9 A digression on the economic costs of war

1
9 A digression on the economic costs of war

2
Source Howard Dick, The Challenge of
Sustainable Development, in Indonesia Today
Challenges of History, Lloyd and Smith, editors
3
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)

4
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.

5
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 govt 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.

6
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.

7
Sri Lanka 1984-94
Direct costs 1996 GDP
Direct govt military exp. 41.3
LTTE military expenditure 4.1
Govt 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
8
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

9
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)

10
The peace dividend in some developing regions
Investment/GDP change () Investment/GDP change () Per capita GDP relative to baseline 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)
11
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

12
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.