The economic costs of the Russia-Ukraine conflict in terms of lost entrepreneurship

The common belief that wars can be good for the economy is a myth; empirical evidence shows consistently that war negatively affects GDP per capita, argue Hanna Motuzenko and Paul Momtaz, co-authors of a new paper analysing the economic impact of the conflict in Ukraine. There are many ways that war reduces GDP per capita, including trade disruptions, human capital losses, physical capital destruction, technological regress, political instability, and more general uncertainty – it also impacts entrepreneurial activity. In this post Hanna and Paul provide insights into the findings of the paper.

Impact of war on entrepreneurial activity

While previous studies have investigated the economic costs of conflict in terms of the GDP per capita, there is no research that assesses the aggregate economic costs of conflict in terms of (lost) entrepreneurship. This void is surprising given that entrepreneurial activity is an important driver of job creation and economic growth in the long run.

Some studies have investigated how entrepreneurs are affected by violent conflict. Quite surprisingly, those studies seem to suggest a positive correlation between violent conflict and entrepreneurial activity (although most are qualitative and or poorly identified, so that the reported findings must be interpreted with caution).

Our new study explores the impact of the Russia-Ukraine conflict that started in 2014 with the invasion of Crimea. Using the synthetic control method to construct counterfactuals of how entrepreneurial activity would have evolved in Russia and Ukraine in the hypothetical absence of the war, we find clear evidence that both countries lost entrepreneurial activity, as measured by self-employment and Small and Medium-sized Enterprises (SMEs).

In Ukraine, the percentage of self-employed dropped sharply by 19.5% in the first conflict year, leading to the unemployment of 675 thousand formerly self-employed Ukrainians. The effect partially subsides over time, but foregone entrepreneurship still accounts for 8% in the fifth conflict year. The difference in SMEs with its synthetic version peaks in 2016, with a gap of 71 thousand SMEs corresponding to a relative loss of 14%, and recovers back to the synthetic trajectory five years into the war. Putin’s war is eroding Russia’s future prospects

In Russia, the effect is persistent and reinforcing over time, with the number of SMEs dropping by 42.2%, accounting for a loss of 1.4 million SMEs. The disappearance of Russian SMEs results from fewer new business creations and more existing business closures.

We also see that the trends in entrepreneurial activity are plausibly affected by the sanctions imposed on Russia by the European Union in 2016. In Russia, entrepreneurial activity declined further after 2016. In contrast, Ukraine seems to recover from the initial shock starting in 2016, and entrepreneurial activity started climbing (almost) back to its pre-war level until 2019.

The study contributes to the literature on the economic costs of war by challenging the scholarly consensus that conflict spurs entrepreneurship. It also offers an empirical basis for policy debates around the Russia-Ukraine conflict.

The study’s conclusions that Ukraine recovers and Russia further erodes its entrepreneurial base have important implications for the economy. Putin’s war is essentially eroding Russia’s economic substance of the future.