What to Do With Peace `Dividend'

AFTER 40-odd years of animosity, it seems just possible that both East and West have tired of the drain the arms race has placed on their economies. If so, what would be the economic consequences of a ``Peace Dividend''? A peace dividend is defined as the freeing of economic resources for use in nondefense spending (both labor and capital), that have been devoted to military spending.

A slowdown in defense spending started even before President Bush startled the world at the NATO summit meeting in May, where he took the initiative from Mikhail Gorbachev with a bold proposal to reduce troops and conventional weapons in Europe - further reducing East-West tensions.

The United States has had four periods of relatively sharp increases in defense spending in the last 50 years.

During World War II, defense spending reached a high of 41.4 percent of gross national product (GNP), that is, the nation's total output of goods and services. It subsequently retreated to 4.3 percent of GNP in 1948.

In 1952, to support the Korean ``Police Action,'' defense spending gained sharply to 13.2 percent of GNP, up from 5 percent in 1950, then retreated to 9.5 percent in 1956.

The Vietnam war buildup was concentrated in the years 1965 through '69 when defense spending rose from 7.2 percent of GNP to 9 percent. Although the war persisted well into the next decade, defense expenditures continued to decline relative to GNP until 1978.

President Carter started the defense buildup that gathered momentum under President Reagan; from 1979 to '85, defense spending rose from 4.9 percent of GNP to 6.5 percent. It remained at that level through 1987. In 1988, defense spending dipped to 6.1 percent of total output and in 1989, according to our estimates, nominal defense spending will fall below 6 percent of nominal GNP.

Of course, spending for defense (or war) is absolutely necessary when a society's existence is threatened by an outside force. But most military spending contributes very little to the future growth of an economy. Economic resources used to build bombs, tanks, and ships, or to support large standing armies, cannot be used to supply the needs of consumers and business.

In 1988, $298 billion was spent on national defense. Our projection for nominal GNP in 1992 (the year Mr. Bush has set to begin troop reductions in Europe) is approximately $6.3 trillion. If defense spending were to drop from the current share to around the relative level achieved after World War II or the Vietnam war (approximately 4.5 percent of GNP), as much as $90 billion to $100 billion a year would be available for other purposes.

From an economic point of view, the current slowdown in defense spending is taking place at a most opportune time. Since the US economy is now operating close to full employment, future economic growth could be limited by slow expansion in the labor force and modest productivity growth to not much more than 2.5 percent a year without triggering a new inflationary wave. The Census Bureau estimates that in the next five years the working-age population will grow only 0.9 percent a year, down from an average 1.5 percent a year in the early 1980s. Thus, a movement of resources from defense to civilian production could help alleviate potential inflationary pressures from this low labor force growth.

Where could the money go which is not spent on defense?

There are so many competing alternatives that society will debate them for years to come. History suggests that total government spending as a percent of GNP tends to decline as defense-related expenditures are cut back. In the past, however, federal debt was not as large a problem as it is today. In 1979, for example, when the Carter/Reagan defense buildup started, the federal deficit was $40 billion (1.5 percent of GNP) and the accumulated gross federal debt was $834 billion. This year the deficit will be about 3 percent of GNP and total federal debt is projected to be near $2.8 trillion.

From an economic perspective, use of some part of the peace dividend to reduce the relative size of the federal deficit makes good sense as this would increase total savings available for investment. Any economic distortion caused by reduced defense spending should not lead to an economic slowdown because the US today is at full employment. A peace dividend of around $100 billion a year would not solve all of our economic problems, but it would certainly be a useful beginning.