War and the U.S. Economy

As it looks increasingly likely that the United States will begin using military force to bring about a regime change in Iraq sometime in the next 4-6 weeks, one can't help but speculate what this will mean for the economy back home. The economic forecasting firm Economy.com (their name is their website address) recently did just that. In a February newsletter, Brian Nottage, Director of Macroeconomics at Economy.com, set forth his firm's estimates. The bottom line: "war in the first quarter [2003] is likely to have a modest negative economic impact, but set the stage for better growth ahead."

In the past war has had a stimulating effect on economic activity. But, the conflicts in which the U.S. has been involved (including the 1991 Gulf War) have involved relatively few troops and little loss of equipment. Consequently, much of the estimated $50 billion out-of-pocket cost of war (impacting the federal budget) is re-stocking of ordinance and ammunition. The bigger cost is the opportunity cost of deploying thousands of reservists for a prolonged period overseas, away from their productive occupations back home.

But, the prospect of war is already costing the U.S. economy. Nottage estimates that the uncertainty over how the Iraq situation will be resolved cut GDP growth by at least half a percentage point since mid-2002, mostly because businesses have postponed investment spending.

A relatively quick end to the hostilities will benefit the economy not only by removing uncertainty, but also because oil prices are likely to fall. Nottage notes correctly that the current high price for oil (in excess of $40 per barrel) is not due to lack of current supply but instead reflects fears about future supplies. Saddam Hussein could torch the Iraqi oil fields like he did in Kuwait in 1991. Barring a recurrence of such a debacle, Economy.com believes that oil prices will rapidly fall to $25 per barrel by mid-2003.

Note that all of this assumes a rapid and successful prosecution of the war, and an assumption that if it happens, it will happen by early spring.