Is war good for the economy? The example of the United States of America

During the early 1940s, a miracle happened in the United States of America. Coming from a pit of economic stagnation, still chewing on the Great Depression, the economy suddenly took off. Within months, unemployment was eradicated, and people who shortly before had to live off food stamps and thin air found themselves working in brand-new factories.

What had happened? The U.S. prepared for war. In the process, annual GDP grew from 89 billion in 1939 to 135 billion in constant dollars in 1944, and unemployment dropped from 14,6 % in 1940 to 1,2 % in 1944. Similar developments could be observed in European countries. There has been, since then deeply rooted in the collective memory of the western world, this mad idea that war is somehow “good for the economy”.

But is this so? The effects of war on the economy are certainly severe. War influences what is produced, by whom it is produced, and of course the possibility to trade. To determine whether a war is “good” or “bad” for an economy, one would have to meticulously calculate the costs and benefits of a conflict. This is not trivial, as a war massively distorts the economy of all directly and indirectly affected countries, making it hard to construct a counterfactual. Furthermore, the fact that war imposes unimaginable and difficult to measure suffering and death on human beings begs the question of whether such a cost-benefit calculation is even a sensible approach.

Nevertheless, economists have, time and time again, attempted to do this, with an approach mainly based on military expenditures and loss of physical and human capital, but also including the effects on technology, institutions, and trade, as well as psychological, social, and environmental effects.

First of all, current empirical studies lend no support to the notion that war is an adequate tool to push your economy out of recession. The Peace & Business Report by the Institute for Economics and Peace uses the GPI Index, which considers not only domestic and international conflict but also internal security and the degree of militarisation in society, concluding that GDP growth is highly correlated with GPI growth. Inflation is also lower and less volatile, and foreign investments are much higher in countries with higher levels of peace.

But if the idea that war is positive for a country is so widespread, there may be an underlying truth behind it. What could be the positive economic effects of war?

Concerning employment, the necessity to increase production during WWII combined with many workers being deployed as soldiers, enabled the labour market participation of groups that were previously largely excluded from it, such as women and black people. The funding of war can also be a source of equality if it is at least partly achieved through an increase in progressive taxation, as it was during WWII and the Vietnam War.

It is often said that without military investment in research and development, we wouldn’t have many technologies we enjoy today, such as GPS, duct-tape, and aviator sunglasses, but considering the vast amounts of money that were invested in military research, one would expect at least some useful results. The number of good scientists being unfortunately very finite, society also faces a trade-off between good civil and good military research that can be conducted at once.

From an efficiency point of view, the main trouble with war is that it dramatically increases the size of government for the sole purpose of coordinating the war efforts, leading to a very inefficient allocation of resources. In the U.S., tax revenue was increased from $8.7 billion in 1941 to $45 billion in 1945, while per capita consumption and private investment decreased. Moreover, the need to convert entire industries to war production causes massive inefficiencies, as many companies must carry out tasks they have no experience with, like a car company that suddenly has to figure out how to produce airplanes. After the war has ended, there is no need for production facilities and workers who specialised in wartime goods. Of course, this problem can be circumvented, as the US did by just waging another war. While, as seen above, there are positive side effects of military spending on equality and economic development, spending with the main purpose of achieving these goals would be far more efficient. Studies have shown that when comparing government multipliers, military spending falls far behind spending on infrastructure, education and even tax cuts.

It is often said that if not a nation as a whole, at least the industries supplying the means for war profit from it and have an intrinsic interest to keep it going, and even cause it. This is often not true for companies that must convert their production – as was often the case in WWI and WWII – but seems plausible considering that the U.S. alone spent $590 billion on defence in 2017, which roughly equals the entire government spending of a country like Spain. Of course, a specialised industry has an interest in keeping this lavish source of income, especially since this money is used to purchase self-destroying products like missiles. On the other hand, some companies that supply military equipment also produce civil goods, like Airbus and Boeing, and would probably profit from a more peaceful and thus more prosperous world. Furthermore, since the defence sector is highly interwoven with politics, it is prone to corruption and rent seeking, slowing down real innovation.

Trade is also affected by war. According to estimations, international trade decreased twofold during WWII. In addition to wrecking trade between opposing nations, war also affects neutral countries that used to trade with the opponents at war, or just used their infrastructure for shipping. Moreover, the effects on trade do not end with the war, as diplomatic tensions carry on and can prevent an optimal level of trade for years after the end of war.

Finally, the effects of WWII on the U.S. economy were not as positive as they might appear at first sight.  In fact, the economy was already on the way of recovery from the Great Depression when war in Europe broke out. The increase in GDP was entirely due to the increased production of war supplies, and even crowded out civil production as many companies were forced to convert to the production of military goods. Even the rise in employment appears far duller when considering that during the war, 20% of the workforce was simply employed by the armed forces in potentially destructive work, paid for with tax money and debt. It is true that WWII laid the foundation for the United States’ overall dominance during the following decades, since the U.S. was the only major power that did not have to deal with enormous capital loss. However, it seems hard to believe that the country would not have profited more from a stable and prosperous world than from one where the light of their success shone so bright only because the rest of the developed world lay in ashes.

If war is so bad for (nearly) everyone, then why does it keep happening? A possible reason is that the world may not be as focused on maximising welfare as one might wish. For example, William D. Nordhaus has shown that political decision-makers systematically underestimate the costs of war, while influential groups profit from war, be they firms benefiting from government spending on war, or warlords hoping for access to natural resources.

Hence, it does not look good for war’s ability to serve as a booster for the economy. Although there are small groups that, at least in the short-term, profit from war, and there have also been examples of positive effects on the economy and a country’s social structure, in the grand scheme of things, war is, in the grand scheme of things, both terrible for everyone involved and bad for business: the 1,739 trillion dollars the world spent on defence in 2017 would have probably been better invested elsewhere.

by Clemens Dieler

Sources in no particular order:

  5. COLLATERAL DAMAGE: TRADE DISRUPTION AND THE ECONOMIC IMPACT OF WARAuthor(s): Reuven Glick and Alan M. Taylor Source: The Review of Economics and Statistics, Vol. 92, No. 1 (February 2010), pp. 102-127
  6. The economic costs of military conflict, Ron P Smith, Birkbeck University of London  Journal of Peace Research 2014, Vol. 51(2) 245–256

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