Macroeconomic effects of war

Macroeconomic Effects of War
Brandon Brice: briceb@uncw.edu

Overview
• Introduction: Is war good for the economy?
• War’s impact on:
• Economic Growth
• Government Spending
• Consumption
• Investment
• Debt and taxation
• Inflation
• Conclusion: Cost and benefit summary
2/2/2020 Presenter: Brandon Brice Macroeconomic Effects of War 2

Introduction: Is War
Good for the Economy?

“Ghastly as it may seem to say this, the terror
attack – like the original day of infamy, which
brought an end to the Great Depression –
could even do some economic good.”
-Nobel Laureate Paul Krugman (September 14, 2001)

“Like it or not, spending on war is good for
the economy.”
-Mike Norman(November 20, 2015)

“The military creates middle-class jobs,
provides health care, and spreads liberal
values.”
-Hal Brands (March 17, 2019)

“War is widely thought to be linked to economic good
times. The second world war is often said to have
brought the world out of depression, and war has
since enhanced its reputation as a spur to economic
growth…Today, we know that is nonsense. The 1990s
boom showed that peace is economically far better
than war. The Gulf War of 1991 demonstrated that
wars can actually be bad for an economy”
-Nobel Laureate Joseph Stiglitz (January 21, 2003)

Which is it?!
War is good for the economy, and even pulled the
U.S. out of the Great Depression?
or
War is bad for the economy, and it is a myth that
it pulled the U.S. out of the Great Depression?

Does War Generate
Economic Growth?

GDP = C + I + G + NX
GDP – Gross Domestic Product
C – Private Consumption
I – Private Investment
G – Government Spending and Investment
NX – Net Exports

U.S. GDP Since 1929

Economic Growth During and After WWII
• GDP growth averaged 8% annually, and was 17% at the peak of the
war
• Unemployment fell from 14.6% to 1.9% with 20% of the population
working for the military
• GDP growth fell by 20.4% in 1946 following the war, falling below the
pre-war trend. Unemployment began to rise
• GDP took years to return to its pre-war trend

GDP and Unemployment in the Long-run
Several years after WWII economic growth returned to its pre-war
trend and unemployment increased to its natural rate

Government Spending,
Debt, and Taxation
During WWII

GDP Growth Through Government Spending
• Government spending rose from 30% of GDP ($408 billion) to 79%
($1.6 trillion)
• Funding was predominately through debt (1048% increase) and
taxation (rates increased for all income brackets)

War Time Debt
Wars often create debt that affect economies long after wars are over

War Time Tax Rates
Consumers and businesses often face higher tax rates to fund wars

Ratchet Effect – Robert Higgs’ Crisis and
Leviathan
While war may temporarily boost economic growth and reduce
unemployment, it results in long-run or permanent increases in
government spending, debt, and taxation

Printing Money: Another Way to Fund Wars
Countries may try to fund wars and pay reparations through
the printing of money. This devalues existing currency and
also results in inflation
• Example: Germany after WWI where the exchange rate of the
German mark to the American dollar went from 4.2:1 to
4.2trillion:1

Is economic growth, driven by increased government
war spending and financed through increased debt,
inflation, and taxation; a benefit or a cost for society?
Remember: All expenditures and use of resources have
opportunity costs!
Broken Window Fallacy – Belief that all economic spending, even
to replace destroyed assets, improves welfare and boosts the
economy. In reality, it only shifts scarce resources away from
other productive uses

Consumption and
Private Investment
During WWII

Consumption, Investment, and Growth Trends
Before, During, and After the WWII

Economic Growth During WWII: 1941 to 1945
• Consumption fell from 67% of GDP to 46%
• Private investment fell from 11% of GDP to 3%

Why Did Consumption Fall?
Increased government demand and reductions in non-
military supply for food, supplies, and munitions
resulted in inflation. PPI rose 17% and CPI 10% in 1941

In an effort to control inflation, the Office of Price
Administration and Civilian Supply established price ceilings

In response to shortages, many products were rationed

Was WWII Good for U.S. Consumers?
• 16 million Americans (11%) fought in WWII. 418,500 died and
671,801 were injured
• Those that did not fight experienced shortages of goods and services,
rationing, stagnant wages, higher tax rates, and fear of attack

The increased economic growth did not improve
the welfare of consumers. It shifted scarce
resources away from productive private
consumption and investment spending toward
war materials and replacing destroyed capital!

What About Economic
Growth in Germany and
Japan after WWII

What Explains High Economic Growth Rates in
Germany and Japan After WWII?
Some nations experienced very high growth rates after war. Did war
benefit these economies?

Destruction in Japan and Germany During
WWII
Hiroshima Dresden

Economic Growth Rates in Japan and
Germany Following WWII
This growth is a result of depleted and destroyed capital stocks
following the war, and diminishing marginal product of capital

Economic Growth Rates in Japan and
Germany Following WWII
They were growing fast because new capital was resulting in
larger returns compared to new capital in nations that did not
experience as much destruction. Eventually the growth rates
slowed as they regained their capital stocks.
Belief that war improved the economies of Germany and
Japan is another example of the Broken Window Fallacy.

Conclusion

Is War Good for the Economy?
Benefits Costs
Increases GDP growth Reduces consumption
Reduces unemployment Reduces private investment
Increases inflation
Increases debt
Increases taxation
Results in deaths and injuries
Destroys productive capital

Macroeconomic effects of war

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