The War and the Recession
By Dean Baker
With the release of the February jobs numbers, everyone except for the economists now acknowledges we are in a recession. The economy is shedding jobs at a rapid pace and it is only a matter of time until we see the unemployment rate rising. In addition to greater difficulty finding jobs, workers can look forward to falling wages and reduced access to health care insurance and pension coverage.
Naturally, people are looking for an explanation for the cause of the recession, and many have turned to the Iraq War. This view is wrong. The war is a drain on the economy, but it is not the cause of the recession. The recession is due to the collapse of the $8 trillion ($110,000 per homeowner) housing bubble.
It is understandable people would look to the war as the villain in this story. After all, the war is costing around $180 billion a year (at 1.2 percent of GDP). This is a substantial drain on the federal budget and the economy. This money could have gone to productive uses that would have benefited people and made the economy stronger.
For example, the proposed expansion of the state children’s health insurance program (SCHIP) would have cost $7 billion a year, an amount equal to what we spend on the war in two weeks. A proposed $2 billion a year increase in childcare subsidies is equal to four days of spending on the war. The hundreds of millions of dollars each year the federal government devotes to energy conservation amounts to less than a day’s spending on the war.
In short, there is a nearly endless list of areas that can be identified in which the money spent on the war could have been spent in ways that would have made the economy stronger. Since the money was diverted from better uses, the war spending has hurt the economy.
There is another way in which war spending hurts the economy: We have to pay for the war. We could have paid for the war with tax increases, but instead, President Bush chose to pay for it by borrowing, making the deficit considerably larger than it would otherwise be. This additional borrowing makes interest rates somewhat higher than they would be otherwise. Higher interest rates can raise the value of the dollar, which makes the trade deficit larger. (A high dollar makes US-made goods relatively more expensive both here and abroad.) Higher interest rates can also reduce investment and homebuilding.
However, the increase in borrowing associated with the war is actually not very large relative to the size of the economy. It can be expected to have a negative effect, but it is relatively modest and only begins to be felt over time. Last year, the Center for Economic and Policy Research commissioned Global Insight, one of the country’s leading economic forecasting firms, to project the impact of the war on the economy.
Their model projected the impact would be initially positive (war spending generates demand), but eventually the effect of higher interest rates imposes a drag on growth. By the sixth year, the effect is negative; and by the tenth year, the economy was projected to have lost about half a million jobs, mostly in manufacturing and construction.
This is bad news, but it is not the recession that we are seeing now. This recession has a different group of villains. First and foremost on this list is Alan Greenspan, who at least ignored the housing bubble, if he didn’t actively promote it. The list also includes regulators at both the state and federal level who tolerated abuses in the mortgage industry that were completely visible at the time they took place. And there is a long list of politicians and community leaders who encouraged low- and moderate-income families to buy homes in the middle of a housing bubble. And, of course, there are the incompetent economic forecasters (is that redundant?), who could not see an $8 trillion housing bubble in front of their face.
These are the people who deserve the blame for what is likely to be the most severe recession in the post-war period. The public’s wrath should be focused on the Fed, the regulators, the Wall Street crooks, and the others responsible for letting a housing bubble wreck havoc on the economy.
There are plenty of good reasons to be opposed to the war and its negative impact on the economy is one of them. But we should not allow the war to be misused to allow some big-time villains to get off the hook. If we had better spent our money over the last five years, we would be better able to withstand the effects of the housing crash - just as a person who eats well and exercises can more quickly recover from a bout of pneumonia. But laziness and a bad diet are not the cause of pneumonia, and the war is not the cause of this recession.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, “Beat the Press,” where he discusses the media’s coverage of economic issues. You can find it at the American Prospect’s web site.