Editors' note: This column is part of the Vox debate on the economic consequences of war.
Military conflicts are associated with profound economic and human capital losses (Harrison 2022, Akbulut-Yuksel 2022). The economic impact depends on several factors: area occupied by enemy forces, bombing intensity, and the destruction of human capital and physical infrastructure. These losses are multiplied by the length of war activities and can have long-term effects. Ichino and Winter-Ebmer (2004), for example, find that Austrian and German children who were ten years old during WWII, or were involved in the war through their parents, received less education than comparable individuals from non-war countries such as Switzerland and Sweden. These individuals experienced a sizable earnings loss of between 3% and 4% a year some 40 years after the war.
Russia’s invasion of Ukraine is unprecedented in recent times, as all military conflicts in the 21st century had taken place in countries with less developed human capital and physical infrastructure. Thanks to its educated labour force and good trade infrastructure, prior to the war Ukraine was among largest grain exporters in the world, dominating the global sunflower oil market, and was also ranked among the largest producers of steel. The deluge of over 6.5 million refugees to neighbouring countries and estimated eight million internally displaced people implies that the disruption is tremendous, even before one can have reliable accounts of the loss in physical capital.
We estimate the likely economic loss in 2022, while spelling out the challenges in doing this estimation. First, war presents a statistical challenge. As some territory falls into enemy hands, local businesses and citizens stop reporting to the statistical agency, even if their economic life is uninterrupted. Ukraine has already fallen victim to this challenge: economic output data, including the GDP flash estimate for the first quarter of 2022, have not been produced as of the time of writing this column.
Second, the nature of Russia’s all-out invasion makes comparisons to previous military conflicts difficult. We use Iraq’s invasion of Kuwait in 1990 – where the Iraqi army badly damaged much of Kuwait’s oil infrastructure – and NATO’s intervention in Serbia in 1999 – where air raids were the main feature of the war, inflicting damage to select infrastructure – as imprecise proxies. The war in Kuwait had a heavy toll on the economy, with the country’s GDP more than halved as this oil-dependent country saw its wells set on fire by the retreating Iraqi army. The rebound, however, was swift and the Kuwaiti economy fully recovered in another two years (Figure 1). In the case of Serbia, the air attack did not damage the economic infrastructure as badly. The economy rebounded the next year, though a prolonged period of stagnation followed.
Figure 1 Real GDP change in selected wars (percent)
(Year 0 is the first active year of a military conflict)
Sources: IMF, authors’ own calculations based on May 2022 consensus forecast for Ukraine.
The forecast is for slow recovery
According to the baseline scenario compiled by a consensus forecast as of May 2022 (FocusEconomics 2022), Ukraine’s real GDP is expected to fall 36.5% in 2022 (Figure 1). That includes a 39% plunge in private consumption, caused by supply shocks, depressed real disposable income and consumer confidence, and by over six million refugees fleeing the country. Investment has collapsed to less than half of where it was in 2021, limited mostly to replacement of capital goods in areas of the country where that is still possible. Government consumption is expected to fall by 7% in real terms, despite a massive fiscal deficit above 15% of GDP.
On the external side, Ukraine’s GDP is expected to face a strong 50% plunge in exports, mostly because of seaports being shut down by Russia’s naval blockade. Stocks of agricultural commodities unable to be shipped abroad are likely to provide some temporary support for GDP via increased inventories. Imports are expected to fall 45% in real terms, softening the decline in GDP.
The most worrying feature of the consensus forecast is that economists do not expect a fast recovery, as it took place in preceding wars. Ukraine’s real GDP growth should average 7.5% during 2023 to 2026, meaning that the economy remains 15% below its pre-war level five years after the Russian invasion (FocusEconomics 2022). That is a pessimistic prediction when one compares this path with after-war recovery in Kuwait or Serbia (Figure 1). The main reason for this forecast is the uncertainty around the end of the war in Ukraine, as hostilities are still taking place in many parts of the country.
Some forecasts are even more pessimistic. In particular, there are forecasts for economic activities almost halved in 2022, including the 45% real GDP decline forecast made by the World Bank,1 which includes expectations for private consumption losing as much as 50% and exports reduced to just a fifth of their 2021 amount (World Bank 2022). The World Bank expects slow recovery in the near term, with GDP growing just 2% in 2023 and less than 6% in 2024. That would imply that the Ukrainian economy would still be around 60% of its pre-war level by 2025.
Recovery challenges
As the war goes on, physical infrastructure suffers further damage and over a third of the Ukrainian population remains displaced from their homes for a fourth month. Estimates for losses of physical capital have already came close to $100 billion,2 or half of Ukraine’s pre-war GDP. For instance, the biggest steel mill in Ukraine (in Mariupol) has already been destroyed, while the second largest steel mill was under heavy bombardment and now is occupied by invaders. These two mills accounted for half of Ukraine’s pig iron output in 2021. This means that Ukraine’s sector is likely to gravitate upstream (iron ore), which implies less value added for national GDP and some additional logistical challenges on top of those that the country is facing now.
To make matters worse, prior to the war, Ukraine had already been a country with worrying demographic trends: aging population and dramatically falling birth rate. The war has deepened these challenges, with five million women and children escaping to higher-income countries, where Ukrainians have been allowed to get local work permits. As the war drags on, some of these refugees will find jobs and decide to settle abroad.
On top of quantitative human capital losses, there is a huge risk for qualitative degradation in human capital. Learning losses by Ukrainian children are a particular worry: Ukraine will end up in lower quality additions to its workforce due to war-caused (and prior to that, Covid-caused) disruptions in the learning process. These losses are estimated to be in the order of $90 billion (Angrist et al. 2022), or almost as much as the losses in physical capital to-date.
Akbulut-Yuksel et al. (2022a) demonstrate that early childhood exposure to war negatively affects not only cognitive ability but also long-term mental health. An increase of one standard deviation in the destruction caused by war during a person’s first five years of life is associated with about a 10% decline in standardised mental health scores when they are in their 60s and 70s. This also translates into an increase of 3.3 percentage points in the likelihood of being diagnosed with clinical depression. Similar evidence of the adverse mental health effects of war on children has also been found among survivors of the Vietnam War. Vietnamese wartime children, especially girls, who were exposed to war before their teen years are significantly more likely to have functional limitations as adults in their daily activities (Akbulut-Yuksel et al. 2022b).
The recovery in human and physical capital lost in the war requires nearly $200 billion, assuming that the war ends now and that no further damage to infrastructure takes place. This amount is equivalent to Ukraine’s pre-war annual GDP and can only be financed with external aid. Post-war Ukrainian and international institutions need to address the economic recovery as well as human capital recovery at the same time and with the same urgency.
The EU accession process would play a central role in the recovery. There is a need for a strong EU-driven post-war recovery effort, similar to the one that allowed most Western European economies to recover after WWII (Vonyo 2019). The outline of a possible recovery programme is given in Becker et al. (2022) in a recent VoxEU e-book. The programme can be structured in two phases: rapid restoration of critical infrastructure and services to revive the basic functions of the economy and the government; and re-establishing the foundations for sustained growth. The latter includes significant focus on human capital accumulation. These phases have different demands. For example, the first phase should include robust macroeconomic stabilisation to ensure that market-based mechanisms can start to allocate resources in the post-war economy.
The local banking sector is to play a significant role in Ukraine’s recovery. Comprehensive banking sector reform has been a prominent success in Ukraine, with its outcomes demonstrating themselves well in times of the pandemic and war challenges. The post-war recovery is a good opportunity to attract international investors into the banking sector as a part of the greater challenge of rebuilding the country.
The second phase would focus on upgrading the institutional environment for growth. The most obvious possibility is to create a carbon-free economy, both as a way to coordinate on investments for the future but also to show how to reduce reliance on fossil fuels. Whole cities – including Kharkiv, Mariupol, and Chernihiv – will need to be rebuilt, and this represents an opportunity to utilise energy efficient building designs and urban planning.
Should the war continue in the coming months, the cost of reconstruction will jump tremendously, as a third of the Ukrainian population spends more time away from their homes, children fall behind in their learning, and businesses cease to operate. The financing needs would be much greater too, requiring new approaches to aid the recovery.
References
Akbulut-Yuksel, M (2022), “Unaccounted long-term health cost of wars on wartime children”, VoxEU.org, 10 May.
Akbulut-Yuksel, M, E Tekin and B Turan (2022a), “WWII blues: The long-run effects of warfare on mental health”, mimeo.
Akbulut-Yuksel, M, Z Zimmer, S Pandey and T K Toan (2022b), “Untold story of wartime children: Results of the Vietnam Health and Aging Study”, mimeo.
Angrist, N, S Djankov, P Goldberg and H Patrinos (2022), “The loss of human capital in Ukraine”, VoxEU.org, 27 April.
Becker, T, B Eichengreen, Y Gorodnichenko, S Guriev, S Johnson, T Mylovanov, K Rogoff and B Weder di Mauro (2022), A Blueprint for the Reconstruction of Ukraine, a VoxEU.org eBook, CEPR Press.
FocusEconomics (2022), “Consensus Forecast CIS Plus countries”, 10 May.
Harrison, M (2022), “Economic warfare and Mançur Olson: Insights for great power conflict”, VoxEU.org, 25 March.
Ichino, A and R Winter-Ebmer (2004), “The Long-run Educational Cost of World War II”, Journal of Labor Economics 22(1): 57–87.
Vonyo, T (2019), “Recovery and reconstruction: Europe after WWII”, VoxEU.org, 21 November.
World Bank (2022), “Ukraine’s Macroeconomic Outlook”, 17 April.
Endnotes
1 https://thedocs.worldbank.org/en/doc/d5f32ef28464d01f195827b7e020a3e8-0500022021/related/mpo-ukr.pdf
2 https://bank.gov.ua/ua/news/all/kolonka-volodimira-lepushinskogo-ta-artema-vdovichenko-dlya-forbes-ukraine-pro-fizichni-vtrati-ekonomiki-ukrayini-vid-viyni-rozvyazanoyi-rosiyeyu
