September 6, 2006

On The Cost of War.  Economists are famous (or infamous) for pointing out the difference between explicit and implicit costs. 

Explicit costs are the ones where there is a monetary exchange or, if you will, some type of payment.  While this is a useful measurement of costs, economists generally find it too narrow.  Instead, economists like to measure both explicit and implicit costs.  That is, we like to talk about the “opportunity costs” of actions.  This, we believe, gives one a more true picture of the costs of any action.

Recently Scott Wallsten, a resident scholar at the American Enterprise Institute and a senior fellow at the AEI-Brookings Joint Center for Regulatory Studies, set out to measure the explicit and implicit costs of the war in Iraq.  A nice summary of his work, along with Katrina Kosec his co-author, is published in the 3^rd Quarter 2006 edition of The Milken Institute Review.

Wallsten and Kosec first lay out the explicit costs of the war to the U.S.:  over $255 billion allocated thus far and another $54 billion on the way for Iraq-specific war efforts.  The implicit costs get a little more tricky.                     

First Wallsten and Kosec have the unseemly job of placing a monetary value of lives lost.  They correctly point out that economist do not see lives as merely a dollars and cents transactions. However in order to have an honest discussion about the “costs” of the war one must attempt to measure the cost of the loss of lives.  Wallsten and Kosec rely on a survey of the literature on the topic conducted by Kip Viscusi of Harvard.  Viscusi found that various studies place the value of a statistical live in the United States in 2001 dollars in the range of $4 to 9 million.

By the end of April 2006, about 2400 American servicemen and women had been killed in Iraq.  Taking Viscusi’s midpoint of $6.5 million, the cost of American deaths have been $18 billion thus far.  Similar calculations are made for deaths of coalition forces and Iraqis.  In addition, the costs of injuries suffered by American and coalition forces are calculated.  Wallsten and Korsec also consider the lost output from called up reservists.  They find the total costs of the war thus far to be just over $500 billion or half a trillion dollars.

Wallsten and Korsec then use the Congressional Budget Office estimates of likely U.S. troop strength in Iraq into the future, which is expected to last until 2015.  Using a 5% discount rate they estimate the cost to the U.S. to be more than $365 billion, non-U.S. coalition partners cost would be $55 billion and $194 billion to Iraq.

Against these costs they consider the benefits of the war, including no longer having to enforce economic sanctions against Saddam Hussein’s regime.  In addition, it has been estimated that Saddam Hussein’s regime was responsible for the killing of about 10,000 people a year.  These avoided costs Wallsten and Korsec considered in conducting a cost-benefit analysis.

The end result is that Wallsten and Korsec find the total cost of the war exceeding $1 Trillion and avoided costs (or benefits) of more than $400 billion.

Others have attempted similar costs benefit analysis and come up with slightly different numbers.  You can change the assumptions Wallsten and Korsec make and see how the results change at www.aei-brookings.org/iraqcosts

Wallsten and Korsec summarize the analysis nicely when they state:

“…hardly anyone would argue that this sort of analysis alone should be used do decide whether to go to war or when to leave it.  But monetizing the costs and benefits does offer a vital perspective.  Is continuing to fight with the hope of bringing democracy to Iraq worth another $600 billion?”

To put these numbers into perspective, the United States federal government plans to spend $2.7 trillion dollars next year.  The U.S. federal government budget deficit will be around $325 billion this year and the U.S. economy is about $13.2 trillion of annual GDP.

Economists are doing similar studies on the current Middle East crisis.  How much will it cost to rebuild Lebanon and who is going to pay for it?  I discuss some of these issues on the first Macro Update pod cast.  See: 

http://media.mccombs.utexas.edu/MacroUpdates/Macro1.wmv

I hope you find it as useful as the written updates.

All the best,

MBrandl