War Costs

The Iraq war is five years old today. Considering the incalculable human costs of the enterprise, there is something almost unseemly about discussing the economic costs, but those are far from trivial.

The Financial Times reports on several different estimates of the war's costs. Economics Nobel laureate Joseph Stiglitz has co-authored a book on the subject, "The Three Trillion Dollar War." He chatted with washingtonpost.com readers today (see also this op-ed with his co-author Linda Blimes).

One interesting point that came up in his discussion was the notion of "opportunity cost" -

San Francisco, Calif.: A trillion here, a trillion there, pretty soon we'll be talking about real money.

Could you address the opportunity costs of the war? For example, health care reform is a major issue in the presidential election, and three million dollars could've gone a long way towards funding it. Social Security is another example.

Joseph E. Stiglitz: That is the right way of asking the question. As a rich country, we can, in some sense, "afford" the war. But spending money on the war means that we are not spending money on other things that we could have spent the money on.

One of the real costs of the war is that our security is actually less than it otherwise would have been (ironic, since enhancing security was one of the reasons for going to war). Our armed forces have been depleted--we have been wearing out equipment and using up munitions faster than we have been replacing them; the armed forces face difficult problems in recruitment--by any objective measures,including those used by the armed forces, quality has deteriorated significantly.

Economically, we are gain weaker. Millions of americans have no health insurance--including many poor children. if they do not get the care they need, they may become scarred for life; but the President vetoed the children's health insurance bill--evidently we couldn't afford it. But we were talking about just a few days fighting in Iraq.

The list of what we could have done with just a month or even a few days fighting in Iraq is long. These are called the opportunity costs of the war. In our book, we give many examples of these opportunity costs.

Opportunity cost is a good concept for thinking the decisions of utility-maximizing agents - when a choice is made, the opportunity cost is the next best alternative which is forgone. However, that may not be a good way of understanding the outcomes of our political process. The Tax Policy Center's Howard Gleckman tried to be realistic about where the money would have gone:

Here is a little thought experiment. Had there been no occupation, we would have had a balanced budget by fiscal 2007. The deficit was $162 billion, almost exactly equal to the direct cost of the war that year. Factor in other foregone costs, such as the expense of caring for wounded vets and the like, and we probably would have had a modest surplus.

And what would we have done with it? This is just speculation, of course, but if Stiglitz can do it so can I. The White House would have said, "We have balanced the budget, so let's extend the 2001 and 2003 tax cuts." Congressional Democrats would have said, "We have a balanced budget, let's extend the SCHIP child health program." And, in the end, they may very well have done a little of both. But long-term entitlement fixes? I don't think so.

Since taxes were not raised to finance the war, the financial burden ultimately takes the form of higher government debt. That will mean taxes in the future will be higher than otherwise in order to pay the interest (currently more than 8 cents of every federal spending dollar goes to interest), and having those costs locked into the budget may hinder a future administration in addressing other issues. Moreover, the government's borrowing contributes to our current account deficit and a significant portion of the future interest payments will be made to foreign creditors. This last point means that some of our future output will generate income for foreigners rather than Americans (i.e. GNP will be less relative to GDP).

Update (3/19): The Times also looks at estimating war costs.

Professor Jones and the Committee of Doom?

Inside Higher Ed reports:

...Blowtorch Entertainment will next month begin filming on “Tenure,” which is about a college professor coming up for tenure (Luke Wilson) and facing off against a female rival who recently arrived at (fictional) Grey College. (The part of the institution will be played by Bryn Mawr College, where the movie will be shot.) David Koechner will play the professorial sidekick to the Wilson character, and the production company is planning kickoff events next year to promote the film in college towns.

Brendan McDonald, the producer, said that he viewed academe as “one of the interesting worlds to explore” and said that he viewed the project as “lampooning the tenure process.”

Hmmm... the tenure process certainly could use some lampooning. Its hard to see that doing well at the box office, but I'll go see it. Then again, maybe I should wait and rent it after I get tenure. OK, back to work...

Steven Colbert: Lose Hope to Gain Confidence

The number of people working fell last month, but the unemployment rate declined (see earlier post). Steven Colbert explains:

The Economics of the Iraq Insurgency

Many countries abundant in natural resources have been development failures. This apparent paradox is sometimes called the "resource curse." In part it is attributable to the opportunities for corruption created by abundant resources and the incentives that exist for diverting effort away from productive activity into fighting - often literally - over the rents associated with resources like oil and diamonds.

The the persistence of the insurgency in Iraq may be another manifestation of the resource curse. The NY Times reports that oil money is fueling the violence:

The sea of oil under Iraq is supposed to rebuild the nation, then make it prosper. But at least one-third, and possibly much more, of the fuel from Iraq’s largest refinery here is diverted to the black market, according to American military officials. Tankers are hijacked, drivers are bribed, papers are forged and meters are manipulated — and some of the earnings go to insurgents who are still killing more than 100 Iraqis a week.

“It’s the money pit of the insurgency,” said Capt. Joe Da Silva, who commands several platoons stationed at the refinery.

Five years after the war in Iraq began, the insurgency remains a lethal force. The steady flow of cash is one reason, even as the American troop buildup and the recruitment of former insurgents to American-backed militias have helped push the number of attacks down to 2005 levels.

In fact, money, far more than jihadist ideology, is a crucial motivation for a majority of Sunni insurgents, according to American officers in some Sunni provinces and other military officials in Iraq who have reviewed detainee surveys and other intelligence on the insurgency....

“It has a great deal more to do with the economy than with ideology,” said one senior American military official, who said that studies of detainees in American custody found that about three-quarters were not committed to the jihadist ideology. “The vast majority have nothing to do with the caliphate and the central ideology of Al Qaeda.”

For more on the resource curse, see this column by Tyler Cowen in the Times last year.

Wall Street, There's a Place You Can Go

I said, Wall Street, when you're short on your dough...

Earlier this week, the Fed announced a new $200 billion program called the Term Securities Lending Facility (TSLF). This will allow investment banks to borrow US Treasury securities by putting up certain assets including some mortgage-backed securities as collateral. The NY Times reported:

The Federal Reserve, in effect, is trying to ease an acute credit squeeze by agreeing to hold large volumes of mortgage-backed bonds that Wall Street firms are struggling to sell and providing them with either cash or Treasury securities that they can immediately convert to cash.

Fed officials are increasingly convinced that the United States is sliding into a recession, and they worry that the deepening credit squeeze will aggravate the problem by making it even harder for consumers and businesses to borrow money for houses, new equipment or new factories.

The Fed’s hope is to relieve some of the pressure on institutions to sell at fire-sale prices, easing the strains on economic activity and making the credit markets feel more comfortable in buying mortgage bonds again.

The Washington Post's Steven Pearlstein puts the Fed's action in context:

[T]he real problem began in late February, as several of Wall Street's biggest investment banks prepared to close their books for the quarter and realized they were looking not only at big declines in profit from issuance of new stocks and bonds and fees from mergers and acquisitions, but also another round of write-offs in the value of their holdings. In response, the banks began to hunker down, instructing their trading desks to raise margin requirements for hedge funds and other customers, requiring them, in effect, to post more collateral on their heavy borrowings.

Thus began a chain reaction in which hedge funds began selling what they could -- largely mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae -- to raise the cash to meet their new margin calls. That wave of forced selling drove down the price of those bonds, which prompted more margin calls and more forced selling. By the end of last week, the interest rate spread on those securities -- the difference between their yield and that of risk-free U.S. Treasury bonds -- had jumped four, five, even 10 times the normal rate.

(Here is an explanation of "margin call").

A central bank is sometimes called upon to act as a "lender of last resort" to banks in crisis. In an age where loans are widely "securitized" - that is, instead of sitting as an asset on a bank's balance sheet, loans are sold on a market (often in a bundle like a mortgage-backed security which entitles the holders to the payments from the underlying mortgage loans) - Willem Buiter has argued that the central bank needs to be a "market maker of last resort." A market maker acts as both a buyer and a seller (not unlike a used car lot), and thereby ensures "liquidity" - that assets can readily be sold. Buiter sees the TSLF as a sign that the Fed is stepping up to this task (albeit in a somewhat indirect fashion):

The old Lender of Last Resort (LoLR) model of providing funding liquidity to solvent but illiquid banks, at a penalty rate and against collateral that would be good in normal times but may have become impaired in disorderly market conditions, may be appropriate in a relationships-based financial system or traditional banking system. It is not capable of dealing with market illiquidity - the kind of liquidity problem likely to arise in a transactions-based model of financial capitalism, that is, a system in which a large share of intermediation occurs through the capital markets rather than through conventional ‘originate and hold’ banks.

In a transactions-based financial system, the Market Maker of Last Resort function complements or even substitutes for the Lender of Last Resort function as the instrument of choice for pursuing financial stability. Rather than disguising the fact that the Fed has woken up to the fact that the world has changed and that central banks have to accept an expanded range of eligible collateral from an expanded range of counterparties when key financial market seize up, the Fed should advertise the fact. They are doing the right thing.

No bank does it all by itself.
I said, Wall Street, put your pride on the shelf,
And just go there, to the T.S.L.F.
I'm sure they can help you today.

Update: Paul Krugman believes it probably won't work.

RFK on GNP

The American Prospect's Kate Sheppard reports on a hearing held by Senator Byron Dorgan on the deficiency of Gross Domestic Product as a proxy for economic well-being. As she notes, the point was eloquently by Robert Kennedy in this 1968 speech. Each semester, as I read a passage from it to my principles students, I am reminded I that I'm no Robert Kennedy. Next time I might play this instead:
Hat tip: Ezra Klein. NB: Kennedy refers to Gross National Product (GNP); nowadays GDP is the more commonly cited aggregate measure, but the two are closely related.

Update (9/13): The Glaser Progress Foundation informs me that video has moved to a new web location.

They Have Us Outnumbered

Inside Higher Ed informs us:

Full Time Professional Positions in Higher Education
Fall 2004
Administrators: 49.4%
Faculty: 50.6%

Fall 2006
Administrators: 51.4%
Faculty: 48.6%

Next time your tuition increases, don't blame us professors...

To Strive And Not To Enjoy

In his NY Times column, Bob Frank looks at the link (or lack thereof) between income and happiness. After discussing some of the flaws in how GDP and price indexes are measured, he says:

But there is a much bigger problem, one that challenges the very foundation of the presumed link between per-capita G.D.P. and economic welfare. That’s the assumption, traditional in economic models, that absolute income levels are the primary determinant of individual well-being.

This assumption is contradicted by consistent survey findings that when everyone’s income grows at about the same rate, average levels of happiness remain the same. Yet at any given moment, the pattern is that wealthy people are happier, on average, than poor people. Together, these findings suggest that relative income is a much better predictor of well-being than absolute income.

That we are so concerned with our relative status - that our happiness seems to depend more on how much (or little) we feel we are getting ahead than on how well off we are - suggests we have still not shaken loose of the attitudes that Keynes describes in his 1930 essay "Economic Possibilities For Our Grandchildren." He believed that a set of values that encouraged accumulation of wealth for its own sake was an important ingredient in promoting the increase of capital required for economic growth. However, continued growth would ultimately liberate future generations from the "economic problem" of scarcity and allow humanity to live "wisely, agreeably and well" by a nobler set of principles. But, Keynes warned, the transition would be difficult:

The strenuous purposeful money‑makers may carry all of us along with them into the lap of economic abundance. But it will be those peoples, who can keep alive, and cultivate into a fuller perfection, the art of life itself and do not sell themselves for the means of life, who will be able to enjoy the abundance when it comes.

Yet there is no country and no people, I think, who can look forward to the age of leisure and of abundance without a dread. For we have been trained too long to strive and not to enjoy...

Has India Traded Its Passion For Glory?

So many times, it happens too fast...
The Economist believes India needs to reform its public sector:

In many ways India counts as one of liberalisation's greatest success stories. For years, it pottered along, weighed down by the regulations that made up the licence raj, producing only a feeble “Hindu” rate of growth. But over the past 15 years it has been transformed into a far more powerful beast. Its companies have become worldbeaters. Without India's strength, the world economy would have had far less to boast about.

Sadly, this achievement is more fragile than it looks. Many things restrain India's economy, from a government that depends on Communist support to the caste system, power cuts and rigid labour laws. But an enduring constraint is even more awkward: a state that makes a big claim on a poor country's resources but then uses them badly...

[Prime Minister] Singh made administrative reform a priority when he took office in 2004, and he duly set up a commission to look into it. But even the finance minister admits that most of its deliberations have been academic. The civil service is expected shortly to be awarded a huge pay rise, which will be swiftly embraced, along with tougher performance standards, which will be studiously ignored...

That is, Singh must not lose his grip on the dreams of the past; he must fight just to keep them alive.

Unemployment: As We Were Just Saying

David Leonhardt's column on how the unemployment rate can be deceptive (see earlier post) was timely indeed. The latest numbers from the Bureau of Labor Statistics have the number of people employed decreasing by 255,000 in February, but the unemployment rate also fell, from 4.9% to 4.8%. This was made possible by a decrease in labor force participation; the labor force declined by 450,000 and the participation rate fell from 66.13% to 65.88%.

Those numbers are from the household survey; the decline of 63,000 jobs reported by the establishment survey got the headlines (which is strange, I would expect the headline writers to prefer the more dramatic figure).

Either way, not a good sign. Paul Krugman pre-empts the NBER and calls it a recession.