"Is The 'Surge' Working? Some New Facts"

This NBER paper by MIT's Michael Greenstone reinforces Paul Krugman's message (in the post below this one) that the "smart money" is betting against Iraq's survival. According to this analysis of the Iraqi state bond market, since the Surge began there has been "a 40% increase in the market's expectation that Iraq will default. This finding suggests that to date the Surge is failing to pave the way toward a stable Iraq and may in fact be undermining it." Here's the abstract, introduction, and conclusion the paper:

Is The 'Surge' Working? Some New Facts, by Michael Greenstone, SSRN, September 14, 2007: Abstract There is a paucity of facts about the effects of the recent military Surge on conditions in Iraq and whether it is paving the way for a stable Iraq. Selective, anecdotal and incomplete analyses abound. Policy makers and defense planners must decide which measures of success or failure are most important, but until now few, if any, systematic analyses were available on which to base those decisions. This paper applies modern statistical techniques to a new data file derived from more than a dozen of the most reliable and widely-cited sources to assess the Surge's impact on three key dimensions: the functioning of the Iraqi state (including civilian casualties); military casualties; and financial markets' assessment of Iraq's future. The new and unusually rigorous findings presented here should help inform current evaluations of the Surge and provide a basis for better decision making about future strategy.

The analysis reveals mixed evidence on the Surge's effect on key trends in Iraq. The security situation has improved insofar as civilian fatalities have declined without any concurrent increase in casualties among coalition and Iraqi troops. However, other areas, such as oil production and the number of trained Iraqi Security Forces have shown no improvement or declined. Evaluating such conflicting indicators is challenging.

There is, however, another way to assess the Surge. This paper shows how data from world financial markets can be used to shed light on the central question of whether the Surge has increased or diminished the prospect of today's Iraq surviving into the future. In particular, I examine the price of Iraqi state bonds, which the Iraqi government is currently servicing, on world financial markets. After the Surge, there is a sharp decline in the price of those bonds, relative to alternative bonds. The decline signaled a 40% increase in the market's expectation that Iraq will default. This finding suggests that to date the Surge is failing to pave the way toward a stable Iraq and may in fact be undermining it.

Introduction

"We need a surge of facts." Tony Snow, Press Secretary for President George W. Bush, July 12, 2007

Is the war in Iraq worth its cost? The rationales for the war include that it plays a central role in protecting the nation against threats from al-Qaeda, ensuring a reliable supply of oil to the world market, preventing a humanitarian crisis in Iraq, providing an environment that allows for a stable Middle East, and ensuring the future of a sovereign Iraqi state. As of September 1st 2007, approximately 27,662 US soldiers have been wounded and 3,735 have been killed in the course of the war’s prosecution. The US has spent about $403 billion (Sunshine 2007) to date on the war and related activities, and it has been estimated that its ultimate costs could exceed $2 trillion (Bilmes and Stiglitz 2006). The current debate about the war in Iraq is centered on whether the Surge is working.

There is a paucity of facts about the effects of the recent military “Surge” on conditions in Iraq and whether it is paving the way for a stable Iraq. Selective, anecdotal and incomplete analyses abound. Policy makers and defense planners must decide which measures of success or failure are most important, but until now few, if any, systematic analyses were available on which to base those decisions. This paper applies modern statistical techniques to a new data file derived from more than a dozen of the most reliable and widely-cited sources to assess the Surge’s impact on three key dimensions: the functioning of the Iraqi state (including civilian casualties); military casualties; and financial markets’ assessment of Iraq’s future. The new and unusually rigorous findings presented here should help inform current evaluations of the Surge and provide a basis for better decision making about future strategy. The central challenge for this analysis is to determine what would have happened in Iraq in the absence of the Surge. In the ideal, there would be two completely identical Iraqs--- one in which the Surge took place and another in which it did not. These two Iraqs could be compared to determine the Surge’s causal impacts. As a feasible alternative, this paper compares outcomes in the period before the Surge to the same outcomes in the period after the Surge’s initiation. In some cases the outcome variables were trending upwards or downwards in advance of the Surge. In order to avoid confounding these pre-existing trends with the effect of the Surge, this paper tests for changes in these trends.

The analysis shows mixed evidence on the Surge’s effect on the current functioning of the Iraqi state. Perhaps the crudest expression of the security situation in Iraq is the rate of civilian fatalities. I find a substantial reduction in civilian fatalities in Baghdad and the rest of Iraq. Further, there isn’t a decline and there may be an increase in the number of hours of electricity available to Iraqi consumers (although not in Baghdad). On the less positive side, the size of the Iraqi Security Force was about 10% lower 25 weeks after the Surge began than would have been predicted by trends prior to the Surge. Additionally, the analysis finds that after the Surge oil production didn’t increase and may have decreased. Oil is Iraq’s primary source of income.

The second category of outcomes examines the impact of the Surge on casualties suffered both by coalition soldiers and Iraqi Security Forces. The analysis indicates that the Surge had little impact on the number of casualties suffered by coalition and Iraqi Security Force troops. There is even some evidence of a decline in the number of non-fatal casualties per day among US soldiers. Since the number of US troops in Iraq was increasing in this period, these findings are noteworthy.

The stated purpose of the Surge was to create the conditions necessary for a stable Iraq to emerge. These first two categories provide mixed evidence on the Surge’s effect on the current functioning of the Iraqi state. Making sound decisions about how to proceed in Iraq based on such conflicting indicators is extraordinarily challenging. For example, does the positive news on security outweigh the negative findings about Iraqi Security Forces (or the failures on many of the 18 congressionally mandated benchmarks)? In the face of this uncertainty, analyst judgment and politics may play too large a role.

There is, however, another way to assess the Surge. This paper shows how data from world financial markets can be used to shed light on the central question of whether the Surge has increased or diminished the prospect of a functioning Iraq. In particular, I examine the price of Iraqi state bonds, which the Iraqi government is currently servicing, on world financial markets. Importantly, these bonds trade on world financial markets; for example, hedge funds hold a substantial fraction of them and their price on the secondary market is quoted in Bloomberg’s financial data services. The appeal of using financial markets is that traders’ only concern is to make profitable decisions and this necessarily requires making correct projections. There isn’t room for personal biases in this setting. Consequently, it isn’t surprising that these markets have a good track record at predicting uncertain future events (Wolfers and Zitzewitz 2004).

Overall, the bond market findings fail to support the view that the Surge is helping to pave the way for a stable Iraq to emerge and may in fact be undermining it. After the Surge, the Iraqi bonds’ yield increased by 115 to 170 basis points, relative to comparison bonds. This translates into an approximate 40% increase in the expected annual probability of default. In other words, the world financial markets are saying that the Iraq’s prospects declined after the Surge.

Examining bond yields to learn about the effectiveness of the Surge requires several assumptions, including that financial markets efficiently accurately aggregate public and private information from diverse sources. Further, the meaning of this exercise would be undermined if the documented movements in bond yields reflect domestic US politics. I find that the increases in default risk remain even after controlling for the probability that a Democrat will be elected President in 2008. This finding does not eliminate the domestic politics explanation, but it substantially weakens the case for it.

There are several caveats to this analysis that bear highlighting. First, due to the absence of data that predates the invasion of Iraq, the analysis can only inform the question of the Surge’s efficacy. This paper is not directly informative about the broader question of the impact of the Iraq war. Second, the data on the current functioning of Iraq fail to cover many outcomes that would be of great interest and are potentially more informative than the available ones. Third, even among the available data, there are legitimate questions about quality and reliability. This is especially the case with the civilian casualty data.

The remainder of the paper proceeds as follows. Section II provides a brief background on the Surge. Section III briefly describes the data file compiled for the analysis (there is a much more extensive discussion in the Data Appendix) and IV outlines the statistical models. Section V discusses the results. Section VI concludes.

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VI. Conclusions There is a paucity of facts about the effects of the recent military “Surge” on conditions in Iraq and whether it is paving the way for a stable Iraq. Selective, anecdotal and incomplete analyses abound. Policy makers and defense planners must decide which measures of success or failure are most important, but until now few, if any, systematic analyses were available on which to base those decisions. This paper applies modern statistical techniques to a new data file derived from more than a dozen of the most reliable and widely-cited sources to assess the Surge’s impact on three key dimensions.

The analysis reveals mixed evidence on the Surge’s effect on key trends in Iraq. The security situation has improved insofar as civilian fatalities have declined without any concurrent increase in casualties among coalition and Iraqi troops. However, other areas, such as oil production and the number of trained Iraqi Security Forces have shown no improvement or declined. Making sound decisions about how to proceed in Iraq based on such conflicting indicators is challenging and uncertain. Moreover, this uncertainty may allow analyst judgment and politics to play too large a role.

There is, however, another way to assess the Surge. This paper has shown how data from world financial markets can be used to shed light on the central question of whether the Surge has increased or diminished the prospect of a functioning Iraq. An appeal of using financial markets is that traders’ only concern is to make profitable decisions and this necessarily requires making correct projections. There isn’t room for personal biases in this setting and it therefore isn’t surprising that financial markets have a good track record of predicting future events.

I examine the price of Iraqi state bonds, which the Iraqi government is currently servicing, on world financial markets. After the Surge, there is a sharp decline in the price of the Iraqi bonds, relative to alternative bonds. This decline signaled an increase of approximately 40% in the market’s expected annual probability of default. This finding suggests that to date the Surge is failing to pave the way toward a stable Iraq and may in fact be undermining it. In many respects, it is consistent with recent assessments that fail to find that Surge has led to substantial progress toward meeting many of the 18 congressionally mandated benchmarks for progress in Iraq (GAO 2007)

This paper has produced a series of new facts on the Surge’s impact. It is straightforward to update these facts as new data becomes available. Further, the new facts can be used to aid decision making about the future of the Surge.

More broadly, the paper shows that even in unconventional wars, it is feasible to measure and analyze important outcomes to learn about the war’s success. Finally, it highlights that world financial markets may be an important new source of information to judge a war’s success.