13 February 2006

Americans are coming to grips with the cost of war. A week ago the Bush administration released a fiscal blueprint that signalled its intent to ask Congress for $120bn in two separate "supplemental appropriations" to fund operations in Iraq and Afghanistan this on the heels of $323bn in such one-time appropriations since 2001. Simultaneously, George W.?Bush unveiled his fiscal 2007 budget, which featured a nearly 7 per cent rise in base defence spending, just over 3 per cent increases in homeland security areas and net cuts elsewhere in the annual funding cycle. In short, the paired requests highlighted the cost of defence funding by squeezing transportation, environmental protection, low-income programmes and the myriad other things Americans equate with government.

With a bit less fanfare, the administration also unveiled the results ofthe third Quadrennial Defence Review a congressionally mandated top-to-bottom review of US defence strategy, as well as the troops, tactics and equipment to execute it. A centrepiece finding is the need to prepare the military to fight a "long war" against terrorism or, put differently, to be ready to undertake Iraq-style actions as a regular diet. Accordingly, the distinction between base and supplemental funding is rapidly disappearing.

Even before these developments defence spending was on an upward track. The combination of increased pay for troops, procurement of newer versions of existing equipment and the costs of military "transformation" plans would raise real defence spending another 20 per cent above current levels and roughly 15 per cent above the cold war era peak. The latest news raises the likelihood of these demands.

Some would argue that even this understates the price tag. Linda Bilmes and Joseph Stiglitz recently argued in a paper that the comprehensive economic costs of the Iraq war alone approach $2,000bn, a number that incorporates loss of life and costs of injury computations that are actually quite tricky. The grief of friends and loved ones is powerful testimony to the immeasurable value of lost love and companionship. A more prosaic approach calculates only the lost economic production due to deaths. Agencies of the US government assign values to lives lost ranging from $3m to roughly $7m, implying fatalities thus far have cost between $7bn and $18bn. The losses from illness and disability among veterans are similar and will materialise as future spending on veteran's health programmes and reduced incomes for veterans.

The war could also have had business cycle effects, for example if it caused higher oil prices, slower US growth and diminished global income. Ms Bilmes and Mr Stiglitz tack $1,000bn on to costs from these sources. But it could also be the reverse war spending may have accelerated the US recovery and global growth. Unfortunately, the net economic impact requires the analyst to predict the future: would oil prices have risen the same, more, or less with Saddam Hussein in power and Iran rattling its proto-nuclear sabre? Would the US Federal Reserve have moved back towards neutral at the same pace, faster or slower in the absence of near-term fiscal stimulus?

While the possibilities are endless, the war probably had little overall impact on the economy. Since the second quarter of 2003, the US economy has grown at above trend rates every quarter (until the last quarter of 2005) and inflation has remained contained.

Thus, the current and future budget cost and loss of life and health probably give the right magnitude. If so, the annual war bill represents only about one cent of the $12,000bn of national income each year, and the total military cost at most, a nickel. And that is the right lesson: the foundation of US international influence is its large, powerful economy which can absorb the narrow, resource costs of war and free the US to pursue strategic and security goals.

America can afford the war but the government also faces pressing demands for funds in social security and health programmes. War will be worth it only if the US is ultimately safer than with a ruthless dictator still controlling Iraq. It will be worth it only if its conduct reduces the need to engage terrorists on other fronts. It will be worth it only if it leads to a greater ability to engage effectively in Palestine, Iran, North Korea and other trouble spots. Politicians agree that the US must stay but costs will remain an issue until such benefits become clear.

The writer, former director of the Congressional Budget Office, heads the Greenberg Centre for Geoeconomic Studies at the Council on Foreign Relations

By Douglas Holz-Eakin