The Opportunity Cost of Conflict: Statistically Comparing Israel and Synthetic Israel

What would Israel’s economy have looked like without the Palestinian Intifadas? Scholars have long debated the impact of the Israeli-Palestinian conflict on Israel’s economy. Some point to Israel’s long-term growth trajectory and conclude the conflict has little or no impact on Israel’s economy, while others argue the conflict has a positive impact on Israel’s economy. For example, Senor and Singer, in their influential book, Start-up Nation: The Story of Israel’s Economic Miracle (2009), argue that Israel’s war economy spurs innovation and entrepreneurship, particularly in high-tech industries. Still others, such as the former governor of the Bank of Israel Stanley Fischer, contend that Israel’s economy could have grown even faster in the absence of the conflict. With a focus on the 2000 Palestinian Intifada, also known as the Second Intifada, we contribute to this debate with new evidence based on new statistical analysis.

Evaluating the impact of the Israeli-Palestinian conflict requires some estimation of what Israel’s economy would have looked like in the absence of conflict. This leads to a fundamental methodological dilemma that has challenged the analysis of opportunity cost: How does one estimate the effect of a particular event or intervention on a country when there is no comparable “untreated” version of that country? To address this methodological problem, we use a method developed by Abadie and Gardeazabal (2003) and Abadie, Diamond and Hainmueller (2010, 2014) called the “synthetic control method.” This approach uses data from multiple comparison units (in our case, 21 OECD countries) to construct a single, synthetic comparison unit that resembles the unit of interest before it experienced the specified conflict.

Figure 1 shows the trajectories of per capita GDP for Israel (the black line) and the synthetic Israel (the gray line), which is generated via the synthetic control method. As expected, per capita GDP was similar between the factual and counterfactual cases up until 2000. Importantly, it started to diverge after 2000, with the synthetic Israel’s economy growing much faster than Israel’s economy. More specifically, in 2000, the per capita GDP was almost exactly the same at about USD 23,000 (in 2005 purchasing power parity) for both Israel and the synthetic Israel. From 2001 to 2003, however, Israel experienced negative economic growth. Israel’s per capita GDP remained almost unchanged from 2000 to 2005. By contrast, per capita GDP for the synthetic control continued to increase during this period, starting at 23,067 USD in 2000 and reaching 26,245 USD by 2005. On average, per capita GDP of Israel during the Second Intifada was reduced by about 2,003 USD per year. This is equivalent to about 8.6% of the 2000 baseline level, which is a substantial reduction.

Figure 1.

figure 1

Given the results of our statistical analysis, we are inclined to believe that the 2000 Palestinian Intifada had negative effects on Israel’s economy and held back its growth. Strictly speaking, however, our analysis only shows that something, which happened in 2000, had such negative effects. Alternatively, some may argue that the collapse of the “dot-com bubble” – a speculative bubble that drove the rapid growth in the economies of industrialized nations from 1997-2000 – also contributed to the divergence in the GDP per capita of Israel and the synthetic Israel. However, regardless of the dot-com bubble’s effect on Israel’s economy, it should not complicate our causal inference. The dot-com bubble impacted not only Israel but also the OECD countries that are used to make the synthetic control. Therefore, the effects of the collapse of the dot-com bubble are already incorporated in the synthetic Israel. In sum, we interpret that the gap between the post-2000 growth trajectory of Israel and its synthetic counterpart is due to heightened conflict associated with the Second Intifada.

Our statistical analysis complicates the view that the Israeli economy benefits from continued conflict. If Israel were at peace with the Palestinians, it could shift defense spending towards more productive endeavors, such as infrastructure spending and investments in education. Israel could have a smaller standing army, which would allow the labor force to expand. The stability of peace would cause a tourism boom in Israel. Perhaps most of all, the lack of violence would boost investment by removing the uncertainty caused by conflict and terrorism. As such, Israel would benefit from a final-status agreement that sets its economy back on track for faster growth. In short, our research suggests that peace pays.

If you want to know more about Professor Horiuchi’s study, we invite you to take a look a his paper published at PSRM: 

Horiuchi, Y. Mayerson, A.“The Opportunity Cost of Conflict: Statistically Comparing Israel and Synthetic Israel”, Political Science Research and Methods vol. 3 (September 2015): 609-618.

About Yusaku Horiuchi

Yusaku Horiuchi

Yusaku Horiuchi is Professor of Government and Mitsui Professor of Japanese Studies at Dartmouth College’s Department of Government, Program in Quantitative Social Science, and Asian and Middle Eastern Studies Program. He is also Adjunct Professor at the Australian National University’s Crawford School of Public Policy and Faculty Associate at Harvard University’s Reischauer Institute of Japanese Studies and Program on US-Japan Relations. Horiuchi earned an M.A. in international and development economics from Yale University in 1995 and a Ph.D. in political science from the Massachusetts Institute of Technology in 2001. His research and teaching interests include comparative politics (electoral politics, political economy, public opinion, Japan) and political methodology (research design, statistical methods).

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