Power and Deficit Spending

July 9, 2003
By David Calleo

(Adapted from The National Interest, Summer 2003)

The durability of the American triumph in Iraq will presumably depend on factors more political and diplomatic than strictly military. Ultimate success will depend on how the occupation is handled and legitimized. It will also depend on public support in the United States itself. Here, economic factors will probably play a significant role. Already, the high economic costs of the administration’s policies are cause for serious concern.  … 

A huge and continuing external deficit means simply that the United States regularly consumes and invests more than it produces. The difference has to be imported; it has to be financed by foreigners. Financing from abroad was no problem in the Clinton era as Europeans flocked to invest in the booming American economy. And despite the massive inflow of foreign capital, price and wage inflation were kept at bay by the strong dollar and cheap imports from Asia. In the end, however, inflation did reveal itself—as “asset inflation”, which led the way from boom to crash—over-investment in the classic manner. Needless to say, as the bubble burst, European investors have lost their ardor for pouring capital into the United States. Slackening foreign investment has exacerbated the crash and continues to weaken the dollar. (1) What are the implications for American power?  

The United States has, of course, run large external deficits with the world economy through much of the postwar era. When one formula for financing the deficit has failed, we have always been able to find another. The U.S. government always had two major advantages in this —one was the Cold War; the other was the dollar. The Soviet threat gave the United States great bargaining leverage over its rich protectorates, Europe and Japan, while the dollar’s international role gave successive administrations wide ability to create new money to spend in the world. Both advantages are now eroded. The end of the Cold War has deprived the United States of its former geopolitical advantage; the advent of the euro threatens America’s monopoly power over the world’s money. Now that Clinton’s investment boom is over, financing America’s future deficits is likely to grow more expensive. It will take higher interest rates to lure foreign savings. Higher rates seem likely to force American politics into harsher choices—between guns and butter, or growth and consumption. Arguably, this would be true even if the Clinton policies were still in effect. But President Bush’s geopolitical and fiscal policies promise to make a difficult situation worse. While Clinton’s policies did not diminish America’s over-absorption and consequent external deficit, they did at least eliminate the fiscal deficit.  

The present Bush Administration came into office scornful of Clinton’s fiscal priorities. As in the Reagan era, the desire to increase military power would take precedence over budget balancing. Bush was able to use 9/11 to carry a giant increase in military spending. Meanwhile, his administration proposed the familiar neo-conservative fiscal model of the Cold War—tax cuts to go with heavy increases in military spending. Like the Reagan experiment, the Bush model implies large Federal deficits. The budget surplus inherited from Clinton was an early casualty. Meanwhile, the huge external deficits grow worse. In effect, the United States has returned to the “twin deficits” of the pre-Clinton era. Current projections foresee a U.S. current account deficit of $ 500 billion for 2003, and a budget deficit of $246 billion for the coming fiscal year—not counting the extra military costs of the war—for which the Bush Administration has asked a further $74.7 billion. (The $74.7 billion figure includes $62.6 billion for Iraq War expenses over a six month period, $7.8 billion for Iraqi reconstruction and relief, and $4.2 homeland security costs related to the war.) Estimates for occupation and reconstruction costs in Iraq vary widely, but the amounts will certainly be significant--one early official estimate puts the cost of stationing troops in Iraq to be $1-4 billion per month. 

Budgetary expectations have to be weighed in the light of the administration’s new strategic doctrine. That doctrine, formally proclaimed in September 2002, warns that, given today’s weapons of mass destruction, together with the lunatic proclivities of rogue states and terrorist organizations, the United States “cannot remain idle while dangers gather.” America’s wars in Afghanistan and Iraq suggest that the doctrine is meant to be taken seriously. But the doctrine’s logic and language imply a still wider application, not merely preemptive strikes at rogue states, but preventive war whenever a hostile power or coalition threatens American military primacy in any of the world’s major regions. Such a doctrine suggests a formidable circle of potential enemies, many with large armies. Indeed, if the doctrine’s logic is taken seriously, the United States could eventually look forward to war with China, Russia, perhaps even Europe. Meanwhile, there are lesser but more urgent challenges—North Korea, Syria and Iran. Even the lesser challenges point to a continuing large investment in military power, with heavy fiscal consequences.  

These geopolitically-driven fiscal prospects raise the all-important question of whether the neo-conservative global agenda is economically sustainable. Just as there has been a revival of “Reaganomics” in America, so it seems likely there will soon be a revival of “declinism”, with its warning of hegemonic “overstretch.” A feeble economy seems a likely and reinforcing complement.  

(1)  Foreign direct investment into the U.S. has dropped considerably since 1999. In 1999, foreign direct investment stood at $283,376 million. In 2000, fdi peaked at $300,912 million. With the onset of the recession in the United States and the starting global recession, fdi flows into the country declined to $124,435 million in 2001 from $300,912 million in 2000 and $283,376 million in 1999. The recently released figures for the first quarter of 2002 suggest an even more negative development: fdi flows into the United States in the first quarter of 2002 have dropped to $15,061 million, down from $42,593 in the first quarter of 2001. 

David Calleo is University Professor and Dean Acheson Professor of European Studies at the Paul H. Nitze School of Advanced International Studies, Johns Hopkins University.