Iraq and the US economy: ills feeding off each other
By Joseph E. Stiglitz / April 11, 2008
Some say there are two issues in the coming American elections: the Iraq war and the economy. On days when the war seems to be going better than expected, and the economy worse, the economy eclipses the war; but neither is faring well. In some sense, there is only one issue, and that is the war, which has exacerbated America’s economic problems. And when the world’s largest economy is sick – and it is now very sick – the entire world suffers.
It used to be thought that wars were good for the economy. After all, World War II is widely thought to have helped lift the global economy out of the Great Depression. But, at least since John Maynard Keynes, we know how to stimulate the economy more effectively, and in ways that increase long-term productivity and enhance living standards.
The Iraq war, in particular, has not been good for the United States’ economy, for three reasons. First, it has contributed to rising oil prices. When the US went to war, oil cost less than $25 a barrel and futures markets expected it to remain there for a decade. Futures traders knew about the growth of China and other emerging markets; but they expected supply – mainly from low-cost Middle East providers – to increase in tandem with demand.
The war changed that equation. Higher oil prices mean that Americans (and Europeans and Japanese) are paying hundreds of millions of dollars to Middle East oil dictators and oil exporters elsewhere in the world rather than spending it at home.
Moreover, money spent on the Iraq war does not stimulate the economy today as much as money spent at home on roads, hospitals, or schools, and it doesn’t contribute as much to long-term growth. Economists talk about “bang for the buck” – how much economic stimulus is provided by each dollar of spending. It’s hard to imagine less bang than from bucks spent on a Nepalese contractor working in Iraq.
With so many dollars going abroad, the American economy should have been in a much weaker shape than it appeared. But, much as the Bush administration tried to hide the true costs of the war by incomplete and misleading accounting, the economy’s flaws were covered up by a flood of liquidity from the Federal Reserve and by lax financial regulation.
So much money was pumped into the economy and so lax were regulators that one leading American bank advertised its loans with the slogan “qualified at birth” – a clear indication that there were, in effect, no credit standards. In a sense, the strategy worked: a housing bubble fed a consumption boom, as savings rates plummeted to zero. The economic weaknesses were simply being postponed to some future date. The Bush administration hoped that the day of reckoning would come after November 2008. Instead, things began to unravel in August 2007.
[Joseph E. Stiglitz, a professor of economics at Columbia University, received the Nobel Prize in economics in 2001. His most recent book, co-authored with Linda Bilmes, is “The Three Trillion Dollar War: The True Costs of the Iraq Conflict.”]