President Barack Obama specifically linked his major strategic move, the “pivot” or “rebalance” to Asia, to the growing economic importance of the region. For example, in his November 2011 speech to the Australian Parliament, Obama said:
During the Cold War, Americans feared a direct attack by Soviet nuclear missiles and a Soviet conventional invasion of crucial allies in Europe. With the collapse of the Soviet Union, that threat faded. In the decade after the 9/11 attacks, Americans focused on the threat of similar terrorist attacks against our homeland, and the United States fought wars in Afghanistan and Iraq that involved direct combat against al Qaeda–linked enemies that sought to kill Americans. Those wars wound down in the early 2010s. With direct threats to U.S. security difficult to find, much of the American strategy debate now turns on economic issues, specifically the contention that forward U.S. military presence underpins international economic stability, hence American prosperity. This chapter argues, conversely, that foreign conflict would be unlikely to hurt the American economy, so forward military presence is unnecessary after all. Because current American strategy is based on a fallacy, the United States should change it, eschewing forward military presence in the future.
As the world’s fastest‐growing region—and home to more than half the global economy—the Asia Pacific is critical to achieving my highest priority, and that’s creating jobs and opportunity for the American people Asia will largely define whether the century ahead will be marked by conflict or cooperation, needless suffering or human progress. As President, I have, therefore, made a deliberate and strategic decision—as a Pacific nation, the United States will play a larger and long‐term role in shaping this region and its future, by upholding core principles and in close partnership with our allies and friends. Let me tell you what that means. First, we seek security, which is the foundation of peace and prosperity. We stand for an international order in which the rights and responsibilities of all people are upheld. Where international law and norms are enforced. Where commerce and freedom of navigation are not impeded. Where emerging powers contribute to regional security, and where disagreements are resolved peacefully As we plan and budget for the future, we will allocate the resources necessary to maintain our strong military presence in this region. We will preserve our unique ability to project power and deter threats to peace Our enduring interests in the region demand our enduring presence in the region.1
The strategy builds on Obama’s hypothesis that without American presence overseas, international tension and even war would hurt the American economy—so, he concludes, American strategy should deploy the U.S. military to economically important parts of the world.
The scholarly debate over American grand strategy is in a similar place. Advocates of primacy, also called “deep engagement,” argue that forward presence and lots of military activity are best, whereas supporters of the alternative strategy of restraint suggest that the United States can achieve security and prosperity better with less spending and less activity.2 Stephen Brooks, John Ikenberry, and William Wohlforth make the most systematic academic case for deep engagement, which is what they call the current U.S. grand strategy, and the major benefit that they claim for their strategy is that it promotes peace and limits the economic externalities of overseas insecurity and war. Much of their article is a response to critics of deep engagement, and in that context they write:
By supplying reassurance, deterrence, and active management, the United States lowers security competition in the world’s key regions The case against deep engagement overstates [the strategy’s] costs and underestimates its security benefits. Perhaps its most important weakness, however, is that its preoccupation with security issues diverts attention from some of deep engagement’s most important benefits: sustaining the global economy.3
Even in criticizing Brooks, Ikenberry, and Wohlforth’s position, Daniel Drezner assumes that foreign political‐military disruptions are costly to neutrals (and the United States would be a neutral in most scenarios under the alternative strategy of restraint). Drezner focuses on whether deep engagement is actually likely to prevent war in Asia under current conditions, and he concludes that, in fact, it might cause status competition and war instead.4 But Drezner casually agrees with Brooks, Ikenberry, and Wohlforth that foreign tension is a threat to American prosperity.
President Obama (like other political leaders before him) is wrong about the economic consequences of foreign tension for the United States, as are most of the academics involved in grand strategy debates. Working with Daryl Press, I have written several articles that build a scholarly, theory‐based argument against the assumption that foreign conflict imposes negative externalities on the U.S. economy.5 The core issue is that scholars and policymakers tend to overstate countries’ reliance on particular trading partners, trade routes, and suppliers of natural resources. Economic actors react to shocks by switching to the new best way of doing business, given new international circumstances. The cost of any disruption, therefore, is not the loss of a valuable economic relationship but the marginal decrease in efficiency between the “old best” and the “new best” way of doing business. In fact, neutrals can often find ways to profit from instability and war by selling to the belligerents, by expanding sales to markets formerly served by the belligerents, by lending money at lucrative rates, and by buying up overseas assets that belligerents liquidate to raise money. The net effect of a foreign war on a particular neutral country depends on whether its participation in these profitable activities outweighs the efficiency loss of shifting from first‐best peacetime economic activity to second‐best wartime patterns of exchange. In the academic work, Press and I show that the positive effects on average outweigh the economic losses for neutrals, and we also show that the United States is especially likely to be a net beneficiary, although only by a small amount that is decreasing as the U.S. external debt mounts.
This chapter extends that academic work with a simple, intuitive argument‐by‐analogy that should make clear that conflict naturally transfers wealth from the tension‐filled parts of the world to relatively peaceful, neutral parts of the world. Wars and arms races are consumption binges, and when foreigners decide to increase their consumption, they have to pay for it, buying products (at high prices) from those who are not binging. Consequently, military instability overseas does not generally present a threat to the United States, unless the United States joins the fight, starting a consumption binge of its own.6 The bottom line is that it is rarely, if ever, worth spend ing American resources to prevent foreign instability in the hope of protecting American prosperity, even assuming that such spending effectively tamps down tension. The threat of economic damage, like many other threats, is often exaggerated.
Instability and War as a Consumption Boom
Wars are many things, many of which are terrible. They are cauldrons of violence that kill and maim soldiers and civilians. They sometimes undermine the enforcement of societies’ basic rules, allowing an explosion of criminal activity. At other times, wars radically increase the power of the state, repressing citizens to force them to contribute to the war effort and stifling the free expression of political views. And civilizations’ artistic touchstones and cultural artifacts can be looted, lost, or damaged in the crossfire. Wars may sometimes be worth fighting for self‐defense, and they may sometimes promote salutary social change, but no one should ever take the cost of war lightly or be too quick to celebrate war’s alleged glory or the opportunity a war might provide to build national identity or to positively mold the character of a nation’s youth. Even international tension—the threat of war—can harm societies through the fear that it creates and through the costs of measures that governments take to prepare for war or in hopes of preventing its onset. Those effects should certainly give the United States pause about getting involved in wars or tense international relationships. At the same time, they might also stir Americans’ altruistic desires to help prevent suffering of other people around the world.
Beyond the killing and war’s political and social effects, wars also have economic consequences. For the belligerents, those consequences are mostly negative, although sometimes countries are willing to pay those costs because the alternative (e.g., surrender) is worse. Wars destroy the fruits of many years of hard work, as fighting wrecks physical infrastructure and capital goods, and that destruction reduces future productive capacity. Mobilization draws people from their civilian jobs into the military, where they continue to consume but at least temporarily stop producing. And modern combat uses munitions at a ferocious rate, equipment manufactured at considerable effort for the sole purpose of exploding downrange.
All of that is quite expensive for belligerents. Governments pay by raising taxes, although they spread out the tax burden over many years by borrowing during wartime rather than raising the taxes all at once. They also pay by printing new money, thus using inflation as an informal tax. Finally, governments pay through conscription, coercing people into the military and paying them less than the wage rate that would be required to get them to fight voluntarily. But whatever the mechanism, governments in wartime transfer resources from normal production into the war effort, which means that the belligerents’ domestic economy produces less of value to nonmilitary consumers, fewer capital goods to prepare for future domestic production, and fewer export products. In sum, war reduces belligerents’ wealth.
Some might object, though, that wars actually increase belligerents’ gross domestic product (GDP). For example, the conventional wisdom tells us that World War II finally ended the Great Depression; many people learn about World War II’s Keynesian stimulus in high school social studies classes. Although that economic benefit of World War II is certainly easily exaggerated—after all, the government rationed goods in the World War II domestic economy, and solving unemployment by putting out‐of‐work people into the military might leave everyone employed but with no more to eat or wear—the increase in total consumption during war is also real, and consumption is a key component of GDP. In fact, belligerents are converting their wealth into consumption, thereby boosting measured GDP during the war by using up accumulated reserves and by mortgaging the value of expected postwar production. It is the equivalent of a family’s deciding to spend some of its rainy‐day fund on a trip to Disney World (or charging the trip on its credit cards). Perhaps the trip is a worthwhile splurge. During the trip, the amount of money flowing through the family’s hands increases, but the family knows that it is a splurge with real long‐term costs: they cannot spend the same wealth on something else, because the consumption binge has used it up.
We can also see the war’s economic effect by looking at national investment. Income is either spent or saved, and the financial system converts savings into investment. Let’s make that process less abstract: when wars create a near‐term need for additional consumption (think of all the bullets and bombs), the investment side of the economy adapts. Firms run their machinery at 110 percent of its rated maximum, and although they continue with essential maintenance, they defer as much as possible routine maintenance, which is required to maximize the long‐term value of the equipment. Those adjustments free up capital for consumption by reducing the amount spent on investment.
Investment certainly does not drop to zero at the start of a war, but much of the investment that continues really just facilitates the transfer of a country’s savings into consumption. Some firms put a spurt of resources into investment to adapt their plants for wartime production, and some build new munitions factories as fast as they can. The spurt is short‐term investment to adapt the economy to the new wartime conditions, and the results have little long‐term economic value once the war ends. In effect, that special wartime investment is much closer to consumption than most of what we think of as investment in the peacetime economy: yes, it meets the formal definition of investment as spending designed to increase the firm’s future income, but that intended increase will last only as long as the war lasts. Firms making that sort of adjustment investment are simply trying to capture unusual, shortterm profits available during the wartime consumption binge.
Those same dynamics apply to increases in international tension short of actual war: tension adds to consumption in essentially the same way that wartime spending does. Fortunately, most countries are not at war most of the time, so their citizens do not often face war’s terrible costs, and no one should expect continuous warfare around the world if the American military withdrew its deep engagement. But most countries are fairly nervous about their neighbors, so they spend money to prepare for national defense. In general, defense spending goes up when international tension increases. If the government opts to expand the military, the additional soldiers eat, wear uniforms, use soap, and otherwise consume but do not produce. If the government spends to expand its arsenal or to develop new weapons technologies, it augments economy‐wide demand at the time of its spending. The money either comes from government borrowing—a direct shift of national savings into consumption rather than investment—or comes from current taxes, which take money from both citizens’ consumption and savings accounts. In the former case, the shift from private to public consumption has no effect on total national consumption, but if citizens pay their taxes by reducing their savings (say, the amount of money they would otherwise set aside for retirement), that payment represents a shift from private savings to government consumption of defense.
Of course, there are several ways in which defense spending may in principle increase long‐term productivity of the civilian economy, in which case that component of the defense effort would count as investment rather than consumption. For example, the training that the military provides to soldiers who serve as mechanics or information technology technicians might increase their productivity when they return to civilian life. The training period, just like a training rotation in the civilian workforce, is one in which a particular worker consumes more than he produces, so the fact that peacetime military service may increase a country’s stock of human capital does not detract from the key point in this chapter: mobilization draws on a society’s stock of wealth. That society is simply fortunate that the mobilization may sometimes have a side benefit, contributing something to the long‐run ability to restore wealth after the mobilization winds down. Similarly, the possibility that spending on research and development (R&D) for defense can have spin‐off effects that increase the long‐term productivity of the commercial economy does not alter the immediate effect of that R&D spending, which uses stocks of wealth to expand current expenditures.7 Perhaps more important, the vast majority of military training emphasizes uniquely military activities such as marksmanship and combat maneuvers, and most military spending is for consumables or the development of uniquely military products. The potential investment component of defense spending in response to a threatening international security environment accounts for, at most, a small fraction of the total effort.
Overall, the key takeaway is that tension and instability, to the extent that they increase a country’s commitment to national defense, convert national savings to current government spending, as does fighting a war. The defense effort might well simultaneously reduce current domestic production by diverting labor and capital into the military. The result is a near‐term gap between demand for goods and services and domestic supply—a gap that is typically filled by imports from international markets. That change in the pattern of trade is the main mechanism by which instability affects other economies.
The Effect of a Foreign Consumption Boom on the United States
When belligerents (or countries facing increasing international threats) increase their current consumption, how does that shift affect their neutral trading partners? In more specific terms, if tensions increase in the Asia‐Pacific region or, worse yet, if war were to break out there, how would that affect the U.S. economy? Are advocates of deep engagement right—and is President Obama right—that the forward presence of the U.S. military, assuming that it dampens foreign security competition, is a good investment of American taxpayer resources? They are not. Although in principle a foreign consumption boom could either hurt or improve the terms of trade for the boom economy’s trading partners, in practice many such binges—especially those like a military mobilization—should transfer wealth from the binging economy to its trading partners.
To make it easier to set aside the moral and military components of the question, let’s consider a different kind of foreign consumption binge, one that would have similar economic effects to a foreign defense buildup or war but that is less freighted with other concerns that might infect our economic analysis of the deep engagement proposition. For example, what if popular taste changed in China such that, all of a sudden, many people there wanted to buy a car?
The answer depends on how the changed demand affects the relative supply and demand of products that the United States wants and, therefore, its follow‐on effect on prices. If the price of U.S. exports were to increase by more than the price of U.S. imports, then the net effect on U.S. wealth would be positive; if the terms of trade changed in the other direction, though, then the new Chinese desire for cars would reduce U.S. wealth.
At first glance, then, the answer depends on whether the Chinese consumers want Chinese cars or American cars. If they want Chinese cars, then their surge in consumption changes their relative taste toward domestic production and away from imports. Domestic production of cars will use a greater fraction of the capital, labor, and land available in China, so production of Chinese export goods will drop (as production of cars for domestic consumption increases). The relative scarcity will increase the price of Chinese exports, meaning that U.S. importers will pay higher prices. Simultaneously, because Chinese consumers are spending a greater fraction of their income on Chineseproduced cars, the relative demand for American products will drop, meaning that the price of U.S. exports to China will go down. Both of those effects push in the same direction: a Chinese binge on domestic cars (or any other domestic products) would hurt American terms of trade, reducing American wealth.
But that logic assumes that the Chinese pay for their binge on domestic cars out of current income. If, instead, Chinese consumers spend some of their reserves (their savings), then they can maintain their level of demand for American products even as they buy the new cars. Using savings (or borrowing, which is just “negative savings”) to pay for the consumption boom mitigates the terms‐of‐trade effect on the United States. Chinese export goods will still be scarcer, meaning that U.S. imports will be pricier, but China could continue to buy the same noncar consumption bundle that it had previously purchased, including continuing imports from the United States that would keep U.S. export prices at their prebinge level. The terms of trade would still shift against the United States, but the adverse shift would be smaller if China drew down its savings.
That second financing scenario is a closer analogy to the situation of increased military spending: a short‐term increase in spending for an arms race or a war is unlikely to come entirely from reallocating national spending priorities. More often, governments borrow for such major expenditures to spread the cost over years of bond repayment. Of course, mobilized economies also change their consumption bundle from premobilization preferences, thus affecting both imports and domestic nondefense production. For example, during wartime, demand for luxury goods and capital goods typically drops (even demand for household capital goods—think of new washing machines and fancy televisions). Apparently, if all of the new Chinese demand were domestically produced but were paid for from reserves or borrowing, the expected terms‐of‐trade effect on the rest of the world would be negative.
Two other economic effects, though, are likely to reverse the net effect of the Chinese car consumption spree on the U.S. economy— meaning that the net effect would be positive for American wealth. First, the spending of Chinese reserves changes who will earn the profits of future production, favoring American investors. In this specific example, high Chinese savings rates mean that a significant fraction of the available investment capital in the world today is Chinese‐owned. Whether entrepreneurs and established firms all around the world get access to that capital through loans, by accepting foreign direct investment, or by enjoying lower near‐term taxes because their government funds itself by borrowing from China rather than by taxing citizens’ current income and assets, the result is the same: those companies owe a share of their future profits to China as the return on Chinese capital invested. But for China to spend on its car‐consumption binge, it must sell some investments (or forgo new investments), likely at relatively low prices (because of the pressure to sell now, at the time of the binge, rather than to hold out for the best price possible).
In economic terms, China’s new taste for increased consumption is an increase in China’s discount rate—that is, China values present consumption relatively more than future consumption compared with the relative values that it had assigned before the binge—and with the discount rate in the United States unchanged, U.S. investors will enjoy a profitable investment opportunity. So one effect of China’s dissaving is that the United States can earn investment income as China’s discount rate changes relative to the American one. That investment gain would help counteract any wealth that Americans might lose, if the terms‐oftrade effect of China’s consumption binge were negative for the United States.
This point should be even clearer if we consider a binge in a country that is a smaller saver than China happens to be today. If the country that suddenly buys a lot of new cars must borrow to fund its spending spree, then it will have to pay enough interest to entice foreign lenders to give it the money for the consumption boom. That interest is a direct cost to the consuming country, and it is a direct profit to other countries, specifically those that are net creditors in international markets. Of course, because the United States today is a net debtor, it does not stand to gain through this mechanism.
But the second economic effect that we have not yet considered means that the United States can earn income directly through trade—that is, the terms‐of‐trade shift is likely to be positive for the United States, not negative. The analysis so far has assumed that all Chinese people purchase purely domestic cars, but that assumption is most unlikely to reflect reality. To begin with, China is likely to import many raw materials and component parts of those cars, meaning that a boom in Chinese “domestic” car production will actually lead to rising Chinese import demand, thus driving up prices for Chinese imports relative to the price of Chinese exports.
Moreover, as Chinese labor, capital, and land are drawn into the Chinese car industry, Chinese domestic demand for other products— ranging from basic foodstuffs and household consumables to industrial goods and construction equipment—will be increasingly satisfied by imports. Some of the increased Chinese import demand will come in industries that are entirely unrelated to the car industry. And final ly, some or all of the Chinese taste for cars might actually be a taste for foreign cars, meaning that the consumption binge might directly increase demand for imports in China (that is, for exports from the United States). If the net effect of China’s car‐buying binge were to increase Chinese import demand, through the combination of buying raw materials, components, and foreign cars, then the obvious termsof‐trade effect would be for the price of Chinese imports to go up and the price of Chinese exports to drop. That terms‐of‐trade effect is bad for China and, because the United States is China’s trade partner in this scenario, it is good for the United States: the price of U.S. exports would rise, whereas the price of U.S. imports would fall.
This final scenario is also likely the closest analogy to a possible increase in defense spending in Asia because of rising tension or even war. Many countries in wartime produce the lion’s share of their small arms munitions domestically, but unlike the United States, many countries also import a significant fraction of their military equipment, ranging from guns to fighter aircraft and tactical missiles. Even the bullets may be made from imported raw materials, because few countries have sufficiently large mining and smelting industries to keep up with voracious wartime consumption. And the cost of defense mobilization is not felt only in the defense sector of the economy: countries that mobilize need to import food and goods for both soldiers and civilians. Even as demand for luxury items drops, demand for basic products increases. Not every foreign country is well positioned to take advantage of the mobilization‐induced consumption binge, but, on net, because the belligerent (or scared) economies increase their overall consumption, neutral countries enjoy an economic benefit.
Of course, in many ways this thought experiment about Chinese people developing a taste for automobiles is already happening in the real world: many are buying their first cars now. And the issue is not entirely free of noneconomic concerns, as many Westerners fear that more Chinese driving will wreak havoc on the environment and will drive up gasoline prices around the world. But with regard to the economic effect of increased Chinese car ownership, it is safe to say that most American companies and workers are glad for the expanded Chinese demand. They think they will make money. And even the Obama administration agrees, as seen in its repeated exhortations to the Chinese government to encourage Chinese people to save less and consume more.8
When we take the issue out of the context of military strategy— but keep the same economic factors in play—even advocates of deep engagement recognize the economic logic at work. The thought experiment about Chinese car consumption is just a simple analogy: there is nothing special about cars or about China being the country on a consumption binge. The logic can apply to any country and any product or basket of products. An increase in foreign consumption is often good for the U.S. economy.
The U.S. Strategy of Buy Low, Sell High
The economic benefit of a foreign consumption boom depends on the continued ability to trade with the country that is temporarily buying more, so an obvious question is whether instability and war would interrupt trade. Perhaps a consumption boom in peacetime differs from wartime consumption, because war and instability might sever economic connections with the rest of the world—that is, maybe Chinese demand for cars benefits the United States, but Chinese demand because of military mobilization would not.
It is relatively easy to see why foreign direct investment might flee from a tense security environment: a mobilizing country is likely to raise taxes on fixed assets such as factories, sooner or later taking some or all of the value of the fixed investment away from its owners, whether foreign or domestic. Furthermore, if the country where the factory is located ends up fighting, the factory also risks destruction during the war. On balance, though, that effect is likely to help the investment environment outside the tense region: foreign investors who are pulling capital out (almost certainly at a loss relative to their investment’s prewar value) will not cease investing altogether but instead will invest elsewhere—in safer places. Sending capital to safer regions of the world will increase investment and spur production and innovation, effectively enhancing economic opportunity and increasing wealth in the rest of the world. At the same time, because the government in the tense region needs to spend more on national security, its taxpayers will need to generate liquidity by shifting out of overseas investments, meaning that they will be forced to sell off their investments at low prices to investors from the rest of the world. During the first half of the 20th century, British investors sold a substantial fraction of their overseas holdings, often to Americans, as a way to help pay for British arms racing and wars with Germany.9 Thus, tension gives investors in the rest of the world an opportunity to “buy low,” which is generally considered a good route to making money.
Trade relationships, conversely, mostly continue during times of tension and war, although the specific products exchanged tend to change relative to what gets traded in more peaceful times. Trade exposes assets to destruction only for short periods (when ships and trains are near the war zone), and governments that need imports to support wartime consumption cannot afford to drive away those goods by taxing them.
Sometimes, foreign shippers are willing to take the risk of trading in the danger zone, thus paying higher costs for insurance or damage repair but passing those costs on to the belligerents, who are willing to pay dearly for the products that they need. For example, the Nordic countries’ shipping industries earned very high profits during World War I.10 Other times, neutral shipping avoids the war zone, so belligerent‐owned ships travel to neutral ports to conduct business. For example, Iranian oil tankers made many runs to deliver oil to friendly ports during the 1980s’ Tanker War with Iraq, so the belligerent bore the risk of destruction and stayed connected to the global market.11 Either way, transportation generally continues, and it gives neutral industry a golden opportunity to “sell high” during tense and conflictual times overseas. Selling high is also generally considered a good route to profit. Trade and investment are the means by which foreign tension and war transfer wealth to more peaceful neutral countries. They are the mechanism by which instability reallocates the global economic pie. But instability also has a simultaneous effect on the size of the pie: as factories are destroyed and workers are killed in a war, the total amount of production possible in the world shrinks. Moreover, as the war shifts savings into consumption and war‐oriented investment, the global pool of capital available to build new factories and to innovate, hence to create future productive capacity, shrinks too. At some point, we can imagine a war that is big enough relative to the size of the global economy that its effect of shrinking the pie overwhelms its effect of reallocating the slices of the pie from the belligerents to the neutrals. In principle, neutrals could become worse off. But in practice, the world economy is sufficiently bigger than the amount plausibly involved in a future regional war—especially as long as the United States (and probably Europe) stays out of the war—that the reallocation effect is very likely to dominate.
Neutrals seem to have made out well even in the world wars of the 20th century (while most belligerents suffered terribly).12 Only a nuclear war seems likely to change that conclusion, and if a nuclear war happens, the world would have bigger, more immediate problems than its effect on long‐term investment in global productive capacity.
To be clear, this analysis suggesting that overseas tension and war are unlikely to hurt the American economy is not a brief for encouraging foreign instability. For many reasons having nothing to do with economics, war anywhere in the world is abhorrent. And even in economic terms, a U.S. policy to foment tension would be too Machiavellian and risky: mucking about in foreign politics would significantly increase the probability that the United States would get involved directly in any crisis or war, and the costs of such involvement would overwhelm the relatively minor economic benefits of neutrality during foreign conflict. Besides, such a policy would violate core American values. It is not the policy of the kind of nation that we want to be.
Interventionist foreign policy need not be cruel to be unwise. Advocates of the grand strategy of primacy or deep engagement have benign intentions, hoping to spread stability rather than tension, and they genuinely hope to encourage global economic growth at the same time that they hope their strategy would protect the American economy. But their policy exposes the United States to foreign conflicts in the hopes of tamping down instability, potentially at significant cost, in the mistaken belief that failure to deeply engage would threaten substantial economic harm to the United States. That threat in reality does not exist.