Credit 279photo/iStock by Getty Images
Credit 279photo/iStock by Getty Images
War is again defining the global landscape. After decades of relative calm following the Cold War, the number of active conflicts has surged in recent years to levels not seen since the end of the Second World War. Meanwhile, rising geopolitical tensions and heightened security concerns are prompting many governments to reassess their priorities and spend more on defense.
Beyond their devastating human toll, wars impose large and lasting economic costs, and pose difficult macroeconomic trade-offs, especially for those countries where the fighting is taking place. Even without active conflicts, rising defense spending can raise economic vulnerabilities in the medium term. After the war, governments face the urgent post-conflict task of securing durable peace and sustaining recovery.
In an era of proliferating conflicts, our research in two analytical chapters of the latest World Economic Outlook highlights the deep and prolonged economic harm inflicted by war, which has particularly affected sub-Saharan Africa, Europe, and the Middle East. We also show that rising defense spending—which can boost demand in the short term—imposes difficult budgetary trade‑offs that make good policy design and lasting peace more important than ever.
Economic losses
For countries where wars occur, economic activity drops sharply. On average, output in countries where fighting takes place falls by about 3 percent at the onset and continues falling for years, reaching cumulative losses of roughly 7 percent within five years. Output losses from conflicts typically exceed those associated with financial crises or severe natural disasters. Economic scars also persist even a decade later.
Wars also tend to have significant spillover effects. Countries engaged in foreign conflicts may avoid large economic losses—partly because there is no physical destruction on their own soil. Yet, neighboring economies or key trading partners with the country where the conflict is taking place will feel the shock. In the early years of a conflict, these countries often experience modest declines in output.
Major conflicts—those involving at least 1,000 battle-related deaths—force difficult trade-offs in economies where they occur. Government budgets deteriorate as spending shifts toward defense and debt increases, while output and tax collection collapse.
These countries may also face strains on their external balances. As imports contract sharply because of lower demand, exports decrease even more substantially, resulting in a temporary widening of the trade deficit. Heightened uncertainty triggers capital outflows, with both foreign direct investment and portfolio flows declining. This forces wartime governments to rely more heavily on aid and, in some cases, remittances from citizens abroad to finance trade deficits.
Despite these measures, conflicts contribute to sustained exchange rate depreciation, reserve losses, and rising inflation, underscoring how widening external imbalances amplify macroeconomic stress during wartime. Prices tend to increase at a pace higher than most of central banks’ inflation targets, prompting monetary authorities to raise interest rates.
Taken together, our findings show that major conflicts impose substantial economic costs and difficult trade-offs on economies that experience conflicts within their borders, as well as hurting other countries. And these costs extend well beyond short-term disruption, with enduring consequences for both economic potential and human well-being.
Spending trade-offs
More frequent conflicts and rising geopolitical tensions have also prompted many countries to reassess their security priorities and increase defense spending. Others plan to do so. This situation presents policymakers with a crucial question about trade-offs involved with such a boost to spending.
Our analysis looks at episodes of large buildups in defense spending in 164 countries since the Second World War. We find that these booms typically last nearly three years and increase defense spending by 2.7 percentage points of gross domestic product. That’s broadly similar to what is required by North Atlantic Treaty Organization (NATO) members to reach the 5 percent of GDP defense spending target by 2035.
Ramping up defense spending primarily acts as a positive demand shock, boosting private consumption and investment, especially in defense-related sectors. This can raise both economic output and prices in the short term, requiring close coordination with monetary policy to temper inflationary pressures.
Overall, the aggregate effects on output of scaling up defense spending are likely modest. Increases in defense spending typically translate almost one for one into higher economic output, rather than having a bigger multiplier effect on activity. That said, the multiplier or ripple effects of such spending vary widely depending on how outlays are sustained, financed and allocated, and how much equipment is imported.
For instance, output gains are smaller and external balances deteriorate when the stimulus is partly spent to import foreign goods, which is especially the case for arms importers. By contrast, a buildup of defense spending that prioritizes public investment in equipment and infrastructure, together with less fragmented procurement and more common standards, would expand market size, support economies of scale, strengthen industrial capacity, limit import leakages, and support long-term productivity growth.
The choice of how to finance defense spending entails critical trade-offs. Defense spending booms are mostly deficit-financed in the near-term, while higher revenues play a larger role in later years of defense spending booms and when the defense spending buildup is expected to be permanent.
The reliance on deficit financing can stimulate the economy in the short term, but strain fiscal sustainability over the medium term, particularly in countries with limited room in government budgets. Deficits worsen by about 2.6 percentage points of GDP, and public debt increases by about 7 percentage points within three years of the start of a boom (14 percentage points in wartime). The resulting increase in public debt can crowd out private investment and offset the initial expansionary effect of defense spending.
The buildup of fiscal vulnerabilities can be mitigated by durable financing arrangements, especially when the increase in defense spending is permanent. However, raising revenues come at the cost of reducing consumption and dampening the demand boost, while re-ordering budget priorities tends to come at the expense of government spending on social protection, health, and education.
Policies for recovery
Our analysis also shows that economic recoveries from war are often slow and uneven, and crucially depend on the durability of peace. When peace is sustained, output rebounds but often remains modest relative to wartime losses. By contrast, in fragile economies where conflict flares up again, recoveries frequently stall. These modest recoveries are driven primarily by labor, as workers are reallocated from military to civilian activities and refugees gradually return, while capital stock and productivity remain subdued.
Early macroeconomic stabilization, decisive debt restructuring, and international support—including aid and capacity development—play a central role in restoring confidence and promoting recovery. Recovery efforts are most effective when complemented by domestic reforms to rebuild institutions and state capacity, promote inclusion and security, and address the lasting human costs of conflict, including lost learning, poorer health, and diminished economic opportunities.
Importantly, effective post-war recovery requires comprehensive and well-coordinated policy packages. Such an approach is far more effective than piecemeal measures. Policies that simultaneously reduce uncertainty and rebuild the capital stock can reinforce expectations, encourage capital inflows, and facilitate the return of displaced people. Ultimately, successful post-war recovery lays the foundation for stability, renewed hope and improved livelihoods for communities affected by conflict.
—This blog is based on Ch. 2 of the April 2026 World Economic Outlook, “Defense Spending: Macroeconomic Consequences and Trade-Offs,” and Ch. 3, “The Macroeconomics of Conflicts and Recovery.” For more on fragile and conflict-affected states: How Fragile States Can Gain by Strengthening Institutions and Core Capacities.
