Is it true that war is good for the economy?

On many occasions, surely many of us have heard that war stimulates economic activity. It has even been said that thanks to it, technological advances have been achieved that today improve our quality of life, but is this true?

War as an engine of growth

Wars often lead to an extraordinary increase in public spending, which can have beneficial effects for many sectors of the economy

Let’s go to the starting point. When it is said that war is good for the economy, it is clear that we are only talking about wars in which one country invades another and comes out the winner. Any other scenario (if one country invades another and fails, or is invaded, regardless of the outcome) will naturally be detrimental. Therefore, war could only stimulate the economy of a country when it achieves a military victory, and the conflict does not take place on its territory. A case, for example, like that of the United States in the two world wars.

Starting from that point, the reasoning is as follows: war increases public spending, not only on weapons, but also on all kinds of supplies for the army. Sectors such as textiles, pharmaceuticals or food, usually benefit from the orders that come from the Government. Therefore, seeing increased demand creates an incentive to increase production. This normally leads to expanding production capacity, stimulating investment and also increasing the demand for machinery and technology.

In addition, the mobilization of workers to the war front leaves their jobs vacant, in an environment where aggregate demand has increased due to public spending. This means that the unemployed will have many more opportunities to integrate into the labor market, leading to a reduction in unemployment. This phenomenon may even be accompanied by an increase in wages.

United States in World Wars

In just 5 years, the US economy went from depression to full employment

USA Wars Unemployment

The case of the United States that we have mentioned is, for the defenders of this position, the most paradigmatic example. As we can see in the graph above, the two world wars led to a very marked reduction in unemployment.

In the Second World War this contrast is even more pronounced, since in 1939 the country was still plunged into the Great Depression and had an unemployment rate of 17.2%, reaching a minimum of 1.2% in 1944. This means that in just 5 years, the US economy went from depression to full employment.

The example of the United States is, for many people, proof enough that war can be an engine of economic growth. But if we do a deeper analysis, we will see that this is not the case. Let’s start with the first premise of this reasoning, the public spending multiplier.

Does the public spending multiplier work?

The public spending multiplier in wars usually works only in the short term, and only if the government issues debt or prints money.

As we mentioned before, the idea is that by increasing state spending on weapons and supplies, many sectors will increase production, investing in their companies and hiring more workers. In turn, the benefited employers and workers will have more disposable income to spend on other things, which will increase demand in other sectors.

This growth process is known in economics as the public spending multiplier. Thanks to him, the economy as a whole would be fueled by the war.

Now, let’s remember that this can only happen if the government runs a deficit or prints new money. Otherwise, if it finances the war by raising taxes, it is difficult for there to be growth, because it will benefit some sectors at the cost of punishing others. In that case, there would be a process of income redistribution, but not growth.

inflation and debt

Inflation imposes cuts in the standard of living of people, and especially of the most humble, since they dedicate almost all their income to consumption

And what happens if the government finances the war with a deficit? Doing so avoids tax adjustments in the present, but not in the future. Let us remember that the deficit is covered by issuing public debt, and the debt is nothing more than a future sacrifice. Therefore, it is possible that the economy can grow in the short term, but in a few years the Government will be forced to cut spending or raise taxes. On occasion, these adjustments have even ended up generating recessions that have made them lose the income earned during the war years.

The third option, monetizing the deficit, is no better either. This alternative consists of the central bank printing new money and with it the expenses of the Treasury are financed. In this case, the problem lies in the pressure on prices that this generates. Above all, if the increase in the money supply is greater than the growth potential of the economy.

In fact, for this reason it is common for wars to cause periods of inflation. The reason is that as the money supply increases, aggregate demand increases. The problem is that, at the same time, the mobilization of workers at the front is causing production to drop in many sectors. There is then a situation in which people have a lot of money in hand and few products to buy in stores. And as often happens in such cases, prices rise.

Inflation imposes cuts in the standard of living of people, and especially of the most humble, since they dedicate almost all their income to consumption. For this reason, many economists have pointed out that inflation is a disguised tax. Here, it is another way for governments to finance wars, at the cost of impoverishing the population.

destruction and reconstruction

The cost of rebuilding Afghanistan has exceeded 5 times the country’s GDP in 2021

On the other hand, wars also tend to have a very destructive effect on the economy of the affected territories, beyond the undoubted tragedy on a human level. In them, not only physical capital is destroyed (factories, infrastructure, etc.), but also a large amount of human capital is lost: people who lose their lives, flee to other countries or are recruited to fight and, in a way or another, they stop contributing their work and knowledge to the economy.

Therefore, taxpayers not only have to bear the cost of the war, but sometimes also have to pay for the subsequent reconstruction. In short, governments force people to finance the destruction of a factory, for example, and then tax them again to rebuild it.

Sometimes the cost of reconstruction is enormous and it takes several years for the country’s economic capacity to return to pre-war levels. In Europe, for example, the Marshall Plan cost about $13.3 billion (about $103.4 billion today, adjusting for inflation). The reconstruction of Afghanistan had an even higher cost, some 104,000 million: a figure that quintuples the country’s GDP estimated for 2021 (20,460 million).

The broken window fallacy

The merchant could have spent that money on something else, and now he will stop because he will have to buy a new crystal

In addition, defenders of the idea that war is good for the economy sometimes forget a very important element in their analysis. This is the broken window fallacy, formulated in the 19th century by the French economist Frédéric Bastiat.

In a nutshell, we can summarize this hypothesis by imagining that a child breaks the glass of a shop, forcing the shopkeeper to buy a new one. There will be people who think that this can be beneficial, since the glazier will see his sales increase and, in turn, with that money he will demand products from other sectors.

However, as Bastiat argues, the fallacy is that opportunity costs are not considered. That is, the merchant could have spent that money on something else, and now he will stop doing it because he will have to buy a new crystal. In the end, the opportunity cost and the glazier’s income will tend to balance out, but one glazing will have been lost. In other words, if we compare the costs and goods produced with that income, the net balance for the economy will be negative.

The same goes for wars, which in the end are nothing more than the example of the broken window on a much larger scale. In war, physical capital is destroyed, and all the resources used to recover it will no longer be spent elsewhere. In the end, if we consider these opportunity costs, the economic balance of a war is always negative.

Adjustments and mismatches

The diversion of resources due to war generates imbalances at the macroeconomic level that later generate recessions and unemployment

Lastly, we must not forget that large-scale wars usually generate a diversion of resources towards sectors that in times of peace would not be in such high demand. First, because they will stop producing goods and services that people usually demand. But in addition, other products that only the Government demands will be produced in greater quantity.

In fact, going back to the graph of unemployment in the United States, we can verify this fact in historical experience. As we can see, after the two world wars there were strong spikes in unemployment.

This was due, above all, to the return of millions of soldiers to the labor market in the midst of a complete reconversion of the economy. To do this, it was necessary to disinvest and lay off workers in sectors linked to the war, while resuming the production of goods and services that were most in demand in times of peace.

All this, added to the fiscal adjustments to pay the debt issued during the war, gave rise to important recessions (1921, 1945-1947, 1949, 1954). The Marshall Plan, according to some economists, would have been precisely a way of softening this adjustment, artificially maintaining part of the production of the US economy in the first years after the war.

In conclusion, we can say that war, in addition to the human tragedy that it implies, also entails economic losses. The supposed benefits, as we have seen, do not usually last over time and usually lead to macroeconomic imbalances that later have to be paid for in the form of recession and unemployment.

For this reason, it is worth remembering that, although the most valuable thing is human lives, the economy also suffers from war.

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