The September 2011 issue of the IMF's quarterly "Research Bulletin" features a Q&A discussion about economic recovery in countries emerging after war or other open. The research summaries in this issue include: "Revisiting Capital Controls"; and "Capital Flows and Financial Stability: Monetary Policy and Macroprudential Responses." The September issue also provides details on IMF visiting scholars (mainly during the September - December 2011 period), as well as recent Working Papers and Staff Discussion Notes published by the IMF.

Abstract

The September 2011 issue of the IMF's quarterly "Research Bulletin" features a Q&A discussion about economic recovery in countries emerging after war or other open. The research summaries in this issue include: "Revisiting Capital Controls"; and "Capital Flows and Financial Stability: Monetary Policy and Macroprudential Responses." The September issue also provides details on IMF visiting scholars (mainly during the September - December 2011 period), as well as recent Working Papers and Staff Discussion Notes published by the IMF.

Wars impose devastating human losses, destroy infrastructure, weaken institutions, and erode social capital. At the same time, periods following the end of conflict can also present economic opportunities. Despite conventional wisdom suggesting that reconstruction efforts in wartorn countries should lead to faster growth, post-conflict economic performance has varied widely. This article provides brief answers to seven questions about growth performance following the end of conflict.

Question 1: Should we expect a growth rebound in the aftermath of wars?

Peace dividends in terms of economic growth are not as certain as many expect. Economic theory does provide strong arguments for a rapid acceleration in economic growth once conflict ends. Standard models predict that, after the destruction of the capital stock observed during the war years, catch-up would be driven by high returns to physical investment relative to the steady state. Furthermore, the end of conflict might also spur increases in total factor productivity because the political and institutional uncertainty linked to war is resolved. But the persistent effects of conflict on human capital and, in many cases, the destruction of nonrenewable resources makes expectations for growth patterns in post-conflict periods less clear-cut (Blattman and Miguel, 2010). Moreover, the nature of the political and institutional environment bequeathed by the conflict can also be an important determinant of the speed of recovery, as discussed below. The empirical literature presents mixed results and points to a great deal of diversity in post-conflict economic performance (Cerra and Saxena, 2008; Chen, Loayaza, and Reynal-Querol, 2008). In fact, the evidence from our dataset containing civil strife episodes in sub-Saharan Africa, confirms that economic performance varies significantly across post-conflict episodes (David, Rodrigues Bastos, and Mills, 2011).

Question 2: What are the main determinants of post-conflict economic performance?

We examined a broad range of factors in a panel of sub-Saharan African countries. Not too surprisingly, changes in the terms of trade (the ratio of the price of exports to the price of imports), have the most statistically and economically significant association with different measures of economic performance after conflict, but we were somewhat surprised to find that institutional quality, specifically as measured by constraints on the executive, was the second strongest explanatory variable. Typically, changes in the terms of trade are associated with an increase in the marginal probability of positive economic performance by about 30 percent. The study controls for a broad set of variables, including legal origin (French or British), the income differential with respect to the United States, population, investment-to-GDP ratio, real interest rate, trade openness, foreign direct investment, and foreign aid flows. Foreign aid had a positive but not statistically or economically significant association with positive economic performance after conflict.

Question 3: How do the terms of trade affect growth in post-conflict settings?

Changes in the terms of trade can affect growth through multiple channels. In some models, the terms of trade affect the expected real rate of return on savings and hence the savings rate and growth (Mendoza, 1997). Other channels include wealth effects that influence domestic demand and incentives affecting the sectoral allocation of resources as the marginal product of factors changes in the tradable sector. Some specific characteristics of post-conflict environments might amplify the typical impact of the terms of trade on economic growth. For example, the onset of peace is likely to reduce overall uncertainty regarding the economic environment and could affect the elasticity of the economy’s savings rate to changes in the return on savings and therefore to changes in the terms of trade. It is also possible that, following widespread destruction of human capital and other sources of growth during conflict, natural resources become the primary source of growth, magnifying the impact of terms of trade shocks (Blattman, 2010). Moreover, post-conflict periods are frequently accompanied by commodity export booms (Collier, 2009), in which expansions are driven by both quantity and price effects, for example as country authorities can negotiate better deals.

Question 4: Why and how are political institutions important for growth in post-conflict settings?

Our results indicate that the likelihood of a post-conflict recovery increases when the executive authority is more limited. This is far from an obvious finding: one could argue that fewer restrictions on the executive support the quick adoption of fundamental reforms and ensure political stability in the aftermath of conflicts. This may be true in some cases, but our findings point to a systematic relationship in the other direction. They are consistent with some explanations featured in the literature. Acemoglu (2008) develops a model in which barriers to competition can emerge as political power becomes more concentrated. Aldashev (2009) surveys models in which constraints on the executive act as a mechanism to reduce expropriation risks, providing incentives for investment and growth. Finally, constraints on the executive could also contribute to consensus building among political players and help to consolidate the peace process. Constraints on the executive are also likely to reduce the probability of retaliation against political losers, thus contributing to stability. Building on these observations, some have gone so far as to suggest recruiting executives for post-conflict countries from outside the country (Rajan, 2011).

Question 5: What is different about institutions in post-conflict settings?

In general, institutions tend to change only slowly, offering little scope for policymakers searching for immediate levers to prop up growth. But post-conflict environments may be conducive to rapid institutional change, partly because conflict is likely to have weakened vested interests and increased the political appetite for reform. Therefore, a post-conflict environment may provide an opportunity to improve institutional quality more rapidly than is usually possible.

Question 6: What is the role played by international aid in post-conflict economic recovery?

Our analysis of post-conflict growth experiences in Africa does not yield evidence of a statistically or economically significant impact of foreign aid on economic growth. Indeed, more generally, a large body of empirical work finds no robust evidence of the effectiveness of international aid in promoting growth (see Easterly, 2009). The possible explanations for these findings include (i) limited absorptive capacity and real exchange rate appreciation in aid-receiving countries (Rajan and Subramanian, 2005); and (ii) adverse effects of volatile aid flows (World Bank, 2011). Nevertheless, it is important to keep in mind the critique of Clemens, Radelet, and Bhavnani (2004), who argue against the use of aggregate measures of aid when looking at its growth impact. Limitations of econometric techniques and difficulties in addressing endogeneity problems also call for caution when interpreting these results. Finally, aid plays a vitally important humanitarian role in post-conflict countries and could be important for immediate stabilization purposes, which may not be reflected in the near-term GDP statistics.

Question 7: If the main correlates of post-conflict performance are in many ways beyond the reach of policymakers, what policy lessons can be drawn from the analysis of post-conflict growth experiences?

The title of our paper asks, “Post-Conflict Recovery: Institutions, Aid, or Luck?” Movements in the terms of trade can be viewed mainly as a matter of luck, but there is still much post-conflict countries can do. The results illustrate that promoting export diversification, leveraging international markets, and mitigating the macroeconomic impact of volatile terms of trade are relevant policies. Countercyclical fiscal and monetary policies would be the first line of defense in attenuating volatility in the terms of trade, but they do not replace structural measures to improve the long-term competitiveness of the economy. Authorities can also promote financial instruments that allow for hedging against fluctuations in the terms of trade. Finally, reforms that restrain the ability of the executive to interfere with property rights, to stifle competition, and to generate business uncertainty are conducive to good economic performance and resilience.

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