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Iraq: The Economic Consequences of War

This parallel, moreover, is optimistic, even simplistic, for the Marshall Plan was introduced after the countries of Western Europe had undertaken much of their reconstruction efforts on their own, and European countries had most of the infrastructure of democracy and civil society in place before the war. Recognizing that nation-building in Iraq begins with much less social capital and civic infrastructure, we might conservatively expect that the effort would require six rather than four years of effort at the expenditure rate of the Marshall Plan, for a total of $75 billion.

The estimates for both reconstruction and nation-building, therefore, are substantial, from a minimum $25 billion for reconstruction to as much as $100 billion.

Humanitarian assistance will be necessary to care for the refugees, the wounded and ill in Iraq, and possibly those in neighboring countries. Estimates of the costs of humanitarian assistance are uncertain because they involve knowing the population at risk, the level of need after the war, and the duration of the assistance. Figures from the Balkans in the 1990s indicate that humanitarian assistance could well cost approximately $500 per person per year.8

A plausible estimate would be that between one and five million residents of Iraq (out of a total population of around 24 million) would require assistance in the postwar environment. If the time required for assistance was between one and four years, then the total cost of humanitarian assistance would range from $1 billion to $10 billion.

Who will pay for all these efforts? One possible source of funds is Iraqioil revenues. If Iraq could rebuild its production back to three million barrels per day, this would yield around $25 billion per year at prevailing oil prices. However, there are many claims on these resources. To begin with, these revenues amount to only $1,000 per capita in today’s Iraq, and much of these funds will be required for imports of food, medicines, and other necessities of daily life. Some revenues would be needed to finance the rebuilding and upgrading of Iraq’s economic infrastructure. Additionally, total claims by other nations against Iraq after the 1991 war were over $300 billion, of which little has been paid or written off. To divert funds from vital necessities to pay the expenses of the US occupation forces would be economic and political folly.

Will other countries come forward to pay the bills, as they did after the first Persian Gulf War? Probably not. If the war is undertaken without UN sanction or broad international support, the US could be forced to pay most of the costs.

Will the US actually undertake the extensive effort required to rebuild and democratize Iraq? In virtually every country where the US intervened militarily over the last four decades, it has followed a “hit and run” philosophy by which bombing runs have seldom been followed by construction crews. The latest war in Afghanistan is a striking example. In the year ending September 2002, the US spent $13 billion on the war effort. By contrast, the total Pentagon effort committed to civil works or humanitarian aid has totaled only $10 million.

The disproportion between military destruction and civilian construction in Afghanistan and elsewhere does not augur well for an ambitious rebuilding effort in Iraq. Is it plausible that Congress will appropriate funds for such a large civilian effort when the US today spends only $15 billion annually on foreign aid for the entire world? An ambitious nation-building plan that leaves Iraq half-built seems the most realistic prospect.

3.

War in the Persian Gulf might produce a major upheaval in petroleum markets, either because of physical damage or because political events lead oil producers to restrict production after the war.

A particularly worrisome outcome would be a wholesale destruction of oil facilities in Iraq, and possibly in Kuwait, Iran, and Saudi Arabia. In the first Persian Gulf War, Iraq destroyed much of Kuwait’s oil wells and other petroleum infrastructure as it withdrew. The sabotage shut down Kuwaiti oil production for close to a year, and prewar levels of oil production were not reached until 1993—nearly two years after the end of the war in February 1991.

Unless the Iraqi leadership is caught completely off-guard in a new war, Iraq’s forces would probably be able to destroy Iraq’s oil production facilities. The strategic rationale for such destruction is unclear in peacetime, but such an act of self-immolation cannot be ruled out in wartime. Contamination of oil facilities in the Gulf region by biological or chemical means would pose even greater threats to oil markets.

Yet another possibility is a concerted reduction in oil production by OPEC countries. This might occur by means of a boycott against the US, such as the one that followed the 1973 Arab–Israeli war; it might also occur if control of a substantial part of OPEC’s oil resources fell under the control of anti-Western elements.

The Brookings Institution economist George Perry recently investigated the economic impacts of disruptions of world oil supplies.9 He analyzed a bad case, a worse case, and a worst case. Although his study referred to terrorism, the underlying economic analysis applies equally well to any kind of reduction in supply.

Perry’s worst case represents a plausible bad outcome of a prolonged war in Iraq. This outcome assumes a decline in world oil production of seven million barrels per day, partially offset by a supply of 2 1/2 million barrels per day drawn from US strategic oil reserves. Many combinations of events—arising from wartime destruction, terrorism, or political reaction of governments in the region—could lead to such an outcome. Concrete examples would be the destruction of most of Iraq’s oil-production capacity along with one quarter of the productive capacity of other Gulf states. Another possible scenario would involve an OPEC boycott of the US and other countries that cut oil production by 25 percent. The use of a boycott is economically plausible in oil markets because producer profits go up rather than down with lower production.

The impacts of such a decline in production would involve sharp increases in oil prices, high inflation, and major transfers of wealth from oil consumers to oil producers. In his worse case, Perry projects a tripling of oil prices to around $75 per barrel, with gasoline rising to almost $3 per gallon. The cost of imported oil imports would rise by $200 billion per year in the US, and the oil-price shock and inflationary impetus would probably set off a recession. To estimate the total costs, I have assumed that the curb on production lasts for one and a half years. Similar results can be derived from an economic model of oil markets using Perry’s estimated oil-price increase. These figures exclude impacts on the US business cycle, which are discussed below.

Strategists in the Bush administration may be betting on happy outcomes in oil markets. A decisive victory in Iraq, with no destruction of oil facilities and followed by political stability in the region, could lead to increases in oil-production capacity in Iraq; and this could put downward pressure on oil prices. The speed at which Iraq can increase its oil production should not be overestimated, however. A reasonable optimistic scenario would involve Iraq increasing its production capacity to around four million barrels per day within five years after a war. Under plausible assumptions about the effects on the supply of oil from other regions, this would lead to a decline of slightly under $1 per barrel over the next decade. Using a baseline forecast of $25 a barrel, this would lead to a decrease in the cost of US oil imports of $30 billion over the next decade.

A final economic concern is the impact of the war on overall economic activity. In the past, major wars, fueling large increases in defense spending, produced economic booms. In World War II, for example, defense outlays rose by almost 10 percent of the total GDP before Pearl Harbor, and this boosted the economy out of the doldrums of the Great Depression. Similar but smaller military buildups accompanied economic expansions dur- ing the Korean and Vietnam Wars.

By contrast, the first Persian Gulf War saw defense spending increase by only 0.3 percent of GDP. The Iraqi invasion of Kuwait produced an adverse psychological reaction in stock prices and consumer sentiment. These factors depressed consumer spending, particularly on consumer durables, and reduced business investment—while defense spending did not fill the gap. The result, unique in wartime in recent American history, was a sharp recession beginning the month after the Iraqi invasion of Kuwait.

The direct military cost of a second Persian Gulf War is likely to be relatively small, which suggests that the macroeconomic impact will be largely driven by psychological factors. A repetition of the 1990–1991 downturn is unlikely because markets have in part discounted the prospect of a war, or at least of a short war. Since summer 2002, stock prices have fallen 20 percent, the dollar has depreciated, and indexes of consumer sentiment are at their lowest level in almost a decade. In the case of a quick victory, the macroeconomic impact will probably be negligible.

If the war goes badly in the initial phases, the macroeconomic outcome could quickly turn sour. Imagine some combination of heavy casualties, protracted urban warfare, gory pictures on the nightly news, widespread foreign denunciations of American policy, rumors of, or actual use of, chemical or biological weapons, or major terrorist actions at home or abroad. Even without any oil-price shock, the economic reactions might resemble the economic decline following the 1990–1991 war or the sharp drop in economic activity following September 11. A plausible outcome would be an average recession set off by a protracted conflict, with output losses in the range of 2 to 5 percent of GDP ($200 billion to $500 billion in today’s dollars). To put the matter concretely, I assume that a protracted war would lead to a recession equivalent to that following the first Persian Gulf War.

4.

We can now collect the different estimates of the cost of the war. It should be emphasized that these estimates vary in precision and in empirical evidence supporting them. Indeed, aside from the projections of direct military costs, all of the estimates should be regarded as informed conjecture. Moreover, these costs do not attempt to estimate the benefits of resorting to arms. Since avoiding future destructive acts by Iraq is the major articulated reason for undertaking war in the coming months, we cannot truly balance the costs and benefits of war without considering any re-duction in risk that would derive from disarmament and regime change in Iraq.

Table 1 shows a summary compilation of the different quantifiable elements. The favorable case in the first column of numbers would entail relatively modest economic costs, on the order of $120 billion. (These are the total costs over the next decade.) This outcome assumes that the military, diplomatic, and nation-building campaigns are successful.

The unfavorable case is a collage of potential unfavorable outcomes rather than a single scenario. It shows the array of costs that might be incurred if the war drags on, occupation is lengthy, nation-building is costly, the war destroys a large part of Iraq’s oil infrastructure, and there are both lingering military and political resistance to US occupation, and major adverse psychological reactions to the conflict. Putting the different adverse effects together adds up to $1.6 trillion, most of which come outside of the direct military costs.

This discussion, however, vastly oversimplifies the analysis by constructing only two cases, whereas reality presents a dizzying variety of outcomes. Returning to the metaphor of war as a giant roll of the dice, we might say that the US could end up paying the “low” costs of around $120 billion if the dice come up favorably. If some dice come up unfavorably, the costs would lie between the low and the high cases. However, if the US has a string of bad luck or misjudgments during or after the war, the outcome, while less likely, could reach the $1.6 trillion of the upper estimate.

Even the upper estimate does not show the limit of fortune’s frowns. The projections I have described exclude any costs to other countries, omit the most extreme outcomes (such as chemical or biological warfare), and exclude Perry’s “worst” case in oil markets. Moreover, the quantified costs ignore both civilian and military casualties suffered by Iraqis and any tangible or intangible fallout that comes from worldwide reaction against perceived American disregard for the lives and property of others.

5.

It seems likely that Americans are underestimating the economic commitment involved in a war with Iraq. This is hardly new, for the record is littered with failed forecasts about the economic, political, and military outcomes of wars. The history of war is, as Barbara Tuchman entitled her wonderful book, the march of folly.10 Is America writing another chapter in the march of folly? It is impossible to know in advance, but historians may look back at several early warning signs of economic and political miscalculations.

The first concern is that the Bush administration has made no serious public estimate of the costs of the coming war. The public and the Congress are unable to make informed judgments about the realistic costs and benefits of the upcoming conflict when none are given. Particularly worrisome is the promise of postwar occupation, reconstruction, and nation-building in Iraq. If American taxpayers decline to pay the bills, this would leave a mountain of rubble and mobs of angry people in Iraq and the region.

Closely related is a second syndrome, frequently found in past conflicts, of entering war prepared militarily but not economically. The finances of the nation have deteriorated sharply since George W. Bush took office. The annual federal budget has deteriorated by $360 billion from the spring of 2001 to the fall of 2002, and, even with a short war, budget deficits are likely to mount in coming years. The Bush administration has not prepared the public for the cost or the financing of what could prove to be an expensive venture. Perhaps the administration is fearful that a candid discussion of wartime economics will give ammunition to skeptics of the war; perhaps it worries that acknowledging the costs will endanger the large future tax cuts, which are the centerpiece of its domestic policy. Nonetheless, the price must be paid—by raising taxes, by cutting expenditures, or by forcing the Federal Reserve do the job by raising interest rates, thereby curbing investment and especially housing. One way or another, Americans will pay for the war.

Third, the predisposition of the United States under the Bush administration to undertake unilateral actions poses major risks. From a military point of view, attacking without a broad coalition of countries can make the conduct of the war more difficult and costly, and it may raise the hopes of the Iraqi leadership that others will come to their aid, thereby extending the conflict. From a political point of view, unilateral actions, particularly those taken without support from the Islamic world, risk inflaming moderates, emboldening radicals, and spawning terrorists in those countries. From a legal point of view, America’s insistence on the right to overturn foreign governments without the sanction of international law will undermine a wide variety of cooperative efforts on international finance, disarmament, the environment, nonproliferation, and anti- terrorism. From an economic point of view, unilateral actions imply that the costs will be largely borne by the United States.

Fourth, strategists may be deluding themselves on the reaction of the Islamic world and the Iraqi people to American intervention. A key uncertainty concerns the loyalty of Iraqi troops and the willingness of the Iraqi military commanders to undertake an urban defense of Baghdad. Furthermore, even though no major Arab government is solidly behind the United States, the administration appears to be persuaded that Muslims are waiting for the overthrow of Saddam to dance in the streets and that Americans will be welcomed in Baghdad as liberators rather than infidels. But major additional costs could result if opposition proves more formidable and admiration for America less widespread than the American administration believes.

Finally, one senses an obsession bordering on woodenheadedness in the Bush administration’s concentration on Iraq in general and on regime change in particular. In contrast to the clear danger from terrorist activities, there is no imminent threat from Iraq. The war in Iraq threatens to claim the scarce resources and attention of the United States for many years, distracting the country from other troubling spots, like North Korea, or from the Israeli–Palestinian conflict. The administration focuses on Iraq while slow growth, fiscal deficits, a crisis of corporate governance, and growing health care problems threaten the economy at home. The domestic economy and the rest of the world will take a back seat while the US is preoccupied with war in Iraq.

Notwithstanding all the warning signs, the administration marches ahead, heedless of the fiscal realities and undeterred by cautions from friends, allies, and foes.

—November 7, 2002

  1. 8

    Zarko Papic, “Normal Social Policy and International Humanitarian Assistance in Conflict Context,” Independent Bureau for Humanitarian Issues, Sarajevo, October 2000.

  2. 9

    George L. Perry, “The War on Terrorism, the World Oil Market and the US Economy,” October 24, 2001; available as Analysis Paper #7 at www .brook.edu/views/papers/perry/20011024.htm.

  3. 10

    Barbara Tuchman, The March of Folly: From Troy to Vietnam (Knopf, 1984).

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