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The Hidden Price of War

28 Feb 2017
Economics

Assessments of the costs of war are typically based on rebuilding costs. New research shows that the economic costs run much deeper and last far longer than is commonly assumed.

In today’s world, global trade and trading patterns are a hot topic.  After decades of deeper trading relationships, governments and people are beginning to reassess the value of globalization and the trading links that underlie global trading relations. Those links can reveal what draws countries together to trade with and invest in each other, and also what pulls them apart and damages their trading relationships.

Since the onset of the financial crisis in 2008, globalization has begun to lose some of its lustre. The evidence of the global reach of financial crises, as well as financial opportunities, was brought home to many ordinary people when the sub-prime mortgage market collapsed in the US, triggering a domino effect on banks around the world. In the wake of the crisis, the global economy began to show some signs of reconfiguration. In the same way that banks around the world are now scrutinizing their business partners and clients more carefully, countries are showing signs of becoming more selective and cautious about which countries they want to do business with. And people are beginning to become more particular about their public representatives and the institutions responsible for setting the ground rules for globalization. Perhaps nowhere has this swerve away from globalization been more visible than in the pre-election rhetoric of the US presidential election. The Republican candidate has made clear his intentions to turn America’s focus inward, with plans to encourage American firms to bring their manufacturing, and their taxes, back to the US, talk of building a wall with America’s southern neighbour, Mexico, and of abandoning long-standing trade agreements such as the 1994 NAFTA accord and cutting military ties with allies around the world. On the other side of the Pacific, disenchanted British voters have chosen to end the country’s 43-year membership of the European Union and go it alone, a choice that is uncharted territory for the EU.

What makes countries good trading and investment partners? A look at trade flows and trade agreements over past decades and centuries highlights several criteria that are repeatedly identified with closer trade relations. Good transport and communication links have been key factors for centuries, and that is still true in today’s globalized world when they have largely replaced the need for geographical proximity.

Today’s global trading system has been driven by huge cuts to transport and communication costs. These cost savings have helped build international supply chains, fuelling fast growth in world trade, which The World Trade Organization says has grown on average almost twice as fast as world production. It is easier for countries with good transportation links to build strong trading relationships and good communication networks speed up trade and help people and companies connect faster and more efficiently.

These considerations have helped the development of the European Union, a sprawling but connected area encompassing 28 member countries. They are also a key factor in the development of ASEAN, which comprises 10 members in the Asian region, and for the birth of the NAFTA trading bloc, which encompasses the US and its two immediate neighbours, Canada and Mexico.

But another key ingredient to building good trade relationships – and one that is often overlooked – is the need for good relationships between trading countries that goes beyond purely economic considerations. When these fall apart, trade relations follow suit. These good relations depend on ordinary people’s experience of the trading partner, and can be damaged by economic inequality in one of the parties, social polarization, and aggression, such as war.

Good cooperation among countries has also played a decisive role in advancing and strengthening the structural trends created by better and cheaper transport and communication. Economic historian Karl Polanyi argued in 1944 that a global free market is not just impossible, but will fall apart without effective international cooperation, notes the WTO.

War between countries, then, can be expected to be a disruptive factor to trade between the same countries. But what is not widely recognized is just how long-lasting the effects of war on trade can be, and the close correlation between casualty numbers in particular regions of a country and trade patterns with the aggressor nation.

This is an area that has been studied in depth by a group of four researchers who published their findings in the Journal of International Economics in 2015. In a study entitled, “Once an enemy, forever an enemy? The long-run impact of the Japanese invasion of China from 1937 to 1945 on trade and investment,” Yi Che, Julan Du, Yi Lu and Zhigang Tao set out to study the long-term impact of conflicts on cross-border trade and investment between countries. They based their investigation on the long-term impact of Japan’s invasion of China, which took place between 1937 to 1945, to see the impact on cross-border trade and investment between the two countries. They found that historical animosity between countries – simple human hatred – costs countries and companies dearly, and over a very long period of time.

The negative impact of aggressive or forced relationships on trade patterns has been shown many times in the international and even the regional level. On an international level, the great imperial powers of the world that once traded forcibly and closely with their dominions found that their trade flows fell apart once their empires crumbled. Now, countries such as Britain trade far more with European neighbours than with former colonies. Similarly, since the implosion of the USSR in the 1980s, trade between the countries that comprised the union have fallen dramatically, and their trade with other neighbours has increased.

On a country to region level, the advent of war between close trading partners Britain and France led to a breakdown in strong centuries-old trade between the UK and one particular French region, says Michael Mussa, Economic Counselor and Director of Research at the International Monetary Fund. The import of wines from the French Bordeaux region wines into Britain was periodically halted by one side or the other, whenever hostilities began – which was often over the course of centuries, eventually leading Britain to identify and help build alternative wine sources in Portugal.

The role of personal hatred in affecting the buying choices of individual consumers is not a new discovery, either. Following World War II, Israel imposed a boycott on the import of German-made products, in protest at the actions of Nazi Germany towards the Jewish people. The two countries did not establish diplomatic ties until two decades after the war ended. Only then did German products start appearing for sale in Israeli shops. Nonetheless, many in Israel disregarded the lifting of the ban even then. According to a report in the Orthodox Jewish Community website, vosizneias.com, many Israelis privately boycotted German-made goods. Both religious and non-religious Israelis maintained a boycott, reported the site, with fans of one soccer team protesting a sponsorship agreement with German firm Adidas, despite the fact that its products were made in China.

What the JIE study shows is the depth of the link between trade and the impact of war, and the length of time that the impact can last.

The researchers compare both the Japanese investment in a Chinese region and the trade between this region and Japan with the corresponding values of other foreign countries, and then examine the variations in these differences across Chinese regions that suffered different degrees of civilian casualties from the Japanese invasion.

Their findings were economically precise. The results showed a direct link between fewer casualties in a specific region and more inward investment. For every 1% fewer casualties, the number of direct investment projects a region received from Japan rose by 7.9%. Calculating the cumulative impact until 2001, they found that investment increased by 16.3%.

The number of casualties per region also affected imports. In the year 2001, for every 1% fewer casualties in a region, China imported 14.7% more from Japan.

The reason behind the startling differences in figures is directly related to people’s level of suffering and their bitterness about that suffering, say the researchers. “We demonstrate how war memories intensified by a lack of reconciliation over war responsibility can add to distrust and cast a shadow over current bilateral economic relations,” say the authors.

One reason memories of suffering have lasted so long in China is that in addition to the particularly strong psychological effect of losing a loved one, Chinese families often live in the same region for generations, keeping the memories and the bitterness alive. “Unlike property losses, the negative effects of human casualties are often irreversible and long-lasting,”say the authors. “Furthermore, Chinese civilians often have extended family relations and social networks in the local areas, many of whom remain in the region from one generation to another. Injury or death among family members and friends during the war could have generated long-term memories from one generation to another, resulting in unfavourable attitudes towards Japan.”

This new research demonstrates that wars extract a sizeable economic cost that is longer lasting and more deeply personal than we may have realized. Governments and policymakers must ask whether it is a price worth paying.

Contributing Reporter: Liana Cafolla

Source: Yi Che, Julan Du, Yi Lu, Zhigang Tao. Once an enemy, forever an enemy? The long-run impact of the Japanese invasion of China from 1937 to 1945 on trade and investment. Journal of International Economics, 2015, 96(1), 182-198.

https://www.sciencedirect.com/science/article/pii/S0022199615000021

Author
Prof. Zhigang TAO
Prof. Zhigang TAO