Defense Cuts: Peace Dividend or Economic Slump?
Business + Economy

Defense Cuts: Peace Dividend or Economic Slump?

iStockphoto/The Fiscal Times

Last week, the government announced that gross domestic product contracted in the fourth quarter, the first time GDP has decreased since 2009. The lack of economic growth was attributed to a reduction in government spending, including defense cuts.  Think of it as a preview of the new 21st century military industrial complex.

The fourth quarter spending cuts are nothing compared to what’s coming – the Pentagon’s nearly $800 billion budget is slated to be slashed by $482 billion in the coming years. The delay in the sequester called for by President Barack Obama would delay, not stop, the process. The Economic Policy Institute, a Washington-based think tank, estimates that GDP will fall 0.3 percent in 2013 and 0.4 percent the following year.

Meanwhile, defense hawks are warning that the cuts make the country less safe; Republican Senator Lindsey Graham has warned that they would “ruin the military.”

The Fiscal Times reviewed the past three large-scale defense drawdowns – after World War II, after the Vietnam War, and after the end of the Cold War – to determine if there’s a correlation between defense spending and economic growth. History shows that military drawdowns have not led to downturns in the economy. But it also shows that these drawdowns have serious and unintended consequences.

Defense spending peaked in 1945 to wartime high of $83 billion, accounting for nearly 40 percent of GDP. By 1950, it had returned the pre-war level of $18.4 billion, adjusted for inflation, or five percent of GDP. To achieve this reduction, cuts were made primarily in two areas: the number of troops and acquisitions.

According to a Congressional Research Service report, the Army had 8 million soldiers in 89 divisions in 1945. By 1950, this number had been reduced by 93 percent.

The Defense Department also stopped acquiring new equipment. By 1950, soldiers were using equipment that the Army Center for Military History called “worn-out leftovers from World War II.”

But these cuts had no impact on the U.S. economy. In 1941, GDP shrunk by 1.1 percent, according to the Bureau of Economic Analysis. In 1950, it grew 8.7 percent.

The Vietnam drawdown began in 1970, a year in which the defense department spend $94.7 billion. This accounted for 9.1 percent of GDP. By 1975, the end of the drawdown, the defense budget increased to $152.5 billion, adjusted for inflation, but accounted for just 6.2 percent of GDP.

This drawdown consisted primarily of eliminating personnel and ending the Vietnam War. The Pentagon ended the draft and cut the number of soldiers from 1.57 million at the height of the war to 785,000.

GDP growth during the drawdown was relatively flat: it grew by 0.2 percent in 1970, and contracted 0.2 percent in 1975, marking the last month of a two-year recession.

The end of the Cold War allowed the United States to drastically cut defense spending, yielding what became known as the peace dividend.

In 1988, the United States spent $330 billion on defense, or 6.5 percent of GDP. By 1995, that number had grown to $419 billion, adjusted for inflation, accounting for just 4.4 percent of GDP.

The Pentagon made drastic cuts in forces, reducing the number of active duty troops by 30 percent. It drastically cut recruiting efforts. It also didn’t update much of the equipment that would have been needed to fight a ground war against the Soviets in Europe.

These cuts coincided with relatively flat GDP growth. In 1988 GDP grew by 4.4 percent, while it grew 2.5 percent in 1995.

No impact on GDP, but with other consequences

Based on past drawdowns, there is little correlation between defense spending and the health of the broader economy. Gordon Adams, a professor at American University and defense budget experts, said this is because defense spending makes up so little of the nation’s GDP, 1945 withstanding.

“From an economic point of view, what’s critical to the direction of the economy is the direction of the economy,” he said. “Over time, the impact is less and less.”

However, Adams said the overall government spending has the potential to disrupt economic growth.

“The key to the decrease in GDP at the end of December was that government spending, of which defense is a piece, went down,” Adams said. “Federal purchases overall went down, and a decrease in defense spending is going to have an effect on overall acquisition activity.”

But the cuts aren’t without consequences. In the years following each drawdown, the United States watched rivals take aggressive military action. Three times, these actions have led to war.

Soon after the World War II drawdown ended, North Korea invaded South Korea. The American Army was largely unprepared for the fight.

In 1979, four years after the end of the Vietnam drawdown, the Soviet Union invaded Afghanistan, threating to spread communism to Southeast Asia. The United States provided aid to Afghan resistance forces, ultimately driving the Soviets out of the country.

And in the years following the Cold War drawdown, Saddam Hussein invaded Kuwait, leading to the first Gulf War. Sources say he viewed the drawdown as evidence that the U.S. would not get involved. In the year after defeating Iraq, the United States continued its military drawdown. But that ended  after the 2001 terrorist attacks.