Dyadic military conflict, security alliances, and bilateral FDI flows

Abstract

Although multinationals operate under cross-border jurisdictions, the relevance of interstate security relations to international business has received little attention. Despite the impressive accumulation of knowledge in international business and international relations, the two intellectual communities have largely ignored the insights from each other. In this article, we seek to bridge this gap. We argue that interstate military conflict and security alliances, as two central features of interstate security relations, often change both government policies toward international business and investor expectations of political risk. From the perspectives of both states and investors, military conflict should reduce bilateral investment whereas security alliances increase it. Our empirical analysis applies the system GMM estimator to a gravity model of bilateral investment flows for 1117 directed dyads among 58 countries from 1980 to 2000. Among 18 countries whose per capita real incomes remain consistently above 12,000 constant dollars, the security factors do not affect bilateral investment; in the high-income/low-income dyads, interstate military conflict and security alliances significantly influence bilateral investment as expected. The findings depict two separate realms in which international politics does and does not interfere with international business, helping us improve political risk assessments and understand the interactions between states and firms.