Evidence from Africa---especially Ethiopia and Uganda---sheds light on why, when a civil war ends, it takes time to claim a peace dividend.
Civil wars differ from international wars: they are informal, often having no clear beginning and end, they weaken rather than strengthen the authority of the state, and they leave two opposing armies to be demobilized within one territory. Perhaps most important, they erode the institutions of civil society, such as respect for the law. But what happens when they end? What are the economic consequences of the transition to peace?
Civil wars vary greatly in the amount of economic damage they do. Nigeria's relatively short civil war appears to have caused only a small loss of output, and much of this loss was recovered after three years of peace. By contrast, Uganda's long and intermittent civil war caused a drastic decline in that country's output: by the end of the war GDP was half what it would have been had there been no war. Angola and Mozambique suffered similarly dramatic declines.[1]
These economies emerging from long, destructive civil wars might be expected to face a large potential peace dividend, but in fact, postwar recoveries have been only partial. Even eight years after peace Uganda's economy remains far below its prewar peak. The private sector remained wary after the war: it neither invested nor consumed as might have been expected had it anticipated recovery with confidence.
The fiscal implications of peace also are discouraging. Because civil wars often do not end decisively, military expenditure cannot easily be reduced. In Uganda military spending actually rose 40% in the early years of peace. Further, revenue may not be buoyant. In wartime Ethiopia the state used coercive revenue-raising measures that had to be abandoned during peace, causing revenue to decline. In Uganda revenue collapsed during the war and was very slow to recover. Moreover, during the last years of a civil war the fiscal position may deteriorate to a level that is unsustainable.
The postÐcivil war government therefore inherits a pressing need for fiscal retrenchment. The only revenue relief lies in the enhanced flow of aid that is typically triggered by the ending of hostilities, which can help moderate the amount of fiscal adjustment required. In the short run, then, there is rarely a substantial peace dividend for the economy or for the government.
The end of a civil war does not automatically lead to the end of insecurity. Indeed, the fear of personal violence and theft may increase in the aftermath of a war. Demobilization is sometimes accompanied by a rise in criminality. But a well-planned demobilization program that provides compensation to the demobilized soldiers, as in Uganda, can help prevent increased insecurity. Uganda actually experienced a net reduction in crime because most of the demobilized soldiers had access to land and the demobilization of men with military training appears to have discouraged existing criminals. But in such countries as Angola, Chad, and Mozambique the key phases of a successful transition---assembly, disarmament, discharge, demobilization, and reintegration---were poorly planned. The release of unprepared and often armed soldiers led to a significant increase in crime, rural banditry, and circulation of weapons in these countries.
The fear that the state may be overthrown also persists during the transition. There often is a continuing risk that the war will be resumed. Governments can reduce military expenditures in the aftermath of civil war, but to prevent an increase in personal or state-level insecurity they may need to make offsetting increases in expenditure in the form of compensation to the losers.
Civil war puts assets and transactions in jeopardy. How much a particular sector of the economy is affected depends on how transaction-intensive it is and on how vulnerable and visible its assets are.
During Uganda's civil war, between 1971 and 1986, the manufacturing sector, both transaction- intensive and asset-vulnerable, shrank by half relative to GDP (which itself declined by half). Although manufacturing recovered after 1986, by 1994 it was still far below its 1971 share of GDP. The sector that contracted most severely during the war was the asset-producing sector, construction. But construction was also the most successful sector in the postwar period. Commerce and transport, a transaction-providing sector, also suffered severely during the war. Although this sector grew more rapidly than GDP after the war, it remained a much smaller share of GDP than before the war. The sector that did relatively well during the war was subsistence agriculture. Relative to GDP, subsistence grew during the war and contracted after peace was restored.
The postwar recovery involves a return to the market and a restoration of confidence in assets. The government can encourage private agents to shift from subsistence activities back into the market by setting both explicit taxation and implicit (inflation) taxation of transactions low in the early postwar years. This means that the government should keep inflation below the revenue-maximizing rate.
During the transition back to the market the return on the rehabilitation of transport infrastructure is likely to be high, as shown by the very high rates of return on road rehabilitation projects in Uganda during its transition. Aid can play a critical role in accelerating the return to the market by permitting a much more rapid rehabilitation of roads and other market infrastructure than would be feasible if the state relied only on taxation.
During civil war private profits can be high. As wartime conditions disrupt markets, competition declines and marketing margins widen. As long as trade is not eliminated, these wider margins can offset reductions in the volume of trade enough to sustain or even increase profits. And once the state has abandoned its role of impartial defender of property rights, there are opportunities to acquire assets by force. Thus, during civil war a significant group of private agents is likely to accumulate substantial assets.
At the same time the uncertainty, vulnerability of physical assets, and high and variable inflation tax that prevail during civil wars lead to substantial capital flight. During the transition from war to peace a key imperative for the government is to take actions to reassure wary private agents and encourage them to repatriate this capital and to make irreversible investments. The emphasis therefore needs to be on the early sequencing of investment-sensitive reforms, such as temporary undervaluation of the exchange rate, the preservation of low inflation using direct targeting of the price level, sale of expropriated housing stock, and restraint in revenue collection.
During a prolonged civil war the institutions of civil society and the trust that are essential to the functioning of the economy are eroded. The economy loses "social capital." Like other types of capital, social capital takes time to restore: in the aftermath of a civil war private agents fear both each other and the government. This fear is perhaps an even greater obstacle to a private sectorÐled recovery than physical damage to infrastructure, because it delays irreversible investment even when financing is available. Thus, the peace dividend comes not from a swift resumption of activities disrupted by the war, but from a gradual recovery of confidence that induces repatriation of financial and human capital. During the transition, then, the most important needs are to rebuild the institutions of civil society and to boost confidence by early sequencing of investment-sensitive reforms.