Tuesday, Jul 13, 2004

In Independence, Missouri, the small town where president Harry Truman started his political career, the economic impact of the war in Iraq has been unambiguously positive. The town of just over 100,000 people is home to Alliant Techsystems' (ATK) small ammunition plant, which has increased its headcount by almost a quarter to 1,380 since the invasion of Iraq in spring 2003.

However, in spite of the benefits to Independence, many commentators doubt that the conflict in Iraq has given much of a boost to the US economy as a whole.

Ever since the second world war helped haul the US out of the great depression, economists have been aware that military conflict can bring important economic benefits.

Government spending on arms can help use up some of the slack in industrial capacity, pumping cash into equipment-makers and boosting hiring.

The US has lavished huge sums on the war, occupation and reconstruction of Iraq. So far it has spent about Dollars 105bn (Pounds 56bn, Euros 85bn) on military operations, and Dollars 18bn has been appropriated for reconstruction.

Congressional Budget Office figures suggest it will cost Dollars 55bn-Dollars 60bn over the coming year to wage the war on terrorism - the lion's share of which will go to the continued military operations in Iraq.These sums are equivalent to a year's worth of the Bush administration's tax cuts.

Armaments companies such as ATK have certainly benefited from the conflict - sales of ammunition and equipment that deflects heat-seeking missiles are up - as have contractors involved in reconstruction.

But the impact seems to have been more modest than almost all previous military conflicts.

First, the sums of money spent have been much smaller. The second world war cost the US the equivalent of about Dollars 2,000bn, or 32 per cent of national income. The US spent about Dollars 264bn, or 4 per cent of national income, on the Korean war. By contrast, the conflict with Iraq has consumed closer to 0.13 per cent of national income.

"The economic benefits of World War II and the Korean war were due not only to the much greater scale of the operations but also to the fact that a lot of the money was going on capital expenditures on new aircraft and armour," says Niall Ferguson, professor of financial history at New York University. "This boosted industrial production and also had technological spin-off effects. The Iraq war by comparison is a low-tech affair."

Instead of buying new weapons and machinery, the US military has frequently decided to repair existing stocks.

"Military spending had been ramped up long before the conflict in the wake of September 11 and there was not much spare capacity in the defence sector anyway," says Daniel Goure, a defence analyst at the Lexington Institute, a military think-tank.

A good deal of the money is being spent on fuel for transport that is largely being bought in the Middle East. Most military experts agree that the higher salaries given to soldiers operating in Iraq are unlikely to provide much of a boon for the US economy.

The army has calculated that on average the 138,000 military personnel in Iraq are earning Dollars 770 more a month more than they would be earning outside a danger zone, but this money is hard to spend on US goods in Iraq.

Around a quarter of the military staff in Iraq are single and are less likely to be sending money home to be spent by their families. Some of the reservists who have been sent out may have even taken a pay cut.

"Many of the reservists are highly skilled people and taking them out of the economy may have caused some disruption to the economy," says Marc Chandler, chief currency strategist at HSBC in New York.

Even if the conflict has provided a modest fiscal boost, that has probably been more than offset by the impact on the budget deficit, interest rates and the oil price, say economists.

These effects are impossible to quantify, but some economists believe higher government borrowing and heightened geo-political risk have taken their toll on financial markets and been a drag on the US economy.

"The fact that the government has had to spend so much on Iraq has pushed up the deficit, and this is likely to have put upward pressure on interest rates," says Jan Hatzius, an economist at Goldman Sachs in New York. "A rough estimate might be that 10-year Treasury bond yields are around 25 basis points higher as a result - not the end of the world but not helpful either."

The impact on oil is also hard to quantify with precision, but is almost certainly negative. Although much of the rise in the oil price has been due to the strong demand resulting from robust global growth, financial markets' fears that the Iraqi conflict threatens stability in the Middle East and may lead to further disruption of oil supplies have almost certainly contributed to the rise in crude prices.

"It seems that the risk premium associated with global uncertainty represents Dollars 5-Dollars 10 of the price of West Texas Intermediate (trading at Dollars 38), and the situation in Iraq is a large part of that," says Mark Zandi, chief economist at Economy.com, the consultancy.

"At the moment one would have to say that the war in Iraq has been unambiguously negative," he adds. "We have taken over Dollars 120bn and spent it in a way that will do almost nothing to support the economy in the long run."

By CHRISTOPHER SWANN

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