Free Term Paper on War and the Economy

War and the EconomyThe link between war and the economy is an ancient one. More than 2,000 years ago, Cicero observed, “Nervo belli, pecuniam infinitam”—the sinews of war are money in abundance (Cicero 2003)—and war has often been viewed as an avenue to economic prosperity. A leading economic history textbook has a chapter entitled “The ‘Prosperity’ of Wartime” (Hughes and Cain 2010), and World War II has become the standard explanation for the end of the Great Depression: “It has long been an article of faith that the Second World War brought an end to the long depression of the thirties” (Smiley 1994). In his Pulitzer Prize–winning history of the era, David M. Kennedy notes that “the war compelled government spending on an unexampled scale, capital was unshackled, and the economy energized.” He concludes: “Ordinary Americans . . . had never had it so good” (Kennedy 1999). In the run-up the to the U.S. invasion of Iraq in 2003, Senator Robert Byrd accused President George W. Bush of using the war as a means of addressing “weaknesses in the economy [and] jobs that are being lost” (Nyden 2002).

Despite the unambiguous tone of these observations, opinions on war’s impact on the economy are hardly unanimous. The great Austrian economist Ludwig von Mises attacked the very notion of wartime prosperity: “War prosperity is like the prosperity that an earthquake or a plague brings” (Higgs 1992). While economists, historians, and politicians debate the point, generals seem less divided. Douglas MacArthur emphasized war’s “utter destruction,” and William Tecumseh Sherman famously said of war that “it is all hell” (MacArthur 1951). Tellingly, neither emphasized war’s prosperity.

What is the supposed link between war and economic prosperity? How might a war lead to prosperity? Why did Mises equate wartime prosperity with that of a natural disaster?

Outline

I. Grasping the Problem

II. What Is War Prosperity?

III. Is War a Human-Made Disaster?

IV. Measuring Wartime Prosperity

V. Winners and Losers

Grasping the Problem

Calculating the cost of war presents economists and historians with a challenge. There are the direct costs—largely government expenditures on material, which are easy enough to track—and there are also indirect costs, which, although just as important in an economic sense, are less easily quantified. Take, for example, the lost economic production that results from a war-related death. We do not know exactly how much output the dead individual would have contributed to the economy over the course of his or her life; neither do we know exactly what the present market value of that worker’s future output would be. After all, the value of a dollar today is not the same as the value of a dollar 10 or 20 years from now. However, because the fact that a topic is difficult does not mean we should avoid it. Economists regularly estimate the future productivity of individuals—for example, those injured or killed in automobile accidents—and they calculate the value today of future income streams, which also happens to be the foundation of the thriving business in annuities. If one applies these techniques to the estimation of the direct and indirect costs of war, some interesting figures emerge.

For example, during the Civil War, the United States government directly spent $1.8 billion, while the Confederate states spent $1.0 billion (in 1860 dollars). Estimates of the indirect costs of the war are in the neighborhood of $1.6 billion for the United States and $2.3 billion for the Confederacy (Goldin 1973). Thus, the combined costs of the war were $6.7 billion ($3.4 billion for the North and $3.3 billion in the South). With a total U.S. population of roughly 35 million, it follows that the war cost about $50 per person per year, during its four years.

To put these figures into perspective, consider that the cost of purchasing the freedom of the entire slave stock in 1860 would have been $2.7 billion, or about 40 percent of the war’s actual cost. Financed by the issue of 30-year U.S. treasury bonds at 6 percent interest, this option would have cost the northern population $9.66 in taxes per person per year. Indeed, depending on which groups were taxed to pay off the bonds, the payments would have been considerably less than this. Given that annual income per person at the time was around $200 dollars, the tax rate would have been less than 5 percent—a fraction of the current average federal income tax rate today. Perhaps somewhat paradoxically, these figures seem to confirm Ulysses S. Grant’s observation that “There never was a time when, in my opinion, some way could not be found to prevent the drawing of the sword” (West Point Graduates against the War n.d.).

Of course, calculations such as these distort the fact that the fundamental economic condition of war is not its average cost or benefit but rather its distributional effect, or, as one economic historian put it: “The economic benefits of the Civil War were bestowed upon those who were able to take advantage of the changes it generated [not the least of whom were the emancipated slaves], while its costs were most heavily born by those who suffered and died on its fields of glory” (Craig 1996).

What Is War Prosperity?

The standard economic indicator for the performance of any economy is gross domestic product (GDP)—“the total value of all final goods and services produced for the marketplace during a given year within a nation’s borders” (Lieberman and Hall 2005). It follows from this definition that GDP is the sum of various types of expenditures on goods and services, including private personal consumption expenditures, investment, expenditures on exports minus those on imports, and government expenditures. In any economy at any point in time, it is possible—perhaps even likely—that there are some productive resources (e.g., land, labor, or capital) that are unemployed or at least underemployed. As war approaches or is unleashed, governments employ their coercive powers to facilitate military operations. Men are conscripted to fight, capital is directed toward the production of war materiel, and so forth. Thus, government expenditures tend to increase, sometimes dramatically, during wartime, and since those expenditures are mathematically a component of the GDP, it typically increases during war.

To see this phenomenon in practice, consider Figure 1. It shows an index of real (i.e., inflation-adjusted) GDP for the U.S. economy before, during, and after U.S. involvement in three wars: World War II (1941–1945), the Korean War (1950–1953), and the recent and ongoing wars in the Middle East. Using the year before the United States entered each war as the base year, in which GDP = 100, the figure illustrates how the economy expanded during the war years and how it leveled off as the war ended. Clearly, from this indicator, one would be justified in referring to the prosperity associated with these wars.

Figure 1. Wartime Prosperity: Economic Output (Real GDP): Before, During, and After World War II, the Korean War, and the Wars in the Middle East

War and Economy Figure 1

If government spending during wartime leads to prosperity, then shouldn’t government spending during peacetime lead to prosperity? In other words, why isn’t more government spending always a good thing? To answer these questions, we must consider where the government obtains the money it spends during wartime or peacetime. Governments obtain funds from three sources. They can raise the money via taxation; they can borrow the money, which is just future taxation; and they can print more money, which just leads to inflation and is a form of taxation. (Since printing money depreciates the value of money, inflation is a form of taxation on those holding money.) So, in the end, all government spending is financed one way or the other through taxation. Typically, governments turn to some combination of all three revenue sources, especially during wartime.

Once we recognize that government spending is just taxation, then we can see why it does not in general lead to prosperity. If governments fight wars with tax dollars, and if they obtain the tax dollars from consumers, then it follows that a dollar of taxation going to government spending and increasing GDP will simply be taken from a dollar of private personal consumer spending, which would in turn decrease GDP.

It does not always work like this, dollar for dollar, for at least two reasons. First, with respect to borrowing, recall that GDP represents the value of current expenditures. Government borrowing is future taxation, and the decrease in consumer spending might not show up immediately. Thus, GDP goes up today and is reduced at some time in the future. This is just robbing Peter tomorrow to pay Paul today. As a general policy, government borrowing might or might not be good for the economy—depending on how the borrowed funds are expended—but the exigencies of war are such that governments often do not worry about the future consequences of borrowing.

Second, war changes the economy in other ways that would offset the decrease in consumption resulting from taxation. For example, one of the most common forms of taxation during war is the conscription or drafting of soldiers who pay the tax with their labor. Historically, soldiers were not paid a market wage, which is why conscription is a regular companion of war. The difference between what conscripted soldiers are paid and what they would have to be paid in order to get them to volunteer represents a measure of the soldiers’ tax burden. When a soldier goes to war, he (historically, conscripts tend to be men) leaves the civilian labor force, which tends to reduce his family’s consumption, but often women (and children and the elderly), who might otherwise have been employed in nonmarket pursuits, replace men in the labor force. Th us, economic activity, as measured in GDP, would now include the government spending on the soldier and the consumption generated by the women who replaced soldiers in the labor force. Rosie the Riveter, of World War II fame, is the classic example of this phenomenon. Since Rosie’s prewar nonmarket activity in the household was not counted as a component of GDP— riveting is; preparing dinner, changing diapers, and cleaning the house are not—when her work is added to the government’s increased wartime spending, GDP increases, just as it did during World War II.

This, then, is wartime prosperity. Unemployed or underemployed resources, or resources formerly employed in nonmarket activity, are put to work by government’s wartime spending—usually spurred by increased borrowing—as companies obtain government contracts and individuals who formerly did not contribute to GDP now do so (like Rosie the Riveter); and many who did contribute to GDP in the private sector are now contributing in the government sector, albeit as conscripted soldiers. Prosperity, at least as measured by GDP, follows. Why, then, have some of the leading figures in economics and economic history questioned the concept of wartime prosperity?

Is War a Human-Made Disaster?

The comparison of war to a natural disaster is common, because both seem to create prosperity. It is not uncommon for certain types of economic activity to pick up following a natural disaster. For example, in the wake of a hurricane, roofing contractors expect to see an increase in the demand for their services, as they are called upon to repair damage to homes resulting from falling trees. Indeed, consider the whole series of related economic activities. A tree service might be called to remove the tree, the family might stay in a hotel until the roof is repaired, painters might repair internal water damage, and so forth. None of these particular expenditures would have been made by the family in the absence of the hurricane. Multiplying these and other costs incurred from damage by the number of households affected by the hurricane would yield an aggregate measure of the value of services rendered following the storm. Thus, one might conclude that the storm itself yielded the resulting prosperity.

The fundamental problem with this observation is that it assumes that the families would have neither spent nor saved the monies they expended as a direct result of the storm. Perhaps they would have purchased a new automobile, a purchase that will now be postponed. Perhaps they would have stayed in a hotel on vacation, a trip that will now be canceled. In these cases, all the hurricane did was redirect the families’ spending from something they had planned or hoped to purchase (i.e., a new car or a vacation) to something they would not have wanted in the absence of the storm (i.e., a new roof and a stay at the hotel down the road).

What if a family had merely taken money out of the bank to pay for the new roof and hotel visit—money that they were, in fact, saving for a rainy day? They could still purchase the car and vacation with other funds. Would these monies not be better spent on a new roof than just sitting in the bank? The answer is no, because the bank does not just sit on the money that is deposited there; it turns around and loans that money for productive economic activity. If people take loanable funds out of banks to pay for new roofs that they would not have needed in the absence of a hurricane—that is, if they reduce the supply of loanable funds—then the banks increase their interest rates in order to induce other people to make new deposits. This increase in interest rates in turn reduces the number of loans taken.

Why not just borrow the money from the bank? Because as people borrow money to repair the storm damage, they increase the demand for loanable funds, which in turn increases interest rates and reduces the number of loans taken. Thus, as a result of the hurricane, economic activity is redirected—from new cars and vacations to new roofs— and less economic activity occurs as upward pressure is placed on interest rates. Neither of these effects is good for the economy.

War has the same two negative effects on the economy. The opportunity cost of war is never zero. A dollar spent on a weapon, a shell, or a uniform is a dollar extracted through taxation or borrowed, which again is merely future taxation, and therefore not spent on some other activity. If consumers were better off purchasing a shell rather than an automobile, they would demand shells during peacetime rather than cars or houses or education for their children. So the forced substitution of war production for private consumption cannot be understood generally as making people better off.

As for borrowing, recall that one of the most common of war’s effects on the economy is an increase in the demand for credit, as countries borrow to finance the construction of their war machines. This increases the demand for credit, which increases interest rates, which tends to drive down or crowd out private investment. So we again see governments’ wartime expenditures simply replacing private expenditures. Since people generally prefer to borrow money for a home, automobile, or education rather than a plane that might get shot down over enemy territory, it is difficult to argue that the increase in government spending improves people’s financial situations.

As for printing money and generating inflation to finance the war, if this were good for the economy (and it is not), then we would expect to see governments doing this during peacetime as well. Although in recent decades there has been some peacetime high inflation, it is not perceived to be a positive factor for the economy, and anything more than a little inflation is generally greeted unfavorably by lenders and consumers (and voters; woe to the president running for reelection during periods of rampant inflation, such as Jimmy Carter).

Of course, war, just like a natural disaster, redirects economic activity. Suppliers of weapons and uniforms will see an increase in the demand for their products relative to other goods and services—just as roofers see an increase in the demand for their services after hurricanes. Those who see their taxes increase, now and in the future, are among the groups whose resources are directed toward military suppliers, but the group most likely to bear a disproportionate share of the tax burden is the soldiers who pay with their labor, especially those who ultimately pay with their lives. The death of soldier is a tragedy to his or her family. For the economy, it represents the loss of all of his or her future economic output.

What does this tell us about the persistent metaphor of wartime prosperity? The main thing is that the manner in which standard economic measures of well-being, such as GDP, are constructed biases them upward during wartime. The substitution of market for nonmarket activity increases GDP, but it does not mean people are necessarily better off . In addition, the substitution of spending today in return for consumption tomorrow might be good public policy, but it should not be confused with prosperity in any conventional sense of the word.

Measuring Wartime Prosperity

Are people better off economically as a result of wars? How do we calculate economic well-being? The great Scottish philosopher and economist Adam Smith had an answer. According to Smith, “Consumption is the sole end and purpose of all production” (Smith 1976). Typically, personal consumption expenditures are the largest component of a country’s total economic output, as measured by gross domestic product. So, looking at what happens to consumption expenditures during wartime is a good place to begin in answering questions about the link between wars and economic prosperity.

Table 1 contains an index of personal consumption expenditures, adjusted for inflation, between 1939 and 1945—the years coinciding with World War II (although the United States did not formally enter the war until after the attack on Pearl Harbor in December 1941, war production had begun to accelerate in 1939). The figures in column 1 are based on U.S. Commerce Department data and show a 23.4 percent increase during the war. This would correspond with an average annual compounded rate of growth of 3.6 percent, which was quite robust at the time, considering that, during the previous decade, the country had weathered the Great Depression. When comparing the war years to the Great Depression, it is not surprising that many U.S. citizens remembered the war as an era of economic prosperity, at least those citizens who were not in Bastogne or on Guadalcanal.

TABLE 1. Estimates of Real Personal Consumption Expenditures (1939–1945)

Year Base Measure Inflation-Adjusted
1939 100.0 100.0
1940 104.6 104.2
1941 110.5 108.7
1942 109.8 104.2
1943 112.4 101.9
1944 115.9 102.0
1945 123.4 106.8

However, the measurement of consumption expenditures is not without controversy. For one thing, there was tremendous inflation during the war—inflation that was accompanied by government-mandated price controls. Thus, the official prices used to adjust for this inflation do not necessarily account for the true inflation rate as reflected in, for example, black-market or illegal prices. The figures in column 2 of the table, which adjust personal consumption expenditures during the war, were calculated using an alternative set of inflation-adjusted prices. Here we see that consumption increased by only 6.8 percent over the course of the war, a rate of growth that did not even keep up with population growth. Thus, during the so-called wartime prosperity, real average consumption per person actually fell. This is not what one typically associates with prosperity. As is often the case in economics, the devil is in the details, and the details are in the numbers.

Winners and Losers

From the discussion above, it appears that rather than enriching an economy, war simply changes it, and the changes are a function of the size of the war relative to the size of the economy. At the peak of government military spending during World War II, in 1944, national defense spending was 41 percent of GDP. Currently, with two campaigns active in the Middle East, the defense share is 8 percent of GDP. This explains the more dramatic curvature of the World War II data relative to the Middle East wars shown in Figure 1.

But, holding other things constant, the key to understanding the impact of war on the economy is appreciating that war represents a net transfer of resources from taxpayers (including soldiers) to suppliers of war materiel (companies), and from borrowers (again, future taxpayers) to holders of savings (buyers of government bonds). Of course, in war, other things are not constant. In particular, the discussion to this point has said nothing about winners and losers. The destruction wrought by war can nearly completely devastate an area. After the destruction of Carthage in 146 B.C., the Romans supposedly sowed salt in the earth so that the Carthaginians would never rise again. Byzantium never recovered from the Fourth Crusade. Hiroshima was turned into ash. Neither the Carthaginians nor the Byzantines nor the Japanese spoke of wartime prosperity.

There is one way in which the economy can emerge a winner from war. This is if war is engaged in to remove a threat to the country and make the economy more secure. Households and businesses will be more reluctant to make important and needed investments in the economy if they fear the country will not exist, or at least will be severely damaged, in the future. In this case, a war to remove the threat and increase the likelihood of a peaceful future can ultimately improve long-term economic prosperity. The cold war’s triumph of capitalism over communism offers a good recent example of this type of benefit, perhaps justifying, in economic terms at least, the war’s tremendous cost in lives and treasure.

Ultimately, however, war is more than an economic activity. Clemenceau’s admonition that war is too important to be left to generals applies here; it is too important to be left to economists as well. For those who see war as the alternative to annihilation, a blip in real GDP in one direction or the other is of little importance. Winning at almost any cost is what matters. Ask the Carthaginians.

 

Lee A. Craig

 

Bibliography:

  1. Atack, Jeremy, and Peter Passell, A New Economic View of American History, 2d ed. New York: W. W. Norton, 1994.
  2. Cicero (Marcus Tullius), The Fifth Philippic. Cambridge, England: Cambridge University Press, 2003.
  3. Craig, Lee A., “Industry, Agriculture, and the Economy during the Civil War.” In The American Civil War: A Handbook of Literature and Research, ed. Steven E. Woodworth. Westport, CT: Greenwood Press, 1996.
  4. Goldin, Claudia, “The Economics of Emancipation.” Journal of Economic History 33 (1973): 66–85.
  5. Goldin, Claudia, and Frank D. Lewis, “The Economic Cost of the American Civil War: Estimates and Implications.” Journal of Economic History 35 (1975): 304–309.
  6. Higgs, Robert, “Wartime Prosperity? A Reassessment of the U.S Economy in the 1940s.” Journal of Economic History 52 (1992): 41–60.
  7. Hughes, Jonathan, and Louis P. Cain, American Economic History, 8th ed. Upper Saddle River, NJ: Prentice Hall, 2010.
  8. Kennedy, David M., Freedom from Fear: The American People in Depression and War, 1929–1945. New York: Oxford University Press, 1999.
  9. Lewis, Lloyd, Sherman: Fighting Prophet. Lincoln: University of Nebraska Press, 1993 [1932].
  10. Lieberman, Marc, and Robert E. Hall, Introduction to Economics, 2d ed. Mason, OH: South- Western, 2005.
  11. MacArthur, Douglas, Farewell Address to Congress. 1951. http://www.americanrhetoric.com/speeches/douglasmacarthurfarewelladdress.htm
  12. Nyden, Paul J., “Bush’s War Plans Are a Cover-up, Senator Byrd Says.” Charleston Gazette (September 21, 2002). http://www.dupagepeacethroughjustice.org/byrd.html
  13. Smiley, Gene, The American Economy in the Twentieth Century. Cincinnati: South-Western, 1994. Smith, Adam, An Inquiry into the Nature and Causes of the Wealth of Nations, Vol. 2. Indianapolis: Liberty Classics, 1976 [1776].