What is MacroWeb?

Predicting the economic impact of war and its aftermath used to be simple. A huge hike in defense spending would boost growth as factories geared up to build more tanks and planes. Then as sure as cold weather in the winter, the economy would hit its limits on production capacity, and inflation would skyrocket. Because the production capacity is coming from government which causes inflation, we have a primary example of expansionary fiscal policy. So does the war in Iraq pose the same risks for the U.S. economy as previous wars?

In the short run, the old rules apply. As military spending goes up, so should the economy. To give a little example of that little boost; defense spending will account for 4.1% of this year's GDP, a big jump from last year's 3.4%.

The long-term economics of this war aren't so rosy. Inflation isn't the worry this time since the 1990s investment boom and its huge productivity gains created plenty of excess capacity. Inflation, outside of food and energy, is still running at only 1.5%. Instead the real threat is to the rapid productivity growth of the 1990s, which may be tough to sustain in an unsettled and hostile world. New economy growth depends on globalization and innovation, both of which could be dampened by war.

As we look at it now, there is a short run upside and a long-term downside. The short run includes: defense spending is propping up a sagging economy, increased hiring for security. And all of this is without pushing up consumer prices. The long-term downside include: competition for resources, a hit to globalization, lost momentum on trade, reduced innovation, less human capital, and a public backlash.

Economists have never really been able to explain why productivity growth accelerates in some periods and slows in others. What we do know is that the market-driven growth the U.S. enjoyed in the 1990s thrived on an atmosphere of global peace and a steadily decreasing role of government in the economy. The war in Iraq, the tough rebuilding task ahead, and the rise in global tension all signal an end to that fertile era.

Who is Dave Tufte?