Economic Effects of the Syrian War and the Spread of the Islamic State on the Levant

• Author: Elena Ianchovichina,Maros Ivanic
• Published date: 01 October 2016
• DOI: http://doi.org/10.1111/twec.12400
• Date: 01 October 2016

Economic Effects of the Syrian War and

the Spread of the Islamic State on the

Levant

Elena Ianchovichina

1

and Maros Ivanic

2

1

Chief Economist Office, Middle East and North Africa Region, The World Bank, Washington, DC, USA

and

2

International Finance Corporation, The World Bank Group, Washington, DC, USA

1. INTRODUCTION

ON the eve of the Arab Spring, six countries in the greater Levant –Turkey, the Syrian

Arab Republic, Iraq, Jordan, Lebanon and the Arab Republic of Egypt –were consider-

ing reforms that would have deepened their trade ties and accelerated economic growth, diver-

sification and job creation. Specific attention was placed on liberalising agricultural trade with

Turkey, reducing the restrictiveness of non-tariff measures, improving transport logistics and

liberalising intra-Levant trade in services. These reforms were considered essential for stimu-

lating regional trade and were the main components of a reform package that would have

been negotiated and implemented as part of a new Levant economic zone (World Bank,

2014).

1

The negotiations of a regional trade agreement among Turkey, Syria, Jordan and

Lebanon were particularly advanced as reflected in the Joint Declaration on Establishing

Close Neighbors Economic and Trade Association Council (CNETAC), signed in July 2010

(Aydin and Yanar, 2011; World Bank, 2014).

2

In 2011, however, many of the Arab countries embarked on political transitions that took

priority over other issues. In Syria, initial demonstrations quickly turned into an uprising

which grew into a civil war and resulted in widespread devastation with spillovers to neigh-

bouring countries. This war and the subsequent advance of the Islamic State of Iraq and Syria

(ISIS) –collectively referred to in this paper as the Levant conflict or war –imposed enor-

mous human, social and economic costs and halted the regional trade integration process, thus

undermining development with serious implications for the future of the Levant.

Despite the attention given to the Levant war, this is the first paper to undertake a system-

atic general equilibrium assessment of the war’s regional and country-specific economic

effects, factoring in both the effects of war and the associated disintegration of regional trade.

The paper is related to and combines features of two distinct literatures –on trade reform and

We are grateful to Shantayanan Devarajan for his comments on previous drafts of this paper. We

also thank Sibel Kulaksiz, Jorge Araujo and participants in the 18th annual conference on global

economic analysis in Melbourne, Australia, for comments on earlier versions of this paper. The find-

ings, interpretations and conclusions expressed in the paper are entirely ours and should not be attrib-

uted to the International Bank for Reconstruction and Development/World Bank and its affiliated

organisations, or those of the Executive Directors of the World Bank or the governments they represent.

1

We refer to the new Levant economic zone as simply the Levant or the Levant area, although the

geographic Levant area includes other countries and territories. The six economies would have composed

the new Levant economic zone.

2

World Bank (2014) provides a detailed account of the trade ties among the Levant countries prior to

2011, documents the increase in intra-Levant trade flows in the 2000s and discusses the potential for

further gains in response to deep trade liberalisation reforms.

©2016 John Wiley & Sons Ltd

1584

The World Economy (2016)

doi: 10.1111/twec.12400

The World Economy

restrictions (Trela and Whalley, 1990; De Melo and Winters, 1993; Yang et al., 1997;

Ianchovichina and Martin, 2004; Anderson et al., 2006; Walmsley et al., 2006) and on natural

disasters and wars (Grobar and Gnanselvam, 1993; Collier, 1999; Rose and Liao, 2005;

Okuyama, 2007). Grobar and Gnanselvam (1993) use a case study approach relying on

national accounts data to examine the economic effects of the Sri Lankan civil war and the

potential future costs associated with a continuation of the conflict. Collier (1999), who pro-

vides an ex post assessment of all civil wars between 1960 and 1990, finds that war affects

not only the level but also the composition of economic activity, especially for manufacturing

and some service sectors in Uganda. Input–output (IO) models, as in Rose et al. (1997), are

the most widely used modelling tools for ex ante assessments of the higher-order effects of

both natural and man-made disasters. The popularity of these models is based mainly on their

ability to reflect the interdependencies within a regional economy and their simplicity, but

they have rigid structure with respect to substitution among inputs and imports. These models

also lack explicit resource constraints and responsiveness to price changes (Rose, 2004).

Unlike these approaches for evaluation of disasters, this paper relies on a global com-

putable general equilibrium (CGE) framework, documented in Hertel (1997). The model, dis-

cussed in the next section, is well suited for analysis of disasters as well as global, regional

and country-specific trade liberalisation agreements. It offers advantages in terms of ensuring

consistency through explicit constraints while including important sectoral detail, such as

input and import substitutability and price responsiveness.

Although widely used and comprehensive in many ways, the GTAP 8 database has insuffi-

cient information on the Levant economies. Therefore, we modify the database and add to it

input–output, trade and protection data on Lebanon, Syria, Iraq, Jordan and several other Mid-

dle East and North African (MENA) economies, including West Bank and Gaza, Yemen,

Algeria and Libya. This major modification required balancing both bilateral trade flows and

macroeconomic country aggregates in the global database and was warranted in order to

reflect accurately the regional spillover effects of the Levant war. We also adjusted trade pref-

erences in all MENA countries in order to reflect accurately existing global, regional and

bilateral trade agreements and avoid overestimating the trade-related effects of foregone

reforms.

Simulation results reported in the paper indicate the qualitative changes likely to occur as

a result of the conflict and regional trade disintegration, while the magnitudes of the direct

war effects reflect the intensity and scope of the conflict as of mid-2014. The results suggest

that Syria and Iraq bear the brunt of the direct war costs, losing 14 and 16 per cent in per

capita welfare, respectively. The embargo on trade with Syria is a major factor behind this

country’s real GDP decline, which is estimated at 30 per cent and is much larger than its per

capita output decline of 13 per cent, due to the effect of Syrian refugees and war casualties

on the population size. All other Levant economies lose in per capita terms, but not in aggre-

gate terms because the inflows of refugees boost the number of people living in these coun-

tries, and therefore aggregate consumption, investment and labour supply. Lebanon’s per

capita welfare losses are largest and reach close to 11 per cent, while those of Turkey, Egypt

and Jordan do not surpass 1.5 per cent. The difference between aggregate and per capita wel-

fare effects are most pronounced in Lebanon, where the increase in the refugee-to-citizen ratio

is greatest, and minimal for Turkey and Egypt, where refugees account for a small share of

the population.

The direct effects of the Levant war are an understatement of the real economic costs of

the Levant conflict. Recall that these countries were embarking on a process of regional trade

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ECONOMIC EFFECTS OF THE SYRIAN WAR AND ISLAMIC STATE 1585

integration just before the outbreak of war. In other words, if the war had not happened,

regional trade integration would have proceeded as envisioned in the Joint Declaration on

CNETAC. If the foregone benefits of this integration, especially those associated with failed

services liberalisation, are included, then the total costs of war for Syria and Iraq are almost

double, reaching 23 and 28 per cent, respectively, and increase to 10 per cent for Egypt and 9

per cent for Jordan. Furthermore, the average welfare effects are not indicative of the distribu-

tional effects of the war within countries. In Syria, all economic groups are hurt but landown-

ers lose the most as people abandon their homes and farms in search of security. By contrast,

in Lebanon and Turkey, land and capital owners benefit while workers lose because the large

number of refugees put pressure on demand and augments labour supply.

The remainder of this paper is structured as follows. Section 2 presents the features of the

CGE model and the data modifications. Section 3 discusses the simulation design, includi ng

the main features of the pre-war plans for trade integration reforms and the war scenario.

Section 4 presents the simulation results focusing on welfare, sectoral outpu ts and factor

prices. Finally, we summarise and offer concluding remarks in Section 5.

2. FEATURES OF THE CGE MODEL AND DATA MODIFICATIONS

The multicountry, multisector CGE model, used in this paper and documented in Hertel

(1997), is widely used for quantitative, ex ante investigations of the effects of trade reform

and restrictions and well suited for disaster assessment, especially those with regional spil-

lover effects. In this model, firms in each country are differentiated by sector and are assumed

to produce for domestic and export markets, using constant-returns-to-scale technology and a

mix of primary and intermediate inputs. Intermediate products are either produced domesti-

cally or imported and substitute imperfectly, following the Armington structure. Product dif-

ferentiation between imported and domestic goods and among imports from different regions

allow for two-way trade in each product category, depending on the ease of substitution

between products from different countries. Land, physical capital, skilled and unskilled labour,

and in some sectors a natural resource factor, are used as primary factor inputs into

production.

The model takes into account the role of overall resource constraints in determining sec-

toral output supply and has an explicit treatment of international trade and transport margins,

a ‘global’ bank mediating between world savings and investment and a consumer demand sys-

tem designed to capture differential price and income responsiveness across countries. The

accounting relationships and behavioural linkages constrain outcomes in ways not possible in

other types of models. Each country’s exports of a particular good equal total imports of this

good in other countries, net of shipping costs; global investment equals global savings; aggre-

gate output determines aggregate income in each country; global supply and demand for indi-

vidual goods balance; demand equals supply for each factor in a country; increases in total

factor productivity which raise competitiveness also raise factor prices and help offset the

original increase in competitiveness. The results obtained with the general equilibrium model

are indicative of medium-term outcomes as returns adjust to changes in economic conditions,

and factor inputs are perfectly mobile across sectors but not across countries. However, the

model permits cross-border labour mobility reflecting cross-border refugee flows.

The global CGE model used in the paper allows for interaction of markets which could

lead to significant non-linearities and sizable feedback effects in response to equilibrium price

changes, even when underlying preferences and production processes are well behaved. Thus,

©2016 John Wiley & Sons Ltd

1586 E. IANCHOVICHINA AND M. IVANIC