the fraction of future periods in which it is
reasonable to assume that demand constraints will be binding.
In the periods at hand, Europe, the United
States, and Japan were all demand constrained throughout the
relevant time, and government expenditures were very much
constrained by the level of revenues (especially in Europe).
In the very short run, it was clear that such constraints were
not perfectly binding in the U.S., but government expenditures
were tempered from what they otherwise would have been by the
looming deficit. This is clearly true for the states and
localities (which make up a third of total expenditure) but even
true at the Federal level. Accordingly, we believe a multiple
period multiplier that is substantially in excess of that
generated by the partial equilibrium American models
(generating, as we have noted multipliers around 1.5) is
warranted. Numbers of the order of magnitude generated by the
IMF model are totally reasonable, but to stay on the
conservative side, we use a much smaller multiplier of 2 as our
(conservative) “moderate” estimate. (We even believe the very
large multipliers implicit in Hamilton’s study are not
implausible.)
However, we do believe that great care must
be used in employing studies based on the impact of earlier oil
price shocks. Changes in the structure of the economy, the
nature of the policy responses, and the state of the economy
(the extent to which it was at or near full employment) can have
large effects on the full response of an oil price increase.
Earlier increases occurred at a time when the global economy was
already facing inflationary pressures (the U.S. from trying to
ignore the fiscal costs of the Vietnam War.) Under doctrines of
monetarism, there were large responses—excessive-- to the
inflation resulting from the oil price shock. Globalization has
put greater downward pressure on prices, so today, inflation is
much more benign. Monetarism has been discredited, and even if
de jure or de facto inflation targeting has meant that some
countries put excessive focus on inflation, including the
inflation generated by high oil prices—and thus monetary policy
exacerbates the contractionary pressures of oil--it does so less
than it did in the earlier oil price shocks.
Thus, while we believe that these global
general equilibrium effects are significant, and should raise
the multiplier considerably about 1.5 or 2, given the
uncertainties associated with these global general equilibrium
effects, we do not include them in our conservative estimate.
For our “moderate” estimate, we use a 6-year impact and a
multiplier of 2. We believe, however, that a substantially
larger multiplier might be justified.
Budgetary costs
The most difficult to estimate
macro-economic costs are those associated with the increased
expenditure. If we were not spending the money on the war,
would we be spending it on something else? Would we have cut
back spending, and had a smaller deficit? Would we have had the
same deficit, but just more tax cuts?
But this is only part of the counterfactual
analysis. How would the Federal Reserve have responded to the
different macro-economic situation? Would it have dampened or
exacerbated these effects?
These are standard questions in
incidence analysis, in which public sector economists
attempt to ascertain the consequence of one policy or another.
One standard methodology focuses on expenditure switching:
it is assumed that the government simply substitutes Iraq
expenditures for other expenditures (some defense, some
non-defense). This is the methodology upon which we focus here.
Another methodology focused on
marginally balanced budgets, where taxes are assumed to
increase in tandem (from what they otherwise would have been;
there may still be tax cuts, but they are somewhat smaller than
they otherwise would have been.) The Bush Administration seems
undeterred in its commitment to make its tax cuts permanent,
unaffected by the War, but Congress is showing some sensitivity
to the size of the deficit.
A third methodology assumes that the
increased expenditure leads to higher deficit
