I came across this article using Google and found it very interesting. It's something I've heard all my life that the second world war was responsible for pulling us out of the depression, and the cold war kept us making money...
Written by Mike Moffit Found it at About.com About.Com Link
One of the more enduring myths in Western society is that wars are somehow good for the economy. Many people see a great deal of evidence to support this myth, after all World War II came directly after the Great Depression. This faulty belief stems from a misunderstanding of the economic way of thinking.
The standard "a war gives the economy a boost" argument goes as follows: Let's suppose that the economy is in the low end of the business cycle, so we're in a recession or just a period of low economic growth. The unemployment rate is high, people may be making less purchases than they were a year or two ago, and overall output is flat. But then the country decides to prepare for war! The government needs to equip its soldiers with the extra gear and munitions needed in order to win the war. Corporations win contracts to supply boots, and bombs and vehicles to the army. Many of these companies will have to hire extra workers in order to meet this increased production. If the preparations for war are large enough, large numbers of workers will be hired reducing the unemployment rate. Other workers may need to be hired to cover reservists in private sector jobs who get sent overseas. With the unemployment rate down we have more people spending again and people who had jobs before will be less worried about losing their job in the future so they'll spend more than they did. This extra spending will help the retail sector, who will need to hire extra employees causing unemployment to drop even further. A spiral of positive economic activity is created by the government preparing for war, if you believe the story. The flawed logic of the story is an example of something economists call The Broken Window Fallacy.
The Broken Window Fallacy is brilliantly illustrated in Henry Hazlitt's Economics in one Lesson. The book is still as useful today as it was when it was first published in 1946; I give it my highest recommendation. In it, Hazlitt gives the example of a vandal throwing a brick through a shopkeeper's window. The shopkeeper will have to purchase a new window from a glass shop for a sum of money, say $250. A crowd of people who see the broken window decide that the broken window may have positive benefits:
After all, if windows were never broken, what would happen to the glass business? Then, of course, the thing is endless. The glazier will have $250 more to spend with other merchants, and these in turn will have $250 to spend with still other merchants, and so ad infinitum. The smashed window will go on providing money and employment in ever-widening circles. The logical conclusion from all this would be ... that the little hoodlum who threw the brick, far from being a public menace, was a public benefactor. (p. 23 - Hazlitt)
The crowd is correct in realizing that the local glass shop will benefit from this act of vandalism. They have not considered, however, what the shopkeeper would have spent the $250 on something else if he did not have to replace the window. He might have been saving that money for a new set of golf clubs, but since he has now spent the money, he cannot and the golf shop has lost a sale. He might have used the money to purchase new equipment for his business, or to take a vacation, or to purchase new clothing. So the glass store's gain is another store's loss, so there hasn't been a net gain in economic activity. In fact, there has been a decline in the economy:
Instead of [the shopkeeper] having a window and $250, he now has merely a window. Or, as he was planning to buy the suit that very afternoon, instead of having both a window and a suit he must be content with the window or the suit. If we think of him as a part of the community, the community has lost a new suit that might otherwise have come into being, and is just that much poorer.
(p. 24 - Hazlitt) The Broken Window Fallacy is enduring because of the difficulty of seeing what the shopkeeper would have done. We can see the gain that goes to the glass shop. We can see the new pane of glass in the front of the store. However, we cannot see what the shopkeeper would have done with the money if he had been allowed to keep it, precisely because he wasn't allowed to keep it. We cannot see the set of golf clubs not purchased or the new suit foregone. Since the winners are easily identifiable and the losers not, it's easy to conclude that there are only winners and the economy as a whole is better off.
The faulty logic of the Broken Window Fallacy occurs all the time with arguments supporting government programs. A politician will claim that his new government program to provide winter coats to poor families has been a roaring success, because he can point to all the people who have coats who didn't have them before. It's likely that there will be several new stories on the coat program, and pictures of people wearing the coats will be on the 6 o'clock news. Since we see the benefits of the program, the politician will convince the public that his program was a huge success. Of course, what we do not see is the school lunch proposal that was never implemented to implement the coat program, or the decline in economic activity from the added taxes needed to pay for the coats.
In a real life example, scientist and environmental activist David Suzuki has often claimed that a corporation polluting a river adds to a country's GDP. If the river has become polluted, an expensive program will be required to clean up the river. Residents may choose to buy more expensive bottled water rather than cheaper tap water. Suzuki points to this new economic activity, which will raise GDP, and claim that the GDP has risen overall in the community although the quality of life surely has decreased. Dr. Suzuki, however, forgot to take into account all the decreases in GDP that will be caused by the water pollution precisely because the economic losers are far more difficult to identify than the economic winners. We do not know what the government or the taxpayers would have done with the money had they not needed to clean up the river. We know from the Broken Window Fallacy that there will be an overall decline in GDP, not a rise. One has to wonder if politicians and activists are arguing in good faith or if they realize the logical fallacies in their arguments but hope the voters will not.
Now on to the war.
From the Broken Window Fallacy it is quite easy to see why the war will not benefit the economy. The extra money spent on the war is money that will not be spent elsewhere. The war can be funded in a combination of three ways:
1. Increasing taxes
2. Decrease spending in other areas
3. Increasing the debt
Increasing taxes reduces consumer spending, which does not help the economy improve at all. Suppose we decrease government spending on social programs. Firstly we've lost the benefits those social programs provide. The recipients of those programs will now have less money to spend on other items, so the economy will decline as a whole. Increasing the debt means that we'll either have to decrease spending or increase taxes in the future; it's a way to delay the inevitable. Plus there's all those interest payments in the meantime.
If you're not convinced yet, imagine that instead of dropping bombs on Baghdad, the army was dropping refrigerators in the ocean. The army could get the refrigerators in one of two ways:
1. They could get every American to give them $50 to pay for the fridges.
2. The army could come to your house and take your fridge.
Does anyone seriously believe there would be an economic benefit to the first choice? You now have $50 less to spend on other goods and the price of fridges will likely increase due to the added demand. So you'd lose twice if you were planning on buying a new fridge. Sure the appliance manufacturers love it, and the army might have fun filling the Atlantic with Fridgidaires, but this would not outweigh the harm done to every American who is out $50 and all the stores that will experience a decline in sales due to the decline in consumer disposable income.
As far as the second one, do you think you'd feel wealthier if the army came and took your appliances away from you? The idea of the government coming in and taking your things may seem ridiculous, but it's not any different than increasing your taxes. At least under this plan you get to use the stuff for awhile, whereas with the extra taxes, you have to pay them before you have an opportunity to spend the money.
So in the short run the war will hurt the economy of the United States and their allies. It goes without saying that flattening most of Iraq to rubble will decimate the economy of that country. Hawks are hoping that by ridding Iraq of Saddam, a democratic pro-business leader can come in and improve the economy of that country in the long run. The economy of the United States could improve in the long run due to the war for a couple of reasons:
An increased supply of oil
Depending on who you ask, the war either has everything to do with Iraq's vast oil supplies, or absolutely nothing to do with it. All sides should agree that if a regime with better American relations were set up in Iraq, the supply of oil to the United States would increase. This will drive down the price of oil, as well as driving down the costs of companies that use oil as a factor of production which will certainly help economic growth.
Stability and Economic Growth in the Middle East If peace can somehow be established in the Middle East, the U.S. government might not have to spend as much money on the military as they do now. If the economies of the countries in the middle east become more stable and experience growth, this will give them more opportunities to trade with the United States, improving both the economies of those countries and the U.S.
Personally I do not see those factors outweighing the short term costs of the war in Iraq, but you can make a case for them. In the short term, however, the economy will decline due to the war as shown by the Broken Window Fallacy. Next time you hear someone discuss the economic benefits of the war, please tell them a little story about a windowbreaker and a shopkeeper.