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“Local” Wars Have Increasingly Global Consequences

03.12.2023
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According to J. Kucik

Ukraine's annual GDP fell by 30 percent in the first year of the fight with Russia. Forecasts for Israel's economic growth were adjusted downwards by 23 percent in the first month of the fight against Hamas. And many other economies—Syria, Myanmar, Ethiopia—bear the indelible scars of long-term conflict. But the economic damage from war is not limited to conflict zones. A full account of the costs of war must include the market turmoil experienced by global markets, including how conflicts undermine economic performance and put developing countries at risk.

Economists provide a laundry list of reasons why market shocks, defined as sharp, unpredictable fluctuations in trade and investment flows, are toxic at all levels of the market. Shocks could, among other things, lead to an increase in the budget deficit and destabilization of the value of the currency. They can divert trade flows and weaken investment. They can even impact individual incomes through lower wages and job losses. The harmful effects can be so severe that long-term exposure to instability slows growth and stunts development.

War makes these problems worse. And political events, including armed conflicts, are the most common causes of day-to-day instability in global markets. There are several simple reasons for this. Not least, conflict could disrupt trade and investment relations, damaging production infrastructure in countries at war and slowing production of non-essential goods. For example, a country like Syria, whose economy is heavily focused on agriculture, lost about a third of its GDP due to the agricultural shutdown. Similar food security problems have already arisen in Ukraine.

Less directly, but no less important, conflict creates political risk. Conflicts are prompting multinational companies, which are notoriously risk-sensitive, to exit fragile economies and redirect supply chains. We see this sensitivity before the violence occurs. Surveys of foreign firms operating in China show that businesses are facing the costs and benefits of exiting an already tight market. Likewise, the protests in Tahrir Square reversed the trend of increasing capital flows that existed in Egypt before 2011.

Whatever the root causes, the results are often the same: war shocks markets. And the rest of the market is feeling the effects. The war in Ukraine is a prime example. Slower production in Ukraine and Russia, which account for about a third of total wheat exports, has led to a doubling of global prices in 2022.

Richer countries are not immune to the damage. In the United States, inflation, caused in part by the war in Eastern Europe, outpaced income growth from 2021 through the summer of 2023, eroding purchasing power. In the UK, energy price increases linked to the war in Ukraine cost around £1,000 per adult. In the European Union, fuel and food prices have driven inflation to 9 percent, more than four times the twenty-year average. The figures all come as firms and governments struggle to cope with a rapidly changing economic climate as political violence continues to undermine long-standing trade and investment partnerships.

Unfortunately, in developing countries this problem is aggravated several times. Smaller and poorer economies are particularly vulnerable to the effects of conflict because poorer markets are already prone to shocks. Their economic well-being often depends largely on trade and investment in a relatively narrow range of raw materials and goods. All of the world's least diversified economies are also the least developed. This has implications for regions such as sub-Saharan Africa, where food prices alone have risen almost 25 percent over the past three years, leaving some 40 million people at risk of hunger. Prices for steel, fertilizer and other critical commodities have soared even higher. These countries, where Covid-19 has taken a heavy toll, depend on Ukraine for wheat and Russia for fertilizer, two markets that have become less predictable and less accessible over the past two years.

In today's globalized, shock-prone international system, the harm of war extends far beyond the battlefield.

 

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