May 2006
Economic Perspectives on the Iraq War
As the Iraq conflict continues into its fourth year, concerns about its costs also continue. Budgetary expenditures for the Iraq war are widely reported, but the financial gains and losses of the conflict are broader and more difficult to assess. Recognizing this fact, some scholars have begun to apply economic principles and methods to help evaluate the costs and benefits of the Iraq war and to assess the potential long-term fiscal liabilities it may cause. Please join us for an event that features three recent studies on the economic aspects of the Iraq war.
Panel 1: War in Iraq versus Containment
Kevin A. Hassett
AEI
When you think about the costs and benefits of war, they are difficult to quantify. There is much uncertainty and conflict, so economists often shy away from defense policy analysis. Steve Davis has sought to examine one counterfactual that is quantifiable: the costs of containment.
Steven J. Davis
AEI
In 2004, William Shawcross asked: “How can the international community best deal with tyrants, rogue states, and terrorists who threaten not only their own people but also others, and who defy the world’s attempts to restrain them?” Drawing on basic economic principles, I will take a quantifiable approach and compare the costs of war and containment policy options.
I shall focus on the following questions:
- What are the direct costs (in terms of lost resources and lives) of the war?
- Is the war likely to bring about an improvement in the economic wellbeing of Iraqis
- Would continued containment have saved Iraqi lives, as opposed to regime change?
I start by summarizing the military resources devoted to the containment of Iraq. There is a real issue regarding whether these were solely dedicated to containing Iraq or whether they served another purpose.
We care about the present discounted value cost of future containment, but we might be able to assume that the regime may not last forever, and may morph into a more benign one. The Iraqi regime had already survived several devastating shocks and would unlikely have been dislodged soon. Assuming a 3 percent annual probability that the regime would have evolved into a more peaceful one, this would lead to an expected total regime duration of fifty-seven years from Saddam’s takeover of power in 1979.
Even if containment had worked as expected, this would have been very costly. We must ask what definition of successful military action corresponds best to the benefits of containment. I would define a stable regime in Iraq as one that does not threaten the national security interests of the United States or engage in large-scale oppression of its own people or others.
To the prewar CBO (Congressional Budget Office) estimates of the cost of war, we add the user cost of capital, costs of occupation, and borrow the Wallsten-Kosec casualty cost estimates. We have calculated cost estimates for several scenarios, depending on the length of time that the U.S. is engaged in Iraq.
The optimistic scenario has a cost of $106 billion, which is less than that of containment. The more likely scenarios cost between $414 billion and $872 billion, in which almost all of the costs come from the occupation phase. Yet, ex ante, more attention was paid to the costs of war than the costs of occupation.
Most of the advocates of the war did not focus so much on the costs of containment, but rather the belief that containment would fail. Containment required occasional mobilization costs to maintain a credible threat over Saddam. Ken Polack emphasized the erosion of containment as a credible threat. He believed that Iraq would begin to be able to rearm, and we would thus be led to a more expensive war with Iraq at a time of its choosing. Present value costs of containment vary wildly according to the various scenarios of what containment would have implied.
Under Saddam, the best estimate of real gross domestic product per capita fell by 60 to 87 percent from 1997 to 2001, representing a huge slump in living standards. The composition of output also shifted away from consumption due to the militarization of society, in which military and security forces accounted for 25 percent of Iraqi employment.
If there is an increase in living standards over the next few decades due to Saddam’s removal, it is hard to escape the conclusion that Iraqis are better off as a result of forcible regime change. The costs of sanctions policies must be included in those of containment.
Our research uses no new statistics, but organizes and analyzes them. I want to compare the loss of lives under containment (which are spread over time) with the loss of lives under war (which are concentrated in time). This means we need to discount future lives.
Alan B. Krueger
Princeton University
For my last “Economic Scene” column for the New York Times, I chose to write about the work that Steve and others have been doing. Calling people who had more expertise than me, the reaction I heard was, “Don’t get me started on this new paper by Bilmes and Stiglitz, but Davis et al. try to do a reasonable job.” William Nordhaus said, “This work represents economics at its best and worst--trying to quantify the almost unquantifiable.” I give the authors credit for that, and think that this work is explicit about the alternative, which is containment policy.
The discounting seems quite reasonable, as was the way they handled regime change to a more benign regime and the way they distinguished between budgetary costs and economic costs. They handle the issue of casualties about as well as one can, and compare the current level of suffering by Iraqis to that under Saddam Hussein--a point to which I had to fight my editors in order to be allowed to refer.
On the other hand, I believe that the containment costs may be grossly exaggerated. I do not think that U.S. Central Command (CENTCOM) would be a third smaller without Saddam Hussein in power. It is hard for me to believe that the United States would not have an enormous presence in the region, especially given the problems in Iran, terrorist threats, humanitarian duties, and the importance of shipping throughout the region.
A great deal of humility is required with cost estimates. One budget expert with whom I spoke said that the cost of containment was in the hundreds of millions, not hundreds of billions, of dollars. There is a long history of underestimating costs. During the Civil War, President Lincoln’s Treasury secretary underestimated costs by a factor of thirteen.
In the first draft of this paper, which was circulated in 2003, the authors used estimates citing the costs of the war at $125 billion. This has turned out to be grossly underestimated. After citing the figure of $380 billion as the cost of containment, they go on to say, “This dwarfs any reasonable estimate of U.S. war costs.” At the time, Bill Nordhaus had his own set of estimates for the costs of war, which gave a range of $99 billion to $1.9 trillion. Although the higher figure may include some dubious macroeconomic costs, without them it still leaves $1 trillion as the upper bound. Nordhaus anticipated that the bulk of the costs would be for the occupation rather than the war. Not much weight was given in this paper to these estimates.
Ex post, it is striking to me to see how successful containment was. There were no weapons of mass destruction. One could even argue that we were overspending on containment. The counterfactuals are extraordinarily hard to assess, but we could argue that Iran has become more belligerent as a result.
This work seeks to evaluate whether the administration was rational in 2003, but it is also useful as a lesson for how to estimate relative costs in the future. The paper concludes that the costs of containment and war were roughly the same.
It seems premature to argue that the end of Saddam should necessarily mean confidence about Iraq’s economic prospects. We have seen how difficult it is to generate economic development. Remember also that since Iraq is an oil economy, the shackles that Saddam put on the economy have merely ensured that much of the wealth has been preserved in the ground as oil prices rose.
It seems that many of the costs of the invasion are missing. For example, we lost much of our international legitimacy and reputation. Some of my studies have also found that occupation has historically been one of the main factors provoking terrorism.
The question is not, “What does it cost?” because the United States is a wealthy country, but, “Why is this the way we benefit most?” This paper provides a very good framework, but the tools of economics are fairly blunt instruments in this case.
Steven J. Davis
I do not see the study as asking whether it was right or wrong to invade Iraq. At the outset, we are explicit that there are many important considerations that we do not cover. We may have overstated containment costs, but we took them from explicit testimony by Tommy Franks and others who say, “These are the resources dedicated to the containment of Iraq.”
The opportunity costs of employing resources in containment are clearly greater than the transport costs, which are all the lower estimates refer to.
Do we systematically understate the cost of war? Did Britain and France understate the costs of stopping Hitler in 1939? I think that many people overestimated the cost of the first Gulf War, for example. Successful brinkmanship is not counted as war, ex post.
Panel 2: Earnings Losses of Activated Reservists
David Loughran
RAND
This study was undertaken for the Office of Reserve Affairs in the Department of Defense. There was legislation in Congress to replace the lost earnings of reservists, and this study was intended to inform that debate.
Forty-nine percent of respondents to a 2004 Status of Forces Survey of Reserve Component Members (SOFRC) survey said they had seen their earnings fall, and 43 percent said they had lost over 10 percent of their income. Legislation was proposed to compensate for this earnings loss from being activated--motivated by both equity and enlistment concerns.
The SOFRC survey achieved only a 30 percent response rate, which is fairly low, and therefore raises concerns that it may have been skewed. We must also bear in mind that the survey ignored the fact that military pay is tax-free whereas civilian pay is not.
Using earnings data collected by the Social Security Administration, we can get information on all reservists and also account for the tax advantages. We found that those on active duty for over thirty days per year earn almost a third more than those who are not. The increase in military pay more than offsets the fall in civilian earnings. Indeed, average earnings increase with the number of active-duty days served, with those serving longest receiving the highest average incomes.
We found that 17 percent of reservists experienced a decline in incomes, and that 11 percent experienced a loss of more than 10 percent of their incomes. Those on active duty for the longest suffered the greatest earnings loss.
Looking at reservists who were not activated, 40 percent suffered an earnings loss in either 2000 or 2002–03. Given that this population consists of younger men, we see a large variation of earnings from year to year. The longer reservists were activated, the less likely they were to suffer a loss. Only 9 percent of those serving over 271 days on active duty per year suffered an earnings loss. Therefore, activation lowered the chance of an earnings loss. The extent of the problem is much lower than represented by the survey data.
The legislation proposed to compensate soldiers in proportion to the decreases in their total income might lead to a situation in which two soldiers are together in a foxhole, incurring the same risks, but being paid different amounts. It is not clear that there is necessarily a correlation between the reservists who experience an earnings loss and those who choose to leave the reserves. It is also not necessarily beneficial for the Department of Defense to target funds at retaining those who have ways of earning high incomes in civilian life.
Concerns remain over how activation interrupts careers and wage trajectories due to forgone promotion activities, lost social networks, and adjustment costs to civilian life. Activation may have long-run consequences or consequences for families and household income, but these are beyond the scope of this study.
Christopher Foote
Federal Reserve Bank of Boston
In economics it is hard to have a control group for experimentation, so you have to tease the information out of data. Here, we actually have all the precise data that you would need to reach a conclusion.
If you want to know how long-run income present value is affected by the loss of income in a year, there is a “tournament model” in labor economics in which the possibility of one day being the CEO is taken as a factor that motivates all workers. However, it is hard to measure how taking a year as a reservist will affect one’s lifetime wage trajectory. There is also no measurement with regard to home production and the consequences for families which must cope with having one or both parents away in Iraq.
Since self-employment is underreported, Social Security Administration income statistics may not fully measure it. Why else might reservists understand that they are earning more? Well, only 30 percent responded to the SORFC survey. If someone is upset about earnings losses, he is more likely to respond to a survey which asks whether this is a problem.
I would like to see data that looks at whether those reserves quitting are those who also suffer falls in earnings, since this is at the core of what the Department of Defense is looking for.
Panel 3: The Economic Costs of the War in Iraq
Scott Wallsten
AEI and AEI-Brookings Joint Center
We did not seek to decide whether the war was worth it, but to provide a framework for coherent decision-making. We do this cost-benefit analysis regularly for domestic government regulations, and so it seems appropriate for this area, too. It does, however, have its limitations. For the sake of precision we include only direct costs and not possible benefits.
We must bear in mind that a money transfer is not an economic event, whereas lost productivity and opportunity costs are. As with domestic regulation, we use the value of a statistical life (VSL) as a tool for making decisions. Policymakers will make this implicit evaluation, and people will put financial values on choices which incur risks to their lives, whether they choose to admit it or not. Given scarce resources, you want to make sure that you are making a good investment. Based on how people value risks to their own lives with respect to money, Kip Viscusi has summarized studies which find that the VSL in the United States is between $4 million and $9 million. We therefore use the midpoint of $6.5 million per person. Across countries, you find a correlation between the VSL and per capita income statistics.
Katrina Kosec
AEI and AEI-Brookings Joint Center
We started from the basic figure of Iraq-specific budgetary appropriations. So far, this comes to a total of $311 billion (in 2005 dollars). We then added in the estimated lost civilian productivity of reserve and guard troops, using their average civilian earnings of $33,465. We tried then to include coalition fatalities, Iraqi civilian fatalities, and coalition contractors.
Calculating the cost of injuries was more complicated, since the value of a statistical life (VSL) and cost of treatment vary by country. We took the value of a statistical injury (VSI) data--which represents a person’s willingness to pay to avoid injury, just as the VSL represents one’s willingness to avoid death--from the National Highway Traffic Safety Administration, the Center for Disease Control, and medical journals. The VSI varies depending on the severity of particular injuries. Using the ratio of VSI to VSL of specific injuries, we calculated and aggregated VSIs for each category of injury.
We also tried to build in lifetime treatment costs for amputation and severe head injuries. On this basis, the total cost of injuries to U.S. troops exceeds $22 billion, with the majority of costs coming from severe head injuries.
Phillip L. Swagel
AEI
When the conflict began I was working at the White House Council of Economic Advisors and was expecting huge fiscal and economic costs via uncertainty created for investment. I thought decision-makers willing to incur these would have a rock-solid case with respect to weapons of mass destruction.
This is a very sober paper, written with much humility. People who do not trust economics will see too many costs and benefits left out. Joseph Stiglitz’s study returns a much higher cost, which almost includes a dynamic scoring analysis. Non-economic costs such as the desire of Iran to seek weapons of mass destruction, or benefits such as the willingness of Libya to forsake them, must be accounted for. Specific analysis of costs like this may have been undesired in the prewar discussion, in which people were more inclined to follow President Kennedy’s principle that the United States should “bear any burden.”
Maybe if we followed Joseph Stiglitz’s advice regarding macroeconomic impacts, cost-benefit analysis would carry more weight with policymakers.
AEI research assistant Chris Pope prepared this summary.
