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Violent Political Conflicts Spell Doom For Private Enterprises

Protesters gather in the street with red flares lit
Violent political conflict causes drop in domestic company investments, according to new research by Imperial College Business School
  • Firms based in countries experiencing violent political conflicts see their inventory purchases drop as much as 20% on average
  • The reduction was found to be most likely due to increased uncertainty rather than capital or potential property destruction
  • To protect themselves, firms should consider adjusting inventory purchases for precautionary motives, rather than solely in response to changes in demand

As the philosopher Bertrand Russel once said, “War does not determine who is right — only who is left”. In the same vein, global and domestic conflict doesn’t just take its toll on innocent civilian lives but the very fabric of their community: education, agriculture, industry and the access to essential provisions.

While much focus should rightly be placed on the humanitarian impact, the brutal repercussions for business and trade should not be overlooked as this can have a direct impact on the livelihoods of those caught in the middle of such volatility. If there is no means to do business and trade, economic prosperity and consequently satisfactory standards of living become a pipe dream for the future.

Typically, it is developing countries that bear the brunt of both domestic and global political conflict, as their economies are not always robust enough to take a big hit. Africa, a continent where the largest reserves of the world’s gold, cobalt, diamonds, platinum and uranium are found, is rife with conflict – for instance; The Tigray War in Ethiopia, a country which fathered the genesis of the first coffee plants, or the country of Mozambique which has suffered greatly from political conflicts, instability and crime. These are all brutal blows to legally operating businesses and trade for residing firms as, in most African countries, natural capital accounts for between 30 and 50 percent of total wealth.

On the other hand, no matter how developed a country may be, they can still feel the consequent impact of conflict. Britain for example imports £16.5 million worth of sugar from Mozambique as well as coffee, tea and cocoa – so much that the UK resides within the top 10 counties for these imports respectively. Similarly, as we have experienced more recently, the knock on economic effect of the war in Ukraine. The country has a massive wealth of natural resources and is the fifth largest exporter of grain, which has resulted in significant supply chain shortages, driving the cost of living up for many living overseas and far away from the conflict zone. The US Federal Reserve recently concluded the war in Ukraine carries the greatest geopolitical risk in the west since 9/11 and the Iraq War, with data suggesting the majority of firms, including automobile, consumer goods, energy and food expressed concern over the war above anything else.

The human cost of political conflict has been rightfully documented in research, through political intervention and and by the media, and should, to rational minds, prove a deterrent enough for war and provide the thrust for establishing peace. But history teaches us that this is rarely so.

So, in impossible circumstances where societies are deconstructed from all angles, we should also be strident in ensuing as many protections as possible to people’s way of life. This includes making sure business can stay stable – even grow – instead of shrink.

New research by Imperial College Business School lays out that conflict does indeed have irreparable damage on firms, especially smaller ones. According to a study by Dr. Claudia Custodio, Associate Professor of Finance at the School, small companies suffer in developing as a consequence of violence and political unrest, however, bigger firms in the same regions are similarly unable to escape the struggle.  

The basis of Dr Custodio’s study was inventory purchases – items purchased to be sold to customers – of 650 firms based in Mozambique. As the research importantly prefaces, the private sector in Mozambique contributes to around 65% of the country’s GDP and it is an important driver of economic development. By analysing two key databases, first from Barclays Bank Mozambique and then ACLED – The Armed Conflict Location and Event Data, they set out to study the impact of violent political conflicts on firms’ investment decisions in the context of developing economies.

The findings were a sobering reflection of domestic conflicts’ throttling effect on economic growth.

The occurrence of at least one political conflict within 10 kilometres of a firm’s location in a given month is associated with as much as a 19 percent reduction in the following month’s inventory purchases. Smaller firms fare worse still with reduced purchases of between 28 and 33 percent more when compared to large firms, following the occurrence of at least one political conflict within 10 kilometres. On a wider scale, the steep growth in conflicts between the years 2010 and 2019 has resulted in a GDP decrease of more than four percent.

The question is, what factors influence the decision making process of these firms when they come to their purchasing decisions?

One, according to the study, is the longevity of the conflict as an additional month of exposure is associated with a 4.3 percent drop in monthly purchases for small firms compared to large firms. Unfortunately they also seem to be less resilient as a result. The research reveals small firms have a significant probability of terminating their existing relationships with suppliers following a conflict. The research concludes the death toll is understandably what leaves them the most shell shocked, as this causes the biggest decrease in their investment in inventory.

Is this pure fight or flight or is there a strategic element at play?  Dr. Custodio’s research suggests firms might respond to violent political conflicts by purchasing less inventory in anticipation of a decrease in consumer demand or due to increased demand uncertainty. Firms might also decrease their purchases to decrease inventory holdings as violence might lead to property destruction and theft, or because firm’s operations and supply chains are disrupted

Even if Mozambique is a geographic minefield for firms, so to speak, one would assume some are unavoidably in the wrong place at the wrong time, meaning they will always take the biggest economic hit. They would assume wrongly.  Dr. Custodio further adds, In low conflict zones where violence is arguably less expected, small firms decrease their purchases by 41 percent. Furthermore, the impact on small firms is disproportionately larger when compared to large firms when conflicts are less frequent.

Ultimately, firms can only thrive in countries where the only obstacle is competition – not bloodshed through political conflict or war. As previous research goes to show nations which are less fractured, and in some cases even nationalistic are better for business success.

So for small business owners who experience this misfortune, how can they ensure their circumstances can best be navigated? After all, for smaller businesses more dependent on investment from outside sources to stay afloat, their attractiveness to investors – whether domestic or overseas – will no doubt be hindered as a result of the circumstances they are surrounded by. We already know from previous research that natural disasters can inversely affect an investor’s decision on whether or not to back a venture in the middle of disaster zones – its not a stretch to assume that war would cause the same reservations.

The solution for managers may be to adopt a level headed and strategic approach amidst conflict. Dr. Custodio’s study found that managers of firms exposed to an increase in violent conflict were found to be more likely to express their intentions to expand to less violent areas. “We suspect smaller businesses are more vulnerable to fear and uncertainty, and less able to bear the cost of protecting their premises against damage and disruption,” she says. “Some small businesses don’t make any further purchases after a violent outbreak; it’s fair to assume that they have gone out of business”.

In summary small firms may have been dealt a very bad hand when it comes to the longevity and proximity of violent conflict, but for the ones which take a strategic response to continue operations, may prove to be the ones that swim rather than sink.

By, James Dugdale

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