Wars as Large Depreciation Shocks

Abstract

In this paper, we propose a theoretical framework to investigate the impact of conflicts and wars on key macroeconomic aggregates and welfare. Using a panel data with 9 countries from 1870 onwards, we first show that the consumption-to-output ratio is minimal during WWII for participants. While this can be explained by an increase in public spending in the USA, this can not be the case in other countries that participated in WWII, as they experience a large fall in output during wartime. To account for this, we build a variation of a Real Business Cycle model first proposed by Hercowitz and Sampson (1991). We extend the initial model to account for specific shocks that destroy private and public capital stocks -- as conflicts do -- by assuming an (exogenously) time-varying depreciation rate of the stock of capital. In addition, the model imbeds generalized TFP shocks capturing standard technological factors as well as the potential effects of war on the labor force. The model is estimated and used (i) to assess the importance of depreciation shocks during war episodes, and (ii) to quantify the welfare effects of conflicts. We show that depreciation shocks are crucial to account for the macroeconomic dynamics of countries that have experienced large war-related destruction, and that the welfare losses from fluctuations can be quite large when considering data samples that include major war episodes.