The effects of inter-state conflicts on foreign investment flows to the developing world: Enduring vs ephemeral risk of conflicts

Abstract

How do inter-state conflicts affect foreign investment flows to developing countries? Conventional wisdom says conflicts disrupt economic interactions. This article develops and tests two competing causal mechanisms of the wisdom by focusing on foreign investment flows to developing countries. The first hypothesis states that conflicts carry enduring risk to foreign investors, making conflict-prone countries persistently less attractive. The second hypothesis says that the risk of conflict is ephemeral, allowing foreign investment to recover during peace-time. A monadic analysis of 95 developing countries from 1980 to 2000 provides strong evidence for the enduring risk hypothesis. However, the finding is limited by both the level of conflict hostility and the ex post immobility of foreign investment. The enduring risk of conflicts is significant for both actual warfare rather than use of force, and foreign direct investment (FDI) rather than foreign portfolio investment (FPI). The finding is robust in a series of subsample analyses, which reflect the distinctive experiences of developing countries in the late 20th century.