Literature Review
A perennial question in the study of the effects of war is its effects on the world economy and financial markets (Addison 8-9). This section of the paper explains what other researchers have said about the research issue. Key sections of this literature review explain how regional conflicts affect the economic performance of key financial markets. The same analysis explores how regional conflicts and political tensions benefit some sections of the economy, while negatively affecting others. However, before delving into the details surrounding this issue, it is pertinent to understand the relationship between conflicts and economic performance.
Relationship between Conflicts and Economic Performance
The 2003 American-led war in Iraq (to oust the Saddam regime) attracted the attention of many economists who wanted to reevaluate the economic and social effects of war on human societies (Schneider 625). However, the main problem associated with this analysis is the inadequacy of enough empirical data to explain the effects of these wars on human societies (Frey and Kucher 468). This problem makes it easy for proponents and opponents of war to exaggerate, or downplay, the effects of such conflicts on the economic development of different countries. King and Lowe (617) draw our attention to the ineffectiveness of scientific theories to demystify this issue. Scholars who support the Marxist school of thought (such as Rudolf Hilferding, Rosa Luxemburg and Lenin) often argue that capitalist societies benefit (economically) from regional conflicts (Schneider 625). However, liberals hold a different view because they say global trade is the main precursor to regional conflicts (Barbieri 299). Although these two ideologies differ, they agree (at least in the conjecture) that regional conflicts would often lead to poor economic outcomes.
Nonetheless, some realists still oppose this view (Fearon 379). For example, realists who believe in the concept of “relative gains” often argue that increased diplomatic tensions (that could potentially lead to conflict may not necessarily affect economic activities between warring factions (Bennett and Stam 239). In fact, some of them hold that trade in military hardware may equalize conflict between the two parties (Morrow 12). Therefore, a skeptical view of the positive relationship between regional conflicts and economic downgrades often emphasize the views of liberals. However, two scholars, Montesquieu and Kant have argued that regional conflicts could lead to trade disruptions (Anderton & Carter 445). Keynes shared the same opinion when he explained how Germany almost destroyed the social and economic infrastructure in Europe before the First World War (Schneider 625). Ideals of commercial liberalism adopt the opposite school of thought (Southall 78). Stated differently, it supports peace using peace-through-trade conjectures. Although it is unclear why this opposite relationship should hold, there is little empirical data to expound on this issue. Studies by Anderton (445) Leach (54) highlighted this fact. However, they did not expand their findings to include a random sample of dyads.
Goldstein (369) believes that the liberal view is the correct understanding of the relationship between regional conflicts and economic growth. However, he advocates for the addition of exceptions to his view (Goldstein 369; Caselli 7). Through this understanding, Schneider says,
“The attributes of a conflict, and most notably whether it comes as a surprise, make a difference. Demonstrating that unexpected onsets of armed conflict affect the bilateral level of trade negatively, they lend partial support to the liberal point of view” (626).
However, Cranna (3-8) opposes the above statement by arguing that trade highs and lows may not be the best indicators for understanding the effects of regional conflicts on financial markets because, unlike capital investments, it is difficult for investors to withdraw their contributions in trade activities. Furthermore, trade volumes only outline one aspect of economic activities (Schneider 626). The “stickiness” of trade supports a null hypothesis (concerning the relationship between regional conflicts and the performance of financial markets) (Schneider 626).
Gilpin (97) focused his analysis on understanding the effects of war on financial markets. He used financial data to explain the liberal case. As a case study, he used the London stock exchange to explain the effects of war on financial markets (Gilpin 97). In detail, he explained the effects of the Second World War on financial markets and found out that most wars bring market inefficiencies that affect financial market performance (Gilpin 97). He also found that some of the effects of war are subjective, based on whether the concerned party concerned gained or lost in the war (Gilpin 97). The loss of Europe and much of Scandinavia during the Second World War and the renewed hope that emerged after the end of the war explains this effect (Barros 67). Comparatively, Holsti (182) digress the effects of the world war on the financial market system by explaining how the prices of securities varied with the intensity of war, during the Second World War.
For example, he says during 1914, rising diplomatic tensions in the global economy led to a rapid decline in security values (Holsti 182). American-based studies also arrived at the same conclusion (Koistinen 87; Gilpin 97). For example, Russett (166) found out that the prolonged Vietnam and Korean wars, of the mid 1970s, negatively affected the American financial markets because investors were concerned about the future of their investments. A detailed analysis of the war at the firm level disapproves the ideas of the Marxist school of thought, which argued that the industrial complex often profited from regional conflicts (Wilson 54). Although these findings are common among many fields of study, Goldstein (369) cautions against the need to generalize these findings across different industries. Instead, he says different industries have different responses to regional conflicts (Goldstein 369). Therefore, the impact of these conflicts may not show uniformity across all economic sectors. To emphasize this fact, Schneider says
“While the dollar, equity prices, and treasury yields declined and the spread of corporate yields widened, oil prices soared. Yet, the impact was not uniformly negative since the escalation that finally resulted in a military campaign did not affect the price of gold or the liquidity premium on the on-the-run ten-year treasury note” (627).
This effect is not only unique to western markets because after analyzing “Saddam Securities” (an online betting exchange that focused on predicting the future of Iraq’s economy, based on whether America ousts him, or not), Graeme (672) found out that regional conflicts negatively affected stock market performance. These negative effects are more severe for countries that depend on the global economy for their economic prosperity (Gupta 98). Therefore, countries that have globally integrated economies and depend on imports are more prone to the economic effects of regional conflicts (Collier 168). Although it may be unwise to generalize the effects of regional conflicts on all industrial sectors, experts know the sensitivity of certain industries to political upheavals. For example, many researchers highlight the negative impact of terrorism on the tourism sector (Fleischer 1335). This effect is especially profound in “easy to substitute” destinations. Broadly, Fleischer (1335) and Schneider (624) say regional conflicts affect key financial variables. They use the effects of American-led invasions in Asia and The Middle East to explain this fact.
How Conflicts Affect Economies
Different studies have shown that regional conflicts affect economies in different ways. For example, studies that have investigated the impact of Kuwait and Lebanon conflicts have noted some common effects of these conflicts, such as the disorganization of the supply system and the destruction of physical capital. They also affirmed the dislocation of labor as another consequence of regional conflicts (Nincic 76). These effects mean that regional conflicts lead to reduced factors of production that emerge from economic inefficiencies and poor technological absorption. The diagram below shows how conflicts cause poor economic performance
The above diagram helps to understand the economic and social effects of war. However, Werner Sombart (a sociologist) was among the first people to investigate this issue and found out that most wars have a double-sided effect on economies (Collier 168). He argued that wars have destroyed different tenets of capitalism (Collier 168). However, he also says that the same capitalistic movement has led to regional conflicts (Collier 168). In this regard, his views are a counter movement to the views of Weber and Marx who tried to explain the concept of capitalism and its effects. Nef (13) was among the first researchers to reject this premise by arguing that, “…peace contributed more than war to the progress of the large-scale capitalism which we associate with modern English and American civilization.” Based on these arguments many economic experts have investigated, directly or indirectly, whether wars could have positive impacts on economies. However, the evidence produced is inconclusive because the researchers have not revealed a criterion showing, which economies would lose or benefit from wars.
For example, Koistinen (263) says that the profits of the American steel industry were higher during the 1917 war period, as opposed to an average of the non-war period (1912-1914). Similarly, British farmers reported increased profitability during the First World War, as opposed to other periods when there was relative peace in the region. Interestingly, the farmers reported increased profitability when the aggregate effect of war on the economy was negative (Dewey 373). To emphasize the possibility of positive economic effects of global wars, Dutch traders also reported increased profits during the first Dutch war (Wilson 149). In fact, their economic contributions affected their government’s foreign policies. Relative to this discussion, Schneider and Tröger say, “There can be little doubt that the first Dutch War was accompanied by economic conditions of prosperity which many contemporaries linked causally with the war, and which encouraged the mercantile community to favor another Dutch War” (4). Researchers have also used political economy explanations to highlight the effects of war on modern economies. For example, they say this reasoning is important in explaining the rise and fall of modern regimes (Koistinen 263). Here, this understanding rejects Marxist ideologies that explained Roman imperialism (Girasa 65).
Harris (1382) draws our attention to the economic benefits of war by suggesting that war survivors always demand economic benefits. Nonetheless, few political science researchers use political logic to explain the distributive effects of war on national economies. Their interest in this subject only emerged in the early 1970s when researchers, such as Kugler (1347), started taking interest in the subject. Other researchers who also took a keen interest on the subject include Gilpin (5) and Rasler (1-10). Studies on war disruptions are the newest addition to this topic because many new researchers have focused their studies on investigating the aggregate, as opposed to disaggregates effects of wars, on national economies (Schulz 34-38). Contravening the views of liberals and realists, Barbieri and Levy (23) say wars have limited effects on trade flows.
Independent research studies, which focused on understanding the effects of regional conflicts on stock markets (and not trade), support the “disruption hypothesis.” However, Schneider and Tröger (7-10) say that financial markets could be immune from the effects of wars when traders believe the conflicts would lead to a resolution of a potential conflict. Such an effect emerged during the 2003 American-led invasion in Iraq (Leigh 1). Comparatively, the British and French stock markets posted a weak performance because of the same conflict. Despite these inconsistencies, Kugler (1347) reveals that few researchers investigated why some markets lost or gained from political conflicts.
The works of Nincic (103) is an exception to this rule because he revealed the beneficiaries of military conflict to explain why some markets are immune from regional conflicts (cleavage between capital and labor exception). Based on findings derived from the Vietnam War, the researcher says labor, as opposed to capital, often benefits from political upheavals (Nincic 103). Although he observes that some markets may be immune from conflicts, he expressed his reservations about the possibility of the markets supporting a prolonged war (Nincic 103). Comparatively, markets that have organized labor are bound to support a prolonged military conflict. Its support stems from the possible improvements that wars bring to employee wages and the redistribution of national incomes.
Positive Effects of Conflict on the Economy
Against a liberal background, Cordesman (89) supports the views of researchers who say that regional conflicts could have positive effects on economies. Researchers, who say that although conflicts are supposed to have negative effects on financial market performance, they could also cause war rallies, which means that most traders would be upbeat about the prospects of a war to solve long-standing political issues (Cordesman 89). Traders usually like to update their economic information using such logic. If they perceive a war as a way to end a long-standing political standoff, they are bound to invest their money in the financial market and boost its performance in the same regard (Colombo 72). Therefore, as opposed to the views of researchers who believe that regional conflicts often cause economic anxiety, Schneider and Tröger (8) say some decisive wars can reduce tension in the financial market and boost its performance instead. Relative to this discussion, Schneider and Tröger say, “Simultaneously, traders might start again to move from less risky options into
the equity market after a political event that will, in their view, end the escalation of the conflict. Hostilities can thus lead to a reduction of uncertainty and an upsurge of the stock market” (8).
Traders use the above-mentioned logic to predict how regional conflicts would affect the performance of different economic sectors. Indeed, this is why the Congressional Budget Office (9) says, some firms may suffer the negative effects of war, while other sectors may benefit from increased hostilities and growing political tensions in the global space. For example, many international firms often expect increased product orders during periods of military conflict (Caprio 72). For example, the American defense sectors prospered on the backdrop of the 2003 Iraq war (Nordhaus 51). Other sectors that benefitted from increased political hostilities are those that offered investors less-risky investment options.
For example, companies that operated in the food and beverage, health, and retail sectors reported insignificant market movements during the 2003 Iraqi invasion (Nordhaus 51). In fact, companies in this sector had the best-performing shares in the FTSE 100 (Nordhaus 51). Their performance stems from a common logic among traders to invest in less-risky industries when conflicts abound. Comparatively, tourism and aviation sectors are bound to be the greatest losers during a conflict. However, they are the biggest gainers when there is peace and cooperation among countries. For example, many studies have shown how regional conflicts affect the tourism industry in the Mediterranean region (Schneider and Tröger 10). The table below shows the effects of regional conflicts on the performance of different economic sectors
The above table analyzes regional conflicts on three platforms – escalation, de-escalation, and severe events. These three measures of war are essential in understanding the impact of regional conflicts on different economic sectors. Particularly, the above table highlights the effects of these wars on the stock market, defense, aviation, hotel, leisure and oil sectors (Ramcharran 97). The “plus” sign signifies a positive impact of these wars on the economic sector, while a “negative” sign signifies a negative impact of these wars on the above-mentioned sectors. The effect of regional conflicts on economic sectors subsided when investors distinguished the effects of the war on different economic sectors (Hoeffler 563). In the same analytical breadth, they started to understand the effects of conflicts on their sales numbers. These intrigues show the effects of political decisions on the equity market. The market movements that accompany regional conflicts show the impact of political activities on the financial market.
Although many researchers agree with the liberal view about the negative effects of regional conflicts on stock market performance (Webb 17), there is reasonable evidence to propose that regional conflicts could also have positive effects on financial market performance. One basis for advancing this argument is the distributive effects of war (Azam 461). Although import and export sectors perform poorly because of political upheavals, military-based industries profit from regional conflicts (Li & Sacko 11). This view affirms the Marxist school of thought, which describes regional conflicts because of capitalism. For example, companies that manufacture military hardware are likely to profit from increased military conflicts. Even if there were no war, a global arms race would translate to increased profitability for these companies (Brandes 98). Comparatively, regional conflicts are bound to affect energy and gold markets negatively. Another challenge to the views proposed by proponents of commercial liberalism is the increased number of stock market rallies that occur when regional conflicts happen.
The positive economic effects of global conflicts sometimes contradict research studies that show the negative effects of these conflicts on human economic development (Wood 54). For example, many Americans supported some American-led wars (such as the Iraqi invasion) and the Afghan “terrorism” wars (Leigh 1; House Budget Committee, Democratic Staff 7). Some of these wars have had positive effects on the American financial market, while others have had negative effects. For example, the Dow Jones plunged by more than 6.3% following the American-led Kuwait invasion (in the 1990s) (Schneider 624). Comparatively, it gained by 1% after the announcement of “Operation Desert Storm.” Similarly, the New York Stock market was bullish after the 2002 Iraqi invasion (Leigh 1). European stock markets also increased their performance by more than 2% during the same period (Schneider 624). However, after the war experienced significant resistance, the stock markets reported increased volatilities (Schneider 624). The mixed effects of conflicts on financial markets also emerged in the Russian-Georgian 2008 war (Frankel 98). Although, abstractly, this war had a negative influence on the financial markets, a Harvard professor, Noel Maurer, disagreed with this view by saying that the war also had a positive influence on the concerned economies (Schneider 624). For example, he said the declined performance of the Russian financial market started before the war. In fact, he believed that the war helped to slow the decline (Schneider 624).
Case Studies
In 2003, financial experts warned of the potential negative effects of an American-led war on the New York Stock exchange market (Elbadawi 54). They also warned of the potential negative effects of increased tensions with North Korea on the New York Stock Exchange (Schneider 624). The latter warning explained the daily movements of asset prices in the US. While some of these warnings may have merit, they are unreliable because they often rely on the anecdotal accounts of market participants (Schneider 624). Part of this problem stems from the difficulty associated with measuring the effects of war on financial markets (financial market performance is subject to many factors). Studies that have investigated the effects of conflicts on Middle East financial markets show the same outcomes as those that have investigated the same issue in other parts of the world (Schneider 624). However, of importance is the fact that the many significant global wars have occurred in the Middle East. Particularly, most American-led conflicts have occurred in this region. Some of the most notable conflicts include the Gulf war, the 2003 Iraqi invasion, the Lebanese civil war and the Arab spring (Nordhaus 51). Another important point to consider is the oil-dependent nature of Middle East economies (Marcel 5).
Studies conducted by Gupta (1) and Harper (169) have shown that regional conflicts in the Middle East lead to slow economic growth and high inflation rates. They also lead to lower tax revenues and low foreign direct investments. However, a common effect of regional conflicts in this region is the shifting tax revenues (from economic investments to military investments). A study conducted by Sab (7) on 79 countries show that the Middle East financial market is vulnerable to regional conflicts. Particularly, it showed that such conflicts affect the stock market by reducing the demand for local currencies (Sab 7). Similarly, Sab (7) found out that political upheavals led to weak financial regulations and negative financial development.
However, such outcomes are mostly common in intense conflicts (Ades and Chua 279). These effects are not only unique to countries that are at war because studies have shown that conflicts in neighboring countries are likely to affect countries that border them (Ades and Chua 279). However, the same studies found out that most countries, which do not border conflict countries, could enjoy positive effects from their adversities (De Groot 149). Such outcomes would mainly occur through increased FDIs. For example, tourists could easily avoid a conflict country and visit a peaceful country. Their actions would translate to increased financial market activities, especially if the industry plays a big role in the country’s economy. Comparatively, research studies show that most employees who move to countries that do not border the conflict zones become wealthier because of skill acquisitions and better economic environments (Sab 7). Broadly, Sab (8) identified two ways that regional conflicts affect such economies – trade disruptions and increased reprioritization of economic investments to the military.
Economic Indicators Affected by Conflict
Gross Domestic Product
According to studies conducted by Sab (9) to investigate the effects of regional conflicts on financial markets, political upheavals lead to GDP contractions. Countries that have protracted wars often reported fluctuating GDP values. For example, the GDPs of oil producing countries often decline sharply during conflicts because they affect oil production. Indeed, Kuwait and Iraq experienced the same challenge when they suffered the effects of a protracted war with America. Kuwait alone reported a 55% decline in its GDP value during the late 1980s and early 1990s (Sab 8). Comparatively, Iraq’s GDP declined by 30% after the 2003 US-led invasion (Sab 8). The contractions of GDP values indicate a negative effect of conflicts on financial markets.
Inflation and Exchange Rate
Researchers have affirmed a positive relationship between high inflation rates and conflict (Ades and Chua 279). For example, Lebanon and Iraq experienced an increase in their inflation rates after the Lebanese civil war and gulf war (respectively). One reason for this outcome is people’s need to increase their liquidity during conflicts. This is what happened in Lebanon because many people liquidated their assets in anticipation for social and economic problems (Noll 53). Coupled with the lack of investor confidence, there was a lot of pressure on the Lebanese pound, which led to a further decline in the domestic value of the pound (Ades and Chua 279). Consequently, the Lebanese pound depreciated by close to 200% (Sab 8). The country’s inflation rate also increased equally. Collectively, these macroeconomic indicators show the positive relationship between conflict, high inflation, and poor exchange rates.
Fiscal Sector
Conflict often leads to a weak fiscal stance in affected countries. Particularly, the absence of a central governing authority often leads to poor national resource allocation (Sab 8). The same problem occurred during the Lebanese civil war because the government lost its fiscal power stance, thereby rendering it inefficient in providing public services. Coupled with dwindling foreign reserves, the Lebanese government also experienced revenue shortfalls and high public spending (Sab 8). Conflict also led to a significant decline in oil exports during the conflict period. It also created a hostile environment for the government to undertake a comprehensive macroeconomic analysis of the country’s economy (Collier 168). Therefore, the government was unable to evaluate the country’s annual fiscal policy. For example, there was insufficient data to explain public debt during the war period.
Current Account Balances
Balanced current accounts often indicate a good macroeconomic environment. However, conflict affects these current account balances negatively (Sab 8). For example, Lebanon posted negative current account deficits during the war period (low confidence among investors and labor dislocation mainly contributed to this situation). The country‘s gross reserves also declined in similar fashion. Depending on the type of government, some countries could also lose a large portion of their foreign account reserves during wars. For example, before the 2003 Iraqi war, government officials withdrew more than $1billion in foreign exchange reserves (Nordhaus 51). Similarly, Russia also withdrew more than $6 billion during the early days of the Russo-Georgian war (Sab 8). Although they recovered most of this money, it shows the effects of conflicts on governments and their willingness to maintain favorable current account balances.
Financial Sector
Well performing financial markets translate to a well performing national economy. However, Winter (1-3) says regional conflicts cause disruptions in the financial sector. For example, before the Lebanese civil war, the country was a regional financial powerhouse. However, it lost this reputation after the conflict. Kuwait suffered the same fate after the Kuwait invasion. Although it reported poor financial fortunes after the 1982 stock market crash, the invasion aggravated its financial problems (Winter 1-3). Some of the potential problems associated with this issue were non-performing loans, disruption of financial contracts, and looting of banking assets (Bliss and Nikolaos 381). Other problems included a destruction of assets serving as collateral, looting of gold holdings, collapse of real estate values, disruption of financial records and unissued currencies (Breeden and Litzenberger 621). Iraq also experienced the same financial troubles after two of its major state-owned banks suffered liquidity problems because most of their assets were in government-held bonds (Center for Strategic and International Studies 1).
Credit rating
A country’s credit worthiness is important in assessing its investment risks (Ciochetti and Dubin 169). Conflicts often lower the credit rating of different countries. For example, during the Georgian war, Fitch ratings lowered the country’s credit rating by two points. Standard and Poor (S&P) also lowered the country’s credit worthiness by the same margin (Winter 3). During the Georgian war, experts feared that the European energy industry would suffer from a destruction of the country’s oil pipeline (Sab 8). Georgia is a key transit route for Russian gas. This prediction sufficed because before the conflict started, the government shut the gas pipeline down. The financial markets reflected this event because the value of light sweet crude decreased from $4.8 to $115 (Sab 8).
The Impact of Conflicts on the Stock Market
To explain the effects of conflicts on stock markets, proponents of the diversionary theory have struggled to understand the socioeconomic conditions that increase the risk of governments to use military force when solving conflicts (Fama 389). Since their results are inconclusive, it is still difficult to know the economic or social conditions of a specific sector that prompt companies to use armed conflicts to solve political issues. A disputed version of the war thesis has tried to explain the socioeconomic conditions that lead to these militarized conflicts (Fama 389). A World Bank researcher, Collier (168) shed more light on this issue by saying that human greed explains why countries chose these alternatives to solve political grievance. For example, he draws our attention to the need for powerful economies to exploit the natural resources of other countries as a key motivator for civil wars (Collier 168). Possible income losses also motivate countries to use arms to solve political differences. Some critics of globalization have used these views to argue that internationalization has more negative (destabilizing effects) on national (developing) economies (Collier 168). Using this argument, they say, globalization has more negative than positive influences on national economies.
Relative to the varying views of these researchers, some experts have highlighted the need to understand the distributive consequences of wars on the world economy as opposed to the distributive consequences of war on specific national economies. Using the same logic, some researchers use the Ricardo-Viner model of trade policy to explain the effects of regional conflicts on stock market performance (Collier 168). This model rejects the generalization of the effects of war on all economic sectors. Instead, they propose that the effects of wars are industry-specific because different economic sectors have unique structures that shape their performance during wars. This argument also means that the import and export sectors have different economic goals when conflicts happen. An extension of this argument shows that both economic sectors often experience increased activities when conflicts occur. The theories of war and peace support this observation through the principles of commercial liberalization and through explicit expectations that war should disrupt economic activities. Based on this logic, Shleifer (12) says the loss of economic income during conflicts often deter countries to use aggressive solutions to solve political conflicts.
Many researchers have used the above-mentioned argument to explain the effects of regional conflicts on stock market performance (Shleifer 12). In line with this argument, Slantchev (135) says political conflicts that have dominant economic ramifications commonly affect stock market performance. This way, regional conflicts would affect equity markets in two ways (Prescott 145). One way is an increase or decrease in the price of stocks. Alternatively, political conflicts increase speculation about the performance of financial investments in the stock market (Thévenoz 77). This effect means that political investments increase stock volatilities.
Based on the above revelations, many researchers agree that regional conflicts change the information structure of financial markets (Thévenoz 77). In this regard, traders are often wary about market changes because ignoring the changing information structure means that they increase their risk of making a loss (Jackwerth 433). Using this logic, some researchers confidently say political events often alter the beliefs about the future development of stock markets. They also affect how people perceive firm development. The efficient market hypothesis supports this analysis because it explains how markets seek information to predict their future performance (Thévenoz 77). Traders often prefer to sell stocks that receive a negative prediction (using the information obtained). In this regard, investors often perceive increased regional hostilities as a disruptive effect of wars on financial markets.
In line with this argument, Sab says, “The most severe conflictive events, at least in case that they were hard to anticipate, simultaneously increase the uncertainty over the possible development of a political crisis” (8). Principles of commercial liberalism also affirm this fact. The mercantilist perspective also supports the same view because it perceives governments as political dictators that use markets to meet their political and economic goals. In this regard, Collier (253) says their foreign policies aggregate the welfare considerations of their citizens at the expense of citizens in other countries. Nonetheless, many researchers agree that global markets are vulnerable to political upheavals (Schneider 635). They also agree that although most of these effects are negative, financial markets occasionally react positively to such conflicts (Sab 8). The diagram below shows the performance of stock markets during the 1990s. It shows that the Dow Jones reported increased expansion during the 1980s. Similarly, it shows that there was a significant downturn during the first six months of the period under analysis
The figure below shows stock market movements during the US-led war on Iraq.
The diagram above shows that the peak of the conflict did not happen during the gulf war. This outcome may suffice because there were few war reports when it was happening. This is unlike prompt media reports that often characterize short wars, such as those witnessed when America and Britain bombed military grounds in Iraq in 1998 (Schneider 635). This conflict led to the highest observable turmoil in the stock market during the period. Nonetheless, among the most common claims of war and conflicts in international business are the negative effects of war on global trade (Polachek 55). Common phrases such as “war-profiteers” and “war dictators” are evidence of the belief that human greed causes armed conflicts (Pollins 103). This reasoning stems from the works of key researchers, such as Austro-German Marxist Rudolf Hilferding (Schneider 635). Some of their early works warned people about the dangers of unlimited profit-making activities (Schneider 635). In fact, from their works, other researchers, such as Rosa Luxemburg and Vladimir Ilyich Lenin, voiced their views about imperialism and the risks of greed in the global economy (Friend & Blume 100). Based on this understanding, Sab warns, “Capital becomes the emperor of the world, and it conquers with every new country the new boundary that has to be transcended” (1).
Winter (45) believes there is enough reason to affirm the effects of regional conflicts on stock markets. For example, he predicted the effects of the US-led invasions (in the Middle East) on equity values. Here, he said political upheavals in the region are likely to affect equity markets through oil sector shocks (Caplan 145). He also argued that these shocks were likely to be strong in the short term, but weak in the long-term (Winter 45). The effects of wars on regional markets also suffice from increased military spending. Companies that operate in the defense sector are likely to increase their profits, but governments that procure these weapons are likely to suffer from an increased debt burden, or poor balance of payments.
The net effects are high equity costs and low equity valuations. These effects are true because equity valuations are sensitive to market changes. The effects of regional conflicts on stock markets also suffice through changing relations between the main protagonists in a war and their trading partners (depending on the positions they take during a war). Long-term trade relationships and investment opportunities are likely to change through a reevaluation of these relationships. For example, Ederington and Guan (12) say the American-led war on terrorism is likely to cause retaliation among nations that do not share the same view of terrorism as America does. In this regard, Iran, North Korea, and countries that hold similar views as they do (about America) are likely to retaliate through increased terrorism funding and such-like activities. Such events are bound to have an effect on the equity market (Perry 7).
Resilience of some Financial Markets to Conflicts
When America invaded Iraq, in 2003, the financial markets of some big Middle East economies did not flinch. Although the conflict could affect the security of Middle East, Reuters (1) points out that, most financial markets in the Middle East were resilient. He believes that the same resilience is likely to prevail in the current escalating conflict in Yemen. However, he acknowledges the potential for a division of the Middle East security structure because different countries are bound to take opposing sides in the conflict. To explain this division, Reuters says, “Air strikes against Houthi forces in Yemen by Saudi Arabia raised the prospect of a proxy war, with Shi’ite Iran backing the Houthis and Riyadh plus other Sunni Muslim monarchies supporting Yemeni President Abd-Rabbu Mansour Hadi” (2).
A blown-out war in the Middle East could potentially undermine some of the economic strides made by major Middle East economies, such as the UAE. Similarly, it could destabilize security arrangements in the Middle East by destabilizing Saudi Arabia’s security structure and Dubai’s security negotiations with Iran (concerning nuclear security). These security fears alone led to a significantly poor performance of the major Middle East stock markets. In fact, Reuters (5) says the Saudi Arabia and the UAE stock market performances slid by 1% after these fears were registered. However, this was the only major financial concern because other market indicators were unmoved. To affirm this fact, Reuters said, “Gulf bonds barely moved and credit default swaps, used to hedge against sovereign defaults, rose only marginally; five-year Saudi CDS are up just 4 basis points in the past week” (5).
The bullish performance of major financial markets in the Middle East shows that some Middle East economies have learned how to insulate themselves from geopolitical upheavals. The minimal effects of the Iraq war and the Arab spring on their financial markets further reinstate this fact (Council on Foreign Relations and James Baker Institute 76). To support this view, a senior investment manager in Germany said the Yemen conflict was not bound to cause any major readjustments in the financial market analysis of the GCC (Reuters 5). Part of the reason for the resilience of these financial markets is the positive credit ratings that their countries have. This is why Reuters says, “The impact on key GCC countries like Qatar or UAE will be miniscule in terms of their credit profile” (6). The resilience of the financial markets also stems from the instrumental role of local financial institutions in boosting financial market performance.
For example, if conflicts force some international investors to sell bonds, local institutions are likely to buy the same financial instruments at an affordable price (Reuters 5). Political upheavals in Yemen also bolster the arguments of some researchers who believe political conflicts may have positive economic effects in Middle East countries because experts say the Yemen conflict may improve the Middle East oil sector after it exhausts its oil revenues through the war (Yemen sells 1.5 million barrels of oil per month) (Reuters 7). Once its oil reserves diminish, other Middle East economies are bound to fill the gap, thereby leading to an improved economy. Comprehensively, the recent military activities in Yemen are advancing a new school of thought that highlights the resilience of some Middle East economies to regional conflicts. Therefore, researchers have varying and developing views regarding the effects of regional conflicts on financial markets (Reuters 5). Nonetheless, the context-specific nature of their assessments is instrumental in understanding their findings.
Summary
Despite the focus on the effects of war on the world economy, there is still little context-specific information explaining how wars and conflicts affect financial markets. The deficiency of information regarding the interrelationships between wars and financial markets could explain the mollifying rhetoric that some politicians use to justify their political activities, globally. Usually, they use such rhetoric to downplay the effects of militarized conflict on the global economy. Schneider affirms this literature gap when he says that “while historians have documented the many miscalculations involved in war, little has been written on faulty economic forecasts” (624). However, there are minimal disagreements among researchers about the significant effects of war on financial markets. In fact, most researchers agree that the effects of conflict on financial markets are devastating (Cranna 197). Optimists also share the same opinion because they posit that the effects of war are likely to subside after many decades.
Works Cited
Ades, Alberto and Chua Hak. “Thy Neighbor’s Curse: Regional Instability and Economic Growth.” Journal of Economic Growth 2.9 (1997): 279–304. Print.
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