The Rising Costs of the Iraq War Essay Example for Free

The Rising Costs of the Iraq War Essay In the 2003 Budget the government set aside ? 3 billion to cover â€Å"the full costs of the UK’s military obligations† in Iraq [1]. In the past four years the amount allocated to this ‘Special Reserve’ has steadily increased, and with an extra ? 400 million in this year’s Budget the total is now over ? 7. 4 billion. This is in addition to recent increases in general military spending. This briefing investigates the financial costs of the Iraq conflict to the UK taxpayer. It notes a significant opaqueness in the budgeting process as well as the potential for costs to continue to escalate. The financial costs of a war may not be the first consideration. War brings many costs, foremost in lives lost and damaged. However, the decision to involve the UK in the invasion of Iraq had substantial implications for UK public spending. Money spent on the Iraq war and wider ‘war on terror’ represents significant diversions from other government budgets. The lack of transparency in the UK finances is in contrast to the US, where all budgetary proposals must be scrutinised by Congress. Comprehensive information about US military spending is available and has contributed to considerable public debate. The sums spent by the US government are many times those of the UK, and there are a number of projects aimed at publicising the scale of US war spending (e. g. http://costofwar. com). The Special Reserve The 2002 Pre-Budget Report set aside ? 1 billion to enable the armed forces to prepare for the coming invasion of Iraq[2]. By the time of the Budget in March 2003, UK forces were in Iraq. The Chancellor increased the amount to ? 3 billion and it became known as ‘the Special Reserve’[3]. In the 2003 Pre-Budget Report another ? 500 million was added for financial year 2003-04 and a further ? 300 million for 2004-05; bringing the total up to ? 3. 8 billion[4]. While there was no increase in the 2004 Budget Report, another ? 520 million for 2004-05 was announced in the Pre-Budget Report of December that year[5]. The 2005 Budget Report included a further ? 340 million added for 2004-05 and ? 400 million for 2005-06[6], whilst the 2005 Pre-Budget Report included another ? 580 million . The 2006 Budget report allocated ? 800 million for operations in 2006-07 and this was followed by ? 600 million in the 2006 Pre-Budget Report. Most recently, the 2007 Budget allocated a further 400million for 2007-08. Thus, to date, the total amount allocated to the Special Reserve is ? 7. 44 billion. The Special Reserve is not only set aside for costs in Iraq, but also for â€Å"the UK’s other international obligations†[7]. However, nowhere in the public domain has the Treasury published how much of the Special Reserve has been spent, nor how much of it has been spent on Iraq. Table 2 (please see pdf file above). , which gives a breakdown of the spending of the Special Reserve, was obtained through a Freedom of Information request solicited by the Iraq Analysis Group. Of the ? 6. 44bn set aside at various times to the Special reserve by March 2006, at least ? 6. 3bn had been allocated to departments, almost the total amount possible. About ? 4. 4bn of the Reserve had been spent by the Ministry of Defence in Iraq[8] between 2002 and 2006, with at least an additional ? 156 million allocated to the Foreign and Commonwealth Office and the Department for International Development. Furthermore, the forecasted outturn for the financial year 2005-06 is larger than that of 2004-05, suggesting that costs in Iraq are still far from settling down to something approaching the spending in Afghanistan. How Much is ? 4. 4 Billion? The ? 4. 4 billion already allocated to operations in Iraq has been raised through the pre-existing tax structure, borrowing and other government revenue and consequently there exists some trade-off between the additional defence spending and other public spending options. ?3. 2 billion spent on education, for example, would be sufficient to fund the recruitment and retention of over 10,300 new teachers for ten years. In health, it would allow the building of around 44 new hospitals. The ? 6. 44 billion Special Reserve represents the entire annual budget of the Department of International Development and would allow a five-fold increase in bilateral aid to Africa[9]. According to UNICEF estimates, ? 5 billion would fund two years of full immunization for every child in the developing world[10]. Oil Prices Any sort of uncertainty in the Middle East is serious because of the possible effects on oil prices and, in turn, the possible effects on the economies of the rest of the world. Iraq is particularly significant because its proven oil reserves are 112 billion barrels or about 10 per cent of the worlds total. Iraqs reserves are second only to its neighbour Saudi Arabia. Further exploration is likely to significantly increase Iraqs proven reserves. Iraqs oil is also said to be very attractive because it is easy to recover and so production costs are among the lowest in the world. (2) Iraqs sustainable production is around 2. 8 2. 9 million barrels per day, with a net export potential of around 2. 3 2. 5 million barrels per day. Those figures compare with total world oil production of 68 million barrels per day and the Organisation of Petroleum Exporting Countries (OPEC) production of 29 million barrels per day, or 42 per cent of the total. (3) The US is by far the biggest consumer of petroleum consuming 19. 6 million barrels per day of which net imports are 10. 9 million barrels per day. (4) Iraqs production potential is limited by aging infrastructure in poor repair. UN sanctions prevent the importation of spare parts and other necessary equipment. The volume of Iraqi exports permitted under UN sanctions (the oil-for-food program) is much lower at around 1. 6 million barrels per day; however, some additional oil is smuggled out of Iraq. According to the US Energy Information Agency some oil experts think that Iraqs oil production could double in the next few years provided sufficient investment were to be made and the UN sanctions lifted. (5) The prospect of continued and possibly expanded Iraqi production is behind some of the optimistic scenarios examined below. Also important have been statements by the OPEC to the effect that they would be able to cover any reduction in supplies from Iraq, despite suggestions that OPEC is producing near full capacity. (6) Any increase in non-OPEC production would also help moderate oil prices. In the longer term supplies from non-traditional sources, including Central Asian members of the former Soviet Union, could put downward pressure on prices. Oil prices have increased throughout most of 2002 and into 2003 from about US$20 per barrel in mid 2002 to around US$35 per barrel in early March 2003. There have been many commentators willing to suggest that oil prices may peak at much higher values. Bad case scenarios have been published that estimate oil prices increasing to US$75 per barrel by George Perry from the Brookings Institute and US$80 per barrel by the Centre for Strategic and International Studies. (7) While such figures tend to be reported by the press, it needs to be kept in mind that these are only worst case scenarios. Large sudden price increases cannot be ruled out. However, it is important to note that war with Iraq has been widely anticipated and we would expect that the effects of war would be anticipated in the markets and already be reflected in prices. Against that, some observers suggest that a quick war without damage to Iraqs oil wells would eliminate the war premium and reduce prices to figures around US$20 per barrel. (8) Effects of Higher Oil Prices Oil price increases act like a tax on fuel that is collected by oil producers and transfers income from users to producers. It increases the burdens on users, and when the users are businesses, it increases the costs that they are likely to pass on to the consumer. The oil tax also involves major changes to international trade and investment flows. The 1970s oil price increases were associated with major disruptions to economic activity sparking international recession as well as inflation. The term stagflation was introduced to refer to the unusual combination of both higher inflation and unemployment that began during this period. The International Monetary Fund (IMF) has done some work on the specific effects of higher world oil prices. Modelling the effect of a permanent US$5 per barrel increase in oil prices the IMF finds that world GDP would fall by 0. 2 per cent in year one and 0. 3 per cent in years two and three. There would be a roughly equal transfer of GDP (also around 0. 2 per cent) to oil producing countries from oil importing countries with additional transfers within countries. Other Macroeconomic Implications Oil prices will play a large part in the eventual outcomes of the war with Iraq. However, there are more than just the direct effects of oil prices involved. The world economy is going through a period of volatility and uncertainty partly associated with geo-political concerns. All economic commentators refer to the present uncertainty and its effects on both investors and consumers. In the case of Iraq, political uncertainty also has a direct impact on the rest of the world through oil prices. A common view seems to be that the uncertainty relates to the immediate future and that, once the Iraq problem is out of the way, everything will be clearer. For example, in his testimony to the US Congress, the chair of the Federal Reserve Board, Alan Greenspan, anticipates the removal of the Iraq-related uncertainties'(17) that seem to be complicating the present view of the world economy. Another observer has said: The common, hopeful view on Wall Street is that a short, decisive victory in a war with Iraq wouldnt cost much and would lead to a big stock market rally, which would be good for investor and consumer confidence. (18) While a war would obviously put pressure on the budget balance that in turn can have other implications for the economy as a whole. War is not necessarily bad for the economy. It is now well known that the rearmament of the major powers in the late 1930s and 1940s, before and during the Second World War, was associated with the end of the great depression of the 1930s. As one student of this period puts it: The Second World War brought the era of the Depression to a sudden and dramatic end, as the entire resources of the major countries were absorbed in the military struggle. With the outbreak of hostilities, full employment was fairly swiftly achieved everywhere. (19) Obviously there is nothing on the horizon that looks anything like the Second World War, but there is likely to be some fiscal stimulus nevertheless. The 200203 budget papers note that fiscal stimulus generally has the effect of supporting the aggregate level of economic activity. As the 200203 budget papers put it: Expansionary fiscal policy settings in 200001 and 200102 helped Australia maintain solid economic growth relative to other developed countries during a period of weakness in the international economy A large part of the stimulus in 200102 was unavoidable given the impact of high priority defence and domestic security expenditure. This outcome is appropriate given Australias recent economic circumstances and international developments. (20) To the extent that there are under-utilised resources in Australia, government spending can lead to an increase economic activity and employment. However, the fiscal stimulus must be put in the context of the damaging effects of the uncertainty facing the world economy. The uncertainty surrounding the war is undoubtably having a negative effect on investment and consumption decisions all around the world. Given that the fiscal stimulus is rather small even in the US, it might be expected that the uncertainty will more than offset any stimulus. However, a short quick war would remove uncertainty allowing the fiscal stimulus to dominate. In this context there are some forecasts that suggest the outcome could be positive for the UK economy, for example. Oxford Economic Forecasting made such a forecast showing modest GDP increases of around 0. 2 per cent in the UK as a result of the stimulus from military spending. (21) Newsletter Economic Scenarios has attempted to model the economic effects of a hypothetical Iraqi war on the Australian economy. (22) The outcome of the Economic Scenarios modelling is that, over the period 200310, Australia would experience a loss in GDP equivalent to US$18 billion in the short war scenario (war is over in 2003 and rebuilding takes two years) or US$69 billion in the long war scenario (conflict and occupation of five years and five years of rebuilding). Using exchange rates at close of business 26 February 2003 puts the loss in GDP at $30 billion (short) to $114 billion (long). These results suggest a very significant adverse impact on Australia. However, those results reflect the nature of the economic model and some possibly extreme assumptions, including that: * Australian government defence outlays increase by one per cent of GDP in 2003 and either 1 or 0. 5 per cent for the next few years depending on the scenario * oil prices jump immediately to US$80 per barrel and then either slowly return to near normal or return quickly depending on the scenario, and * uncertainty has an effect equivalent to investors demanding 5 per cent in greater returns on their investments causing investment outlays to fall. That premium on investments fades away either slowly or quickly depending on the scenario. The first assumption is just a guess based on Congressional Budget Office estimates that the US will spend something of that order and that small countries involved will likely spend similar amounts as a share of GDP. One percent of Australias GDP is around $7 billion. Access Economics puts the likely costs of war at around $700 million for a three month engagementa tenth of the Economic Scenarios assumption. Access Economics also estimates that over $200 million has already been spent in pre-deployment. (23) Even then, reallocating resources within the Defence Department could absorb a good deal of the $700 million. The Economic Scenarios study received headlines because it purported to show a massive cost to the Australian economy as a result of war in Iraq. However, those models are only as good as the assumptions on which they rest, and if the assumptions are extreme then results will be unrealistic.