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9 A digression on the economic costs of war

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Figure 1. Indonesia, GDP per capita (1983 Rupiah '000 - oil at shadow price)

0

100

200

300

400

500

600

700

800

900

1,000

1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

Source: Howard Dick, ‘The Challenge of Sustainable Development’, in Indonesia Today: Challenges of History, Lloyd and Smith, editors

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Wars and economic development

“Peace is prerequisite to successful development. Most of the economically successful countries have been able to enjoy sociopolitical stability. By contrast, most of the thirty-six countries that have lost ground over the past twenty-five years were involved in a substantial military conflict”

-- Summers and Thomas (1993)

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The costs of wars• Direct costs:

• Destruction and damage to capital & labor assets

• Military expenditures

• Medical and refugee care

• Possible expansionary impact from employment of idle resources

• Indirect costs:

• K flight, loss of export revenues, loss of FDI, emigration of skilled labor

• Efficiency losses: resource misallocation, uncertainty, diminished quality of policy-making and implementation, corruption.

• Efficiency gains: acquisition of new (specialized) information and skills; productivity spillovers to nonmilitary industries.

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Indirect costs• Most direct (and short-run indirect) impacts affect the level of output and

income. – Can therefore calculate present value of the costs of war through a comparison of

actual and counterfactual growth rates.

• Indirect growth effects are likely to be felt through resource allocation decisions:– Military exp. by government ‘crowds-out’ other forms of gov’t investment and

expenditures (Sri Lanka budget data)

– Milit. expenditures (and actual conflict) may reduce exp. return on private investments, and may increase the volatility of those returns, and raise risk premia and other transactions costs.

• Less tangible consequences: – Constraints on government policy-making capacity

– Restrictions on information flows

– Smuggling, corruption and other rent-seeking opportunities.

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Indirect costs• Sectoral effects of conflict and military expenditures. Distortions

(relative to peace time) in relative returns to factors and sectors:– Moveable assets (war discourages fixed investments)

– Discount rates applied to natural resource depletion (plus, loss of rule of law creates de facto open access, e.g. Angolan diamonds, Cambodian timber and gems).

• Political polarization and degradation of institutions and processes of governance– E.g., conflicts over land ownership in Zimbabwean politics, 20 years after

the war.

– E.g., Political conflicts over exchange rate policies when military supplies are mainly imported.

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Sri Lanka 1984-94Direct costs % 1996 GDP*

Direct gov’t military exp. 41.3

LTTE military expenditure 4.1

Gov’t exp. on relief services 3.0

Cost of lost infrastructure 13.5

Indirect costs

Lost income due to foregone public investment 8.6

Lost income from reduced tourist arrivals 17.0

Lost income from reduced foreign investment 71.2

Other sources of foregone income 10.3

Total 168.0

* Assumes 5% interest rate, excludes many intangible & efficiency costs

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The long-term costs of war • Short-run damages, long-run fiscal costs, plus efficiency losses reduce level and

growth rate of income• Post-war reconstruction (e.g. replacing damaged infrastructure) further

competes with ‘counterfactual’ investment and expenditures• Industrial structure biased toward military supplies, industries with mainly

mobile assets• Less tangibly, wars degrade institutional robustness and policy-making capacity• The poor and the young, with fewer and/or less mobile assets, lose relatively

more• Diminished rule of law creates de facto open access to env. & natural resource

assets• Wars create poverty & social tensions-- the precursors to future strife• Domestic costs also spill over to neighbors and other countries

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What about a ‘peace ‘dividend’? • Knight et al 1996:

– Military exp. and wars reduce growth– Milit. exp. also reduces total investment– Simulated cuts in milit. exp raise growth and

investment, by differing amounts in each region depending on initial milit. expenditure shares:

– Conditional convergence model (steady state values)– Table 7: effects of late 1980s reductions in milit. exp. – Table 8: effects of “global peace” (all regions’ milit. exp.

reduced to that of lowest region)

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The peace dividend in some developing regions Investment/GDP change

(%)Per capita GDP relative to

baseline *

Region (M/GDP)

Future exp at 1986-90

Future exp at lowest

Future exp at 1986-90

Future exp at lowest

Asia

(6.35)0.66 1.63 13.6 32.7

Middle East

(10.34)0.25 3.30 3.6 46.2

N. Africa

(8.13)0.70 1.81 15.7 39.6

* Steady state value relative to baseline (Source: Knight et al 1996)

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A few researchable topics

• General equilibrium output effects of war and peace, taking account of intersectoral resource allocation

• Static (“impacts”)

• Dynamic -- including investment changes

• Distributional effects & political economy

• Effects on ‘rents’ and efficiency

• Inter-country spillover effects

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References

• Arunatilake, N.; S. Jayasuriya, and S. Kelegama, 2001: The economic cost of the war in Sri Lanka. World Development 29(9): 1483-1500.

• Knight, Malcolm; Loayza, Norman; Villanueva, Delano, 1996: The peace dividend: Military spending cuts and economic growth. International Monetary Fund. Staff Papers 43(1) March.

• Summers, Lawrence H; Thomas, Vinod, 1993: Recent Lessons of Development. World Bank Research Observer, vol. 8, no. 2, July, pp. 241-54.