Wars as Large Depreciation Shocks

In this paper, we propose a theoretical framework to investigate the impact of conflicts and wars on key macroeconomic aggregates and welfare. Using a panel data with 12 countries from 1875 onwards we first show that consumption drops more than output during conflicts, while the opposite is true during \peaceful" recessions. To handle both cases, we build a variation of a Real Business Cycle model first proposed by Hercowitz and Sampson [1991]. We extend the initial model to account for specific shocks that destroy capital stocks -as conflicts do- by assuming an (exogenously) time{varying depreciation rate of the stock of capital. In addition to these shocks, the model also imbeds generalized TFP shocks capturing standard technological factors as well as the potential effects of human losses on production. The model is able to reproduce the different responses of macroeconomic aggregate to productivity shocks during peaceful periods as well as their responses during conflicts. We describe how these two sources of randomness in the model may be extracted from the available data, and analyze how they interact. We conclude that conflicts have significant and persistent influence on generalized TFP shocks, while the \reverse" effect is not statistically significant. Finally, we show that the welfare costs of conflicts such as World War II are substantially larger than the welfare costs of business cycles usually reported in the literature