Potential Economic Implications of the US’s Involvement in Iraq

President Barack Obama won office and re-election partly because of his commitment to ending American military involvement in Iraq and Afghanistan, two drawn out conflicts that have been widely criticized since the Bush administration. Times have changed since then, with crises on multiple fronts across the world and the rising threat of the Islamic State of Iraq and Syria (ISIS) threatening to bring the United States back into the fray. Tension has been building since early June when ISIS, a Sunni militant group, initiated a major offensive in Northern Iraq against the Iraqi government. With the Iraqis losing control, the United States sent military advisors to the Middle East and launched an airstrike campaign against ISIS targets following the execution of journalist James Foley in August. The execution of a second American, Steven Sotloff, further increased pressure on President Obama to take action.

In a press conference last week, President Obama stated that the current objective is to “degrade and destroy ISIL so that it’s no longer a threat, not just to Iraq but also [to the] region and to the United States.” This statement suggests that future strategy will extend beyond simply protecting American interests in Iraq. A direct assault against ISIS would more than likely require American intervention in Syria, which the president has been reluctant to do given the complexity of its current civil war. Eliminating ISIS will also be near impossible to do, a task that draws parallels to years of fighting against Al-Qaeda. Although he admitted that he had not yet formulated a strategy for combating ISIS, the president remained determined to first gather support from allies and was adamant against sending in ground forces.

The perspective that the United States must take additional action to protect its interests abroad and to stop the expansion of the ISIS terrorist threat is certainly logical. The vocal opponents against such a move have cited the mistakes made during the 2003 invasion of Iraq. In addition to the social and political costs of war, there are also economic implications that accompany them. It is widely believed by the general public that war generates positive outcomes for the economy as a result of increased military spending. Through analyzing several major wars of the past century, we can attempt to generalize the macroeconomic effects of war.

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There are several indicators to consider when analyzing macroeconomic changes. These include gross domestic product (GDP), the debt level, changes in inflation, spending as a percentage of GDP, and income distribution. The belief that military spending can generate jobs, spur growth, and lead to technological innovation is true to an extent. These effects can also lead to positive benefits in other industries. However, we must also consider any unintended effects as a result of military spending, as well as how long these benefits last.

A primary example of a war which led to both positive and adverse effects is World War II, which had a major role in guiding the United States out of the Great Depression. During the years of the war, from 1941 to 1945, the US economy experienced a significant period of short-term growth driven by government spending. Despite the sudden increase in GDP and reduction in the unemployment rate, investment and consumption levels did not increase. Instead, by the end of the period, per capita consumption was lower than it was in 1941. This phenomenon can be explained because of rationing, where resources and production went towards the war effort rather than towards household goods. This is one unintended consequence of military spending. While the economy experienced short-term, rapid growth, as well as additional jobs, it cannot be said that the standard of living for consumers increased. In the long run, GDP growth declined immediately following the war before falling back to the pre-war growth trend.

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The Vietnam War is an important case to analyze because it has several similarities to the conflict in Iraq. Support for the war quickly waned over the years as strategists could not determine how to defeat the guerrilla style of warfare employed by the Vietcong and the North Vietnamese. The US first sent military advisors to Vietnam in 1955 but did not deploy ground troops until a decade later, in 1965. Compared to World War II, the cost of the Vietnam War was less expensive in terms of percentage of GDP, reaching a peak of about 9 percent in 1968. Coinciding with spending on the effort in Vietnam were President Johnson’s Great Society programs, the most ambitious of which was the “War on Poverty.” As a result of higher expenditures, there was an increase in taxes from 1968 to 1970. Expansionary monetary policy combined with increased spending led to rising inflation in the 1970s. In addition, consumption fell because of rising unemployment and inflation caused by oil shocks in the Middle East. This ultimately led to the problem of stagflation, wherein prices rose but the economy did not grow.

So far we have established that despite short-term increases in output, these effects often do not last in the long run, and often yield adverse effects instead. Leading up to the wars in Iraq and Afghanistan, the US was recovering from a recession from 2001-2003. In order to finance these wars, increases in taxation were not implemented. Instead, most of the financing came from borrowing. The increase in the debt level combined with the Bush tax cuts caused serious constraints to be placed on the US economy. Although there were high expenditures, lack of economic growth mitigated the rise of inflation. A sharp increase in oil prices also led to lower domestic demand while increasing inflation pressures abroad. With a weak economy and large budget deficit, policymakers were unable to use fiscal policy effectively to stimulate activity and drive demand. Pressure to stimulate growth was placed on the Federal Reserve, which found that monetary policy could not completely solve the problems at hand. In fact, low interest rates, high liquidity, and lack of effective banking regulations led to the growing housing bubble. In this case, not only did the wars in Iraq and Afghanistan fail to stimulate the economy, the U.S. found itself in a worse situation than it did before, ultimately leading to the 2008 financial crisis.

The total cost of the Iraq War is estimated to be over $1.7 trillion not including the benefits owed to war veterans. Even Americans who support the current campaign in Iraq fear another long-term struggle that will be difficult to overcome. Right now, the estimated cost of involvement in Iraq is $7.5 million per day, compared to $240 million during Operation Iraqi Freedom and total spending since mid-June is over $560 million. According to White House officials, spending increased as the conflict escalated and continued to rise when the US began airstrikes against ISIS targets. With the US economy experiencing limited growth today and with the Department of Defense having already cut its spending, there is concern over how the government will finance further military involvement. The main financing methods include increases in taxes, reduction in non-military expenditures, government borrowing, and money creation, all of which have drawn criticism in the past. We are unlikely to see any significant increase in taxes because President Obama has fought for lower taxes for the middle-class since he was elected. Simply increasing taxes for higher income families will also not generate a significant amount of revenue. With the Federal Reserve winding down its asset purchasing program, we also will not be seeing any type of monetary stimulus. Congress is also reluctant to approve additional funding that would add to the federal deficit.

A major concern regarding the conflict in Iraq is the price of oil. The Middle East is one of the world’s largest oil producers with Iraq producing over 3.3 million barrels a day alone. Shocks to supply can drive up prices rapidly. Although it is unlikely for such a severe shock to occur in this case, a significant increase in oil prices would have several effects on the overall economy. When oil prices increase, we often expect increases in gasoline prices as well. As seen in the graph below, oil and gasoline prices follow a similar pattern. Higher gasoline prices mean that households must spend a larger share of income to refuel their vehicles, leaving less to spend on other goods and services. In addition, costs increase for businesses and as they increase their prices, other items become more expensive. In terms of the macroeconomy, high oil prices are often believed to lead to inflation and stagnated growth because of indirect effects on a variety of industries. As costs increase, the ability to produce other goods decreases. Demand for these goods may fall as wealth decreases. Furthermore, uncertainty about the future may prolong these effects as consumers reduce spending.

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Despite the rise in turmoil in Iraq, fears of an energy crisis may be premature at this stage. Oil prices are largely driven by speculation and may have been driven up as a result of uncertainty. Investors often move towards the yen and the Swiss franc during times of financial turmoil. However, both currencies have held relatively stable. In the case of an oil supply shock, investors will likely move towards those safe-haven currencies as well as the dollar. This benefits oil importers such as the U.S. and Japan while a sustained rise in oil prices would benefit oil exporters. As of now, production is not significantly impacted with the majority of conflict occurring in the northern part of the country, away from major oil fields.

With President Obama still unsure of a definite strategy in Iraq, it is likely that American involvement will be limited to airstrikes until he gains the support of international allies and the approval of Congress to take further action. In terms of economic ramifications, the cost of the current campaign is trivial compared to that of the Iraq War. This time around, it seems that the president is being more cautious and deliberate in his approach to the conflict. The worst scenario would be to send in ground forces prematurely and find ourselves mired once again in a long-term, unwinnable conflict.