The economic consequences of the Israel-Hamas war

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What did Hamas hope to achieve by its attack on Israel of October 7? The answer was surely to set the region aflame. More narrowly, it was to provoke the response we see, with inevitable consequences for Israel’s global reputation and the prospects for peace in the region. The strategy, in other words, is to make martyrs of the people of Gaza in a greater cause. Alas, it is working.

The way this unfolds will have implications for human lives, the regional balance of power and perhaps even global peace. But it also has implications for the global economy, which has been battered by a series of shocks over the past four years: Covid-19, the post-Covid inflation, the Russia-Ukraine war and now this. How big a shock then will this latest horror prove to be?

This is more than a matter of dollars and cents. According to a “special focus” chapter of the World Bank’s most recent Commodity Markets Outlook, on the “Potential Near-Term Implications of the Conflict in the Middle East”, the number of people suffering from severe food insecurity jumped by more than 200mn between 2019 and 2021. The Russia-Ukraine war must have made this considerably worse, though the facts are not yet available. This is partly because of its direct effect on food prices and partly because of higher energy prices. Another big jump in energy prices would make this worse.

So, how big might the implications be? This depends on the answer to two further questions. How severely and how far might the war and its political ramifications spread? In addition, what might be the consequences for the global economy, largely (but not exclusively) via energy markets?

Fortunately, Gideon Rachman has recently addressed the first question. He reminds us that the first world war began as a conflict between Austria and Serbia, both allies of greater powers. In this case, Israel might be viewed as a proxy for the US and Hamas and Hizbollah as proxies for Iran (which might turn out to be a proxy for Russia or even China). A chain of disastrous events might, he notes, spread to the Gulf itself. It could even lead to conflict among superpowers. Moreover, we can add, the region’s regimes might be destabilised by popular anger over failure to help Gaza. It is worth remembering that the hugely damaging 1973 oil embargo was not a direct outcome of war, but a political response of Arab oil producers.

If the war were to spread, would it matter? Yes, definitely. The region is far and away the world’s most important energy-producer: according to the 2023 Statistical Review of World Energy, it contains 48 per cent of global proved reserves and produced 33 per cent of the world’s oil in 2022. Moreover, according to the US Energy Information Administration, a fifth of world oil supply passed through the Strait of Hormuz, at the bottom of the Gulf, in 2018. This is the chokepoint of global energy supplies.

The World Bank also notes that past energy shocks have been significantly costly. Iraq’s invasion of Kuwait in 1990 raised average oil prices three months afterwards by 105 per cent, the Arab oil embargo of 1973-74 raised them by 52 per cent and the Iranian revolution of 1978 raised them by 48 per cent.

So far, however, the effects on oil prices of the Hamas attacks on Israel and the war in Gaza have been modest. In real terms, oil prices in September were close to their mean since 1970. In all, there is little dramatic to be seen so far. In addition, adds the report, oil has become less important and oil markets less vulnerable since the 1970s: oil intensity of global output has declined by close to 60 per cent since then; sources of supply have also diversified; strategic reserves are bigger; and the creation of the International Energy Agency has improved co-ordination.

Nevertheless, oil remains a vital transportation fuel. Liquid natural gas from the Gulf is also an important part of global supplies of natural gas. Big disruptions to these supplies would have a powerful impact on energy prices, global output and the overall price level, notably in foodstuffs.

The bank envisages scenarios with small, medium and big disruptions to supplies: the first would, it assumes, reduce supply by up to 2mn barrels a day (about 2 per cent of world supply), the second would reduce it by 3-5mn barrels a day and the last would reduce it by 6-8mn barrels a day. Corresponding oil prices are estimated at $93-$102, $109-$121 and $141-157, respectively. The last would bring real prices towards their historic peaks. If the Strait were to be closed, the outcomes would be far worse. We are still in the fossil fuel era. A conflict in the world’s biggest oil-supplying region could be very damaging.

The best way to think about this is to emphasise the uncertainty. The great probability is that the conflict will be contained. If so, the economic effects will stay insignificant. But it is possible that it will spread and so become far more serious. Civil unrest might also force governments in the region to consider embargoes. Hamas might wish the region to be aflame. But that is certainly not going to be in the interests of the billions of people who want to get on with their lives as best they can. It is up to policymakers in the region and outside to avoid the sorts of mistakes that have proved devastating in the past.

Right now, the big question is what Israel is going to do. I understand the outrage Israelis feel over the brutal assault and their determination to eliminate Hamas. But is that feasible by any military means? What is their political end game? What, if any, is the strategy for reaching an accommodation with the Palestinians? Above all, how wise will it turn out to behave just as Hamas so evidently wanted?

martin.wolf@ft.com

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