TCS Daily

Our Military Economy

By Michael Feroli - April 10, 2002 12:00 AM

When John Grisham passed Tom Clancy on the bestseller lists in the early 90's, it was taken as a sign that in the post-Cold War era America's attention would be focused on the drama of the courtroom rather than the battlefield. Though Grisham still outsells Clancy, the topic of national security has reentered the national conversation in a way unseen since the fall of the Soviet empire. Along with this renewed interest have come questions about how the ongoing military buildup will affect the nation's economy.

The economic impact of this buildup can be divided (rather unimaginatively) into the short-term and long-term effects. It is almost unanimously held that the short-term consequence of a large increase in military spending is a jump in aggregate demand which tends to raise the overall level of economic activity. Of course in economics nothing is unanimous. Some have argued that an increase in defense spending will reduce consumption by households one-for-one and that even a deficit-financed military buildup will cause consumers to pare back spending as they calculate the increased future tax burden that a higher national debt implies. Not surprisingly, this dissenting view, with its conception of pure homo economicus, is overwhelmingly rejected by the data. Just consider the thankless task of explaining the economic expansion in the first half of the 1940's without reference to the war mobilization.

While the Pentagon can give a boost to the economy in the near-term, it's unlikely that military spending is a major factor in causing the economy to pull out of the recent recession as quickly as it did. In the fourth quarter of 2001, the only quarter so far in the war on terror for which we have output data, the economy grew at a much better than expected annual rate of 1.7%. Since firms in the fourth quarter largely chose to sell out of inventories rather than ramp up production, output grew less than sales, which expanded at an annual rate of 3.8%. Defense spending accounted for only about 0.3 percentage points of this 3.8% increase in final demand. The lion's share of sales growth in the fourth quarter came from consumer purchases of durables, which contributed 2.8 percentage points to the pickup in demand. Of course, this is not to say in the future the war on terror won't have an impact on demand, but rather that the early phases of this war have not been of the same economic magnitude as past conflicts.

The more controversial aspect of military spending is its long-term effect on economic growth. Few doubt that defense expenditures constitute a use of society's resources that, in a peaceful world, could more usefully be devoted to things people actually want and enjoy. What is in question is whether some portion of the resources that society commits to defense will ever find their way back to the consumer economy, in particular through growth-enhancing technology created by defense research and development expenditures. One obvious example of defense R&D that found its way back to the civilian economy is the Internet, originally created by the Pentagon as a post-nuclear attack communications system. In fact, the military provided much of the R&D funding in the crucial early stages of development in many of the fields in which the U.S. enjoys technological preeminence, including avionics, semiconductors, and advanced ceramics.

There's good reason to believe that the investment into basic science research that the military has subsidized over the past half century would not have been undertaken by the private sector unassisted. The simple reason is that benefits of investing in knowledge creation tend to spill over into sectors that did not make the investment. While institutional devices such as patents can go along way toward equating the private and social gain of investing in research, these devices are often imperfect. Knowledge, once created, can be reproduced at virtually zero cost. So conceptual breakthroughs, such as the invention of the mathematical field of linear programming under the patronage of the Air Force, tend to create returns to society that are much higher than the returns accruing to private researchers. This is the rationale behind federal support for R&D in such agencies as NIH and NSF and the rationale for thinking that military R&D may have positive spillover effects on the overall economy.

Two objections are sometimes raised against the proposition that military technological research can stimulate economic growth; first, military R&D "crowds out" civilian R&D, and second, government R&D expenditures would do more to induce growth if they were focused on civilian rather than military applications.

The crowding out argument assumes that resources which can be devoted to research, in particular research scientists, are in fixed supply in the short-run. Thus as the military increases expenditures on research, the price of these research resources will increase and so civilian expenditures on research will decrease. The structure of this argument is sound, yet technological growth is more usefully analyzed in a long-run perspective, and in the long-run resources will shift into the R&D sector if the prices those resources command increase. Furthermore, federal R&D contracts with university researchers usually include funds for the overhead of university research facilities. Thus these research dollars have the effect of subsidizing the overall operations of American universities which, in the final analysis, are the crucial institutions in the development of the country's research resources, both civilian and military.

The second objection argues that R&D directed toward civilian uses would do more to enhance economic growth than military research spending. This argument is completely correct and completely misses the point. Military spending, R&D or otherwise, is determined by the level of threat posed by our enemies. Noting the positive economic spillover effects simply allows for a more accurate accounting of the true cost of security.

The writer is an economist living in New York.

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