Economic decline triggers war (more detailed version)

This paper investigates the impact of a shock to a country’s national income on the intensity of conflicts. It does so by exploiting the commodity terms-of-trade (ToT) as an exogenous source of income variation. Our approach uses a more comprehensive ToT index than earlier studies, tracking a variety of commodities and time-varying trade shares while being scaled to the impact on aggregate income. As a result, our measure minimizes the dependence of results to movements in individual commodities such as oil and is sensitive to fluctuations in aggregate income. Our analysis indicates that a negative ToT shock significantly increases the intensity of conflicts, as measured by the number of conflict events per one million population. We find that the impact tends to be larger and more persistent for Low-Income Countries (LICs) and for Fragile and Conflict-affected States (FCS). Moreover, the impact is positively correlated with the level of inequality and a country’s external debt burden. The former effect is consistent with the opportunity-cost channel, which posits that lower income incentivizes individuals to participate in non-productive activities such as violence. The latter supports the relevance of a state-capacity channel, with lower income weakening a government’s capacity to address the impact of an economic shock on income levels and/or the fallout from conflicts, including through adequate social safety nets. Moreover, we find second-round effects from ToT shocks on the security situation of neighboring countries through spillovers of conflict. Overall, our results highlight that ToT shocks have heterogeneous consequences on the incidence and intensity of conflicts, as the impact is affected by a country’s underlying macroeconomic, institutional, and geographical conditions. The paper’s empirical results suggest that policies matter for the link between macroeconomic shocks and conflicts. First, inclusive growth that increases incomes and reduces inequality should help to enhance an economy’s resilience to shocks and work towards preventing violence. Second, adequate fiscal buffers in the form of sustainable (external) debt levels are critical to mitigate the impact of ToT shocks on an economy’s income and thus the likelihood of conflicts. It is plausible to assume that these fiscal buffers can facilitate the provision of adequate social safety nets, ideally targeted to vulnerable households, to break the negative cycle between economic shocks and violence. The results also suggest that financing engagement by international institutions can play an important role to help countries reduce the likelihood of conflicts when faced with an economic shock, as such financing increases the scope for more budget spending and eases foreign exchange constraints that many LICs tend to experience.