Wars are frequently catastrophic for the economies of the countries involved. A key driver of the long-term damage is fragility within the financial systems of the warring countries, as this impedes the ability of a nation to mobilise capital and rebuild following a war’s conclusion.
The experience of several countries in the Middle East and North Africa region underscores the long-term value of building a financial system strong enough to limit the devastation wrought by conflict.
Much of how wars harm economies is common sense: physical capital is destroyed; workers are killed; funds are redirected from development to arms; and trade with the outside world is impeded. But a recent paper by Northwestern University’s Efraim Benmelech and Einaudi Institute’s Joao Monteiro analyses data from 115 conflicts in 145 countries over 75 years to identify some of the underlying factors that complicate recovery efforts.
Their study confirms the high economic cost of wars: real gross domestic product falls by 13 per cent on average, and – most importantly – there is no recovery even a decade after the war ends.
Dr Benmelech and Dr Monteiro gathered a wide range of macroeconomic data to assist in parsing the mechanisms, leading them to the conclusion that financial frictions are the main conduit through which wars cause persistent investment collapses.
In particular, when war destroys physical assets, it also destroys financial confidence, as such assets are usually a primary source of collateral for prospective borrowers. With collateral values collapsing, credit dries up, investment stalls and weakened balance sheets keep economies trapped in a slow-motion downturn.
Several of the recent and ongoing conflicts in the Middle East viscerally display the mechanisms analysed by Dr Benmelech and Dr Monteiro. Syria, which is gradually emerging from a 13-year civil war, is struggling to rebuild an economy whose financial system seems to have been permanently derailed.
On the one hand, the sheer scale of destruction means that investors can expect extraordinary returns as the country is rebuilt; yet, for the time being, a multitude of financial frictions is keeping the economy in stasis, unable to fulfil its latent potential.
For example, a key challenge for the Syrian government is the de facto fragmentation of financial authority. A number of monetary centres now exist across state and opposition-controlled areas, undermining the credibility of the Syrian pound and eroding public trust in financial institutions.
These challenges were previously exacerbated by the severe sanctions imposed upon the national economy, though the US government has recently offered some respite. Nevertheless, in general, war-related economic sanctions are increasing in incidence, reinforcing the role that financial barriers play in retarding economic recovery.
While the study’s authors do not suggest specific countermeasures, they can be inferred from the detailed exposition of the faulty mechanisms often present in many financial systems. In other words, countries would do well to implement preparatory financial investments and reforms to better insulate themselves from economic damage as an outcome of war.
For instance, policymakers should strengthen a financial system’s shock absorbers by ensuring that key banks have emergency credit lines and can withstand losses from risks, with central banks planning for emergency liquidity facilities. Authorities should also accumulate foreign exchange reserves and establish contingent credit arrangements with institutions such as the International Monetary Fund.
At a more functional level, governments should digitise and back up property and banking records abroad or in secure data centres, while guaranteeing household deposits and ensuring cash supply continuity through mobile banking and central-bank digital channels.
Lebanon’s economy continues to struggle six years after it suffered an extraordinary breakdown. Yet it would surprise many to note that, in the wake of its 1975-1990 civil war, it was the resilience and sophistication of its financial sector that provided it with a springboard for rapid recovery, in line with the tacit recommendations made by Dr Benmelech and Dr Monteiro.
The Levantine state’s banks were well-capitalised and further strengthened by maintaining the trust of its large international diaspora, whose remittances were critical to the economy. In the 1990s, the monetary stewardship of the country’s central bank, the Banque du Liban, was highly disciplined. This enabled the government to finance reconstruction through domestic borrowing. Consequently, Lebanon’s infrastructure recovered unusually quickly for a country so devastated by war.
Of course, even though success stories like that of post-war Lebanon provide far-sighted policymakers with cause for optimism, no amount of financial buffers and agile statecraft can fully offset the credit paralysis and investor anxiety that accompany violent conflict. Put differently, while building a deep and sophisticated financial sector is a welcome insurance policy, there is no substitute for avoiding a war.
