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Could We Get an Iran Peace Dividend?

Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of “Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy.”
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The possibility of a deal to limit Iran's nuclear capabilities and end the international trade sanctions against the country raise a fascinating question: Will there be a peace dividend? 

A look at history may provide some insight. Based on what we have seen in the past, it is possible that an agreement would have a positive economic impact. But there are many variables that will determine the outcome, not the least of which is what this obstructionist Congress does. 

For those too young to remember, the “peace dividend” was a term popularized by former President George H. W. Bush in the early 1990s. It referred to the economic benefit generated by a reduction of U.S. defense spending after the collapse of the Soviet Union. Once the Cold War and arms race ended, that money would be put to more productive uses than building a nuclear arsenal that everyone hoped would never be used. 

Dollar for dollar, nonmilitary spending tends to generate more economic benefits than military spending. The term weaponized Keynesianism is often used to describe the stimulative effects of military spending, but it is typically more modest than civilian spending. The Pentagon is saddled with a noncompetitive bidding system, contractor cost overruns on big weapons systems that don't work as planned and plenty of good old-fashioned corruption. In other words, it is very costly and inefficient. This is especially true when compared with government spending on civilian and pure research.  

The Berlin Wall fell in 1989, a few years after military spending peaked. The end was already near for the Soviet Union, which would collapse in 1991. As the chart below shows, once the Cold War ended military spending fell for most of the next decade. Meanwhile, nonmilitary government spending rose. The reduction in spending, plus an increase in tax revenue during the dot-com boom, led to the last balanced federal budgets we have seen in more than a decade.  

Source: National Priorities

But military spending had started to rise again at the time of the Sept. 11 terrorist attacks. Spending on defense, security and intelligence accelerated afterward, exceeding Cold-War levels on an inflation-adjusted basis.

More recently, we saw a decline in military spending that coincided with the beginning of the drawdowns in the Afghanistan and Iraq wars, starting in about 2010. Much of the decrease in federal deficits of the past few years can be attributed to falling military spending, as well as rising tax revenue amid the prolonged recovery from the financial crisis.

All of which is a long-winded setup to questions about the future of the Middle East, a very complicated region that has defied the predictions of experts for ages. However, we can at least raise a number of issues as a starting point for debate.

First, the U.S. involvement in the Middle East has been costly in terms of both blood and treasure. Estimates of the unfunded cost of the war in Iraq exceed $3 trillion. That is before we fully factor in care of returning military veterans. We should expect a significant reduction of military spending to continue having a positive effect on federal deficits.

The bigger issue is the role of the U.S. in the Middle East if tensions with Iran are eased. Recall that for many years, the Middle East served as a proxy battlefield for the conflict between the U.S. and the Soviet Union and many of today's hostilities evolved from those earlier confrontations.

Perhaps the biggest unknown is the role of U.S. in the Middle East as the country becomes less dependent on the region for energy. It isn't just whether cessation of hostilities and ending of sanctions against Iran will create a peace dividend, but whether the U.S. footprint in the region will be as large and as costly. If the huge amount of American spending in the region were used domestically, say on infrastructure projects, the impact in terms of the economy and quality of life would be significant.

How Congress responds may be the key determinant. The congressional deficit peacocks, as I have called them, love to talk about debt reduction. But this hypocritical group loves military spending, and has never met an unfunded tax cut its members didn't embrace. Anyone who believes these self-proclaimed deficit fighters care about deficits has not been paying attention. How Congress acts in the face of reduced military needs has yet to be determined.

There is potentially a significant and beneficial peace dividend that could result from detente with Iran. To be sure, there are many variables that make it hard to say with any confidence that there will even be a deal with Iran, much less benefits that accrue to the U.S. But then again, who in 1985 could have imagined that the Soviet Union would cease to exist and that the Cold War would end a few years later?

  1. See the Osprey and F-35 weapons systems. 

  2. Pure research includes areas such as the Defense Advanced Research Projects Agency, or Darpa, which gave us the Internet and all of the good economic things associated with it.

  3. Under former President George W. Bush, both military and civilian spending rose, and tax revenue fell, leading to the deficits of the 2000s. About half of the deficits from 2001-2009 were related to unfunded tax cuts.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Barry L Ritholtz at britholtz3@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net