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Jewish World Review Feb. 7, 2001 / 25 Shevat, 5762

Amity Shlaes

Amity Shlaes
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Budgeting for victory: Requiem for a peace dividend -- BOTH the increase in defense spending and the looming budget deficit are in the news this week. Still, there is a connection between these two new facts of post-Sept. 11 life.

Defense spending, so necessary to fulfill America's wartime obligation, helped to create the deficit. Given a choice between budgeting for victory and budgeting for bookkeepers, President Bush is choosing the former. And who cannot understand that choice? Still, coming around the bend of history as we have done since Sept. 11, we can now see a series of larger truths about budgets, the U.S. economy, war and peace.

The biggest of these is that the federal surplus of the 1990s and the "peace dividend" from the end of the Cold War amounted to the same thing--the surplus was the financial mirror of peace. That means the new threat of terror will make it harder for America to innovate, grow and generate surpluses in the future.

Consider, first of all, the record in terms of budget numbers and nominal dollars. In spring 1989, a point when Erich Honecker was still presiding over the May Day parade from a dais in East Berlin, total U.S. defense outlays peaked at $304 billion. By the following year, the world had changed. From that point onward, U.S. defense spending began to drop and drop--hitting a low of $266 billion by 1996.

It is important to emphasize that we are talking here not about smaller increases but of something normally unheard of in the world of budgets: real dollar decreases in the amount spent. Although defense spending did rise at the end of 1990s, it remained below the 1989 high throughout the decade. This net reduction enabled the U.S., in 1998, to achieve its first surplus in three decades. To put the story another way, had defense spending continued its 1980s growth trend through the 1990s, there would have been no surplus to wonder at.

Another way to look at this is the proportion of the budget taken up by defense. During the 1990s, defense spending decreased from what today seems an astoundingly high 30 percent of the federal tax take to something like 15 percent in 2000. Relative to gross domestic product, U.S. defense spending dropped to 3.8 percent of the economy in 2000 from 6.7 percent at the end of 1990.

In other words, the U.S. economy in the 1990s became free of a burden--war, or the threat of it--that it had shouldered since the early 1940s. It could at last unknit its figurative brow, cast off irrationalities, distortions and inefficiencies and do what economies do when they are happy: innovate. Quantifying the dollar value of this period of liberty is hard but we can point to obvious factors.

The country did not have to worry about heavy security; visitors could walk the halls of Congress or universities without identity badges. Former defense-related projects such as the Internet could migrate to the private sector, where they helped to fuel growth. Technology that had been confined to museums--visible in Chicago only at, for example, the Museum of Science and Industry--was suddenly accessible to every 12-year-old. Life became all butter and no guns.

It is important to recall what a contrast this was with the Cold War years, when economic innovation and growth were monitored by a heavy-handed Washington. Think of Big Steel and Big Labor meeting President John F. Kennedy to establish market prices and wage rates. It was no accident that this command-and-control philosophy of economic management was in place in 1960, when spending on national defense represented half of all federal outlays. Even as late as the 1980s, simple private sector tasks such as export licenses were national security nightmares.

Sept. 11 has forced us back in the direction of those days. The trend is visible in budget numbers. The surplus of $313 billion forecast for 2002 disappeared in the haze of the World Trade Center; the Congressional Budget Office says there will be a deficit of $21 billion. Increases in defense spending account for some of that but the greater part of the loss--three-quarters of it--is owed to a recession that has been so accentuated by Sept. 11.

Yet more costs will come if Congress approves--as it probably will--increases in the annual defense budget for which Bush is now asking, along with hefty increases for spending on homeland security.

But what about the as-yet-unquantified damage that war will inflict on the economy in the future? One of the more obviously vulnerable areas of the economy is insurance. What premiums will companies end up paying to insure against the threat of terror?

Another is the travel industry. Even a federal bailout has not been sufficient to spare the airlines. Yet another problem is the new burden of regulation. All companies are likely to suffer under the sort of onerous prescripts we can expect from our new bureaucracy, the Office of Homeland Security.

Less discussed, but potentially very damaging, is the prospect that America will now shut the door to immigrants. These--both the legal and illegal variety--contributed to the increases in productivity the U.S. saw in the 1990s. It is too early to know precisely how much of a drag the new circumstances will impose. What is clear is that the outlook for strong growth in this new decade is less certain than it was in the 1990s and less certain than before the Sept. 11 attacks.

We always knew that the ending of the Cold War was a great good.

What a pity that it took the start of a new war--this war on terror--to reveal exactly how great.

JWR contributor Amity Shlaes is a columnist for Financial Times . Her latest book is The Greedy Hand: How Taxes Drive Americans Crazy and What to Do About It. Send your comments by clicking here.


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© 2001, Financial Times