9 A digression on the economic costs of war

1. 875-9.ppt 9 A digression on the economic costs of war

2. 875-9.ppt Source: Howard Dick, ‘The Challenge of Sustainable Development’, in Indonesia Today: Challenges of History, Lloyd and Smith, editors

3. 875-9.ppt 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. 875-9.ppt 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. 875-9.ppt 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.

6. 875-9.ppt 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. 875-9.ppt Sri Lanka 1984-94 * Assumes 5% interest rate, excludes many intangible & efficiency costs

8. 875-9.ppt 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. 875-9.ppt 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. 875-9.ppt The peace dividend in some developing regions * Steady state value relative to baseline (Source: Knight et al 1996)

11. 875-9.ppt 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. 875-9.ppt 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.