The price of pro$perity is often war

Why do economies collapse? Harold James notes that global conflict can cause major economic slumps - but that could change as warfare grows cheaper. Below, Simon Targett ponders lessons from the ancient world.

One of the comfort blankets that modern people clutch is the idea that there was only ever one big simultaneous world depression, produced by such an odd confluence of causes as to be unique: the legacy of the First World War and of the financial settlement of reparations and war debt; the chaotic banking system of the world's largest economy, the US; and inexperience in handling monetary policy in a world that was still pining for metallic money.

A great deal of historically informed literature on globalisation makes the point that there were several periods before this in which increased worldwide integration came to a halt and was reversed with painful consequences. Although the most familiar precedent for modern globalisation is that of the late 19th and early 20th century, ending with the interwar Great Depression, there were earlier examples: the Roman Empire, the economic rebound of the late 15th and early 16th centuries (the economic backdrop to the Renaissance), and the 18th century, in which technology and increased ease of communications opened the way to global empires (for Britain and France). All these previous globalisation episodes ended with wars.

There are significant ways in which war undermines globalisation. The first, most obvious, and most studied, way is simply the consequence of the cost of war: the problem of financing unproductive military activity, the disruption of commerce, the suspension of migration and the freezing of capital movements because of security priorities. The second is the tendency for armed conflict to provoke international discord in other areas of international interaction. War challenges assumptions about the global distribution of economic and political power.

Most periods of modern conflict have been accompanied by inflationary war finance and followed by sharp periods of deflation. The most obvious cause of postwar deflation is the effect of increased government expenditure on interest rates. An alternative way of thinking about this is as the destruction or wearing-out of capital in wartime, and consequently the higher price of new capital. The rise in real long-term interest rates makes peacetime investment more expensive and depresses activity. This effect is enhanced if governments try to return to prewar exchange-rate systems with prices and wages that have been boosted and distorted by the high levels of wartime demand.

Almost all the most dramatic historical episodes of sustained deflation came in the aftermath of war. A sustained economic depression followed the American War of Independence and accentuated the initial anti-commercial bias of the politics of the new republic. After the Congress of Vienna ended the Napoleonic Wars, Europe experienced decades of deflation, in which industrial investment was costly and the bankruptcy of entrepreneurs frequent. The aftermath of the 1860s civil wars (or wars of unification) in Italy, Germany and the US saw an immediate speculative bubble, and then the bursting of the bubble (after 1873), with stock-market price collapses, bankruptcies and reduced investment. The First World War was also followed by a brief reconstruction boom in 1919, then a collapse in the major Western economies in 1920-21; a decade later came the Great Depression.

Some of these classic effects, in which war produces monetary instability, are still very visible in the aftermath of the major international conflicts of the post-1945 era. The wars in Korea and Vietnam both produced inflationary surges, which initially reduced, but then increased, real interest rates, and which corresponded to investment surges and declines.

The 1991 Gulf War, however, no longer fits this pattern: both inflation and interest rates fell, although the war was followed by a brief recession, which was generally held by political analysts to have frustrated the re-election in 1992 of President George Bush senior.

One explanation of the changing effects of war in recent times is that the cost of each conflict for the major superpower has been falling since the middle of the 20th century. In today's terms, the Second World War cost about $4,700 billion (£2,600 billion), Korea $400 billion, Vietnam $572 billion, the 1991 Gulf War $80 billion, and the 2003 Iraq War cost little over $20 billion. It would consequently be appropriate to expect a diminution of the purely fiscal impact of wars and their deflationary legacy. Taking a naive approach to the demand for military action and its supply, falling costs should suggest increased demand and a new likelihood of the use of force to effect regime change. The less a war costs, and the fewer the casualties, military and civilian, the more likely it becomes.

Adam Smith, author of The Wealth of Nations , made a similar point about some of the wars of the 18th century. The combination of technology, which made war between advanced and backward countries less costly for the former, and new methods of spreading the financial burden of war through the sale of debt instruments, made war more likely. "In great empires the people who live in the capital, and in the provinces remote from the scene of action, feel, many of them, scarcely any inconveniency from the war; but enjoy, at their ease, the amusement of reading in the newspapers the exploits of their own fleets and armies."

But wars also lead to questions about the rules that guide economic interaction, internationally and domestically. All wars, big or small, produce new problems and divisions. Security concerns spill over into economics. One tradition of thinking about wars (especially of the smaller-scale wars of the late 19th-century era of globalisation) suggests that they have economic origins and are fought to gain control of a greater share of global resources. This is familiar to historians and social scientists as the Hobson-Hilferding-Lenin interpretation of imperialism. It is largely wrong as an explanation of the origins of wars, but powerful in understanding the political response to them.

The model of the imperialist war that the British liberal John A. Hobson, and the Marxists who adapted his explanation, had in mind was the relatively short, non-total war that characterised the era of high globalisation. The Spanish-American War of 1898 that brought the US into the international system was, unlike the sustained conflicts earlier in the 19th century, an unequal conflict between the world's fastest-growing industrial economy and a very backward European imperial power. While 4,000 US soldiers were deployed, only 379 were killed. It was soon followed by another unequal conflict, the British conquest of the Boers.

Both of these unequal wars were acutely controversial in domestic politics and could be interpreted as "land grabs" - demands for resources that were scarce: sugar from the Caribbean and diamonds and gold in southern Africa.

At first, the wars produced electorally successful nationalism: the 1900 British "khaki election" produced a large Conservative and imperialist vote, and there was a surge of popularity for Theodore Roosevelt, the hero of the 1898 war. Then there was a backlash, in which critics pointed out associations between war and the personal gains of a small group of corrupt businessmen and financiers.

These wars also made international relations significantly more tense. The Boer War was one of the decisive moments in the growing breach between Britain and Germany, with the German Kaiser publicly supporting the Boers.

Small conflicts thus set the stage for bigger, more global clashes, in which arguments over the distribution of spoils worsened the international climate.

This capacity of relatively small conflicts to destroy large elements of international agreement looks familiar. And the danger of escalating conflict disrupting globalisation has precedents that go back further than the world of late 19th-century globalisation.

The first volume of Edward Gibbon's classic study The History of the Decline and Fall of the Roman Empire was (by chance) published in 1776, the year the American Declaration of Independence was signed, and the year Smith's Wealth of Nations was published. Gibbon's advice and Smith's concern about war destroying commerce are relevant today, and quite alarming. Both were thinking, in the wake of the humiliation of a global British commercial and military system, about the problems of what might be termed a reverse of globalisation.

Gibbon begins with praise for the peaceful character of the Emperor Augustus, and of Roman realism and multilateralism: "Inclined to peace by his temper and situation, it was easy for him to discover that Rome, in her present exalted situation, had much less to hope than to fear from the chance of arms; and that, in the prosecution of remote wars, the undertaking became every day more difficult, the event more doubtful, the possession more precarious, and less beneficial."

This is a fine description of the attractions and perils of economic prosperity. Rome might have basked in consumer prosperity, but this prosperity sucked her into a world of conflict that, in turn, ruined her economy.

Harold James is a professor in the history department at Princeton University.