Social Issue
Terrorism and the World Economy
Alberto Abadie { Harvard University and NBER
Javier Gardeazabal { University of the Basque Country
August 2007
Abstract
It has been argued that terrorism should not have a large e®ect on economic activity,
because terrorist attacks destroy only a small fraction of the stock of capital of a
country (see, e.g., Becker and Murphy, 2001). In contrast, empirical estimates of
the consequences of terrorism typically suggest large e®ects on economic outcomes
(see, e.g., Abadie and Gardeazabal, 2003). The main theme of this article is that
mobility of productive capital in an open economy may account for much of the
di®erence between the direct and the equilibrium impact of terrorism. We use a simple
economic model to show that terrorism may have a large impact on the allocation of
productive capital across countries, even if it represents a small fraction of the overall
economic risk. The model emphasizes that, in addition to increasing uncertainty,
terrorism reduces the expected return to investment. As a result, changes in the
intensity of terrorism may cause large movements of capital across countries if the
world economy is su±ciently open, so international investors are able to diversify
other types of country risks. Using a unique dataset on terrorism and other country
risks, we ¯nd that, in accordance with the predictions of the model, higher levels
of terrorist risks are associated with lower levels of net foreign direct investment
positions, even after controlling for other types of country risks. On average, a
standard deviation increase in the terrorist risk is associated with a fall in the net
foreign direct investment position of about 5 percent of GDP. The magnitude of the
estimated e®ect is large, which suggests that the \open-economy channel" impact of
terrorism may be substantial.
Alberto Abadie, John F. Kennedy School of Government, 79 John F. Kennedy Street, Cambridge MA
02138, USA. E-mail:...
View Full Essay