Terrorist attacks, foreign direct investment and foreign aid

 
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With the end of the days-long siege at Nairobi’s Westgate Mall, the Kenyan government and other authorities have begun to investigate who the perpetrators were and what motivated them. Given that the attack targeted an upscale mall favored by international visitors, one of the immediate effects is likely to be at least a short-term decrease in travel to the country and, potentially, foreign direct investment — global companies putting in capital and resources.

In addition to the human toll they inflict, terrorist attacks, rebellions and civil wars are often an economic disaster for affected countries. The destruction of buildings and infrastructure hurts enthusiasm among potential investors, while the loss of business travel and tourism can have deep effects. Economic downturns in Lebanon have been “primarily caused by security incidents or regional conflicts,” according to the IMF. Even a decade after the end of Liberia’s 14-year civil war, the country is still repairing extensive damage to its infrastructure. And before Egypt’s 2011 revolution and its violent aftermath, tourism accounted for 13% of the country’s GDP; now it has fallen 21 spots in the World Economic Forum’s  Travel and Tourism Competitiveness Index. The ongoing conflict in Syria has been devastating for the country, particularly its six World Heritage sites.

A 2013 study published in Oxford Economic Papers, “Foreign Direct Investment, Aid and Terrorism,” looks at the quantitative effect of terrorism on foreign direct investment (FDI) in developing countries and whether it can be offset by foreign aid. The authors are Subhayu Bandyopadhyay of the Federal Reserve Bank of St. Louis, Todd Sandler of the University of Texas at Dallas and Javed Younas of the American University of Sharjah (UAE). They analyze data from 78 developing countries over the period of 1984 to 2008, excluding four major outliers — Afghanistan, Iraq, Palestine and Western Gaza.

The calculations are based on information from the World Bank’s World Development Indicators, the Global Terrorism Database, and the Development Assistance Committee database from the Organisation for Economic Co-operation and Development (OECD). For the purposes of the study, terrorism events were separated into domestic (targets and victims are from the same country) and transnational (at least two countries are involved). Bilateral aid is defined as one government directly assisting another government; multilateral aid involves a group of nations or an international institution giving to one or more countries.

Key findings from the study include:

  • Both domestic and transnational terrorism have a negative effect on both a country’s foreign direct investment and GDP: “A one standard deviation increase in domestic terrorist incidents per 100,000 persons reduces net FDI between $323.60 and $512.94 million for an average country, whereas a one standard deviation increase in transnational terrorist incidents per 100,000 persons reduces net FDI between $296.49 and $735.65 million for an average country.”
  • Total foreign aid can mitigate losses caused by domestic and transnational terrorism: On average, FDI losses can be reduced to $113.44 million for domestic terrorism and $45.24 million for transnational terrorism.
  • In order for foreign aid to completely offset the negative effects caused by domestic or transnational terrorism, it would need to range from 7.02-8.47% of GDP for countries afflicted by domestic terrorism and 7.57-9.43% for transnational terrorism. “Given that the average (median) level of aid is 6.427% (2.472%) of GDP in our sample, these calculations imply that a substantial amount of aid is required to offset the negative effect of terrorism on FDI.”
  • Bilateral aid was found to reduce the adverse effects of transnational terrorism, while multilateral aid reduces the adverse effects of domestic terrorism. “This apparently [results] from bilateral donors being able to tie some aid to counterterrorism, while multilateral aid improves general welfare, thereby alleviating domestic grievances. Without data on counterterrorism-tied aid, we cannot explicitly test these underlying conjectures.”

“The choice between bilateral and multilateral aid by the donor country hinges in part on its FDI interests in the recipient country,” the authors note. “Bilateral aid is best when these interests are large and the donor ties the aid to counterterrorism efforts.”

Keywords: terrorism

Last updated: September 25, 2013

 

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Citation: Bandyopadhyay, Subhayu; Sandler, Todd; Younas, Javed. “Foreign Direct Investment, Aid, and Terrorism,” Oxford Economic Papers, July 2013, 1-26. doi: 10.1093/oep/gpt026.