Battles Erupt Over How to Spend the Peace Dividend : Economy: Most agree deficit should be reduced. But a host of worthy causes will compete for the windfall, which some dismiss as a fiscal ‘mirage.’

By Pentagon standards, a minuscule amount of money was at stake--$500 million, less than one-fifth of 1% of this year’s defense budget.

But the bitter debate last month over whether to devote that modest sum to helping the Soviet Union dismantle its massive nuclear arsenal illustrates the deep chasm that has developed in Washington over how best to reap the fruits of victory from the defeat of communism.

Proponents of the Soviet disarmament proposal argued that a small amount of money invested today in preventing instability could save billions of dollars that might be needed to deal with the results of violent upheaval five years from now.

But others, weary of the huge economic burden of the Cold War, are determined to address urgent needs at home before helping the Soviet Union out of its morass. And where better to find the funds, they argued, than in the defense budget.

America’s role in the new world “does not require a continuing defense budget of $300 billion a year,” said Paul C. Warnke, a former senior defense and arms control official. “A good part of that expense can be diverted to programs that promote genuine national security in a world where external military threats are disappearing and our internal social difficulties continue to increase.”

How that can be done--or indeed whether the whole idea of a substantial peace dividend is a mirage--is the subject of a profoundly important debate that will reverberate in next year’s elections and dominate deliberations in Washington for years to come.

Over the span of more than four decades, America has spent an estimated $6 trillion to contain and ultimately overcome communism, a diversion of resources that many believe has shackled the economy while building the most formidable military machine in human history.

Many historians and economists argue that the struggle against communism distorted U.S. spending priorities, drained off its most gifted scientists and engineers, caused huge budget and trade deficits and otherwise sapped its economic strength.

Meanwhile, America’s chief economic rivals, Japan and Germany--sheltered behind the U.S. security shield--surged past it in virtually every field of economic performance.

Today, these experts argue, the United States must rechannel the money and the human resources of the Cold War into revitalizing itself economically and socially. America, they say, can now afford to confront crying domestic needs that went unaddressed for two generations--education, infrastructure, civilian research, health care, industrial competitiveness.

Although the true savings resulting from future defense reductions may amount to no more than $10 billion to $20 billion a year, it could produce tangible results if invested productively and with long-term goals in mind, analysts say.

In deciding how to spend it, most analysts and lawmakers agree that reducing the federal budget deficit should be a high priority. Cutting the deficit would lower interest rates, temper inflation and free public and private funds for investment, economists believe.

But beyond agreement on the need for deficit reduction, consensus collapses.

Charles L. Schultze, former director of the Council of Economic Advisers, says much of the peace dividend could go to infrastructure projects that for years have been shortchanged: airports, prisons, ports, mass transit, highways and bridges. He argues that improvements in transportation and telecommunications networks more than pay for themselves in a few years with increased and more efficient business activity.

Alan Randall, professor of resource economics and environmental policy at Ohio State University, contends that some of the funds should be used for environmental restoration. Left to fester, environmental problems grow exponentially more expensive to repair, Randall says.

Ted Galen Carpenter of the libertarian Cato Institute says the savings should be returned to the private sector in the form of tax cuts. Carpenter says that experience has shown that private individuals and corporations are much better than government economists or members of Congress at picking economic winners and losers.

Liberal economist Jeff Faux of the Economic Policy Institute believes that the federal government should create a civilian counterpart to the Pentagon’s Defense Advanced Research Projects Agency (DARPA), which funds high-technology ventures. Providing seed money for future technologies could help the United States regain its competitive position, Faux argues.

Peter F. McCloskey, president of the Electronic Industries Assn., would like some of the funds used to ease the adjustment of communities that will suffer from military spending cuts and to retrain defense workers for civilian-sector jobs. McCloskey notes that American education has been shortchanged over the years and that improving the nation’s schools is the only way to produce the engineers, scientists and technicians needed to compete in the global marketplace.

Worthy goals, all. But most analysts predict that the peace dividend--no matter how it is spent, saved or invested--is not likely to produce a dramatic transformation of the American economy. Much of the historic evidence appears to support their case.

The costly Cold War struggle was not to blame for America’s relative economic decline, so its end will have only a marginal impact on its ability to recover lost ground in the years ahead, these specialists contend.

In fact, most economists find no correlation between heavy military spending and declining American productivity and competitiveness. The years that America was in its strongest competitive position--the 1950s and early 1960s--were also the years that it spent the highest proportion of its gross national product on defense--about twice the current share. The nation’s competitive position consistently slipped in the 1970s and 1980s as Pentagon spending fell, rose and fell again.

The argument that military pursuits siphoned off the nation’s engineering and scientific talent and resources also doesn’t stand up to scrutiny. Far from being a laggard in civilian research and development spending, the United States spends more today on non-military R&D; than Japan, Germany and France combined.

In a new argument advanced about four weeks ago in an interview with the San Diego Union, Defense Secretary Dick Cheney said further cuts in the defense budget “will do more damage (to the economy) than any good you might do with the resources that are freed up.”

Cheney said that the $265-billion cut from planned Pentagon spending since 1989, with the resulting cancellation of more than 100 weapons systems and the closing of dozens of domestic military bases, already is “having an impact on the economy, slowing the recovery from the recession.”

But Cheney’s argument does not find support in history.

The United States enjoyed an unprecedented boom after World War II because of pent-up consumer demand, not huge cuts in military spending. The early 1950s, following the Korean War, were a period of strong growth because of America’s preeminent global economic status, not the relatively modest drawdown in defense expenditures. And while the nation entered a recession immediately after the Vietnam War, virtually nobody ascribes the economic problems of the mid-1970s to a decline in military spending and employment.

In fact, the defense cuts projected for the next four years will have a far smaller impact, as measured against total U.S. economic output, than any of the reductions after the previous three conflicts.

In the immediate post-World War II period, the defense share of the gross national product declined by an average of 11.5% a year; after Korea, the annual decline was 1.4%; after Vietnam, 0.7%. Under current planning assumptions, the Pentagon’s share of the GNP will shrink by only 0.3% a year for the next four years.

The military now consumes about 5% of the GNP, a low figure by post-World War II standards. If the Administration’s current spending plans are adopted, the Pentagon budget would represent only 3.6% of the GNP by 1996, the lowest share since before Pearl Harbor.

Measured in terms of the overall federal budget, defense will represent 18% of federal spending by 1996 under current scenarios. During the Ronald Reagan buildup, the Pentagon consumed 27% of the federal budget; at the peak of the Vietnam War, the figure was 43%.

Even if the current numbers are relatively small and the reductions gradual, the result will be a peace dividend of significant proportions--at least in terms of earlier assumptions about the defense budget. But these numbers can be misleading, too.

For example, if the budgets projected by former Defense Secretary Caspar W. Weinberger were in effect today, the Pentagon would be spending $450 billion this year, as opposed to its actual budget of about $290 billion.

So where’s the $160-billion payoff? On paper, alas, where most of the peace dividend is to be found.

Lawrence J. Korb of the Brookings Institution notes that any of several gaping holes in the federal budget could swallow up the peace dividend whole: the savings and loan and bank bailouts, the cost-of-living increases for Social Security recipients, the deficit reduction, a comprehensive health care program for the uninsured.

The one move that could make a difference, Korb said, would be for Congress to abandon its traditional year-to-year budget process and begin to look at spending decisions over a 10-year span. He said that $40 billion spent haphazardly on an annual basis will have a negligible impact. But $400 billion spent in a planned way over a decade could make a vast improvement in education, industry or infrastructure.

Defense as a Share of Federal Spending FISCAL YEAR 1950: 27% 1965: 39% 1980: 23% 1992: 19.6% Dept. of Defense