I awoke last Saturday morning to hear that the 2012 Nobel Prize for Peace had been awarded to the European Union (EU). The award of a peace prize to the EU may seem surprising given that much of the EU's role is concerned with economic issues such as the regulation of the single market or external trade. The thinking behind the award seems to have been that closer economic ties between countries have been an important factor preventing a major war in Europe since 1945. In political science, numerous studies have attempted to use statistical techniques to examine how the likelihood of two countries going to war varies with the level of between-country trade (for example Hegre et. al 2009). The results have not been particularly consistent with some studies finding that the level of trade between countries is positively associated with conflict while other studies have found the opposite result. I don't know this area well but it would seem likely that estimates of the effect of trade on wars might vary across time and contexts and also be sensitive to how reciprocal relationships between war and trade are taken into account. So this is probably not an argument that is going to be settled anytime soon.
Economists have also been interested in the relationship between trade and wars but have mainly been interested in the magnitude of trade losses associated with wars. While the effect of trade on war seems likely to remain ambiguous, the effect of war on trade is anything but. In a recent paper, Glick and Taylor showed that wars result in large trade losses not only between those countries directly involved in conflict but also for neutral countries. The dataset and a copy of a NBER working paper with the same title is available on the authors' webpage and in the following we will use the dataset to replicate part of their work.
The data and analyses are similar to that used in the article I wrote on the effect of the Olympics on trade recently. The main data source is the IMF Direction of Trade Statistics and the dataset contains 251,905 yearly observations on the level of trade between pairs of countries from 1870 to 1997. In total, data is available for 172 countries and 11,535 pairs of countries. The table below illustrates the structure of the data using, as example, trade between the UK and both Germany and Switzerland over the period between 1938 and 1947.
The outcome that the analysis seeks to explain is the logarithm of the level of trade between countries measured in US dollars adjusted for the effects of inflation (LogTrade). For the UK-Germany observations in the table above, the variable War is equal to 1 for the period from 1939 to 1945 while, for the UK-Switzerland observations, the variable Neutral takes the value of 1 for the same period. The variables War1 - War10 are dummy variables recording the time elapsed since the end of hostilities so that, for UK-Germany observations, War1 takes the value 1 in 1946, War2 takes the value 1 in 1947 etc. The variables Neutral1 - Neutral10 are constructed in a similar fashion for the UK-Switzerland observations. These variables allows us to examine firstly, how far war influences the level of trade both between countries at war and between countries at war and neutral countries, and secondly, how the level of trade recovers following the end of hostilities. The data also includes an indicator for each pair of countries (Pairid). Including this term in the analysis is important because it means that the information used to calculate the effect of war on the level of trade comes from a comparison of trade for each country-pair when at war to trade for the same pair of countries when not at war. Many countries lack trade data when they are at war but perhaps surprisingly some countries which are at war do trade more than blows, with a positive level of trade being recorded during a war for 206 country-year observations and 75 different country pairs.
Estimates of the effect of war on trade are shown in the figure above1. The coefficients indicate that war between countries reduces the level of trade by over 80 percent relative to its peacetime level and that the effect of war on trade persists for over a decade following the end of conflict. The results also show that war reduces the level of trade taking place between countries at war and neutral countries with a reduction of around 12 percent in wartime which persists for up to 8 years following the end of conflict. While relatively infrequent wars have large and persistent effects on trade.
The point here is not to argue that the main losses associated with war are declines in the volume of world trade. But I also don't find the argument that globalisation and the rising volume of world trade will itself reduce the risk of conflict between countries particularly convincing. Resources are becoming increasingly scarce and it would certainly seem possible that in the future countries will fight wars over access to resources. Unrestrained free-market capitalism seems likely to result in more rather than less wars but if economic institutions provide a way to stabilise relationships between countries with competing interests, then the award of the Peace Prize to the EU is perhaps something we can all support.