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July 30, 2006
David Warsh, Proprietor


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Gauging the Costs of the War

Like a lot of Americans this week, I have been reading Thomas Ricks’ Fiasco: The American Military Adventure in Iraq. Ricks is chief Pentagon correspondent of The Washington Post. Two lengthy excerpts that appeared in the paper last week helped catapult his book to the top of the best-seller lists. His first-paragraph summary of the story so far:

“President George W. Bush’s decision to invade Iraq in 2003 ultimately may come to be seen as one of the most profligate actions in the history of American foreign policy. The consequences of his choice won’t be clear for decades, but it already is abundantly apparent in mid-2006 that the US government went to war in Iraq with scant solid international support and on the basis of incorrect information — about weapons of mass destruction and a supposed nexus between Saddam Hussein and Al Qaeda’s terrorism — and then occupied the country negligently.  Thousands of US troops and an untold number of Iraqis have died.  Hundreds of billions of dollars have been spent, many of them squandered.  Democracy may yet come to Iraq and the region, but so too may civil war or a regional conflagration, which in turn could lead to spiraling oil prices and a global economic shock.”

Ricks’ reporting — and that of Michael Gordon and Bernard Trainor, both associated with The New York Times, in Cobra II: The Inside Story of the Invasion and Occupation of Iraq — is powerful evidence that daily newspaper journalism is still our first best method of approaching the truth of rapidly unfolding events.  The historians will come later.

The rest of my time last week, I spent reading up on another, quite different but complementary method of thinking about the outcome of the war so far — the economic analysis of its costs and benefits. A day-long meeting of the Working Group on the Economics of National Security produced a revealing exchange at the Summer Institute of the National Bureau of Economics Research.  No voices were raised, but the exchange was as compelling in its way as is high-grade journalism in its.

Most readers will remember that there was a bit of controversy before the war began about its potential cost. National Economic Adviser Lawrence Lindsey told an Iraqi newspaper that it might cost as much as 1 percent to 2 percent of the national gross domestic product, or $100 billion to $200 billion. He was much criticized inside the administration for broaching such a large number, and dismissed from his job on the eve of the war.

L. Glenn Hubbard, chair of the Council of Economic Advisers, knocked down Lindsey’s numbers behind the scenes, but the paper that did so is still classified. The most widely-cited pre-war estimate of its military cost, by Office of Management and Budget director Mitchell E. Daniels Jr., was in the range of $50 billion to $60 billion — the same range produced by the Democratic Party staff of the House Budget Committee (though they estimated another $40 billion in humanitarian aid and reconstruction expense might be needed).

Meanwhile, Congress has already appropriated more than $250 billion for the war in Iraq, and the Congressional Budget Office estimates that its midrange scenario will cost another $270 billion over the next decade.

It’s probably fair to say that the economics of national security had its beginnings in an essay by William D. Nordhaus of Yale University that appeared in December 2002, first in a non-technical essay in The New York Review of Books, then as a publication of the American Academy of Arts and Sciences, available here on the Web.

It might seem faint-hearted to take seriously beforehand the task of estimating war’s potential cost, wrote Nordhaus, slyly anticipating his critics, “a sign of insufficient resolve at best and appeasement at worst,” but in fact it was simply realistic. “…[M]ost people recognize that the costs in dollars, and especially in blood, are acceptable only as long as they are low. If the casualty estimates mount to the thousands, if oil prices skyrocket, if a war pushes the economy into recession or requires a large tax increase, and if the United States becomes a pariah in the world because of callous attacks on civilian populations, then decision-makers in the White House and the Congress might not post so expeditiously to battle.”

That said, Nordhaus waded into the task of estimating — before the fact — the range of possibilities of what the war might cost.  For purposes of eventual comparison, he recalled the best estimates of previous wars’ cost — from 63 percent of annual gross domestic product for the American Revolution to 104 percent for the two sides together in the Civil War (169 percent for the Confederacy!) to 130 percent for World War II to 12 percent for Vietnam and 1 percent for the first Gulf War.

Nordhaus made rough calculations of what might be the impact of war in Iraq on petroleum prices. (Lindsey had suggested that the price of oil might fall following a successful war.)

And after disentangling direct military spending from various follow-on costs — occupation and peacekeeping, reconstruction and nation-building, humanitarian assistance, the impact on oil markets and macroeconomic impact, Nordhaus produced a pair of estimates of the war’s likely cost over a the course of a decade, low and high –$99 billion after a short and favorably resolved battle, compared to $1,934 billion, or almost $2 trillion dollars, nearly 20 percent of GDP, in the event of a protracted war with an unfavorable outcome.

As it happened, a trio of University of Chicago economists also produced in 2003 an estimate of the costs of the war, which came to very different conclusions — partly by taking the analysis a step further and asking, compared to what?  Steven J. Davis, Kevin M. Murphy and Robert Topel of the Graduate School of Business circulated a working paper dated the day the battle began, in which they compared the cost of waging war to continuing the policy of containment, “no fly zones” and all the rest,  that the US had pursued ever since the first Gulf War had concluded in 1991.

Assuming that Saddam had the same kind of staying power as repressive regimes in North Korea and Cuba, the Chicago economists concluded that the invasion would be a bargain, for Americans and Iraqis alike. The cost of continuing to contain Saddam at the same level as the precious decade — 30,000 troops, 30 ships and 200 aircraft and their crews — would add up to $380 billion going forward.  “This dwarfs any reasonable estimate of US war costs,” they wrote — even before the possibility of increased terrorism was over the next twenty years was added in.

What about the Iraqis?  What about the cost of war to them? Since Saddam came to power in 1979, their economy had stagnated, the Chicagoans noted; income per person had fallen by as much as 75 percent.  They toted up the loss of lives as well — the war with Iran, the repression of the Shiites, the Kurds and the Marsh Arabs, something like half a million premature deaths over a quarter-century, and projected the record into the future (with a suitable discount rate of 2 percent, and a 3 percent probability of spontaneous regime-change) and concluded another 200,000 to 600,000 Iraqis could be expected to die under a policy of continued containment were Saddam and his henchmen to continue to rule for another 33 years.

In contrast, after a forcible regime change, the Iraqi economy begins growing again.  The war itself costs no more than a half a year’s GDP. Oil revenues swell, income per person grows enough to make up for the quarter-century decline.  “At first, it may seem surprising that war can lead to a huge improvement in human welfare.  But, in fact, this conclusion is hard to escape so long as regime change even partly undoes the collapse in living standards under Saddam” — at least it does as long as the killing stops.

And what if doesn’t?  Last week the Chicagoans were back, with a revised and considerably expanded rewrite of their 2003 paper, presented by Davis to the NBER’s Summer Institute.  Gone were some of the slam-bang certainties of the earlier version (“…[T]he costs of containment dramatically outweigh the costs of war according to our analysis”). Added were a number of cost-of-capital subtleties in calculating the cost of various contingencies, and a broader view of the possibilities themselves.  Unchanged was the insistence that any judgment of the cost and efficacy of the invasion of Iraq would have meaning only when compared to the cost of /not/ invading — that is, to maintaining a policy of containment.

What was striking, however, was that somehow the Chicagoans’ numbers had changed.

In his role as discussant, Yale’s Nordhaus underscored the disparity.  In 2003, he noted, on the eve of the war itself, the Chicagoans had rated the cost of containment as $630 billion, compared to a projected $125 billion cost of war — a virtual no-brainer. In the 2006 version, with the advantage of “partial hindsight” creeping in despite their determination to write as though they were still looking forward from early 2003, their (backward-looking) forward-looking cost of containment had become $297 billion, against a best guess of the cost of the war of $414 billion — a very dramatic swing.

Nordhaus continued in this vein for a little longer. The estimates of the human costs of containment seemed much too high to him, he said.  After all, there had been no American combat fatalities in the Iraq theatre between 1992 and 2000. Perhaps such containment exercises should be viewed as a plus, training troops and testing weapons systems, instead of degrading them. Perhaps choosing war begets more war over a wider area instead of less. Perhaps considering a broader range of options would have yielded quite different results. What about the cost of inspections?  Or coercive inspections?  All aspects of the fascinating subject that had opened up.

For his part, Davis took the discussion with good grace.  The Chicagoans’ paper, he explained, had been the result of conversations around the business school lunch table in the run-up to the war, resulting in “something between dissatisfaction and disgust” with the way the issue was being framed — a first step in the right direction, nothing more.  Certainly a broader range of options, not to mention a capacity for sequential analysis of them, was a good idea. But any such scheme would begin with the sort of present-value calculation that he and his co-authors had devised. And on this much probably all those present could agree.

It may be that, if an American president really wants to go to war, as did Bush, and if he is willing to exaggerate the threat of terrorism, then it will happen. But the effect of these early efforts in dispassionate economic analysis means that never again can war begin with so flimsy an accounting of the expected cost of achieving its objectives as what Larry Lindsey told an Iraqi newspaper.  The words with which Nordhaus closed his 2002 discussion of the economic consequences of a war with Iraq suggest just how imaginative a before-the-fact analysis must be in the future if it is to be persuasive.

“The cost of a war may turn out to be low, but the cost of a successful peace looks very steep. If American taxpayers decline to pay the bills for ensuring the long-term health of Iraq, America would leave behind mountains of rubble and mobs of angry people. As the world learned from the Carthaginian peace that settled World War I, the cost of a botched peace may be even higher than the price of a bloody war.”

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