How to Pay for the Global Policeman

By David Hale

As appeared in the Financial Times on November 21st, 1990

With or without war, the Gulf crisis of 1990 is likely to go into the history books as a watershed event in US international relations. In political and economic histories, it will be viewed as the precedent-setting exercise which turned the US military into an internationally-financed public good.

The crisis has brought into focus all the economic contradictions created by the western world's lingering dependence upon US military power. The Bush administration has deployed more than 300,000 troops in the Gulf region - a number over three times greater than all of America's allies combined, including Saudi Arabia. This ratio is not dissimilar to the one which prevailed during the Korean War 40 years ago despite the tremendous economic revival which has occurred in Europe and Japan during the intervening years.

But while the Gulf operation proves that the US is not a marginal power, it is unfolding against a backdrop of domestic economic crisis which could curtail US willingness to act as a global policeman. The 1991 federal deficit could exceed Dollars 300bn if the US economy experiences only a mild downturn.

Because of German unification costs and reduced investment outflows from Japan, the US Treasury must now compete for funds in a far more crowded global capital market than prevailed during the early Reagan years, when the US was the world economy's de facto borrower and spender of last resort.

As a result, there is a serious risk that Congress will create a global security vacuum by slashing US defense spending more quickly than other countries are prepared to increase their own. Even before the latest budget debacle, Congress was committed to reducing the defense share of gross national product from 7 per cent in the late 1980s to 3.5 per cent in the mid-1990s, or the lowest level since the 1930s.

With the cold war winding down, it is natural that Congress would seek large cuts in defense spending. But as events in the Gulf have shown, the new international political order will continue to require a policeman.

While Mr. Gorbachev has made the Soviet Union appear less threatening, his country is also sliding into such severe economic anarchy that it is not difficult to construct scenarios in which the Soviet Union would experience political instability, if not civil war, on a scale that would create new security threats for Europe.

It should not be difficult for the US to obtain financial support for its Gulf campaign within the region. If oil prices hold at Dollars 35 per barrel, Saudi Arabia's export income will soar by Dollars 40-50bn. Recycling petrodollars into Pentagon dollars could finance the cost of the US deployment.

There will be no simple way of realigning global security relationships to match the changing shape of the world economy. Although its share of world GNP has fallen by half since the early 1950s, the US is still a superpower with strategic interests in the Gulf, the Pacific and continental Europe. Germany and Japan are now stable democracies with prosperous economies, but most of Asia is still afraid of Japanese rearmament while Germany's unification treaty prevents it from significantly expanding its armed forces.

As a result of these historical constraints, the western countries must develop a new formula for the sharing of global responsibility which provides some countries with non-military options for contributing to western security while assuring that America's fiscal crisis does not cause it to disarm too rapidly.

The first component of this new system should be the development of national burden-sharing indices for measuring each industrial country's contribution to a diverse mixture of international public goods, such as external defense expenditures, untied foreign aid, grants to multilateral economic development institutions, and world environmental protection. The purpose would be to establish macroeconomic targets for global responsibility-sharing and then permit countries to satisfy them in ways consistent with their historical experience.

Under such a system, the old superpowers, such as the US and Britain, would probably achieve most of their targets through foreign military expenditures or bilateral foreign aid while countries with smaller military forces, such as Japan, Sweden or Canada, would do it through development aid or contributions to multilateral organizations.

Because of America's highly integrated economic and military relationship with Japan, the second big component of the new western security system should be the development of a separate US-Japan bilateral burden-sharing program specifically targeted on sustaining an effective US military presence in the Pacific and Indian Oceans after the Gulf crisis has passed.

Because of Japan's high rate of investment and productivity growth, its real GNP has grown from 25 per cent of America's in the mid-1960s to more than 50 per cent recently. If current trends persist, Japan's GNP will grow to levels equal to 65-70 per cent of America's by the early 21st century. Such a prolonged period of stagflationary US economic performance compared to much stronger growth in Japan could greatly intensify US perceptions that Japan is a 'free rider' on the US

security system unless the two countries develop a more extensive burden- sharing program than now exists.

One useful model for such a relationship could be the 'offset program' which the US developed with Germany during the 1960s and under which Germany attempted to compensate the US for its European military spending through a variety of financial and commercial transactions. These included direct spending to upgrade US bases, purchases of US Treasury bonds at below market interest rates, preferential treatment of US defense contractors in weapons purchases for the German armed forces, and a promise by the Bundesbank to suspend dollar conversions into gold.

The economic objective of the program - which was eventually dismantled after 1971 because of America's decision to abandon the Bretton Woods system - was to reverse the so-called dollar drain from the US to Germany by generating capital flows and commercial deals which would offset the balance of payment effects of US military outlays.

In many ways, the US already has a de facto 'offset program' with Japan. In 1987 and 1988, the Japanese government played a role in stabilizing the US financial markets both through direct currency market intervention and the use of moral suasion with Tokyo's big insurance companies to discourage the sale of dollar securities. Japan has also traditionally purchased such a large share of its aerospace equipment from the US that the European Community is now complaining about trade discrimination.

But the informal and covert 'offset program' which Japan developed with the US during the late 1980s no longer appears adequate. The US public has given Japan no credit for the financial aid which it gave to the US during the final Reagan years because it was done through the back door rather than through a transparent program comparable to Germany's in the 1960s. The easy monetary

policy which Japan pursued to bolster the dollar after 1986 also helped to lay the groundwork for the recent boom and bust cycle in Japanese stock prices.

Finally, the US has not done a good job of developing long-term programs for maximizing the economic value of its defense industry. Although the US retains an overwhelming commercial dominance in the sector, Washington has been unsuccessful at developing an effective policy for managing technology transfer and scientific joint ventures with Japan.

Some Americans will question the morality of the US military assuming a more explicitly mercenary role than it has played in the past. Other countries also may demand that defense burden sharing be accompanied by joint decision making on the deployment of military forces. But in the 1990s there is no realistic alternative to the US continuing to play the role of global superpower.

As a result, the coming showdown in the Gulf between the eagle and the scorpion should mark the evolution of the US military from a national defense agency providing free western security into an internationally-financed police force.

The writer is chairman of David Hale Global Economics

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