Economics Of War Essay, Research Paper

Economics of War

The choice to bomb the World Trade Center was more than symbolic. The collapse of the towers has coincided with an already slowing global economy and was probably intended to cause as much economic as physical harm. The crisis will have deep economic repercussions in a number of areas; while some parts of the economy will be hurt, other sectors may actually benefit, and it is possible that increased defense spending could stimulate the slowing economy in the short run. A global economy requires openness and speed, whereas increased security often entails putting up barriers and walls. The war on terrorism will also dramatically increase security costs at every level. America’s distant global commitments may become enormously expensive and draining. The war on terrorism will decrease consumer spending, the stock market, exchange rates, airline costs, and immigration rates. Furthermore, how will a slowing global economy respond and deteriorate the slowing American economy?

The terrorist attacks on the World Trade Center will cost New York’s economy up to 105 billion dollars and 115,000 jobs. Allen Hevesi, the city comptroller, did a recent report of the breakdown of some costs: Rebuilding the World Trade Center as smaller buildings will cost 6.7 billion; Repairing and restoring other damaged buildings will cost 5.3 billion; Value of equipment, vehicles, computer systems destroyed will cost 12 billion; Lost wages using estimate of 5,600 people will cost 11 billion; Clean-up and stabilization of WTC site will cost 9 billion; City government overtime, vehicle losses, road building will cost 7 billion; Spending by private owners on repairs will cost 1 billion; Treating injured, loss of income from injuries will cost 3 billion; Lost business and economic activity will cost 21 billion; Lost rent for damaged buildings will cost 1.75 billion; Lost wages because of companies leaving New York will cost 3 billion. The city will need additional federal aid to recover. The long-term impact of the attacks depends on how quickly the nation’s economy recover and the decisions on where to locate by the companies. The city initially paid for clearing the area and the most visible portion of the cleanup, which was nearly a half a million tons of steel, concrete and debris.

The World Trade Center attacks were said to be hurting the civilian economy in ways that merely a military engagement like the Persian Gulf War didn’t. MSNBC news reported that because of its global scale and long-term nature, the war on terrorism will cost more than the Persian Gulf War, which totaled about $80 billion in constant fiscal-year 2002 dollars. The Vietnam War, by contrast, cost $572 billion in 2002 dollars. US government spending as a percentage of gross domestic product peaked at 43.7% in 1944 during World War II and was only 20.5% at the height of the Vietnam War in 1968. It is currently about 18% (see table 1). This is all said to be because in relation to the size of the overall economy, the increase in government spending this time will not be sufficient to compensate for the dampening effect of the threat itself. MSNBC news also reported that the money expected to be spent as a result of the attacks overstates the great impact of fresh government spending, since much of it will simply go to replace lost incomes.

The economics of war show that in wartime, the production of standard consumer goods has to be curtailed in favor of weapons, army supply, medications and other products that are in high demand. The best way to do this is to let the private sector respond to incentives, even though government spending now plays a big part in determining what should and should not be produced since it becomes the biggest client for these products. That is not the way things have been done in the wars of the 20th century though. On the contrary, governments have used each such opportunity to increase their control on the productive sector, proving that indeed, war is the health of the state. Wars have powerful and mostly negative economic effects, arising from loss of production capacity, movement of manpower, reduced foreign exchange earnings and subsequently imports. The United States Civil War Center gave a statistical summary of America’s major Wars (see table 2).

The cost of disasters has been said to be very expensive. The Federal Emergency Management Agency (FEMA) reported that damage from hurricanes over the past ten years has been more frequent and costly to American taxpayers than any similar period in recent history. According to FEMA data, a total of 32 Presidential major disasters were declared from 1988 through 1997 for damage from Atlantic and Pacific hurricanes affecting 17 states on the United States mainland, Puerto Rico and the US Virgin Islands in the Caribbean, and American Samoa and Hawaii in the Pacific. The cost to the nation for these disasters currently stands at more than $5.2 billion in FEMA recovery funding alone. Those figures contrast with the previous ten years when 21 major disasters were declared and $552 million in FEMA assistance was needed to aid recoveries from ten hurricane strikes affecting 12 mainland states, Puerto Rico, the US Virgin Islands and American Samoa. FEMA figures also show that the 1988-1997 period spawned several of the most intense hurricanes in recent history, led by Hurricane Andrew’s assault on South Florida and parts of Louisiana in 1992.

A recent article on the Internet titled, “ Attack on America”, reported that the Federal Reserve to push a key interest rate to its lowest level in four decades in an effort to get consumers spending again. In the midst of the terrorist attacks, consumer confidence has plunged by a large amount, which is a threatening development given that consumer spending accounts for two-thirds of total economic activity. In the New York Times Business Day section, The Commerce department reported “Consumer spending fell 1.8 percent in September and that Construction Spending declined 0.4 percent in September, the fifth consecutive monthly drop. The decline brought spending to $843.1 billion at an annual rate, the slowest this year. The drop in Consumer Spending, after a rise of 0.3 percent in August, was larger than expected and the sharpest since January 1987, when blizzards kept shoppers at home. Growth in personal incomes, which rose less than 0.1 percent in August, was the weakest since incomes fell 3.9 percent in January 1994.” Many analysts believe that the country is now in a recession, which will probably last until next year. Because of the attack on America, Feds are trying to cut interest rates. The New York time reports, “The rate is now the lowest in four decades. Investors are expecting a quarter-point cut next week and another quarter-point decrease by the end of the year, based on trading in federal funds futures contracts. The factory report on November 2, showed little threat from inflation, making it easier for the Fed to lower rates. The index of prices paid for raw materials fell to 32.5 in October, the lowest in more than fifty years, from 36.3 the previous month.” The University of Michigan’s initial report on consumer confidence for September showed a large, unexpected decline. While most economists had earlier predicted that the economy would recover later in the year, the August Blue Chip consensus predicted GDP growth of 1.7 percent in the third and 2.8 percent in the fourth, which made it seem possible that the current disruptions could push GDP growth into retrenchment and potentially recession.

The attack on the World Trade Centers has caused a major drop in the stock market. One of the nation’s largest bond dealers continues to struggle to put their business back together. The Washington Post reported that “ More than 40,000 people occupied offices in a cluster of seven buildings surrounding the Trade Center Towers, and there was still no accurate count of how many were killed. The firms battered by the attack span a wide range of financial and business specialties, including the brokerage desks of Morgan Stanley Dean Witter & Co., insurance and risk management services at Marsh & McClennan Companies Inc., investment banking offices of Salomon Smith Barney and market analysts at Fred Alger Management Inc.” Many of the firms played a major role in the stock market. The Washington Post also reported “ Harwick Simmons, chief executive of the Nasdaq Stock Market, said that 19 of the 32 small stock brokerage firms located in the World Trade Center failed to respond to a test of the market’s electronic network. Securities and Exchange Commission spokesman John Heine said that the agency did not yet know the names of the 19 or where customers of those firms should go to find out about their accounts or recover their money.

The foreign exchange markets have remained relatively calm, but within the bounds of normal variation. The New York Times reports that “ One of the central concerns over recent years in the US has been the emergence of the significance imbalance in the external account, as domestic consumption has continued to grow strongly with exceptionally low levels of private sector saving being recorded. The IMF were estimating a US current account deficit of 4.5 percent of GDP in 200 and 4.3 percent of GDP in 2001. The fear in the aftermath of the attacks is that US growth and confidence would evaporate and lead not only to a decline in in-coming capital flows but also to capital outflows. In these circumstances, the prospect of serious funding difficulties would some more sharply into focus with the dollar likely to come under pressure.” The effect of exchange rates has had a major impact on immigration.

Many other countries are pleading with America not to band them from migrating and exchanging goods. A recent article by The Dallas Morning News reported that “ Mexico’s president Vincente Fox is hoping he can use his friendship with Mr. Bush to persuade the United States not to abandon Mexico after having earlier applauded its democratic transition and economic policies. Already, talk of easing immigration rules has been put on a back burner as the United States has turned its attention to the war on terrorism and its own increasing economic problems. Layoffs, recession, budget cuts and tighter borders are hardly what Mr. Fox expected in the first year of his administration.” Immigration laws probably are not subject to change but the effects of war can put a limitation of the exchanging and sell of goods.. Dallas Morning News reports “ In Guadalajara, foreign-owned factories have thrived for years by pumping out gadgets from laptops to personal digital assistants for US consumers. But those plants initiated layoffs even before the September 11 attacks because of the slowing US economy. Their future seems even darker now.” This year, as many as 500,000 people have lost their jobs nationwide. The economy has slimmed for almost three quarters in a row, with no recovery basically in sight.

The Scottish Executive, a internet article on the global insurance markets, reported that “ There have also been impacts via the insurance sector: firstly, the direct impacts on individual insurance companies which will suffer losses as a result of the attacks; secondly, the concern that falling equity prices might trigger automatic sale by insurance companies of their stockholdings in order to meet the FSA solvency rules; and, thirdly, the possibility that UK air carriers would not have adequate third party war risks insurance to allow them to fly. Estimates of the cost of the damage in New York have risen sharply, although the scale of the losses for individual insurance companies will be unclear for some time. There was a concern that falling equity prices might trigger an automatic sale by insurance companies of their shareholdings in order to meet the Financial Services Authority (FSA) solvency rules, thereby exacerbating market trends.” Some of these problems have impacted some of the largest insurance markets. For instance, Guardian Unlimited reports, “ As it released its first estimate of the size of claims it expects to receive, Lloyd’s, which insures buildings, planes and even film stars, moved to make speculation that it would collapse from the financial burden of paying out claims of 1.3 billion dollars. Lloyd’s predicted that terrorism would lead to sweeping changes through the insurance world. The cost of insurance will rise dramatically because of the perception that the world is now a riskier place while some of the while some of the syndicates which underwrite the insurance policies will stop taking on any new business.” Because of the terrorist acts, the whole insurance landscape has changed.

The WTC attacks have increased the spending of defense buildup. The defense department has been spending a lot of money to create more weapons for war. Gary Gentile, a Business Writer writes “Unlike previous conflicts, which relied heavily tanks, fighter jets and ships, a prolonged campaign against terrorists will place increased emphasis on an electronic battlefield that will require sensors and software. The Senate is considering a request for $343 billion for Defense and Energy department needs. The spending bill already has passed the House after legislators there diverted some money President Bush wanted for his missile-defense program to counter terrorism efforts. The Defense Department’s research arm also is working on a system to allow surveillance planes or satellites to track moving targets, something existing bombs and missiles cannot do with precision. The system uses airborne radar that tracks a target and provides the information immediately to missiles in flight.” On the contrary some major defense companies are battling it out to be the primary defense supplier. Business Week reports that ‘ Boeing is bracing for yet another big blow because Lockheed Martin is positioned to beat out Boeing for the largest defense contract in US history. For Boeing, losing the JSF would come at a bad time: It’s already cutting 30,000 jobs at its commercial aircraft division in the wake of the WTC attacks. Winning the JSF contract would have restored 6,000 jobs in Seattle and St. Louis. Lockheed’s Ford Worth Factory, which now builds F-16s, would likely need up to 9,500 new workers if the company wins the contract. Losing the JSF will mean Boeing likely will turn into the military’s supplier for large cargo and refueling aircraft, while Lockheed becomes the sole builder of fighter jets.”

There are a variety of ways in which the attacks are immediately affecting the demand for air travel, including through the fears of further terrorist attacks involving airlines, and through the impact on unrestricted spending which arises as consumer confidence declines. The IATA press release reported that “ In a monthly fall of a size not seen since the immediate aftermath of the Gulf War, more than 10 years ago, passenger traffic on the international scheduled services of IATA airlines declined 17 percent in September, compared to September 2000, and as a result showed no growth in the first nine months of the year. Carriers were unable to adjust their seat supply quickly enough; the passenger load factor fell from 78 percent in August to 69 percent in September.” The New York Times did a breakdown of the economic costs for airlines. “ British Airways have announced 7,000 job cuts; American Airlines and United Airlines have announced 40,000 job cuts; Virgin Atlantic has announced 1,200 job losses; Air Canada are preparing to cut a further 7,000 jobs, on top of the 7,500 announced earlier this year; Delta Airlines is also expected to announce a cut of 16,000 jobs; Swiss Air has suspended all flights and is likely to be taken over or split up; Sabena has filed for bankruptcy.”

Over 25,000 It and telecommunication workers around the world have been working intensely to assure continuity of service. The Washington Post reports “ Inclusive of the immediate cost of hardware and software replacement, over 20,000 IT and telecommunications contractors will support in-house teams for several weeks to ensure continuity of business for financial services. The costs include telecommunications and computer equipment replacement, installation and support. Over 100,000 IT personnel will be relocated. There will be more investment in security, data storage, back-up and disaster recovery audits, procedures and policies. The full extent of damage to telecommunications infrastructure in Manhattan is still not known. Underground installations will systematically need to be assessed, repaired, redesigned, replaced and re-routed as the clean up and reconstruction continues at least until 2004. The immediate impact of cost on communications infrastructure was 1.7 billion dollars and the long term impact is estimated to be 6 billion dollars.”

The US policy response was that the US responded quickly to support economic activity by cutting interest rates. The Scottish Executive Publications reports “ Large amounts of liquidity were injected into the monetary system following the WTC attacks by the major monetary authorities across the G7 economies in order to ensure that the global financial system continued to function smoothly. The impact of this easing of policy will not be immediate: there is a broad view that there is a 6 to 9 month lag operating in the US between monetary easing and the subsequent impacts on the real economy. This cut has now been followed by a further half point reduction on October 3rd, taking rates to 2.5 percent, their lowest for almost 40 years. Moreover, the consensus appears to be that further cuts will be seen this year, possibly taking rates down to 2 percent.”

The Fiscal policy was also eased significantly in the immediate aftermath of the attacks. Business Week reported that “ The US Congress rapidly approved a $20 billion announcement by the President, and then promised a further $20 billion for the restoration work. In addition, the Administration announced another set of support measures with a $15 billion rescue package for airlines, including $5 billion in direct grants to cover immediate losses, and $10 billion in loan guarantees. These latter guarantees necessarily imply a potentially huge contingent liability and not without their critics. Additional spending on defense expenditure is suggested to be of the order of $18 billion this year, and a massive $60 billion next year.” Business Week continues to write that “ Altogether, this represents a very major fiscal stimulus, primarily resulting from the decision to effect a military response and the recovery/restoration work, together with the perceived desirability of immediate action in support of some specific sectors. It does equally provide a major economic stimulus at a time of very fragile confidence and the threat of a significant slowdown in activity.” The key issue determinant in the US is likely to be the short and medium trend in business and, particularly, consumer confidence, and it will take time before this can be assessed properly.

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