HOW CIVIL CONFLICT DISRUPTS THE ECONOMY: New evidence from the West Bank and Gaza

01 Nov 2018

Conflict in Palestine in the early 2000s had a devastating effect on the economy, largely because local manufacturing firms were unable to get access to the inputs they needed from foreign markets. That is the central finding of research by Francesco Amodio and Michele Di Maio, published in the November 2018 issue of the Economic Journal.

Their study shows that Palestinian firms’ increased difficulty in accessing foreign inputs was only partially driven by the temporary closure of borders enforced by the Israeli authorities. Instead, it was due to a change in the terms of transaction between firms and their foreign trade partners. The uncertainty due to political instability made foreign suppliers less willing to sell inputs on credit, thereby limiting the opportunities for trade.

The authors calculate that more than 70% of the total fall in the value of manufacturing output during the Second Intifada (2000-2006) can be attributed to the negative effect of conflict on access to foreign input markets. This result has clear implications for policy: once internal warfare is over, policies that quickly restore international trade and the means by which it is financed can be very effective in fostering economic growth.

Civil conflicts have devastating economic consequences. Comparing countries over time, the data clearly show that internal warfare is associated with lower economic output, lower investment and lower growth.

The mechanisms through which conflict affects the economy are many and not easily separable. Some are obvious, such as the disruption of infrastructures. Others are more complex, such as capital outflows due to increased uncertainty linked to political instability.

Understanding the relevance of each of these channels separately is important in the design of effective post-conflict recovery policies. Once the conflict is over, and government resources are scarce, what should be the priorities? For example, should the government rebuild major infrastructures first, or instead subsidise access to capital for private firms?

Using the Israeli-Palestinian conflict as a case study, the new study provides some answers. The violence that erupted during the Second Intifada (2000-2006) had catastrophic consequences for the economy of the occupied Palestinian territory. This can be clearly seen in Figure 1, which shows that GDP fell by more than 20% between 2000 and 2002.

The researchers use a comprehensive dataset on Palestinian firms to investigate the precise ways in which the conflict affected their operations. The results indicate that Palestinian manufacturing firms were mainly affected by their inability to access foreign markets for necessary inputs.

Indeed, firms located in districts where the conflict was more intense – as measured by the number of Palestinian fatalities – were forced to substitute foreign materials with locally produced ones in production. This negatively affected the value of their final output.

Perhaps more importantly, the results also show that the increased difficulty in accessing foreign inputs was only partially driven by the temporary closure of borders enforced by the Israeli authorities.

Instead, it was due to a change in the terms of transaction between Palestinian firms and foreign trade partners. The uncertainty due to political instability made foreign suppliers less willing to sell inputs on credit, thereby limiting the opportunities for Palestinian firms to engage in international trade.

The authors calculate that more than 70% of the total fall in the value of manufacturing output in the period can be attributed to the negative effect of conflict on access to foreign input markets.

This result has clear implications for policy: once internal warfare is over, policies that quickly restore international trade and the means by which it is financed can be very effective in fostering economic growth.

Making Do With What You Have: Conflict, Input Misallocation and Firm Performance’ by Francesco Amodio and Michele Di Maio is published in the November 2018 issue of the Economic Journal.