Category Archives: Property Rights

THE ECONOMIC COSTS OF CONFLICT

THE ECONOMIC COSTS OF CONFLICT: A CASE STUDY OF THE BASQUE COUNTRY

A. Abadie & J. Gardeazabal

The American Economic Review, Vol. 93, No. 1 (2003) pp. 113-32

Principal Research Question and Key Result Did the conflict in the Basque country affect the economy? The results suggest a 10% loss of GDP due to the terrorism.
Theory Terrorism could affect GDP in various ways. The most important is likely to be investment. If earning a return on investment becomes uncertain because either the return may be extorted or the entrepreneur killed then this acts as a random yet significant tax on investment. Under such a circumstance investment is depressed and this will affect output and hence GDP. Additionally foreign investment in the affected region could be reduced if conducting business in that region is thought to be risky, although the mechanism is exactly the same, although it operates on international rather than domestic actors.

 

Motivation Political instability is often said to have strong effects on economic prosperity. However, studies to date have largely been cross country studies which suffer from comparability issues (as conflicts are rarely similar). This study seeks to explain how the richest region in Spain subsequently dropped to the 6th position in terms of GDP per capita. As it is focused on only one such conflict the heterogeneity issues outlined above are circumvented to a certain extent (although, as ever at the expense of external validity).

 

Data They have panel data for 1968-1997 which includes variables on deaths and killings, as well as GDP and other variables that can be thought to determine GDP such as investment ration, and human capital measures.

 

Strategy They exploit the fact that ETA was created in 1959 but did not implement large scale terror operations until the mid-70s. Additionally in 1998 a ceasefire was declared which was subsequently cancelled, and this provides testing ground for looking at how economic outcomes varied during both the scale up of violence (largely killings and kidnappings), and the cease fire.

They essentially do a DID, however they cannot simply compare the Basque country to another region, as there was no comparable region – the Basque country was the richest, most industrialized etc. So they construct a synthetic control group. They do so by identifying a list of variables that are thought be drivers of economic growth (agriculture share etc. table III) and assign weights to the other possible control regions such that when aggregated the weighted averages of the variables resemble the observed variables for the Basque country subject to the constraint that the variable that should best be reproduced is the GDP per capita for the Basque country in the 1960s. When this is done, they end up with a synthetic control group that is comprised of 85% Catalonia and 15% Madrid.

During the ceasefire they look at the cumulative abnormal returns of stocks listed as Basque stocks, relative to other stocks on the Spanish market. Asset prices should reflect all available information, and if instability is important then Basque stocks should have performed better when the ceasefire was announced and became credible, and worse as the cease fire broke down. They categorized the stocks using market professionals.

 

Results They plot the GDP growth of the synthetic control and the Basque country and they follow each other closely until the mid-70s, when the Basque country falls behind. This suggests a loss of 10% of GDP due to the terror. The gap in the GDPs of these regions seems to spike at the same time as the deaths from terrorism in the Basque country. 

The results of the ceasefire study are that the good news dummy coefficients are significant and positive for Basque stocks and negative for Bad news.

Robustness The do a placebo study, by comparing Catalonia and a synthetic Catalonia (constructed as above but excluding the Basque country as a possibility) and find that there is no significant gap in GDP, although the real Catalonia did outperform the synthetic one by 4% around the time of the Barcelona Olympics.

 

Problems
  • The synthetic control is made up almost exclusively of Catalonia, thus it is not very balanced, or impervious to idiosyncratic shocks in that region. Additionally, it is not clear that selecting weights so that GDP is matched is the best strategy, as similar GDP levels in the 60s does not guarantee that what is salient in terms of future growth has been captured.
  • They do not actually estimate the DID using regression techniques as far as I can see, so we have no idea what the standard errors are, or what the other significant factors were in determining outcomes in the Basque country. This does not allow us to verify how important e.g. industrial decline was in explaining GDP in the Basque. Without such results it cannot be said conclusively that the higher industrial share in the Basque country pre-terror was not driving lower GDP in the face of industrial decline post-terror.
  • The authors state that Catalonia and the Basque country were both highly industrialized regions. If one of the effects of terror was to incentivize entrepreneurs or businesses to move away from the Basque country due to instability, the chances are they would relocate to somewhere that was similar to the Basque country, which surely would be Catalonia. As the synthetic control is made up predominantly of Catalonia, any significant movement of human capital from the Basque to Catalonia could have affected GDP outcomes in Catalonia, and hence this would tend to overstate the results.
  • It is not clear that they have isolated anything to do with property rights as such.

 

Implications Conflict can harm the economy. This is not a new idea. Not sure what the policy implications are, other than avoid civil conflict if possible.

 

 

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