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Hormats: Iraq War Historic for Lack of Cost Transparency

Interviewee: Robert D. Hormats, Vice Chairman, Goldman Sachs International
Interviewer: Lee Hudson Teslik, Assistant Editor, CFR.org
March 28, 2008

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The total economic costs of the wars in Iraq and Afghanistan are hotly disputed. Experts disagree even on the basic point of whether the wars will have a positive or negative economic impact. The wars’ budgetary costs have well outpaced initial White House estimates, though the total costs remain somewhat shrouded by the fact that war-spending has been funded almost entirely through debt—and has been paid for through budgetary supplements, and thus excluded from the U.S. Defense Budget. Robert Hormats, the vice chairman of Goldman Sachs International and the author of a book on U.S. war financing, argues for more transparency in war financing. He notes that the run-up to the current wars stands in sharp contrast to the planning periods before other wars in that there was very little national debate on how war costs would be financed.

There’s a fair amount of discussion going on right now about the overall economic costs of the two U.S. wars, in Iraq and Afghanistan. There are some rather contradictory numbers bouncing around, from those used by the Congressional Budget Office (PDF) to those used by Joe Stiglitz in his new book, to the estimates in a recent report by congressional Democrats has been getting a fair amount of attention. From a bird’s eye view, what’s your take? How significant are these wars to the U.S. economy?

Well, you can look at it two ways. As a portion of GDP [gross domestic product], this war is very cheap, in the sense that, for instance, World War II at its peak was between 35 and 40 percent of GDP in a given year. And this war at its peak is between 1 and 2 percent of GDP, in terms of budgetary costs.

But the war in Iraq also has a number of other costs that are not easily calculated or particularly well understood. It clearly has a very direct cost over the longer term because of the need to care for a lot of wounded veterans. The medical care for these men and women is going to be very expensive, and will be required by many over the course of their lifetimes. And the U.S. government has a moral obligation and an economic obligation—both, I believe—to pay those costs and give them the best care they can possibly get. That’s going to cost a lot of money. And that of course is not in current budgetary projections.

The second thing we’ve got to do is what they call reset the military. A lot of equipment has been used up during this war, and it’s going to have to be modernized. All the weapons that have been used up, or at least most of them, will have to be replaced over a period of time. That bill is going to be quite substantial.

Then you have the homeland security bill. A lot of homeland security equipment costs have not been met because the notion has been that the best defense is a good offense—that is to say if you can deal with a problem in Iraq, you’ll have less of a security problem at home. So a number of our own domestic needs haven’t been met. These are additional costs that are not factored into the sum six hundred billion dollars that has been spent on the war directly through the budget.

Much of this is being paid for with debt. You write in your book that in the early part of U.S. history, paying down wartime debt was a national obsession. Do you think this war is going to mark a counterpoint to that?

Absolutely. For the better part of American history, starting with the revolution, and through the War of 1812, the Civil War, World War I—even World War II, which was massively expensive, the most expensive war in American history—there was a major effort after the war to pay down a large portion of wartime debt. In part because, from Hamilton on, Treasury secretaries had concluded that having the country on a sound financial footing was very important to national security.

There was also the notion of generational fairness. Washington, in his farewell address, said that you shouldn’t throw burdens on future generations for war expenditures that should be borne by the current generation. So that notion of current generations paying at least a portion of the cost of a war was considered both a necessary sacrifice and a way of avoiding throwing all of the burden on coming generations.

And there was always a debate, before every major war, as to what portion should be paid by taxes and what portion should be paid by borrowing. During the Civil War they agreed around 25 percent of the war paid for by taxes, and 75 percent by borrowing. World War I, Secretary McAdoo, who was the treasury secretary, worked out with Congress that it would be a third of the war paid for by taxes, and two-thirds by borrowing. And then during World War II, they aimed for 50 percent taxes and 50 percent borrowing. But there was a national debate—there was a debate in Congress on how to pay for the war. We’ve had no such debate this time. None at all. And no sacrifice at all. No tax increase. In fact, there was a tax cut. And, in fact, domestic spending, which has been cut in every major war in American history, went up during this war.

You say sound national finances are indispensable to military strength. The U.S. economy is in a bit of a struggle right now, but at the same time, we spend substantially more in nominal terms on defense-related operations than any country in the world—and by a pretty wide margin as well. Could a weakening U.S.economy plausibly change that dynamic? And if so, on what sort of time frame would you think?

I don’t think it could change the dynamic in a dramatic way. I think there’s always got to be enough money in this country for America’s national security if we need to defend it. The problem is that you could find yourself spending sufficient money for national security but having many other aspects of the economy suffering for lack of resources. One, borrowing increases, which over a period of time is not a stable thing for the economy because it means there’s more debt. Or you try to hold back on the borrowing by taking money from other parts of the economy. You can do that to a degree because there are certainly a lot of wasteful programs in our budget. But if you continue to do that, you’re going to cut some programs that are very important. You don’t want to have to sacrifice education. You don’t want to have to sacrifice programs for poor people. You don’t want to have to sacrifice research and development on new medicines, or on new source of energy. So you may be able to have money directly available for the military, but many other sources of economic strength and of social strength could be compromised very badly.

If the security situation improves markedly in Iraq over the next few years, would it be feasible that oil production could increase in a way that would maybe offset some of the losses that have already happened?

Yes. I mean, the United States may well have to spend another 120 billion dollars a year to do it, but it is certainly conceivable that if the situation in Iraq stabilizes for a long period of time, and therefore enables investors to go in and actually drill and export oil in larger amounts, that would have a very positive effect on the oil market, and therefore on the global economy. Iraq has the second largest reserves of oil in the world. Many of them are in the western desert. And the problem is you just can’t send oil teams in there with any degree of security and have the oil pumped out of the ground. And the other is that Iraq’s oil capacity was badly degraded, not just by the war, but by the sanctions against Saddam Hussein, and by the mismanagement under the Saddam regime. So getting these oil fields up to, say, 3 million barrels a day of exports is going to take a lot of time.

Do you believe in the idea of a war economy—the idea that war spending can actually stimulate the economy?

It depends on the state of the economic cycle. World War II certainly was very stimulative for the American economy—it was really what you could call a Keynesian war. Now, it’s not the most efficient way of stimulating the economy, to be sure. The most efficient way is to spend money not on war material but on productive investment, like infrastructure, and research and development, and education. But World War II was very stimulative, and helped to pull us out of what was called the Roosevelt Recession. There was a huge amount of unemployment in 1939, 1940, and the war created a lot of jobs and a lot of good jobs as well. The standard of living certainly improved for most Americans during the war. But today, one shouldn’t really look at it that way because you can look at a lot of other, more productive ways of using the money. Money spent on Iraq is really a one-time thing. When you have a bullet, you shoot the bullet, the bullet’s gone. If you’re investing in education or infrastructure here, you have a longer term productive benefit.

Broadly, theoretically, is it a fair comparison putting the war on terror and the wars in Iraq and Afghanistan next to the wars of the past? Should military spending be higher than in the past, given this new kind of war? Or maybe should it be lower, given that we no longer have the Cold War?

In a way, juxtaposing the wars of the past merely is a way of looking at orders of magnitude relative to the size of the economy. And the reason we’re able to afford these wars today more easily than the past wars is that the economy has grown so much in the period since World War II. But one has to ask whether this war serves U.S. national security interests. First of all, it’s a war of choice, rather than say Afghanistan, which I would regard as a war of necessity. Second, I’m not arguing that one should look at the costs of this war and say, “this cost is an argument for not continuing the war.” My judgment is that the troop levels should be determined by whether our national security is served over the medium term and whether it creates stability in Iraq and stability in the region, or not.

But I do argue the following two points. First, if this is a war of choice, Americans should know the economic costs of the war. There should be an open debate. An informed electorate is an important part of a democratic society, and I place emphasis on the word informed. American people really have not been well informed about the costs of this war because it’s been financed by supplements—which skirt the normal budget process—and because a lot of the cost has been borrowed.

Second, if you’re going to have a war, you should figure out how to finance it in a responsible way, as has been done in the past. As I was saying earlier, this is the first major war where we’ve had no tax increase. We’ve had a tax cut. It’s the first major war where we’ve had increases in non-essential, non-security-related domestic spending. It’s the first war which is financed entirely, almost entirely, by supplementals. No other war has that been the case. Even Vietnam was only 25 percent supplementals. This war has been paid for by borrowing. And 40 percent of that comes from abroad. So you’re not only building up debt, you’re building up debt to other countries. We really haven’t had that sort of rigorous oversight that the founding fathers anticipated there would be. And I think that has meant that many of the war costs haven’t been very transparent, and you haven’t had a debate on how to finance the war. Those are the kinds of issues that we need to think about as we go forward.

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