How to measure the true cost of war: Justin Wolfers shows you the math | Diving In

The Pentagon says the war has cost twenty five billion
dollars so far. But what does that number count. It
counts the missiles already fired, and the plane's already flown,
and the gear already chewed through it. But that's it.
That's the whole ledger stuff that's already exploded, Which means
the Pentagon looked at the smoking crater in the global
economy and said, there's nothing to see here except the
cost of the bomb that caused that crater. Look. The
number the Pentagon gave is precise, it's official, but it's
almost completely beside the point. It's a tidy answer to
a tiny question, dressed up as the big one. They're
answering the question what's the price tag on the bombs
we've already exploded? But the question that real people care
about is broader and more important. It's what does this
war cost us? How are our lives different? What future
did we have last year that we don't have now?
I just wrote not bad on this for the New
York Times. In that piece, which I'll link in the comments,
I make the case that the Pentagon has dramatically understated
the cost of war. The true cost is not tens
of billions of dollars. It's hundreds of billions and maybe trillions.
The cost of your family is thousands of dollars or
perhaps tens of thousands. Honestly, I'm pretty proud of this
analysis because we're entering a virtual void of informed discussion
that Pentagon puts out nonsense. Wall Street runs numbers and
quietly emails them to clients, and the government analyzes, which
I hope exist. Well, they're kept secret from the taxpayers
who paid for them, so you and I that broader
public don't see any of this. So I'm here to
work through the numbers in the open with you. This
video is the director's cut, not because economic analyses need
to be more drawn out, but rather to show you
how we economists do our work. And the question is
big and messy and unfamiliar, because those tend to be
the most important question. The central idea behind everything I'm
going to show you is pretty simple, and that brings
us to our first big idea for today. It's an
idea that economists have a name for. We call it
opportunity cost. The cost of any choice isn't just what
you pay for it and money. It's what you give
up by choosing it. Opportunity cost means comparing the world
you have to the world you might have had. The
real cost of war isn't just what exploded, it's the
future we don't get. Okay, sit with that for a second.
Opportunity cost asks a baseline question compared to a world
where we hadn't gone to war. What's different now that
difference that's the cost. The cost of war is measured
and foregone possibilities, output that we don't produce, jobs that
are destroyed, and jobs that aren't created. It's in their
that doesn't take place. It's future budgets that are going
to be committed elsewhere to defense spending, living standards that
are lower than they would otherwise have been, and possibilities,
personal possibilities, national possibilities, geo political possibilities that are now gone.
That's a much broader and more economically coherent way to
think about costs than just dadding up the dollars already spent.
And that's why the Pentagon's twenty five billion dollars is
so grotesquely misleading, not because it's made up, but because
it answers a narrow and fairly uninteresting question while sounding
like it's answering the big one. Look, here's an inside
I've learned from years of economisting. Every number answers a question,
But one of the most important habits you can develop
is to stop and ask, is this number answering the
question I actually care about? Often the answer isn't wrong,
And in the narrow sense HeiG sets twenty five billion
dollars isn't wrong, but it's the right answer to the
wrong question. Okay. Our second big set of ideas to
think about is the role that oil plays in the economy.
After all, whenever you think about the broader costs of
war in the Middle East, honestly, this is the natural
starting point, and it matters because oil sits upstream of
just about everything. It powers transport, It moves through shipping,
It hits aviation and logistics and chemicals and plastics. It
feeds into food costs and delivery costs and production costs.
When oil prices rise and stay high, that ripples through
the whole economy. Oil is where geopolitics turns into economics.
A war in the Gulf isn't just a foreign policy
and it's a shock to one of the most important
input prices on the planet. In the New York Times piece,
I point out that oil futures for the end of
twenty twenty six, twenty twenty seven, and twenty twenty eight
are all still sitting above where they were before the war.
In fact, over the past week or so, they've hit
record highs, which tells you something about how the war's
going point is. Markets aren't treating this as a a
short term scare. They're pricing in a more expensive energy
world that will stick around for years. That means that
the same work as the same machines and the same
effort produces less real value than they otherwise would. The
economy's productive possibilities shift down. Now, let's start building a
real number estimate of the cost of all of this,
which is why I want to introduce you to the
third big actor in this play. It's the Fed. Hey
j Before the war, markets are expecting two rate cuts
this year, each of a quarter point. Since the war,
FED funds futures have shifted to pricing in no rate cuts,
so the expected path of interest rates is now about
half a percentage point higher than markets had penciled in
just before the war. That means war didn't just raise
oil prices, it also changed the expected future path of
monetary policy. Higher oil prices means inflation pressure that gives
the Fed less room to cut It's particularly worrying at
a moment when inflation has been above the Fed's inflation
target for years. Ordinarily the FED might try to look
through that or ignore an oil driven supply shop, but
this time it's worried that this could cause inflation expectations
to rise. That's why Jay Powell's got that gray hair.
So the Fed has abandoned the idea of cutting rates
this year, and when markets go from expecting rate cuts
to expecting none, the tighter expected path is itself a
drag on economic growth. Now here's the rough arithmetic. The
FED has a gigantic macro econometric model called Frbus Ferbus
to its friends, and it uses it to forecast the economy.
It's especially useful for things like figuring out what happens
to output after a rise in rates. We can actually
look it up on the Fed's website to see the
effects that Ferbus expects to see on the economy. So
we have to scale this picture so it's the right
one for rates rising by half a percentage point, and
we add up the effects quarter by quarter on the
output gap, and this gets you to a sum total
of about zero zero point six two five percent of
GDP thirty one trillion dollar economy. That's about one hundred
and ninety three billion dollars. Hey, let's just call that
two hundred billion. Okay. That's the kind of back of
the envelope arithmetic that economists do all the time. Not
because I think this model or this exercise gives you
the one true number, but because I'm trying to get
a sense of the orders of magnitude here. And so
that brings us to the fourth big idea, which is
to look at geopolitical risk, which is itself an economic factor.
Two are fed economists Dario Caldara and Matteo Atchaveello, whose
name I surely just butchered. They built something called the
Geopolitical Risk Index. This basically measures how much geopolitical fear
and instability is in the air. Since the war began,
that index has gone from about one hundred and fifty
to about two hundred and fifty. Now here's how that
becomes an economic estimate. First, I worked out how big
of a shock that is in the language of their paper,
So it comes out to be roughly a two standard
deviation shock, if you remember your statistics, pretty unusual. Second,
the appendix to their paper shows what a two standard
deviation shocked to geopolitical risk does to GDP over time.
And then I just added up those GDP effects quarter
by quarter, and when you do that, you get a
total loss of about zero point six percent of GDP,
which doesn't sound like much until our remind you, in
an economy of our size, that's about two hundred billion dollars.
Fun thing to note here, different methods, same number of zeros.
We're now on to idear number five, which is to
see what markets are telling us. This might be the
most provocative estimate of the lot. Over weeks and months,
stock prices move for all sorts of reasons. There's earnings news,
there's AI mania, inflation data, consumer spending, apossum sneezes in
Palo Alto, and invidious stock moves up four percent. So
if you want to isolate the part of the stock
market that's about the war, you need some kind of
index of war news, how it's going, the intensity of
it all. Look, I don't have a perfect index, but
I do have a pretty good proxy. Let's track daily
movements and oil prices, because when the war news has
gotten worse, oil prices have tended to rise. Oil has
basically become a running scorecard of how bad markets think
the war news is on any given day. So then
I just asked a simple question. On days when oil rises,
suggesting the wars going poorly, what happens to stocks? I
regressed daily percentage changes in the S and P five
hundred on daily percentage changes in West Texas in immediate
my favorite flavor of oil, and I discovered the slope
is about zero point zero nine. Let me say that
in English, a ten percent rise in oil is associated
with about a zero point nine percent fall in the
S and P five hundred. Now, zoom out. Oil rose
from roughly sixty five dollars before the war to roughly
one hundred and ten dollars after. That's nearly a seventy
percent jump. Apply that rough relationship, and that means you
get a rough implication. Seventy percent change and oil prices
times point nine means that stock values are about six
percent lower and they would otherwise have been. I'll round
down to five percent to be conservative and keep it
a nice round number. And if the SMP is worth
about sixty trillion dollar, then losing five percent off the
value of the S and P means we lost about
three trillion dollars of value for American corporations. Hey, look,
I want to be clear about what sort of estimate
this is. It's a provocative rough cut, but that's all
it is. Even so, it's useful because it captures something important.
Financial markets seem to think the future part of profits
for American companies is materially all the material a light
worse because of this war. Hey, there's one more way
to get at this, and that brings us to our
sixth idea. Instead of building one mechanism at a time,
we can look at professional forecasters who are trying to
integrate many effects at once. Look, I get to see
what Wall Street economists are saying, and I'm going to
share it with you. Goldman Sachs cut it's twenty twenty
six GDP growth forecast by half a percentage point because
of the Iran war. First they cut up by less,
but then things didn't go so well. What matters here
isn't just the growth rate headline, it's what it means
for the level of GDP and for how long GDP
remains lowered and would otherwise have been onomy grows more
slowly for a while and only gradually claws back to
its old path than the missing output during that transition
is gone. You don't just magically make it up later.
So I translated Goldman's growth downgrade into the implied path
of GDP levels over time and compared that to what
they reckon would have happened with no war. And I
added up all the output we never produce, and that
gets you to roughly four hundred billion dollars. There was
that independent of the FED estimate, the oil estimate, and
the geopolitical risk estimate. Probably not entirely. Wall Street economists
are trying to account for each of those factors. The
point of looking at this problem, though, from many different angles,
isn't to stack them up like poker chips. The point
is that a whole bunch of different approaches are landing
in the same broad territory. They're telling you the stakes
here should be thought of in terms of hundreds of
billions of dollars, possibly much more, And that gets us
to the seventh big idea? What does this mean in
the longer run? Wars change the strategic environment. If Iran
is now seen as a bigger long run thread, or
if the region becomes more dangerous, or if our alliances
have become afraid, then policymakers will argue that maintaining US
military supremacy now costs more, or if others spend more
on the military, we'll have to spend more to keep up.
It's an arms race, so nobody wins except defense companies
who get rich. How big are these numbers? Look, I'm
just going to tell you I don't know. So I
figured we could go to the White House to find out. Hey,
come with me. The White House requested a defense budget
of one point five trillion dollars for the twenty twenty
seven fiscal year. That's about a six hundred billion dollar increase. Now,
there's roughly one hundred and thirty million households in America,
so that's about four thousand dollars a year that your
family's being asked to chip in in extra defense spending.
Here's the thing, that's only the number for twenty twenty seven.
The White House has been very loud about next year's
increase and very quiet about what it expects in twenty
twenty eight and twenty twenty nine and all the years
after that. History gives you pretty clear hint, though. Defense
buildups have a habit of sticking around. The contractors get organized,
the bases get their own zipcades, the supply chains acquire
political constituencies, and what was sold as an emergency response
suspiciously quickly starts to transform into the new normal. So
if the past is any guy, to six hundred billion
dollar rise in defense spending just for next year could
easily pencil out to three or four trillion more in
defense spending over the next decade. That's money we won't
use to build roads or hospitals and to help people
get health insurance. There are a million other ways we
can live richer, fuller lives. Saying it this way makes
it clear that this is not a side issue. It's
a big part of the cost of war because war
doesn't just consume resources in the moment, it also locks
in a more expensive future. That brings us to our
eighth big idea. And I never thought i'd come to
explain this to you. It's incredibly important, but it sounds
incredibly dull. It's cash flow accounting versus a cruel accounting.
I know your eyes are glazing over mine too, and
I love this stuff. But for war, this distinction is
absolutely central, because war is one of those choices where
huge share of the costs show up later. Cash Flow
count accounting us what money has gone out the door
so far. That's basically what the Pentagon's twenty five billion
dollars is doing. Accounts. The missiles already fired, the plane's
already flown, the equipment already lost, and that's it a
cruel accounting us. The deeper and more important question, what costs,
losses and obligations? Has this decision, the decision to go
to war create it? We care about all of those costs,
whether whenever it is that their bills arrive. That's the
economically serious question. This is where perhaps maybe a few
analogies will help. You can't say the cost of a
puppy is two hundred dollars because that was the adoption fee. Mate,
my good dog Max. He also eats, he gets expensive
vet care, and he demands lots of toys. You can't
say a house only costs the down payment. The mortgage
still exists. You're paying big amounts every month for thirty years,
and just like that, you can't say a war costs
only the missiles already fired. Wars also create future obligations veterans,
medical care, disability payments. Look, a bloody conflict makes it
harder to recruit soldiers, and this shows up as higher
recruitment and retention costs in the future. And then you
compound all of these costs with the interest bill on
the money borrowed to pay for it all. Linda Bilmers
and Joe Stieglitz made this point powerfully back during the
Iraq War. Note the cue I'm talking about a previous
war Iraq. Their estimate of the Iraq War's true cost
rendering around three trillion dollars, and a huge share of
that arrived after the main fighting, because the obligations created
by war kept generating bills for years. That's the deeper
logic here. The Pentagon's giving you the sticker price. I'm
trying to estimate the total cost of ownership. And if
the Iraq War teaches us anything, it's at the costs
run to trillions of dollars, and these costs are paid
out over decades. Let me try to wrap this up
and make sense of it all with a somewhat broader
economics lesson artificial precision. It's the easiest way to make
an economic number go viral, and the Pentagon's twenty five
billion dollars has gotten far more attention than it deserves.
A tidy number beats a messy one almost every time
when it comes to the media. Politicians know this, They're
counting on it. My approach is different. I'm not trying
to give you an exact answer that's probably wrong. I'm
trying to think like an economist, where the question is big,
messy and unfamiliar. Start with the right baseline, compare the
world we have to the world we might have had,
followed the clues through oil, interest rates, market prices, growth forecasts,
and future budgets, and above all, try to figure out
the right number of zeros. That's more important than any
minor detail. When I do that here, the answer isn't subtle.
The war isn't costing America twenty five billion dollars. It's
costing hundreds of billions of dollars, and quite possibly trilling
would be a country that's poorer more constrained and living
with a worse set of possibilities than those we had
before this war began. And that's the final lesson. Look,
every number answers a question. The trick is to ask
whether it answers the question you actually care about, or
whether a politician has instead handed you a neat little
number so precise you won't notice. My analysis echoes both
common sense and many historical lessons. War is hell, and
hell comes with a hefty price tag.