Terrorism: A Threat to Foreign Direct Investment

An article in the most recent issue of The Regional Economist, published by the Federal Reserve Bank of St. Louis, examined the research on the link between terrorism and foreign direct investment (FDI).

As an example, the case of Colombia, which was notorious for drug violence and terrorism in the 1980s and 1990s, suggests such a link. As terrorist incidents have declined in the country, FDI has risen. However, Subhayu Bandyopadhyay, a research officer and economist with the St. Louis Fed, and Javed Younas, an associate professor of economics at American University of Sharjah, United Arab Emirates, noted in their article that careful analysis is needed when examining whether the apparent relationship is indeed causal. To that end, the authors discussed results from several studies on terrorism and FDI.

Developing Nations

A study by Bandyopadhyay, Younas and Todd Sandler of the University of Texas at Dallas¹ found that both domestic and transnational terrorism significantly depressed FDI in developing countries:²

• A one-standard-deviation increase in domestic terrorist incidents per 100,000 people reduced net FDI between about $324 million and $513 million for the average sample country, whose GDP totaled $70 billion.
• A one-standard-deviation increase in transnational terrorist incidents per 100,000 people reduced net FDI between about $296 million and $736 million for the average sample country.

The study also noted that this problem can be partly alleviated by foreign aid for combating terrorism. The low end of the FDI loss range due to domestic terrorist incidents dropped from $324 million to about $113 million for the average aid-receiving nation, while the lower estimate for transnational terrorism fell to about $45 million from $296 million.

Additional Studies

Other notable studies include a 1996 study examined how transnational terrorism had affected Spain and Greece over the period from the mid-1970s through 1991, finding that net FDI was annually reduced 13.5 percent for Spain and 11.9 percent for Greece.³

A 2006 study investigated how terrorist attacks in other nations may have affected FDI from the U.S. into these nations. The study concluded that terrorist attacks lowered U.S. FDI by 1 percent in nations that belonged to the Organization for Economic Cooperation and Development (OECD), but had no statistically significant effect on non-OECD nations.⁴

A 2008 study showed that even when the direct damage to a nation’s capital stock is not large, overall impact may be large because, for example, fearful foreign investors divert their money to other nations. A one-standard-deviation increase in the intensity of terrorism in a particular nation can reduce the net FDI position of that nation by about 5 percent of its GDP.⁵

Conclusion

Bandyopadhyay and Younas concluded, “By focusing on the existing literature on FDI and terrorism, we can see that policy efforts targeted at reducing terrorism can provide substantial economic benefits to the terrorism-afflicted nations.”

Notes and References

¹ Bandyopadhyay, Subhayu; Sandler, Todd; and Younas, Javed. “Foreign Direct Investment, Aid, and Terrorism,” Oxford Economic Papers, January 2014.

² Transnational terrorism occurs when a terrorist incident in a certain country involves citizens or property of another country.

³ Enders, Walter; and Sandler, Todd. “Terrorism and Foreign Direct Investment in Spain and Greece,” Kyklos, August 1996.

⁴ Enders, Walter; Sachsida, Adolfo; and Sandler, Todd. “The Impact of Transnational Terrorism on U.S. Foreign Direct Investment,” Political Research Quarterly, December 2006.

⁵ Abadie, Alberto; and Gardeazabal, Javier. “Terrorism and the World Economy,” European Economic Review, January 2008.

Additional Resources

• Regional Economist: Terrorism: A Threat to Foreign Direct Investment
• On the Economy: The Link between Default and Depreciation
• On the Economy: Is the Large and Persistent U.S. Trade Deficit a Concern?