The Economic Costs of Conflict: A Case-Control Study for the Basque Country

This paper investigates the economic effects of conflict, using the terrorist conflict in the Basque Country as a case study. Our analysis rests on two different strategies. First, we use a combination of other regions to construct a “synthetic” control region which resembles many relevant economic characteristics of the Basque Country before the outset of political terrorism in the 1970’s. The subsequent economic evolution of this “counterfactual” Basque Country without terrorism is compared to the actual experience of the Basque Country. We find that, after the outbreak of terrorism, per capita GDP in the Basque Country declined about 10 percent points relative to the synthetic control region. Moreover, this gap seemed to widen in response to spikes in terrorist activity. The second part of this study uses the truce declared in September 1998 as a natural experiment to estimate the effects of the conflict. If the terrorist conflict was perceived to have a negative impact on the Basque economy, stocks of firms with a significant part of their business in the Basque Country should have shown a positive relative performance as the truce became credible, and a negative relative performance at the end of the cease-fire. We find evidence that is consistent with this conjecture using event study methods. Alberto Abadie, John F. Kennedy School of Government, 79 John F. Kennedy Street, Cambridge MA 02138, USA. E-mail: [email protected]. Javier Gardeazabal, Dpto. Fundamentos del Análisis Económico, Avda. Lehendakari Aguirre 83, 48015 Bilbao, Spain. E-mail: [email protected] We thank Josh Angrist, Adolfo de Motta, Esther Duflo, Jim Heckman, Dani Rodrik, Gonzalo Rubio, Emmanuel Saez, Jaume Ventura, and Richard Zeckhauser for helpful comments and discussions. David López-Salido, Mikel Tapia, and Fernando Tusell helped us obtain the financial data. Henry Aray, Francisco Blanch, Sara Piccicuto, and Elena Zoido provided expert research assistance and contributed comments. Gardeazabal thanks the Department of Economics at the University of California, Santa Cruz for its hospitality while part of this work was carried out. Political instability is believed to have strong adverse effects on economic prosperity. However, to date, the evidence on this matter is scarce; probably because it is difficult to know how economies would had evolved in absence of political conflicts. This article investigates the economic impact of conflict, using the terrorist conflict in the Basque Country as a case study. The Basque conflict is especially interesting from an economic perspective. At the outset of terrorist activity in the early 1970’s, the Basque Country was one of the richest regions in Spain, occupying the third position in per capita GDP (out of 17 regions). In the late 1990’s, after 30 years of terrorist and political conflict, the Basque Country had dropped to the sixth position in per capita GDP.1 During that period, terrorist activity by the Basque terrorist organization ETA resulted in almost 800 deaths. Basque entrepreneurs and corporations had been specific targets of violence and extortion (including assassinations, robberies and kidnappings-for-ransom). Not surprisingly, the economic downturn suffered by the Basque economy during these years has been attributed, at least partially, to the effect of terrorism. However, to the best of our knowledge, almost no research has been carried out to assess the economic effects of the conflict.2 This type of study is difficult. On the one hand, a pure time series analysis of the severity of terrorism and the evolution of the Basque economy will be contaminated by the economic downturn which Spain suffered during the second half of the 1970’s and the first half of the 1980’s, at the peak of terrorist activity. On the other hand, at the outset of terrorism, the Basque Country differed from other Spanish regions in characteristics that are thought to be related to potential for economic growth. Therefore, a simple comparison of the evolution of the Basque economy and the economy of the rest of Spain would not only reflect the effect of terrorism but also the effect of pre-terrorism differences in economic growth determinants. Our analysis rests on two different strategies. First, we use a combination of other Span1See Fundación BBV (1999). 2The only exceptions that we are aware of are Enders and Sandler (1991, 1996) who study the effects of terrorism on tourism and foreign direct investment in Spain.