Estimating the Economic Benefits Derived From ForwardEngaged Naval Forces

1
Estimating the Economic Benefits Derived From
Forward-Engaged Naval Forces

• Dr. Robert LooneyDr. David Schrady National
  Security Affairs and Operations Research
  DepartmentsNaval Postgraduate SchoolBriefing
  for RADM Byrd, N3/5B
• 24 October 2000

2
Outline

• Background
• The First Study
• Purpose of the Current Study
• Acknowledgments
• Overview
• Main findings
• Conclusions
• Areas for Further Research

3
Background

• April, 1996 - Discussion with VADM Lopez
  regarding potential
• NPS study of the economic aspects of forward
  engagement
• Prior studies were mainly anecdotal--
• No analytical rigor, no emphasis on economic
  benefits
• A new approach was required to quantify the
• economic benefits derived from forward engaged
• naval forces in understandable terms
• Felt that a joint effort by OR/NSA Departments
  needed
• to combine disciplines and approaches

4
Steps in the Analysis

• Is there a credible methodology for measuring
  the economic
• benefits associated with Naval forward presence?
• Does this methodology produce non-trivial
  results in most
• situations involving crisis response?
• Are there situations in which Naval response
  destabilizes prices
• and thus produces added costs to the US economy?
• What are the mechanisms through which economic
  benefits
• accrue?
• What can we expect in the future? What forces
  may
• enhance/weaken the economic impact of Naval
  forward
• deployed forces?

5
First Study Assumptions

• Oil markets should provide an index of the manner
  
• in which markets assess the economic
  consequences
• of crisis and Naval forward presence/crisis
  response.
• In particular oil futures prices reflect market
  expectations
• based on available economic, political and
  military
• informationthey are unbiased estimators of
  the future.
• If Naval forward presence is perceived providing
  a
• stabilizing role, then Naval crisis response
  should affect
• market outlook with futures prices
  decreasing following
• crisis response.

6
First Study Overview

• Developed the methodologies for quantifying the
  economic benefits associated with Naval forward
  presence
• Key factor identified Spot and forward oil
  prices and
• their relationship to Naval movements during
  periods
• of crisis.
• Differential movements in oil prices before and
  after
• Naval crisis response measure the initial
  economic impact of Naval crisis response.
• In turn, these oil price changes flow through
  economies to produce the total impact of Naval
  crisis response.
• Significant economic benefits found.

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Spot Oil Prices Desert Storm
NYMEX Spot Prices
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Forward Oil Prices Desert Storm
NYMEX Futures Prices
/bbl
Post-crisis response move to equilibrium
Market response to invasion
Months to Next Futures Contract
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General Pattern Oil Prices and Naval Response
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Method of Naval Crisis Response Benefit
Calculation
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First Study Main Findings

• Significant economic benefits attributable to
  Naval
• Forward presence/crisis response were found
• Gulf War -- 55.2 billion
• 1994 Iraq-Kuwait Border Incident -- 11.7 billion
• 1987 Iranian Attacks on Gulf Shipping -- 11.2
  billion

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First Study Conclusions

• Linkage between oil prices and naval forward
  engagement and crisis response has been
  established
• oil prices decline a day or so after naval crisis
  response and the declines spread rapidly through
  the futures markets.
• gains increase with further equilibration in oil
  markets.
• linkage occurred in three different
  economic/political settings.
• Spot price movements by themselves may seem small
  yet produce significant positive economic impacts
  when they affect forward markets and ripple
  through the economy.
• These patterns are consistent for the United
  States as well as the other major world economies.

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Purpose of the Current Study

• To further assess and quantify the nature and
  scope the economic benefits associated with
  forward-engaged naval forces the current study
  was undertaken to
• Provide Economic Input for QDR 2001.
• Assess the generality of the first study.
• Provide greater rigor to the approach.
• Identify Productive Areas for Further Research.
• Final written report 1 October 2000.

14
Acknowledgments

• Class Participants NS4141 Economic Intelligence
• Key Contributors
• LT Francisco Martinez Case Time Lines
• Lt Michael Hobaugh -- Maritime Insurance
• Lt Timothy Sullivan -- Libyan Case
• Lt William Sutton -- Piracy
• Major Juergen Merrath -- Globalization
• Major Ivo Musil -- Globalization

y
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Event Analysis

• Main extension over first study
• Introduction of event analysis to statistically
  link events such
• as naval movements to economic variables.
• Basic idea is that certain economic systems
  equilibrate over
• time to maintain a long-run relationship or
  pattern.
• Occasionally, these systems are shocked by
  various events
• and subsequent naval response from forward
  deployed locations.
• Naval impacts on prices can be short run, but
  more commonly
• have a long-run impact on the movement of
  economic series
• such as oil prices, exchange rates and share
  markets.

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Importance of Event Analysis

• Earlier study had to infer links between naval
• forward presence/crisis response and oil
  prices.
• Often subjective and impressionistic
• Process of elimination of other causes.
• With event analysis, it is possible to
  statistically link
• changes in market prices to Naval movements.
• Non-naval variables can also be tested.
• Lag structures can be tested and verified.
• Long-run nature lends credibility to benefit
  estimates.
• Event analysis allows hypothesis testing
• Do naval events help or hurt in stabilizing
  prices?
• Which Naval/non-Naval events are most
  significant?

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Cases Examined

• The Taiwan Strait Crisis (1996)
• Apparent non-oil case
• Operation Desert Strike (1996)
• Sudden action with little warning
• Operation Desert Fox (1998)
• Long build-up of tensions
• Operation Attain Document I (1986)
• Non-Gulf oil case

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Taiwan Strait Economic Benefits
19
Desert Strike Economic Benefits
20
Desert Fox Economic Benefits
21
Attain Document I Economic Benefits
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Summary

• Summarizing the studys main findings
• As in the first study, Naval forward
  presence/crisis
• response was shown to produce significant
• economic benefits in all cases.
• Also similar to the first study, oil markets
  provided a
• constant link between Naval events and the
  US economy.
• Naval events were also found to affect in the
  short- and
• longer- term the pattern and movement of in
  
• The dollar/yen exchange rate,
• commodity indexes, and
• major stock exchanges

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Globalization and the Navy

• Implications for Globalization
• Likely patterns of globalization will strengthen
  the economic
• impact of forward deployed Naval forces.
• World trade likely to increase demand for
  oiltighter markets.
• More rapid growth will place greater stress on
  financial markets.
• Rapid capital movements-- greater foreign
  exchange volatility.
• In turn the stabilization of oil/financial and
  exchange rates will
• Stimulate more rapid globalization and thus world
  growth.
• Naval forward presence and globalization create a
  virtuous cycle
• that should result in expanded world trade and
  economic growth.

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Over-All Conclusions
Research undertaken at NPS has demonstrated
that 1. Economic benefits associated with Naval
forward presence are widespread occurring in oil
and non-oil situations. 2. Movements in Naval
forces during crisis periods often
impact positively and statistically on a variety
of markets. 3. The linkages between crisis
response and markets is complex -- initial
impacts spreading to related marketsoil to
commodity etc. 4. The ultimate impact on the US
economy is dependent on the strength of these
market linkages, which in turn are dependent on
the environment created by the state of
globalization. 6. Naval forward presence
enhances the positive aspects of globalization
and hence the US economy
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Areas for Further Research
1. What factors ultimately determine why, given
similar oil price movements, the economic
benefits from Naval crisis response are
considerably higher in one instance than in
another? 2. How can we predict in advance the
general magnitude of economic benefits occurring
from similar situations in the future? 3. What
can the US do to enhance the economic benefits
associated with Naval forward presence? 4. Are
there any likely changes in the world
economy that will weaken/strengthen the economic
impact of Naval forward presence? 5. Will the
New Economy strengthen or weaken the
usual Economic impacts of associated with Naval
forward presence? Why?
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Backup/Documentation
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Taiwan Strait Event Analysis
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Naval Forward Presence and Globalization
Complementarities and Impact on US Economy
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Naval Forward Presence Impact on the Components
of Increased Globalization
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Affect of Likely Globalization Trends on the
Economic Impacts Associated With Naval Forward
Presence