Why economics requires more than arithmetic
CalPundit offers the proposition that the bulk of recent GDP growth is a consequence of the increase in defense spending. Noting that GDP rose by $56 billion, he then adds:
the war in Iraq provided a one-time spike in defense spending (and therefore GDP) of about $40 billion, all of it deficit spending. Without the war, GDP would have increased by only $16 billion, an annualized rate of .67%. That’s not so hot.
Kevin is doing arithmetic here, but not economics. Defense spending rises by $40 billion. How does it get paid for? Given Kevin’s assertion that it additional deficit spending, then it comes from the sale of bonds. People who buy those bonds have $40 billion less, which means they do not buy the things they otherwise would have bought. This could mean that the extra military spending had no effect on GDP at all, and the war made no difference. Suppose alternatively that the $40 billion spent on bonds came from people who, because of economic uncertainty, had kept the cash hidden in their mattresses. In this case, the money is now being spent that otherwise would not have been, and the spending raises GDP by $40 billion. My point is that how the money would have been spent otherwise determines how much the military spending contributes to GDP.
It is a lot harder than that, of course. Suppose the government borrowing raises real interest rates. Then private investment falls, lowering GDP. So the net effect of the $40 billion is less than a $40 billion GDP rise, and again you cannot attribute $40 billion of the GDP increase to military spending.
I do not know how much of the GDP hike is a consequence of military spending. [I would have to read the empirical literature, and I would much rather make progress on a book on the economic history of the whaling industry.] My point is that you cannot deduce it from simple arithmetic alone.
Robert Barro had a Business Week column back in 2001 explaining the connection between the war on terror and the economy. Tyler Cowen has some extra thoughts on fiscal policy.