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There has been relatively little attention paid to the Iraq War's impact on the U.S. economy. It is often believed that wars and military spending increases are good for the economy. This is not generally true in most standard economic models. In fact, most models show that military spending diverts resources from productive uses, such as consumption and investment, and ultimately slows economic growth and reduces employment.
In order to get an approximation of the economic impact of the recent increase in military spending associated with the wars in Iraq and Afghanistan, the Center for Economic and Policy Research commissioned Global Insight to run a simulation with its macroeconomic model. It produced a simulation of the impact of an increase in annual U.S. military spending equal to 1 percent of GDP, approximately the actual increase in spending compared with the pre-war budget (see appendix). We selected the Global Insight model for this analysis because it is a commonly used and widely respected model. Global Insight produced a set of projections that compared a scenario with an increase in annual military spending equal to 1.0 percent of GDP (current about $135 billion) relative to its baseline scenario. This is approximately equal to the increase in defense spending that has taken place compared with the pre-September 11th baseline.
The projections show that:
- After an initial demand stimulus, the effect of higher defense spending turns negative around the sixth year. After 10 years of higher defense spending, payroll employment would be 464,000 less than in the baseline scenario. After 20 years the job loss in the scenario with higher military spending rises to 668,100 compared to the baseline scenario.
- Inflation and interest rates would be considerably higher in the scenario with higher military spending. In the first five years, the annual inflation rate would be on average 0.3 percentage points higher in the scenario with higher military spending. Over the full twenty year period, inflation averages approximately 0.5 percentage points more in the high defense spending scenario. After five years, the interest rate on 10-Year Treasury notes is projected to be 0.7 percentage points higher than in the baseline scenario. After ten years, this gap is projected to rise to 0.9 percentage points, and after twenty years to 1.1 percentage points.
- Higher interest rates are projected to lead to reduced demand in the interest sensitive sectors of the economy. After five years, annual car and truck sales are projected to go down by 192,200 in the high military spending scenario. After ten years, the drop is projected to be 323,300 and after twenty years annual sales are projected to be down 731,400.
- Annual housing starts are projected to be 17,900 lower in the high military spending scenario after five years, 46,200 lower after ten years, and 38,500 lower after twenty years. The cumulative projected drop in housing starts over the twenty year period is 530,000. The drop in annual existing home sales is projected to be 128,400 after five years, 247,900 after ten years and 286,500 after twenty years.