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Iraq:
The Economic Consequences of War
By
William D. Nordhaus
The New York Review of Books
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The
United States is marching, two steps forward and one step backward, toward war
with Iraq. The Bush administration has articulated its reasons for war, but has
produced no official estimates of the costs. Although cost estimates are often
ignored when war is debated, most people recognize that the costs in dollars,
and especially in blood, are acceptable only as long as they are low. If the
estimates of American casualties mount to the thousands, if the costs to the
economy are major tax increases or a deep recession, or if the United States
becomes a pariah in the world because of callous attacks on civilian
populations, then decision-makers in the White House and the Congress might not
post so expeditiously to battle.
In
views of the salience of cost, it is surprising that there have been no
systematic public analyses of the economics of a military conflict in Iraq. This
essay attempts to fill the gap.[1] We must start by acknowledging that the
estimates given here are virtually certain to be wrong in some respects, for the
fog of war extends far beyond the battlefield to include forecasts of political
reactions and economic consequences. However, as Keynes said, it is better to be
vaguely right than precisely wrong.
1.
An assessment of the costs of a war with Iraq needs to be based on scenarios
for the conduct of the war, the aftermath of hostilities, the impacts on the oil
market and other related markets, and the "macroeconomic" impacts,
i.e., on the overall US economy. It is impossible to project detailed military
strategies. However, we can describe the general contours of a "quick
victory" and a "protracted conflict" and attempt to put price
tags on each.
The
difference between good and bad cases does not depend on who will win, for there
is little doubt among military specialists that the United States will prevail
if it enters with overwhelming force and is willing to persevere through all
obstacles. Rather, the difference lies in the duration of the conflict, the
total damage to Iraq, civilian casualties, the potential for unconventional
warfare, and the spread of the conflict outside Iraq.
A
study prepared by the Democratic staff of the House Budget Committee [2] and
other studies by private specialists such as Anthony H. Cordesman and Michael E.
O'Hanlon[3] lay out a plausible starting point for an analysis. These studies
estimate that in order to achieve overwhelming force, the US will deploy between
150,000 and 350,000 personnel, which is approximately one half of the level
deployed in the first Persian Gulf War of 1990 to 1991. Specialists provide a
wide variety of scenarios for a war, including heavy reliance on Special Forces,
intensive air war, and ground invasion. The tactical details are unpredictable,
but they are not essential for an economic analysis.
The
"quick victory" scenario would resemble the first Persian Gulf War,
the Kosovo war, and the Afghanistan war. It would involve some combination of
strategy and luck in which Saddam Hussein and his top leadership are captured or
killed, the Iraqi army surrenders quickly, and US forces prevent the breakout of
disorders in the south or in the Kurdish regions in the north. This is the
"New War A" analyzed in the Democratic staff report, which envisions
between thirty and sixty days of air war and ground combat, followed by two and
a half months of post-victory presence by troops in the theater. It is hard to
see how anything short of preemptive capitulation by the Iraqi regime could be
less costly than this scenario.
A
"prolonged conflict" is a situation where the dice of war roll unfavor-ably.
Analysts point to a wide variety of potential complications and costs that need
to be considered. These include prolonged conflict and an Iraqi strategy of
concentrating forces in urban areas such as Baghdad; adverse impacts on oil
markets; escalation of war by Israel; terrorist acts around the world; heavy
occupation and peacekeeping costs; burdensome reconstruction costs and
nation-building; costly humanitarian assist- ance; shocks to the overall US
economy; and the use of weapons of mass destruction.
2.
Two conceptual points need to be made before starting an analysis. First, we are
attempting to estimate the total costs to the nation, not just the budgetary
costs. We are asking how much of our national output will be sacrificed by the
war and its consequences —in effect, the loss of butter because of the resort
to guns. Second, these estimates should count only the incremental costs of the
war. The 82nd Airborne Division has to be paid whether it is in Iraq or in North
Carolina. Only additional costs such as those for transport, combat pay, and the
replacement cost of munitions should be counted in the cost of the war.
There
have been only two detailed studies of the cost of a war with Iraq, both
produced by congressional budget analysts. One was the aforementioned study
undertaken by the Democratic staff of the House Budget Committee (the House
study) and the second was by the Congressional Budget Office (the CBO study).[4]
The
House study was from the "top down." It projects the costs of the
second Persian Gulf War based on the costs of the 1990–1991 conflict. The
study estimated the cost of two scenarios for the war. The relevant one involves
250,000 troops. Under the House scenario, the estimated cost is between $48
billion and $60 billion excluding interest. This figure is slightly less than
the cost of the first Gulf War, which ran to about $80 billion in today's
dollars.
The
CBO used a different methodology, a "bottom up" approach, which
calculated the prices of the different components of a war with Iraq and then
invited us to add them up. The most relevant case, labeled the "Heavy
Ground" option, involves 370,000 military personnel in and near Iraq.
We
can compare the two congressional studies by applying the assumptions behind the
House report to the CBO estimates for the different components. For what the
House calls the "New War A" conflict, i.e., a short successful war,
the CBO formula yields $44 billion as compared to the House estimate of $48 to
$60 billion. Based on these two studies, a rough estimate is that a short and
successful war would cost around $50 billion. This compares with the cost of $80
billion for the first Persian Gulf War in 2002 dollars.
Neither
report provides estimates of the costs of a protracted war. These costs would
depend upon the length of the conflict, the extent to which it spread to other
countries, and the additional resources devoted to carrying on the war.
Consider, as a reasonable high estimate, a case in which neighboring countries
refuse basing and overflight rights to the US and Iraq pursues an urban defense
strategy. In this situation, the conflict might drag on for a year, and the US
might need to devote 50 percent more resources than it would in the "heavy
ground" war analyzed by the CBO. In that case, the cost would rise from $50
billion to around $140 billion. While much larger, these costs would still be
only around 1.5 percent of
GDP—on
the scale of the Mexican or Spanish-American Wars rather than the more costly
Vietnam or Korean Wars.
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The
two congressional studies are valuable contributions to public awareness of the
costs of a military conflict. But they are incomplete. In addition to the direct
military costs of a war in Iraq, further expenses are virtually inevitable after
a conflict. The estimates that follow sum up the major identifiable costs to the
United States for the decade following the start of a war, that is, from 2003 to
2012.
The
first category, of course, concerns the need to install a substantial occupation
and peacekeeping force in Iraq for a lengthy period after the war. There is no
evidence that the American people are prepared for the potential scale of the
operation. The CBO estimates that occupation will cost between $17 billion and
$45 billion per year, which is approximately $250,000 per peacekeeper per year.
This figure is at the low end of the estimated cost of US peacekeepers in Kosovo;
it might actually underestimate the cost if the post-combat environment in Iraq
is hostile and its dangers resemble those on the West Bank more than those in
the Balkans.
The
duration of the occupation-peacekeeping effort is unpredictable. The occupation
of Japan lasted seven years, while the US has stationed more than 30,000 troops
in South Korea for a half-century. It is difficult to see how a successful
occupation of Iraq could be less than five years and it might easily extend for
two decades. While there are no public estimates of the total, an estimated
minimum total cost would be $75 billion with a maximum cost of up to $500
billion; these figures would be consistent with peacekeeping operations in the
Balkans and the size and scope of the task in Iraq. [5]
When
some degree of order has been imposed, the US and its coalition partners must
turn to reconstruction and nation-building. What are the goals for Iraq, and how
would these goals be accomplished? Would the "regime change" be
followed by turning over the task of selecting leadership to a loya jirga, as in
Afghanistan? Would the US install an occupation regime like those in Germany or
Japan after World War II, imposing a Western-style constitution, a free press,
free elections, and all the other infrastructure of Western democracy? Would the
US introduce a new Marshall Plan for democracies of the Middle East?
Scholars
who have studied the history of nation-building caution that the process is
difficult, costly, and fraught with dilemmas. Recent examples of US attempts at
nation-building, including in Haiti, Bosnia, and Afghan- istan, indicate that
the United States has not discovered any formula for quick and inexpensive
success. The length of the nation-building effort is highly uncertain, but it is
hard to see how a serious attempt to turn Iraq into a modern democratic society
could be accomplished in less than a decade.
Reconstruction
and nation-building costs will be largely determined by the ambitions for
postwar Iraq. If Iraq is to attain a per capita GDP equal to Egypt or Iran, and
if one half of the capital stock requires rebuilding, this would imply
reconstruction needs of about $800 per capita, or a total of $20 billion. This
estimate is close to post-conflict rebuilding estimates by the World Bank for
Lebanon, East Timor, and Bosnia, which required approximately $1,000 per
person.[6]
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A
more ambitious plan would be a "Marshall Plan for Iraq."[7] Recall
that the Marshall Plan cost the United States $13.3 billion over a four-year
period. This amounts to about 4 1/2 percent of today's GDP, or $450 billion. At
today's income levels, the assistance amounted to about $2,000 per person, or
$500 per person per year, in the recipient countries, more than twice the size
of the figure of $800 per capita cited above.
This
parallel, moreover, is optimistic, even simplistic, for the Marshall Plan was
introduced after the countries of Western Europe had undertaken much of their
reconstruction efforts on their own, and European countries had most of the
infrastructure of democracy and civil society in place before the war.
Recognizing that nation-building in Iraq begins with much less social capital
and civic infrastructure, we might conservatively expect that the effort would
require six rather than four years of effort at the expenditure rate of the
Marshall Plan, for a total of $75 billion.
The
estimates for both reconstruction and nation-building, therefore, are
substantial, from a minimum $25 billion for reconstruction to as much as $100
billion.
Humanitarian
assistance will be necessary to care for the refugees, the wounded and ill in
Iraq, and possibly those in neighboring countries. Estimates of the costs of
humanitarian assistance are uncertain because they involve knowing the
population at risk, the level of need after the war, and the duration of the
assistance. Figures from the Balkans in the 1990s indicate that humanitarian
assistance could well cost approximately $500 per person per year.[8]
A
plausible estimate would be that between one and five million residents of Iraq
(out of a total population of around 24 million) would require assistance in the
postwar environment. If the time required for assistance was between one and
four years, then the total cost of humanitarian assistance would range from $1
billion to $10 billion.
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Who
will pay for all these efforts? One possible source of funds is Iraqioil
revenues. If Iraq could rebuild its production back to three million barrels per
day, this would yield around $25 billion per year at prevailing oil prices.
However, there are many claims on these resources. To begin with, these revenues
amount to only $1,000 per capita in today's Iraq, and much of these funds will
be required for imports of food, medicines, and other necessities of daily life.
Some revenues would be needed to finance the rebuilding and upgrading of Iraq's
economic infrastructure. Additionally, total claims by other nations against
Iraq after the 1991 war were over $300 billion, of which little has been paid or
written off. To divert funds from vital necessities to pay the expenses of the
US occupation forces would be economic and political folly.
Will
other countries come forward to pay the bills, as they did after the first
Persian Gulf War? Probably not. If the war is undertaken without UN sanction or
broad international support, the US could be forced to pay most of the costs.
Will
the US actually undertake the extensive effort required to rebuild and
democratize Iraq? In virtually every country where the US intervened militarily
over the last four decades, it has followed a "hit and run" philosophy
by which bombing runs have seldom been followed by construction crews. The
latest war in Afghanistan is a striking example. In the year ending September
2002, the US spent $13 billion on the war effort. By contrast, the total
Pentagon effort committed to civil works or humanitarian aid has totaled only
$10 million.
The
disproportion between military destruction and civilian construction in
Afghanistan and elsewhere does not augur well for an ambitious rebuilding effort
in Iraq. Is it plausible that Congress will appropriate funds for such a large
civilian effort when the US today spends only $15 billion annually on foreign
aid for the entire world? An ambitious nation-building plan that leaves Iraq
half-built seems the most realistic prospect.
3.
War in the Persian Gulf might produce a major upheaval in petroleum markets,
either because of physical damage or because political events lead oil producers
to restrict production after the war.
A
particularly worrisome outcome would be a wholesale destruction of oil
facilities in Iraq, and possibly in Kuwait, Iran, and Saudi Arabia. In the first
Persian Gulf War, Iraq destroyed much of Kuwait's oil wells and other petroleum
infrastructure as it withdrew. The sabotage shut down Kuwaiti oil production for
close to a year, and prewar levels of oil production were not reached until
1993—nearly two years after the end of the war in February 1991.
Unless
the Iraqi leadership is caught completely off-guard in a new war, Iraq's forces
would probably be able to destroy Iraq's oil production facilities. The
strategic rationale for such destruction is unclear in peacetime, but such an
act of self-immolation cannot be ruled out in wartime. Contamination of oil
facilities in the Gulf region by biological or chemical means would pose even
greater threats to oil markets.
Yet
another possibility is a concerted reduction in oil production by OPEC
countries. This might occur by means of a boycott against the US, such as the
one that followed the 1973 Arab–Israeli war; it might also occur if control of
a substantial part of OPEC's oil resources fell under the control of
anti-Western elements.
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The
Brookings Institution economist George Perry recently investigated the economic
impacts of disruptions of world oil supplies.[9] He analyzed a bad case, a worse
case, and a worst case. Although his study referred to terrorism, the underlying
economic analysis applies equally well to any kind of reduction in supply.
Perry's
worst case represents a plausible bad outcome of a prolonged war in Iraq. This
outcome assumes a decline in world oil production of seven million barrels per
day, partially offset by a supply of 2 1/2 million barrels per day drawn from US
strategic oil reserves. Many combinations of events— arising from wartime
destruction, terrorism, or political reaction of governments in the
region—could lead to such an outcome. Concrete examples would be the
destruction of most of Iraq's oil-production capacity along with one quarter of
the productive capacity of other Gulf states. Another possible scenario would
involve an OPEC boycott of the US and other countries that cut oil production by
25 percent. The use of a boycott is economically plausible in oil markets
because producer profits go up rather than down with lower production.
The
impacts of such a decline in production would involve sharp increases in oil
prices, high inflation, and major transfers of wealth from oil consumers to oil
producers. In his worse case, Perry projects a tripling of oil prices to around
$75 per barrel, with gasoline rising to almost $3 per gallon. The cost of
imported oil imports would rise by $200 billion per year in the US, and the
oil-price shock and inflationary impetus would probably set off a recession. To
estimate the total costs, I have assumed that the curb on production lasts for
one and a half years. Similar results can be derived from an economic model of
oil markets using Perry's estimated oil-price increase. These figures exclude
impacts on the US business cycle, which are discussed below.
Strategists
in the Bush administration may be betting on happy outcomes in oil markets. A
decisive victory in Iraq, with no destruction of oil facilities and followed by
political stability in the region, could lead to increases in oil-production
capacity in Iraq; and this could put downward pressure on oil prices. The speed
at which Iraq can increase its oil production should not be overestimated,
however. A reasonable optimistic scenario would involve Iraq increasing its
production capacity to around four million barrels per day within five years
after a war. Under plausible assumptions about the effects on the supply of oil
from other regions, this would lead to a decline of slightly under $1 per barrel
over the next decade. Using a baseline forecast of $25 a barrel, this would lead
to a decrease in the cost of US oil imports of $30 billion over the next decade.
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A
final economic concern is the impact of the war on overall economic activity. In
the past, major wars, fueling large increases in defense spending, produced
economic booms. In World War II, for example, defense outlays rose by almost 10
percent of the total GDP before Pearl Harbor, and this boosted the economy out
of the doldrums of the Great Depression. Similar but smaller military buildups
accompanied economic expansions dur- ing the Korean and Vietnam Wars.
By
contrast, the first Persian Gulf War saw defense spending increase by only 0.3
percent of GDP. The Iraqi invasion of Kuwait produced an adverse psychological
reaction in stock prices and consumer sentiment. These factors depressed
consumer spending, particularly on consumer durables, and reduced business
investment—while defense spending did not fill the gap. The result, unique in
wartime in recent American history, was a sharp recession beginning the month
after the Iraqi invasion of Kuwait.
The
direct military cost of a second Persian Gulf War is likely to be relatively
small, which suggests that the macroeconomic impact will be largely driven by
psychological factors. A repetition of the 1990–1991 downturn is unlikely
because markets have in part discounted the prospect of a war, or at least of a
short war. Since summer 2002, stock prices have fallen 20 percent, the dollar
has depreciated, and indexes of consumer sentiment are at their lowest level in
almost a decade. In the case of a quick victory, the macroeconomic impact will
probably be negligible.
If
the war goes badly in the initial phases, the macroeconomic outcome could
quickly turn sour. Imagine some combination of heavy casualties, protracted
urban warfare, gory pictures on the nightly news, widespread foreign
denunciations of American policy, rumors of, or actual use of, chemical or
biological weapons, or major terrorist actions at home or abroad. Even without
any oil-price shock, the economic reactions might resemble the economic decline
following the 1990–1991 war or the sharp drop in economic activity following
September 11. A plausible outcome would be an average recession set off by a
protracted conflict, with output losses in the range of 2 to 5 percent of GDP
($200 billion to $500 billion in today's dollars). To put the matter concretely,
I assume that a protracted war would lead to a recession equivalent to that
following the first Persian Gulf War.
4.
We can now collect the different estimates of the cost of the war. It should
be emphasized that these estimates vary in precision and in empirical evidence
supporting them. Indeed, aside from the projections of direct military costs,
all of the estimates should be regarded as informed conjecture. Moreover, these
costs do not attempt to estimate the benefits of resorting to arms. Since
avoiding future destructive acts by Iraq is the major articulated reason for
undertaking war in the coming months, we cannot truly balance the costs and
benefits of war without considering any re-duction in risk that would derive
from disarmament and regime change in Iraq.
Table
1 shows a summary compilation of the different quantifiable elements. The
favorable case in the first column of numbers would entail relatively modest
economic costs, on the order of $120 billion. (These are the total costs over
the next decade.) This outcome assumes that the military, diplomatic, and
nation-building campaigns are successful.
The
unfavorable case is a collage of potential unfavorable outcomes rather than a
single scenario. It shows the array of costs that might be incurred if the war
drags on, occupation is lengthy, nation-building is costly, the war destroys a
large part of Iraq's oil infrastructure, and there are both lingering military
and political resistance to US occupation, and major adverse psychological
reactions to the conflict. Putting the different adverse effects together adds
up to $1.6 trillion, most of which come outside of the direct military costs.
This
discussion, however, vastly oversimplifies the analysis by constructing only two
cases, whereas reality presents a dizzying variety of outcomes. Returning to the
metaphor of war as a giant roll of the dice, we might say that the US could end
up paying the "low" costs of around $120 billion if the dice come up
favorably. If some dice come up unfavorably, the costs would lie between the low
and the high cases. However, if the US has a string of bad luck or misjudgments
during or after the war, the outcome, while less likely, could reach the $1.6
trillion of the upper estimate.
Even
the upper estimate does not show the limit of fortune's frowns. The projections
I have described exclude any costs to other countries, omit the most extreme
outcomes (such as chemical or biological warfare), and exclude Perry's
"worst" case in oil markets. Moreover, the quantified costs ignore
both civilian and military casualties suffered by Iraqis and any tangible or
intangible fallout that comes from worldwide reaction against perceived American
disregard for the lives and property of others.
5.
It seems likely that Americans are underestimating the economic commitment
involved in a war with Iraq. This is hardly new, for the record is littered with
failed forecasts about the economic, political, and military outcomes of wars.
The history of war is, as Barbara Tuchman entitled her wonderful book, the march
of folly.[10] Is America writing another chapter in the march of folly? It is
impossible to know in advance, but historians may look back at several early
warning signs of economic and political miscalculations.
The
first concern is that the Bush administration has made no serious public
estimate of the costs of the coming war. The public and the Congress are unable
to make informed judgments about the realistic costs and benefits of the
upcoming conflict when none are given. Particularly worrisome is the promise of
postwar occupation, reconstruction, and nation-building in Iraq. If American
taxpayers decline to pay the bills, this would leave a mountain of rubble and
mobs of angry people in Iraq and the region.
Closely
related is a second syndrome, frequently found in past conflicts, of entering
war prepared militarily but not economically. The finances of the nation have
deteriorated sharply since George W. Bush took office. The annual federal budget
has deteriorated by $360 billion from the spring of 2001 to the fall of 2002,
and, even with a short war, budget deficits are likely to mount in coming years.
The Bush administration has not prepared the public for the cost or the
financing of what could prove to be an expensive venture. Perhaps the
administration is fearful that a candid discussion of wartime economics will
give ammunition to skeptics of the war; perhaps it worries that acknowledging
the costs will endanger the large future tax cuts, which are the centerpiece of
its domestic policy. Nonetheless, the price must be paid—by raising taxes, by
cutting expenditures, or by forcing the Federal Reserve do the job by raising
interest rates, thereby curbing investment and especially housing. One way or
another, Americans will pay for the war.
Third,
the predisposition of the United States under the Bush administration to
undertake unilateral actions poses major risks. From a military point of view,
attacking without a broad coalition of countries can make the conduct of the war
more difficult and costly, and it may raise the hopes of the Iraqi leadership
that others will come to their aid, thereby extending the conflict. From a
political point of view, unilateral actions, particularly those taken without
support from the Islamic world, risk inflaming moderates, emboldening radicals,
and spawning terrorists in those countries. From a legal point of view,
America's insistence on the right to overturn foreign governments without the
sanction of international law will undermine a wide variety of cooperative
efforts on international finance, disarmament, the environment,
nonproliferation, and anti- terrorism. From an economic point of view,
unilateral actions imply that the costs will be largely borne by the United
States.
Fourth,
strategists may be deluding themselves on the reaction of the Islamic world and
the Iraqi people to American intervention. A key uncertainty concerns the
loyalty of Iraqi troops and the willingness of the Iraqi military commanders to
undertake an urban defense of Baghdad. Furthermore, even though no major Arab
government is solidly behind the United States, the administration appears to be
persuaded that Muslims are waiting for the overthrow of Saddam to dance in the
streets and that Americans will be welcomed in Baghdad as liberators rather than
infidels. But major additional costs could result if opposition proves more
formidable and admiration for America less widespread than the American
administration believes.
Finally,
one senses an obsession bordering on woodenheadedness in the Bush
administration's concentration on Iraq in general and on regime change in
particular. In contrast to the clear danger from terrorist activities, there is
no imminent threat from Iraq. The war in Iraq threatens to claim the scarce
resources and attention of the United States for many years, distracting the
country from other troubling spots, like North Korea, or from the
Israeli–Palestinian conflict. The administration focuses on Iraq while slow
growth, fiscal deficits, a crisis of corporate governance, and growing health
care problems threaten the economy at home. The domestic economy and the rest of
the world will take a back seat while the US is preoccupied with war in Iraq.
Notwithstanding
all the warning signs, the administration marches ahead, heedless of the fiscal
realities and undeterred by cautions from friends, allies, and foes.
=====
Notes
[1]
This essay is an abbreviated version of a longer study available at
www.econ.yale.edu/~nordhaus/iraq.html.
[2]
Assessing the Cost of Military Action Against Iraq: Using Desert Shield/ Desert
Storm as a Basis for Estimates, an analysis by the House Budget Committee,
Democratic Staff, September 23, 2002.
[3]
Anthony H. Cordesman, Iraq's Military Capabilities in 2002: A Dynamic Net
Assessment (Center for Strategic and International Studies, September 2002);
Michael E. O'Hanlon, "Three Months to Baghdad," The Washington Times,
August 30, 2002.
[4]
Congressional Budget Office, "Estimated Costs of a Potential Conflict with
Iraq," September 2002, available at www.cbo.gov.
[5]
The low and high numbers assume, respectively, peacekeeper costs of $200,000 to
$250,000 per peacekeeper per year, with the number of peacekeepers from 75,000
to 200,000, and for a period of five to ten years. We set ten years as the outer
limit of the estimates in this study.
[6]
World Bank, "Afghanistan: World Bank Approach Paper," November 2001;
available at worldbank.org.
[7]
This was discussed in Roger D. Carstens, "A Marshall Plan for Iraq,"
The Washington Times, August 5, 2002.
[8]
Zarko Papic, "Normal Social Policy and International Humanitarian
Assistance in Conflict Context," Independent Bureau for Humanitarian
Issues, Sarajevo, October 2000.
[9]
George L. Perry, "The War on Terrorism, the World Oil Market and the US
Economy," October 24, 2001; available as Analysis Paper #7 at www .brook.edu/views/papers/perry/20011024.htm.
[10]
Barbara Tuchman, The March of Folly: From Troy to Vietnam (Knopf, 1984).
December
5, 2002 Bulatlat.com
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