With the Third Gulf War raging since late February, the prophecies of economic doom have been rolling in ever since. Iran’s economy is predicted to shrink by nearly 10% this year, while forecasts for growth in the Gulf nations are expected to fall from 4.4% in 2025 to 1.3% in 2026. It’s estimated that the Middle East’s tourism industry alone is losing $600 million a day through lost visitor spending.
The global fallout has also seen projections of misery for all. With wholesale gas prices rising by 67% and oil up by 35%, global stocks down and bond yields up, the gloomsters are having a field day. The IMF has warned that Iran War escalation could trigger a global recession, with others claiming a global fertiliser crisis brought on by the closure of the Strait of Hormuz threatens long term food security. So far, so doomy.
But there are an ever-growing number of thinkers and the historical evidence to back them up that point to major crises – wars, depressions, state collapses – often being followed by unusually strong growth. Scholars as diverse as Joseph Schumpeter, James A Robinson, Alexander Gerschenkron, Milton Friedman and more recently Carmen Reinhart and Kenneth Rogoff all put forward their own theories as to why this is, but all are united in the belief that a crisis can lead to a boom if it’s responded to in the right way.
For Joseph Schumpeter, he thought that crises accelerate the replacement of inefficient capital, firms and institutions with more productive ones and thereby remove the constraints on innovation. James A Robinson pointed to crises creating rare windows where a weakening of entrenched elites allows deep institutional reforms to become politically possible.
Alexander Gerschenkron argued that devastated economies can grow faster by rebuilding with newer, more productive technology. Milton Friedman has made the case that crises break political resistance to the pro-market reforms necessary to usher in sustained growth.
West Germany’s experience after World War Two is perhaps the gold standard case of this rebound phenomenon in action. With its capital stock largely destroyed, West Germany was facing industrial collapse and suffered rationing, price controls and rampant black markets – the situation was bleak.
But in 1948 the appointment of Ludwig Erhard as Director of the Economic Council for the Anglo-American occupation zone heralded a dramatic turnaround. Erhard restored sound money by replacing the worthless Reichsmark with the Deutsche Mark and removed price controls and rationing overnight, bringing in sharp tax reductions to incentivise production and a commitment to free trade. The result was the Wirtschaftswunder or “economic miracle”, with explosive industrial growth throughout the 1950s. By 1960, Germany was the third largest economic power, behind the US and Japan.
Japan’s comeback is another classic example of post-catastrophe recovery. By the end of 1945 its industrial base was shattered and two of its cities had been wiped out by atomic bombs. But by embracing strong property rights, gradual trade liberalisation and a stable macroeconomic policy, with low inflation and a high savings rate, from the 1950s to the 1980s it enjoyed one of the fastest periods of growth in history.
The nightmare of Chile under socialist dictator Salvador Allende and the turnaround effected after he was toppled is also instructive. His rule saw large scale nationalisations, price controls, wage hikes, and a rapid expansion of the money supply, which inevitably led to inflation spiralling into percentages in the hundreds, severe shortages and economic paralysis.
Catastrophe was converted into opportunity when Allende was toppled by Augusto Pinochet in 1973 and a group of economists known as the Chicago Boys, trained by Milton Friedman, delivered shock therapy to the Chilean economy. Most price controls were quickly abolished, tariffs were slashed dramatically and widespread privatisation saw a return to the private ownership of production. Chile would become one of the most open economies in the world and by the late 1970s it was growing at 7 – 9% a year.
More recently there’s the experience of the Gulf after the First and Second Gulf Wars. The crises exposed structural weaknesses in the Gulf states – namely their overdependence on oil revenues, their large, inefficient state sectors, weak private sector dynamism and their vulnerability to geopolitical shocks.
Both wars catalysed the Gulf states to move towards more open, market-oriented, globally integrated models. The Second Gulf War in particular delivered such a shock to the region that it galvanised a major shift towards the reduction of trade barriers, joining or deepening ties with the World Trade Organisation, partial privatisation of state owned industries such as telecoms, utilities and airlines, the encouragement of public-private partnerships and a liberalised business environment, with the widespread implementation of free enterprise zones.
In the years following the Second Gulf War growth surged in the region, with some states pushing 8-10%. Since the 2010s, non-oil growth has been humming at 4-6% in a sign that free market and free trade reforms spurred on by the conflict were having an effect.
As Milton Friedman put it, “Only a crisis – actual or perceived – produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around”. The situation in the Middle East is already prompting a shift in the debate in the UK, one of the global poster children for bad policy, with Net Zero being ever-more eroded amid a renewed embrace of North Sea drilling, fracking, and cheaper energy production as politicians reach for better ideas. If the right moves on free markets and free trade are made, when the Third Gulf War comes to an end, it might not just be the Middle East that booms but the world.
