“What would a U.S. economy in wartime be like?” my friend asked.
This is an important question right now, so I gave a full and precise answer: “It depends.”
How any war affects a nation’s economy depends on how large the war effort is relative to the nation’s output and the degree to which war disrupts production and consumption.
The Spanish-American War of 1898, which lasted just 16 weeks, was small relative to the nation’s economy and affected it little. The Civil War, on the other hand, reduced the South’s economy to subsistence level. Inflation destroyed the banking system and transportation and communication were riven by Sherman’s march.
In a war with Iraq, the economy is likely to perform more like it did in the Spanish-American War.
There won’t be food shortages, meatless or wheatless days as in World War I, or sugar, gasoline and tire rationing as in World War II. The average American won’t be able to tell we are in a war, just as there were few visible signs during the first Gulf War in 1991 or during the Vietnam War.
I remember Vietnam well. I was about to enter 10th grade when the Tonkin Gulf Resolution came in 1964, and I was a Vietnam veteran farming in Minnesota with a wife and child when Saigon fell 11 years later. My memories of the political divisions are sharp, but I don’t remember shortages, crushing taxes or other economic negatives.
Indeed, the higher military spending on Vietnam coupled with Lyndon Johnson’s unwillingness to raise taxes resulted in an era of prosperity. Factories were booming; unemployment was low; gas, meat and college tuition were cheap.
Johnson’s unwillingness to raise taxes shoved the war’s negative economic consequences into the future. We ran federal deficits that were large for the time. They were financed by the Federal Reserve buying a substantial proportion of the new bonds issued. In other words, we printed money.
That decision meant that people don’t remember the Vietnam War years badly in economic terms. However, the subsequent period of the mid- to late-1970s was one of inflation, wage and price controls, rising unemployment, gas shortages, the implosion of the post-WWII Bretton Woods international economic system and a general national “malaise” in Jimmy Carter’s accurate term. If we had raised taxes more from 1964 to 1972 to pay for the war , the period from 1972 to 1980 might have been less traumatic.
Cost estimates for our war in Iraq vary widely. Former Bush economic adviser Lawrence Lindsey said the war might cost $200 billion. That’s chicken feed, a mere 2 percent of the nation’s $10 trillion economy.
Yale economist William Nordhaus, well known as a Democrat, estimates the war might cost as much as $2 trillion over the next decade. His numbers reflect lower output and thus lower income as a result of the war, not direct costs to the Treasury and taxpayers. Nordhaus is saying that the direct budgetary cost of the war will be about $1,000 per household in our country but that the effect of longer-term, lower incomes might average $20,000 per household over 10 years. That’s not chicken feed, though it depends on many assumptions.
A conservative economist, with the support of the bellicose faction within the Bush administration, is likely beavering away to produce a study that will show how the economy will get a huge boost from bringing democracy and free markets to the Middle East.
I’m skeptical of estimates at either extreme. This war isn’t going to bring immediate economic deprivation to many of us. But the lessons of Vietnam are also clear: Trying to push the costs off until after the 2004 or 2008 election will be just as foolish as it was in 1968 and 1972.
If the federal deficit increases substantially in the next few years, interest rates will, too. So, here’s my advice for handling war in your personal finances: Support a special war surcharge on federal income taxes, something which will help keep the deficit in check. And, just in case the government doesn’t take that step, protect yourself from steep interest rate increases by switching your variable-rate mortgage to one with a fixed rate.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.