Microeconomics of War
10 February 2015 at 11:16 am Peter G. Klein 1 comment
| Peter Klein |
The old Keynesian idea that war is good for the economy is not taken seriously by anyone outside the New York Times op-ed page. But much of the discussion still focuses on macroeconomic effects (on aggregate demand, labor-force mobilization, etc.). The more important effects, as we’ve often discussed on these pages, are microeconomic — namely, resources are reallocated from higher-valued, civilian and commercial uses, to lower-valued, military and governmental uses. There are huge distortions to capital, labor, and product markets, and even technological innovation — often seen as a benefit of wars, hot and cold — is hampered.
A new NBER paper by Zorina Khan looks carefully at the microeconomic effects of the US Civil War and finds substantial resource misallocation. Perhaps the most significant finding relates to entrepreneurial opportunity — individuals who would otherwise create significant economic value through establishing and running firms, developing new products and services, and otherwise improving the quality of life are instead motivated to pursue government military contracts (a point emphasized in the materials linked above). Here is the abstract (I don’t see an ungated version, but please share in the comments if you find one):
The Impact of War on Resource Allocation: ‘Creative Destruction’ and the American Civil War
B. Zorina Khan
NBER Working Paper No. 20944, February 2015What is the effect of wars on industrialization, technology and commercial activity? In economic terms, such events as wars comprise a large exogenous shock to labor and capital markets, aggregate demand, the distribution of expenditures, and the rate and direction of technological innovation. In addition, if private individuals are extremely responsive to changes in incentives, wars can effect substantial changes in the allocation of resources, even within a decentralized structure with little federal control and a low rate of labor participation in the military. This paper examines war-time resource reallocation in terms of occupation, geographical mobility, and the commercialization of inventions during the American Civil War. The empirical evidence shows the war resulted in a significant temporary misallocation of resources, by reducing geographical mobility, and by creating incentives for individuals with high opportunity cost to switch into the market for military technologies, while decreasing financial returns to inventors. However, the end of armed conflict led to a rapid period of catching up, suggesting that the war did not lead to a permanent misallocation of inputs, and did not long inhibit the capacity for future technological progress.
Entry filed under: - Klein -, Business/Economic History, Entrepreneurship, Innovation, Myths and Realities, Public Policy / Political Economy.
Organizations and Markets 
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Fred Thompson | 14 February 2015 at 4:45 pm
I have never known of any Keynesians who believed that war is good for economies, Keynes especially. War is inherently wasteful. As the saw goes, the only thing worse than winning a war is losing one. And that’s probably true only if your country suffers extensive physical damage (recovery from the Revolutionary War took at least a decade and South didn’t recover for 20 years or more after the Civil War; the War in Viet Nam did more damage to the winners than to us). Rather, the point Keynesians make is that, in the US, the increase in aggregate demand fueled by government purchases after 1938 ended the Great Depression and that, despite the massive increase in government debt that occurred during the war, the huge and widespread increase in net private savings (mostly in the form of T-bills and bonds) assured rapid growth in the postwar era. Both points are arguable, of course, but they are by no means obviously wrong. There are some economic historians who attribute the rise of the West and even the industrial revolution to the internecine warfare in Europe from the 16-18th centuries. Seems doubtful to me, however, but again, not impossible.