Permanent or Transitory? The Full Economic Implications of the War on Lebanon
Mazen M. Soueid Al-Hayat - 21/08/06//
The Israeli war on Lebanon has necessitated an urgent re-evaluation of Lebanon's economic prospects. The effects of the war, by all estimates, are so massive relative to the size and capabilities of the Lebanese economy, that many government and private sector analysts are describing it in terms of massive natural disasters such as earthquakes and Tsunamis. Basic economics would tell us, however, that if total economic consequences are similar to those of an earthquake, we would, believe it or not, be relatively lucky.
From a static perspective, the first round of effects of the war are clear -- from the human loss of more than 1000 civilian (which can never be really compensated or quoted in economic terms), to the damage in infrastructure, factories and other productive facilities, all estimated at around USD 2.5 billion. The implications of these losses on the economic activity are surely severe, and several agencies have already revised significantly down their growth projections for 2006 from 6% to zero, at best, i.e. a loss of USD 1.1 billion. The implication on the fiscal front, for a country with already a very high debt ratio, will also be hard, from loss of revenue from taxes and custom duties, estimated at around USD 700 million, to the massive increase in expenditures required later to deal with the effects of the war, for health reasons, compensation, and reconstruction, which will be hard to estimate at this stage and should depend on the extent of financial support and transfers from the international community. As for the balance of payments, the loss of exports, estimated at USD 200 million, combined with the loss of revenues from a promising tourist season, estimated at USD 3 billion, will weaken the current account, which would in turn weaken the balance of payments if capital inflows are not stepped up. Indeed, the opportunity loss in foreign direct investment is already estimated at USD 2 billion. In a sense, this may all indeed be compared to an extraordinarily devastating natural disaster, with the overall losses (actual and lost opportunities) being estimated to be roughly USD 9.5 billion or 40% of GDP.
But, from a dynamic perspective, second round effects could be even more damaging. It is here that an interesting economic and policy question arises. A good student of economics knows that the first question a policymaker should ask oneself when designing a response to an economic shock is whether the shock is permanent or transitory. Transitory shocks, such as the deterioration in the terms of trade (price of exports relative to imports), or a natural catastrophe like an earthquake, have very severe real, fiscal and balance of payment implications. The result is a diversion of the level of actual income from its trend. This in turn, could be tackled by higher financing and targeted spending by the government which, if well designed, would in time bring back the level of income to its equilibrium. On the other hand, a permanent shock, such as the loss of a natural resource, does not cause the level of income to divert from its trend, but rather causes an adjustment to the trend itself. The level of "potential" or "equilibrium" income is the one affected by a permanent shock and not the level of "actual income" hence the basic economic wisdom encapsulated in the phrase "finance a temporary shock and adjust to a permanent shock".
What then, are the full effects of this war? Lebanon is a country that has suffered many wars in its recent history, seven in the last thirty years, more than any other country according to a local politician. All of them have been treated by its residents, investors, tourists, and the international community, as a mostly transitory shock. Even the last couple of Israeli aggressions, in 1993 and 1996 were treated as transitory shocks mostly due to the efforts of an exceptional visionary, Rafic Hariri. The reconstruction efforts, investment in infrastructure, plants and factories, return of tourists, are only a manifestation of this judgment. But "Mr. Lebanon" is no longer with us to tour the world and raise the faith in the country. In addition, with time, and repeated experience, there is learning and adjustment of actions and strategies. If international investors, tourists and even residents start to see the present war as a harbinger of indefinite conflicts in the future, the full economic implications of this war would be much higher indeed. The question to ask then, as the economic cost is assessed and as economic policy is formulated in the future: would the shock be perceived as permanent or transitory?
The answer may depend significantly on actions undertaken by policymakers but also by the international community. A comprehensive and sustainable solution that tackles once and for all the original sources of the problem would ensure that this war be seen by residents, investors, and tourists as transitory shock, an earthquake. Financing, although huge, would be enough not just to bring income back to trend, but may even increase it as everybody would finally see the full potential of a country with great geography, history, and rich in human capital.
On the other hand, an end to the hostilities that does not address the causes behind them would mean that residents, investors, and tourists, all of whom have been burned so many times already, may start to think about the series of wars and aggressions as a permanent trend rather than a transitory shock. Lebanon would then turn into an example of how things can change in 24 hours in a doomed country whose fate is dictated by forces greater than its geography and history, and where the best its human capital can hope for is an evacuation by a US, Canadian, or European ship.
So is it permanent or transitory?
For residents who have chosen to believe in it, again and again, after every war, the answer to the question above is of crucial importance. For investors who watched their factories burning and buildings, the answer to the question above is of crucial importance. For several hundred thousand tourists that were evacuated after they had planned to spend vacation time in a country that, despite recent history, was climbing again and quickly up the chart of the "places to be", the answer is crucial. For the international community who stood with Lebanon in Paris 2 and was eager to show its support in the forthcoming Beirut 1, the answer to the question above is of crucial importance. But above all, for a country that has already been given a second, third and fourth chance, the answer to the question above is crucial.
The line between permanent or transitory, doom or opportunity, field or state will be determined in the months to come. The plan presented by Prime Minister Siniora, if properly implemented, is a major step in the right direction of finding a comprehensive, final, and viable solution to the roots of the problem. Hence a strict and unconditional adherence to this plan is not only a political need to stop the historic vicious cycle of war and destruction, but also an economic necessity to prevent a disastrous shift in the income level and trend . A firm standing behind the Prime Minister, above all, is a moral obligation for everyone who believes in this country as a permanent home, relevant model, or viable democracy.
* Mazen M. Soueid, Chief Economist, BankMed
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