The post-1989 economy reaped the benefits of a ‘peace dividend’. There was actually no ‘peace’. Economists contest the empirical reality of the ‘dividend’. But the global economy did gain in a number of ways.
First, defence spending declined, freeing up resources for other expenditure. US defence spending fell from around 5.5 per cent of GDP in 1989 to 2.6 per cent of GDP in 2000. The reduction in defence spending was more marked in Western Europe and in the Russian Federation.
Second, scientific and mathematical resources previously employed in the defence-industrial infrastructure were re-deployed, helping accelerate the growth of other parts of the economy, especially technology industries.
Third, it allowed the integration of former communist economies into the Western trading economy opening up new markets. That increased the global labour pool from approximately 1.5 billion workers to nearly 3 billion workers, reducing production costs and keeping inflation low. And fourth, the dissolution of Cold War alliances, and improved security conditions for trade and commerce, provided impetus to globalisation of production and capital flows.
The peace dividend may now be reversing. Russian revanchism now threatens a return to the Cold War. Radical Islam, the Sunni-Shia conflict, nuclear ambitions and geo-political positioning have destabilised the Middle East. One manifestation of this is the rise in terror attacks, including the attack on a Russian civilian airliner and those in Europe. Another is the flow of large numbers of refugees into Europe fleeing conflict and a lack of economic opportunities in the region.
Territorial disputes between China and several neighbours, much of it focused around potential hydrocarbon resources, have led to escalating tensions. The shift will have several effects. First, there is pressure to increase spending on defence and national security. Following 9/11, US defence spending rose to 4.7 per cent of GDP in 2010 before declining to 3.6 per cent of GDP in 2014. It may have to increase to the 1970s level of 6-8 per cent, lower than the 10.5 per cent level of the 1950s. In response to the perceived threat of terrorism and porous borders, European and UK defence spending – currently around 1-2 per cent of GDP – will need to increase even more due to degraded military capabilities.
Some economists have argued that this spending could boost economic activity. However, any rise will be artificial and short-lived. In the 19th century, French economist Frederic Bastiat explained why there is no benefit to the destruction of productive assets or expenditure on unproductive assets.The money expended could otherwise have been put to more productive uses, generating greater wealth. Higher defence expenditure will, ultimately, divert resources.
The spending will also place additional stress on already fragile public finances in many countries. France has already indicated that it is "at war" following last year's terror attacks on Paris, and will not abide by limits on budget deficits and public debt – potentially invoking the emergency or exceptional circumstances provisions of the EU.
Normal trading and financial activities are also affected by the changing geopolitical climate. Between 2010 and 2014, Western investors invested more than $300 billion in Russian stocks and bonds. Western sanctions on Russia now make it very difficult for a number of heavily indebted companies to refinance existing foreign currency borrowing or raise new capital internationally.
Western sanctions of Russia are also costly for European economies, especially Germany. Pre-crisis, total German trade was around €80 billion. Approximately 350,000 German jobs directly depend on German-Russian trade, with around 8-10 per cent threatened by sanctions. Europe is dependent on Russian energy supplies. And rising security concerns and political risk reduce the attractiveness of global supply chains and deter foreign investment.
An uncertain geo-political and security environment may reinforce the trend to closed economies, with capital controls and trade restrictions. China is moving to domestically source previously imported critical defence and infrastructural components, to ensure self-sufficiency.
Actual conflict increases the cost dramatically. There is the direct cost of dealing with the issue of conflict. There is also the indirect cost, by way of disruptions, restrictions on normal commercial and personal life, and the loss of confidence which impinges on economic activity. Even minor conflicts can disrupt critical resource supplies, such as oil or crucial minerals, and trade routes.
Conflict can displace large numbers of people resulting in large numbers of refugees. The Syrian civil war illustrates the high humanitarian cost and the economic expense of dealing with the crisis. Combating and controlling failed states, resulting from conflict, such as those in the Middle East, Africa and central Asia, requires commitment of vast resources, by way of manpower and treasure. Asymmetric warfare, cyber-attacks or isolated terrorist attacks, impose high cost on economies. Increased security measures designed to prevent or minimise the effects of such attacks are expensive.
The large and rising homeland security costs in the US and elsewhere is a large and unproductive expense. The reversal of the 'peace dividend' now weighs heavily on the prospects of the global economy.
Satyajit Das is a former banker. His latest book, A Banquet of Consequences, is available now
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