Monday, December 31, 2007

Costs of Conflict

An important issue in the study of violent conflict is the nature of the economic costs that are imposed. On the one hand, instability drives away investment, and resources committed to fighting and the destruction wrought by conflict both steal from productive capacity. On the other hand, it is conceivable that political change ushered in via conflict can result in redistribution of assets and opportunities that increase long run efficiency. The economic costs of conflict are conventionally understood as fundamental in determining whether protagonists decide to fight.

A major difficulty in addressing this issue is measurement. A new paper by Zussman, Zussman, and Oregaard in the current Economica (gated link here) shows how asset market data can be used to measure the economic effects of conflict. Their key methodological contribution is a way of identifying "turning points" in financial time-series. They apply this method to data from Israeli and Palestinian asset market series. They find that their methodology does a good job at identifying turning points in the market series that correspond to key events in the Israeli-Palestinian conflict. Aggregates over periods between turning points can be used as summaries of economic costs of conflict. Doing so, they find that "rough calculation based on the results of our analysis yields a drop of 22% in the value of the Tel Aviv Stock Exchange resulting from the outbreak of the Intifada and an increase of 25% in market value arising from the adoption of the Road Map peace plan."

So can we interpret this as saying that about a quarter of Israeli asset market activity was sensitive to the conflict? If so, one wonders what factors contribute to the extent to which markets are sensitive to conflict. In addition, to what extent does this number characterize general economic sensitivity to conflict in Israel? To the extent that markets are made more resistant to conflict, are incentives to fight altered?

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