What price peace?

David Warsh, author of Knowledge and the Wealth of Nations, and the best weekly commentator on Economics matters I know of, writes about the cost of the war in Iraq. There are potential lessons for us in India, in our war with terrorism. I have little to add where people brighter and more knowledgeable than I am have thought so long and so hard. However, Pakistan is clearly a failed state- and its failure is inflicting terrible suffering on its own people. Moreover, the place is a breeding ground for terrorist activity directed at India. It is tempting to think that our problems originate across the border, and that if we could only remake the place more to our own liking, using force if required, our problems would be solved. This piece should give us pause.

What is our greatest problem? There are 10,000 armed Maoists tormenting at least 170 of India’s 602 districts, and Diarrhoea is the second leading cause of death among children here. Economics suggest that we should spend our resources where the marginal returns are greatest. We spend 15% of our central government budget on defense, and 2% on health and education each. Containment looks like a better policy than ever.

It's probably fair to say that the economics of national security had its beginnings in an essay by William D. Nordhaus of Yale University that appeared in December 2002, first in a non-technical essay in The New York Review of Books, then as a publication of the American Academy of Arts and Sciences…

It might seem faint-hearted to take seriously beforehand the task of estimating war's potential cost, wrote Nordhaus, slyly anticipating his critics, "a sign of insufficient resolve at best and appeasement at worst," but in fact it was simply realistic. "...[M]ost people recognize that the costs in dollars, and especially in blood, are acceptable only as long as they are low. If the casualty estimates mount to the thousands, if oil prices skyrocket, if a war pushes the economy into recession or requires a large tax increase, and if the United States becomes a pariah in the world because of callous attacks on civilian populations, then decision-makers in the White House and the Congress might not post so expeditiously to battle."…

And after disentangling direct military spending from various follow-on costs -- occupation and peacekeeping, reconstruction and nation-building, humanitarian assistance, the impact on oil markets and macroeconomic impact, Nordhaus produced a pair of estimates of the war's likely cost over a the course of a decade, low and high --$99 billion after a short and favorably resolved battle, compared to $1,934 billion, or almost $2 trillion dollars, nearly 20 percent of GDP, in the event of a protracted war with an unfavorable outcome.

As it happened, a trio of University of Chicago economists also produced in 2003 an estimate of the costs of the war, which came to very different conclusions -- partly by taking the analysis a step further and asking, compared to what?...

Assuming that Saddam had the same kind of staying power as repressive regimes in North Korea and Cuba, the Chicago economists concluded that the invasion would be a bargain, for Americans and Iraqis alike. The cost of continuing to contain Saddam at the same level as the precious decade -- 30,000 troops, 30 ships and 200 aircraft and their crews -- would add up to $380 billion going forward. "This dwarfs any reasonable estimate of US war costs," they wrote -- even before the possibility of increased terrorism was over the next twenty years was added in.

What about the Iraqis? What about the cost of war to them? Since Saddam came to power in 1979, their economy had stagnated, the Chicagoans noted; income per person had fallen by as much as 75 percent. They toted up the loss of lives as well -- the war with Iran, the repression of the Shiites, the Kurds and the Marsh Arabs, something like half a million premature deaths over a quarter-century, and projected the record into the future (with a suitable discount rate of 2 percent, and a 3 percent probability of spontaneous regime-change) and concluded another 200,000 to 600,000 Iraqis could be expected to die under a policy of continued containment were Saddam and his henchmen to continue to rule for another 33 years.

In contrast, after a forcible regime change, the Iraqi economy begins growing again. The war itself costs no more than a half a year's GDP. Oil revenues swell, income per person grows enough to make up for the quarter-century decline. "At first, it may seem surprising that war can lead to a huge improvement in human welfare. But, in fact, this conclusion is hard to escape so long as regime change even partly undoes the collapse in living standards under Saddam" -- at least it does as long as the killing stops.

And what if doesn't? Last week the Chicagoans were back, with a revised and considerably expanded rewrite of their 2003 paper, presented by Davis to the NBER's Summer Institute. Gone were some of the slam-bang certainties of the earlier version ("...[T]he costs of containment dramatically outweigh the costs of war according to our analysis"). Added were a number of cost-of-capital subtleties in calculating the cost of various contingencies, and a broader view of the possibilities themselves. Unchanged was the insistence that any judgment of the cost and efficacy of the invasion of Iraq would have meaning only when compared to the cost of /not/ invading -- that is, to maintaining a policy of containment.

What was striking, however, was that somehow the Chicagoans' numbers had changed.

In his role as discussant, Yale's Nordhaus underscored the disparity. In 2003, he noted, on the eve of the war itself, the Chicagoans had rated the cost of containment as $630 billion, compared to a projected $125 billion cost of war -- a virtual no-brainer. In the 2006 version, with the advantage of "partial hindsight" creeping in despite their determination to write as though they were still looking forward from early 2003, their (backward-looking) forward-looking cost of containment had become $297 billion, against a best guess of the cost of the war of $414 billion -- a very dramatic swing.

The words with which Nordhaus closed his 2002 discussion of the economic consequences of a war with Iraq suggest just how imaginative a before-the-fact analysis must be in the future if it is to be persuasive:

"The cost of a war may turn out to be low, but the cost of a successful peace looks very steep. If American taxpayers decline to pay the bills for ensuring the long-term health of Iraq, America would leave behind mountains of rubble and mobs of angry people. As the world learned from the Carthaginian peace that settled World War I, the cost of a botched peace may be even higher than the price of a bloody war"