Most people are able to establish the connection between wars and growth. The net impact is usually negative. Since the cold war era, we have seen different wars come and go, and their impact had varied depending on the intensity of the war. The objective of this article is to quantitatively review some of the impact of the recent wars.
Every war, especially if a belligerent country is in the offensive, is likely to gain support from the west. This leads to a heavy amount of funding from taxpayers. For instance, data from the CFR showed that the U.S. has provided about $75 billion in foreign aid to Ukraine since the beginning of the war with 62% of that amount in the form of military assistance. Based on data from the IFW, the total bilateral commitment from countries and regional economic groups is $278.06 billion since 2022. There are foreign aids that have also been given to Russia, but there is no accurate tracker of overall size. Israel, on their part, got $14 billion as first round of aids from the U.S. for the war with Hamas in Palestine. Interestingly, a report from Reuters claims that Ukraine needs about $486 billion to rebuild its economy, perhaps if the war with Russia ends in 2024. This suggests that for every penny spent on the war, there is a multiplier cost, greater than one, which will be spent on reconstruction.
Can you imagine the growth impact of these foreign aids if invested in other sectors? There are past studies which have estimated the fiscal multipliers. Eden and Kraay (2014) put the figure at 1.5x (on private investment) and 2.0x (on output) for low-income countries. Leduc and Wilson (2013) estimated 2.0x using public infrastructure spending in the U.S. For advanced economies, fiscal multiplier was calculated as ranging from 0.4x in the short term to 1.4x in the medium term (IMF, 2014; Coenen et al., 2012). A more recent analysis by IMF (2020) showed that “1 percent of GDP positive shock to public investment is associated to an increase in the net investment rate by 6.5 percent at the impact of the shock.” Looking at these multipliers, it is clear that all the aids spent on the war ‘shorted’ private investment, GDP and household consumption. We can hypothesize that the world lost about $800 billion of private investment from the foreign aids spent on the Russia-Ukraine war alone. This explains why economic growth is still struggling to near pre-pandemic levels.
Another major concern with wars is the fact that it implants a nudge in governments to spend more on defence. In most western countries, latest budget proposals are heralding higher allocation for defence. For instance, U.S. defence budget expanded to $1.60 trillion in FY-24 from $1.52 trillion in FY-23. Canada also plans to double its defence budget to C$40 billion (2026-2027) from C$18.6 billion (2016-2017). This rising defence budget trend is also observed for other heavily-militarized countries (Russia: from RUB6.4 billion to RUB10.6 billion; North Korea: $1.5 billion to $3.5 billion; China: from Yuan1.58 billion to Yuan1.70 billion). The rationale for rising defence budget is simply a herding effect. In other words, militarization is now a competition among western countries. This has crowding out effect for private investment, which is generally speculated to have a stronger impact on growth than defence spending. Additionally, as western countries keep spending heavily on their defence budget, the risk of wars and invasion keeps rising, resulting in rising foreign aids, fresh cost of reconstructing war-thorn economies, and further need to spend more on defence. I would call this the war-growth cycle illustrated below.
With the current trend of rising defence budget, the outlook of geo-political risks remains on the downside. A support for this outlook is that the UN seems to be ineffective in preventing these war and invasion or even stopping them when they emerge. Also, with interest from countries, which are open to joining NATO, global defence spending is not expected to reduce in the short term. Therefore, there is no end in sight for geo-political risks in the short term, and rising geo-political risks will likely continue to pose adverse imminent implications for economic growth.
Written by Michael Ogunremi
Cover picture credit – Getty Images
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