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A Business Way to Look at "the Surge"

If you were to ask a Democrat about the success of President Bush’s “surge” in US troops, she’d (probably) tell you the Surge was a failure. If you ask a Republican, she’d (probably) tell you the Surge was a success. Both sides can cite valid statistics which seem to tell contradictory messages. Yes, civilian casualties are down without an enormous increase in soldier death, and yes, some progress has been made in training and in other areas. But, at the same time, there seems to be no significant improvement in the prospect that the violence will one day end, nor does there seem to be much improvement in the prospect that the Iraqi government will soon be able to take over the security and finances of the country.

How do you determine which side is right?

First, you have to ask yourself what constitutes success. Lets just say (since this seems to be the general consensus) that the end goal of the War in Iraq is a stable Iraqi government. If one exists, then the War was a success. If one doesn’t, then the War was a failure. Therefore, the Surge is a success if it contributes towards establishing a stable Iraqi government, and the surge is a failure if it is not contributing (and a particularly bad failure if it is making it less likely) to that goal.

So, is the Surge a success? How do you find out? You could ask the politicians to debate, or you could ask a political expert/pundit — but, generally, pundits and politicians seem more interested in sounding right rather than being right.

Luckily, there is an easier and more impartial way to determine this. Every government running a deficit issues government bonds. These bonds, for those who don’t know, pay an interest rate to whoever is willing to loan the government money. After a bond is sold, the interest rate is effectively set in stone. If the payor of the bond suddenly seems much less likely to pay off the loan, the value of the bond drops (because the interest rate isn’t going to move, who wants to hold onto a bond that pays the same but is a lot less likely to pay out?). If the payor of the bond suddenly seems more likely, the value of the bond increases (more people would love to get their hands on that bond).

So, one way to tell if the Surge was a success or a failure is to check the price of Iraqi government bonds before the Surge and after. If the price drops, the Surge has been deemed by the market to have not contributed to stabilizing the Iraqi government. If the price goes up, the market perceives that it has.

Why is this true? It’s the profit motive of the investors involved. Yes, an investor may be Republican or Democrat, but if a bond is worth more than it should, then someone is going to sell. If a bond is worth less than it should, then people are going to buy (and bid up its price) — and you can count on this aggregate group of investors doing their best and spending their time and effort on figuring out the right answer.

And this is precisely what a paper by Michael Greenstone seeks to do. From the abstract:

“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.”

This is the essence behind prediction markets, which use the profit motive coupled with human knowledge and reasoning to aggregate the collective wisdom of many people. This isn’t to say that these markets are necessarily correct or that they can pinpoint exactly what will happen (the answer above is a risk assessment), but this is about as unbiased and accurate a method as any to figuring this out.

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