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Increased Defense Spending Could Hurt Long-Term Economic Growth - 2001-10-02

The end of the cold war yielded a "peace dividend" - a redirection of U.S. resources and people from the military sector to the commercial sector. The response to the September 11 terrorist attacks is reversing that trend.

During the last ten years, U.S. defense spending and government outlays as a percent of economic output fell to the lowest levels since the end of World War II. And private sector spending soared, causing the economy to expand globally, financially and technologically.

Thomas Carpenter, chief economist for ASB Capital Management, says moving money back in the other direction is less beneficial. "When you start transferring resources back into the government, back into the military, you may have some temporary boost to economic growth, but the long term gains to the society as a whole are diminished," he explains. "Those sorts of areas are not the kind that leads to a high return on equity, and that's why we've lost several thousand points on the Dow."

Expect lower growth rates and less innovation, "" chief economist Mark Zandi says, as research money shifts toward technologies that enhance national security rather than productivity. "If you have scientists who are making the next best products and machines and making our lives better, that's one thing," he adds. "It's totally different when you have to hire people to guard facilities and build more sophisticated installations to protect us."

Thomas Carpenter believes the most serious repercussion will occur in the area of world trade, a key source of both national and international prosperity. "Exports as a percent of global output is somewhere around 20 percent today," he says. "In 1970 it was nine percent. The bottom line here with this terrorist attack is that the seamless movement of people, resources, technology, goods, services across borders is now going to be taxed - by fear, and by governments that are going to slow the movement of goods across borders - and that will slow growth."

Economist Mark Zandi agrees. "Trade has been very important to the growth of the entire global economy and I do think this is a key risk," he says. "Another thing that's at risk is immigration policy. I think it is necessary for us to become more open and allow more immigrants into our country. That's going to be more difficult too in the wake of what happened."

Mr. Zandi says tightened border controls mean tightened labor markets and slower economic growth.