How conflict disrupts the economy: New evidence from the West Bank and Gaza

Francesco Amodio, Michele Di Maio 09 December 2018

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The economic consequences of conflict are devastating. At the aggregate level, violent conflict is associated with lower output (Cerra and Saxena 2008, Chen et al. 2008), lower investment (Eckstein and Tsiddon 2004) and lower growth (Alesina et al. 1996). The incidence of conflict is also several times higher in poor countries than in rich countries (Blattman and Miguel 2010). Understanding the specific mechanisms through which aggregate negative effects materialise is critical for the design of effective policies that can unlock the potential for economic growth in the conflict-ridden regions of the world. 

Disentangling and identifying the many different ways in which conflict affects the economy is challenging for several reasons. First, collecting micro-level data during conflict is problematic. The few studies on the firm-level effects of conflict look at stock prices (Guidolin and La Ferrara 2007), investment (Singh 2013), probabilityof exit (Camacho and Rodriguez 2013), and employment (Collier and Duponchel 2013). Second, the possible mechanisms at play interact and magnify each other. For instance, the disruption of infrastructure makes it difficult for firms to acquire their production inputs, but also to reach final consumers. A theoretical framework is needed in order to capture and represent these layers of complexity. 

The effect of the Second Intifada on Palestinian firms

The Occupied Palestinian Territory during the Second Intifada (2000-2006) stands out as an ideal setting to try to answer the questions on how conflict disrupts the economy. First, the Palestinian Central Bureau of Statistics makes available yearly establishment-level data for a representative sample of manufacturing firms for the entire conflict period and before, with detailed information on production inputs and output. Second, the Second Intifada was characterised by meaningful variation in violence across time and space, about which detailed information is available. Finally, the economy never collapsed entirely in either the West Bank or the Gaza Strip. This makes this setting representative of those situations where economic activity and continuous low-intensity violence take place side by side: an increasingly common scenario in many parts of the world (World Bank 2011).

Figure 1 illustrates the aggregate relationship between conflict intensity and economic activity in the Occupied Palestinian Territory. It plots the evolution of real GDP together with the total number of Palestinian fatalities over time during the Second Intifada. The graph suggests that a negative relationship exists between the two.

Figure 1 Palestinereal GDP vs total number of Palestinian fatalities during the Second Intifada

Our recent work (Amodio and Di Maio 2018) studies one important margin along which conflict negatively affects the economy, namely the distortions it induces in the functioning and accessibility of markets for production inputs. The conceptual framework of our analysis builds upon Hsieh and Klenow (2009). With well-functioning markets, firms operating in the same sector combine inputs in the same proportions, getting larger or smaller depending on their productivity. Any distortion in the accessibility of markets for specific inputs makes firms use that input less intensively in production. It follows that by comparing input usage across firms that are in the same sector but located in more- versus less-violent districts, we can infer which input markets are more severely affected by conflict.

We then take these theoretical insights tothe data. We combine information at the establishment level with data on conflict intensity across locations in the Occupied Palestinian Territory over time, proxied by conflict-related Palestinian fatalities. We find that Palestinian firms located in more violent districts use relatively less imported materials in production than firms operating in the same sector, but located in less violent districts. This holds true after taking into account overall time trends and permanent differences across districts. This finding does not depend on changes in relative input prices, or in the population of active or surveyed firms at the locality level. 

Perhaps more importantly, we show that while Palestinian firms’ access to foreign inputs is made more difficult by the temporary closure of borders enforced by the Israeli authorities, this alone does not explain our result. We find instead evidence of a different channel: a change in the terms of transaction between local firms and their foreign trade partners. Using World Bank Enterprise Survey data from the same period, we show that Palestinian importing firms located in more violent districts in the Occupied Palestinian Territory report a lower value of inputs purchased on credit. This suggests that the uncertainty due to political instability made foreign suppliers less willing to sell inputs on credit to Palestinian firms located in conflict-affected localities, thereby limiting the opportunities for trade. 

The channel of trade disruption that we identify using microdata finds support in aggregate trade figures. Figure 2 shows the evolution of the real net balance of trade—total value of exports minus total value of imports—in the Occupied Palestinian Territory during the Second Intifada, combined with the number of Palestinian fatalities. The graph suggests that the two are positively correlated, indicating that the (negative) change in the value of imports was much more sizable than the change in the value of exports. 

Figure 2 Real net balance trade with Israel and number of Palestinian fatalities during the Second Intifada

We find that firms in conflict areas substitute locally produced materials for imported ones in production. But how does this translate into aggregate economic losses? Our calculations indicate that this specific channel accounts for more than 70% of the total fall in the value of manufacturing output during the Second Intifada.

How trade disruption can fuel political violence

Imported inputs are crucial for productivity and growth, especially for small economies like the Occupied Palestinian Territory. This finding resonates in our working paper (Amodio et al. 2018), where we explore the economic (and political) consequences of the import restrictions imposed by Israel on the West Bank. 

In 2008, Israel issued a list of goods and materials subject to severe import restrictions because of the possibility of their military use, i.e. the dual-use list. The dual-use list includes a wide range of products: chemicals, raw materials for industry, steel pipes, etc. To understand the impact of this policy, we combine yearly Palestinian establishment-level data, input-output tables, and labour force survey data. 

Our analysis shows that, after 2008, those manufacturing sectors that use restricted materials more intensively as production inputs experience a differential loss in output value and pay differentially lower wages. As a result, labour market outcomes worsen differentially in those West Bank localities, where employment is more concentrated in these sectors. Finally, the incidence of episodes of political violence is also differentially higher in these localities: as labour market outcomes deteriorate, the opportunity cost of engaging in violence decreases.

Concluding remarks

Our research documents that conflict negatively affects manufacturing firms’ economic activity by making it more difficult and costly to access to foreign input. At the same time, our more recent study indicates that reducing access to imported production inputs may create the conditions for an increase in political violence.  

Taken altogether, these findings demonstrate that trade and security policies are interlinked. On the one hand, post-conflict recovery policies that restore international trade and its financing can potentially be highly effective in fostering economic growth. On the other hand, security policies that involve trade restrictions can have negative economic and political effects. 

References

Amodio, F, and M Di Maio (2018), “Making do with what you have: Conflict, input misallocation and firm performance”, The Economic Journal 128: 2559–2612. 

Amodio, F, L Baccini and M Di Maio (2018), “Security, trade, and political violence”, mimeo. 

Alesina, A, S Özler, N Roubini and P Swagel (1996), “Political instability and economic growth”, Journal of Economic Growth 1(2): 189–211.

Blattman, C, and E Miguel (2010). “Civil War”, Journal of Economic Literature 48(1): 3–57.

Camacho, A, and C Rodriguez (2013), “Firm exit and armed conflict in Colombia”, Journal of Conflict Resolution 57(1): 89–116.

Cerra, V, and SC Saxena (2008), “Growth dynamics: The myth of economic recovery”, American Economic Review 98(1): 439–457.

Collier, P, and M Duponchel (2013), “The economic legacy of civil war: Firm-level evidence from Sierra Leone”, Journal of Conflict Resolution 57(1): 65–88.

Chen, S, NV Loayza and M Reynal-Querol (2008), “The aftermath of civil war”, World Bank Economic Review 22(1): 63–85.

Eckstein, Z, and D Tsiddon (2004), “Macroeconomic consequences of terror: Theory and the case of Israel”, Journal of Monetary Economics 51(5): 971–1002.

Guidolin, M, and E La Ferrara (2007), “Diamonds are forever, wars are not: Is conflict bad for private firms?”, American Economic Review 97(5): 1978–93.

Hsieh, CT, and PJ Klenow (2009), “Misallocation and manufacturing TFP in China and India”, Quarterly Journal of Economics 124(4): 1403–48.

Singh, P (2013), “Impact of terrorism on investment decisions of farmers: Evidence from the Punjab Insurgency”, Journal of Conflict Resolution 57(1): 143–68.

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Topics:  Development Politics and economics

Tags:  economic activity, Conflict, Occupied Palestinian Territory

Assistant Professor, McGill University

Associate Professor, University of Naples Parthenope

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