EFFECTS OF WAR ON ECONOMY

Abstract

This project aims to study the relationship between war and economy and the
effects each of them as on the other. Economists around the world are divided
over the impact war has on an economy. One class of economists argue that a
war usually has a positive impact on an economy, death and destruction
notwithstanding. The other firmly believes that wars are ultimately bad for the
economy. This paper attempts to look into both sides of the issue and conduct an
analysis, through secondary research, on the positive and negative effects a war
has on an economy.

Introduction

War has been one of the constant features of human history. The frequency of
wars has increased as time progressed, with the past century alone witnessing
more than a hundred skirmishes. Along with the increase in the number of wars,
the gory and bloody nature of the war has terrified humanity and made the world
a more insecure place to live in. Economists have often tried to assess the cost
of war in economic and monetary terms, from the defence expenditure of a
nation to the cost of walls wreaked in a city that has been attacked. Any
representation of a country’s economic growth will show that wars, strife and
other similar unrests have been major points of change in the growth of an
economy. We can argue that armed struggle is often a cause of a paradigm shift
in the way an economy runs or is run.

Assessing an economy before, during and after a war is a very good mechanism
to study various types of policies applied in an economy and the various
approaches to running an economy. The major wars in the 20 th century were the
two world wars. These wars did in fact witness an amazing economic and
technological growth in many countries, especially the USA and to an extent
Germany and the erstwhile USSR. But a huge volume of examples to argue on
the other side can also be presented. Iraq and Afghanistan are present day
examples which are staring at our face. History offers many more similar
examples of countries whose economies have been ruined by war. Economists
mostly treat wartime periods as natural macroeconomic experiment, from which
conclusions can be drawn keeping in mind the various factors prevalent during
the time period. It is one of the few instances in which economists have come
close to having a “laboratory setting” to conduct a large-scale study. The paper
is a general assessment of the effects of war on economy, keeping in mind a few
specific cases.
The Good

Historians and economists have waxed and waned with regard to the effect of
military expenditures on the U.S. economy. Charles and Mary Beard in The Rise
of American Civilization (1927) and Louis Hacker in The Triumph of American
Capitalism (1940) argued that the Civil War destroyed not only slavery but also
the Southern “slaveocracy”, thus allowing the balance of political power to shift
to Northern industrialists and hence spurring American economic growth. Prior to
these accounts, the classical economists (Adam Smith, David Ricardo, and
Thomas Malthus) were concerned with the effects of war on aggregate demand.
The eighteenth and early nineteenth centuries saw very high levels of military
expenditures in Britain, for example, which these economists believed had a
negative impact on industrial growth. The national debts resulting from war,
Smith believed, “enfeebled every state ….. enriching in most cases the idle and
profuse debtor at the expense of the most industrious and frugal creditor.”

Critics of the capitalist system in more recent years have argued that capitalist
societies are prone to periodic stagnation, and that only wars of the magnitude
of World War II are capable of curing massive unemployment. Alternatively,
liberal economists argue that war, and particularly World War II, was the
strongest influence establishing Keynesian economics as a guideline and a
justification for U.S. government fiscal policies for the post-war era—policies that
led to widespread employment, high earnings, and a modest measure of income
redistribution. Even some strong opponents of the Vietnam War began to argue
in the mid‐1990s that full employment was only possible in the late 1960s
because of that war.

If the effect of military spending during the war years is the most obvious point
of impact on the economy, the most lasting one has to do with veterans' benefits
paid after the war to veterans and their dependents. Veterans' benefits have
been paid for every war since the American Revolution. They amounted to about
two‐thirds of the total dollar cost of the Revolutionary War; more than half the
cost of the War of 1812; and 3.7 times the cost of mobilizing the Union forces in
the Civil War. Surprisingly, these benefits continued to rise for about forty to
sixty years after the end of each of these wars and did not cease until well over a
century later. Benefits for Civil War veterans and spouses ceased only in the
1980s; World War II benefits will be paid until sometime after 2070. To date,
World War II veterans’ benefits have amounted to more than $300 billion, only
somewhat less than the original cost of that war in current dollars. Clearly,
veterans' benefits have been a major infusion of funds into the economy, and
were the major direct federal subsidy to families prior to the welfare state.
Compared to other countries, American soldiers and their dependents received
benefits much earlier (since 1783) and in more generous amounts than
elsewhere. The average payment to a still‐living World War I veteran, for
example, was $6,500 in 1992. Confederate soldiers, of course, received no
federal veterans’ benefits, although some southern states sought to add them.

Case study: History of combat by the United States of America.

As the United States have been involved in a major number of wars in the
twentieth century, it is reasonable to take its history with regard to warfare and
assess the impacts those wars had on its economy.

Although the United States lacked the ability to mobilize the necessary resources
to achieve its goal of conquering Canada in the War of 1812, the nation suffered
little loss of life and—despite the burning of Washington—property destruction.
Financed mostly by the sale of bonds and new excise duties, the war also
created relatively few financial problems. The British blockade and pre-war trade
embargoes led to a revival of American manufacturing and a post-war
commitment to maintain self‐sufficiency with protective tariffs.

The impact of the War of 1812 on the economy was somewhat greater than
some of the earlier wars it had been involved in, like the Revolutionary War. The
War of 1812 has been credited with providing many long-term boons to the
American economy. British blockades of U.S. ports almost dried up American
exports. This also meant that foreigners could not trade with the United States—
hence encouraging import substitutes, especially textiles. Some see this
development as the first faint beginnings of industrialization in America.

A stronger administration and an improved economy enabled the United States

in 1846 to project its military power deep into Mexico and the Pacific coast. With
all but two battles fought on Mexican territory, the United States suffered little
property damage during the Mexican War. Its casualties were light as was the
financial cost of a war that increased the national domain by over a half million
square miles.

To achieve its aims during the Civil War, the Federal government relied upon
bond sales, heavy taxes, minimal issue of “greenbacks,” and generous contracts
to mobilize its superior economy sufficiently to defeat and occupy an area
roughly equal to western Europe. Despite unprecedented governmental controls
over railroads, foreign trade, agriculture, and business, the Confederacy
repeated Revolutionary War financial errors and failed to make effective use of
its limited resources.

Along with 260,000 deaths, the Confederacy suffered virtual economic collapse.
Military operations and the end of slavery devastated Southern agriculture and
destroyed its rail net and nascent industry. Despite a slowdown in the growth
rate of the entire nation's economy, wartime inflation created the illusion of
greater growth in the Union, whose farmers, meat packers, canneries, railroads,
canals, and farm implement makers made substantial profits.
The loss of over 600,000 lives and the intangibles make it difficult to assess
precisely the Civil War's economic legacy. What talents fell on the battlefield?
What benefits resulted from post-war investment of wartime profits? From skills
businessmen acquired when filling large military contracts and distributing goods
to far flung armies? From the electoral triumph of a political party committed to
using Federal power to promote economic development?

The impact of the Civil War on industrial growth has been much studied.
Traditionally (that is, in major studies of the topic from the 1920s to the 1950s),
the Civil War was seen as a spur to industrialization. Charles and Mary Beard as
well as Louis Hacker took this position, arguing that by destroying the Southern
“slaveocracy”, the Civil War shifted the balance of political power to the
industrial North, and the Northern Republicans passed laws that stimulated
industrialization. In a classic article in 1961, Thomas Cochran argued that the
rate of real growth in value added in U.S. manufacturing actually slowed during
the Civil War decade. Pig iron and bituminous coal production—key elements in
the manufacturing process—also declined or showed little growth during the war
years. Railroad track growth rates were retarded, immigration declined, bank
loans dropped, construction slowed. Nor did freeing the slaves help
industrialization because former slaves largely became sharecroppers.

Other writers have emphasized the continuity of industrial development prior to

and after the Civil War. Factory building and mechanized transportation were
continuous and rapid, both before the war and after. Industrial “takeoff” was well
underway before the war started, Walt Rostow has argued, and industrial profits
during the war largely lagged behind price increases. Real wages fell about 20
percent during the war. Government borrowing certainly drove up interest rates,
as public debt rose from $65 million in 1860 to $2,678 million in 1865. In short,
Cochran's position that the Civil War actually retarded industrial growth has
become the dominant one, but it needs to be modified by the less quantifiable
view that changes wrought by the rise of the Republican Party probably did
enhance the “capitalist spirit,” and certainly a host of Supreme Court decisions
over the next three decades favoured industrialists over labour and farmers and
legitimized a high protective tariff.

Despite the greater intensity of World War II the parallel circumstances, policies,
and consequences of both it and World War I justify joint assessment. Particularly
in World War II, an effective, if gradual, mobilization of its industrialized economy
offered the United States a range of strategic options and permitted it to fight a
modern, mechanized war, eventually on several global fronts, while also
sustaining the military efforts of its allies.

World War I marked the transfer of world economic leadership from Europe, and
especially Great Britain, to the United States, and quickly proved a boon to U.S.
industrial economy. Early on, America became the arsenal as well as the granary
for the Allied powers. To achieve this end, the government quickly seized control
of the economy and passed laws to fix prices, shifted plants to war needs,
established minimum wages and maximum hours, and imposed controls on
foreign commerce. By 1918, the government had absolute control over industrial
raw materials, the railway system had been nationalized, and marginal mines
had been brought into production. Estimates of the growth of GDP during
wartime are controversial, ranging from 5 to 18 percent, but by 1920 the high
levels of wartime employment in manufacturing had been reached again, thus
preparing the nation for a period of prosperity. Finally, World War I changed
America's role in the world economy from a debtor nation to a creditor nation,
and clearly established the United States as the foremost industrial nation in the
world.

The United States, confounded by economic downturns in 1914 and 1938, first
felt the economic stimulation of war while still a neutral. By wars' end, the nation
enjoyed unprecedented prosperity, a booming economy pressing on the short‐
term limits of its capacity, and a vast improvement in its global economic and
financial position. In nominal terms, both wars doubled the gross national
product. By 1916, the United States had become a creditor nation and seized
many formerly European markets in Latin America. By the end of World War II,
due to allied losses, America's wartime industrial expansion, and new technology
resulting from scientific research and engineering development, the United
States dominated its former economic competitors.

While most traditional economic sectors benefited from mobilization, World War I
prompted the United States to create a chemical industry, and both wars led to
vast expansions of shipbuilding and aircraft production. To meet the wars'
demands and compensate for loss of workers to the armed forces, agriculture
increased its mechanization and applied new technologies that boosted output.
Though making limited use of government corporations, Washington gained the
compliance of private producers largely through controlling scarce raw materials,
banning production of inessential goods, offering lucrative contracts, subsidies,
and tax breaks; patriotic appeals, and suspending antitrust laws. To win workers'
cooperation, the government encouraged unionization and placed labour leaders
on various government boards, while overlooking use of various devices to
escape the worst effects of wage controls. By wars' end, the War Industries
Board of World War I and the World War II's Office of War Mobilization sought to
coordinate economy and allocate production among the armed forces, the
civilian sector, and the Allies. Washington financed both world wars largely
through new taxes and loans. Though applied too gradually in both cases,
government management of the economy—to include rationing of consumer
goods in World War II—reinforced sound war finance and helped limit wartime
inflation.

World War II solved the problem of the Great Depression, the greatest economic
calamity America has ever faced. Even before the attack on Pearl Harbour,
unemployment and industrial sluggishness had almost vanished in the wave of
increased defence spending, and by 1945 the real GDP per capita had almost
doubled from its pre-war base. Expenditures of the War Department rose from $2
billion in 1939 to $80 billion in 1945. The impact of industrial war spending was
most dramatic in the Far West, and especially California, which became the
fulcrum for the naval war against Japan. By the end of the war, California was the
centre of the aircraft industry and Los Angeles had risen from a film industry city
to a centre of shipyards and aircraft plants. In fact, World War II really set the
stage for the West to become the fastest‐growing region in America since 1945.
Overall, by 1944 the United States had indeed become the “arsenal of
democracy,” outproducing both Germany and Japan almost twofold, boasting the
world's largest navy and air force and one of the world's largest armies.

The War Production Board controlled all raw materials and finished goods, both
military and civilian, and the Office of War Mobilization and Reconversion served
as an umpire over conflicting claims of government agencies. Under their
guidance unemployment fell to 1 percent by 1944; industrial employment for
blacks and other minorities jumped dramatically; and about half of all new
civilian jobs were filled by women. Almost half of all men over the age of sixty‐
five were in the workforce during that war, compared to 2 percent in the 1990s.
The war also saw a tremendous increase in union membership, but union leaders
had to accept modest wage increases and agree to a “no‐strike” pledge. A
government freeze on prices, wages, salaries, and rents made inflation less of a
problem than in World War I, but these controls were widely resented and a
black market of troubling proportions emerged.

Great advances in technology and scientific research were achieved through war
expenditures—most notably jet engines, rocket propulsion, plastics and other
synthetics, and television and radar. Many if not all of these products would have
come about anyway, but World War II certainly speeded their development.
Medical breakthroughs, including sulpha drugs, penicillin, and quinine, were also
a consequence of the war. Most obviously, nuclear energy, with all its positive
and negative consequences, was a direct result of the development of the
atomic bomb.

World War II industrial mobilization was paid for by taxes and borrowing in about
equal proportions. The national debt rose from $41 billion in 1941 to $271 billion
in 1946, or 114 percent of GDP. It has never been paid off, although it has been
paid down to 52 percent of GDP (which includes non-war debt as well). Few have
questioned the value of this investment. The war also altered fundamentally our
attitude toward government, making Keynesian fiscal policy the preferred
approach to industrial development. With the passage of the Employment Act
(1946), the federal government became responsible for maximum industrial
development, employment, and purchasing power. Consequently, the public has
come to expect full employment and an ever‐growing economy.

Although early Cold War programs like the Marshall Plan had a limited
stimulating effect on the economy, the four‐decade confrontation with the Soviet
bloc began to produce significant economic effects with the onset of the Korean
War and concurrent American rearmament, which led to sustained high levels of
defence spending and the nation's first large peacetime armaments industry.
Many feared this military‐industrial complex might threaten democracy or
prolong Soviet‐American hostility for the benefit of the military, arms
manufacturers, defence workers.

When the Cold War turned “hot” in Korea, defence spending, a civilian buying
spree prompted by recent memories of wartime shortages, and a delay in tax
increases and governmental controls resulted in a burst of inflation. By 1951,
however, a tax hike, wage and price controls, and a significant spending‐induced
increase in the gross national product (25 percent above the 1948 level) kept
inflation below 3 percent.

Sharp limits on defence spending during the administration of President Dwight

D. Eisenhower cut that rate in half—and contributed to three recessions—until
the Vietnam War, when President Lyndon B. Johnson sought to manage the
Southeast Asian conflict and the Great Society domestic programs without resort
to typical wartime economic controls. By war's end, with the economy no longer
booming and the fight against inflation seemingly lost, government offered
automatic cost of living adjustments for workers and government beneficiaries
until, in the Cold War's final decade—the 1980s—high interest rates and limits on
social programs helped tame inflation even as defense spending surged during
the presidency of Ronald Reagan. With the reduction of military spending at the
end of the Cold War, many feared a major recession, but the American economy
boomed throughout most of the 1990s.