Key message 3 – In the aftermath of conflict, restoring investor confidence and rebuilding trust should be high priorities

Strengthening peace and building trust among different groups in society are key priorities once a conflict ends. Restoring investor confidence, as well as strengthening political stability and inclusiveness, should be important areas of focus to help prevent future negative cycles of conflict resurgence and economic shocks. These policy challenges are described below.

Restoring investor confidence

Conflict can increase risk perception of investors by increasing expectations about the potential for future outbreaks and instability. Political risk is transmitted to foreign investors in conflict-affected countries through three main channels: destruction of assets from the conflict; unavailability of inputs and adequate human resources; and sharp declines in domestic demand that lead to lasting impoverishment (Mueller et al., 2016).

A number of studies have tried to quantify the effects of conflict on investment-related indicators, including stock market evaluations and housing prices. Overall, this research shows that the political risk of a resurgence of violence can directly influence expectations, asset prices, and investment, emphasising the economic importance of sustained peace.
Evidence suggests that much of the economic impact of violent conflict comes from changes in expectations about future violence. Figure 3 shows that foreign investment inflows to countries during conflict (black line) are much lower than in post-conflict countries (purple line). Enterprise surveys show that both multinational and local firms react strongly to political instability.

Figure 3: Foreign investment during and after conflict

Source: Mueller et al., forthcoming

Micro-level evidence here includes a study showing that a shift from violence to peace in Belfast, Northern Ireland, after the 1993 Downing Street Declaration, led to a 6–16% increase in housing prices (Besley and Mueller, 2012). Another empirical study explores how conflict affects stock market evaluations (Zussman et al., 2006). Using data on Israeli-Palestinian conflict since the late 1980s, the researchers found that major escalations in violence led to significant declines in asset prices in both Israel and the Palestinian Authority (PA). Similarly, rocket attacks by Hezbollah during the 2006 Second Lebanon War led to a 6–7% decline in house prices and rents in the most severely hit localities – and these effects persisted until 2012 (Elster, Zussman and Zussman 2016).

Policies to de-escalate conflict and commit warring parties to stable peace once the fighting ends can thus help to attract investments needed to rebuild the economy. Countries should be poised to take advantage of the potential opportunity for large increases in foreign investment when there is a credible end to civil war. On average, investment inflows increase by 50% – amounting to 2–4 billion USD annually – when the violence stops (Mueller et al., 2016).

Building trust and inclusive political institutions

Conflict often has lasting effects on the political environment and social trust in a society. Inequality between groups along ethnic or other lines is a major potential source of conflict. Political exclusion can perpetuate the unequal distribution of economic resources, which may further fuel instability and conflict.

Inclusive political institutions and constraints on executive power can help to break the links between ethnic diversity, inequality, and conflict (Burgess et al., 2015; Besley and Persson, 2011; Mueller and Tapsoba, 2016). These institutions can help prevent conflict because they prevent ‘winner takes all’ dynamics where a loss of political power leads to economic decline.

Conversely, there is strong evidence of a link between conflict and weak political institutions. Chen et al, (2008) find that, compared to similar countries, conflict-affected states are slower to develop their political systems. Countries with a history of internal conflict manage to collect a much smaller share of taxes relative to GDP. One study suggests a tax take that is 7% lower than countries without conflict (Besley and Persson, 2008).

A related body of research focuses on societal trust and ethnic tensions. A study on civil conflict in Uganda in 2002–2004, for instance, suggests that intense conflict can disrupt trade and lead to a breakdown of inter-ethnic trust, particularly in areas with high ethnic fragmentation (Rohner et al., 2013). Using satellite night-time light data as a proxy for economic activity, this research finds that fighting in these areas is associated with a large and significant fall in living conditions.

An analysis of road-building in Kenya across five decades finds that democratic institutions can help to decrease ethnic favouritism in the provision of public goods (Burgess et al., 2015). Other research points to the importance of post-conflict justice institutions, such as the post-conflict trials in Rwanda, in helping to build inter-ethnic trust and also attract FDI (Bert and Marijke, 2015; Appel and Loyle, 2012).

A randomised study on the introduction of new ‘Alternative Dispute Resolution’ bodies for protecting property rights in Liberia, found that these informal institutions helped to inhibit violence (Blattman
et al., 2014). Finally, there is some evidence from Liberia on the effectiveness of community-driven reconstruction efforts and work training programs for ex-soldiers (Fearon et al., 2009; Blattman and Annan, 2015).

In summary, enhancing the stability and inclusiveness of political institutions is important to help build trust, mitigate the economic costs of conflict, and support lasting peace.

Building in Angola

Photo: Getty Images | Eric Lafforgue