Nowhere to Go: FDI, Terror, and Market-specific Assets

Abstract

Under what circumstances does terrorism repel foreign investment? The negative effect of terrorism on foreign investment identified in current scholarship masks heterogeneity across host markets and industries. Foreign investment ought to react less to political violence when host markets match firms’ input requirements, when firms lack viable alternative hosts, and when assets are immobile across markets. We model the endogenous codetermination of terror and investment to derive these comparative statics, highlighting empirical challenges in identifying the effects of terror on foreign direct investment. To overcome these obstacles, we use an instrumental variable estimator which exploits differences in the networks along which terror and investment spread. Using industry-level data on the activities of US multinationals, we test our model and conclude that foreign investors that find it hard to leave particular host markets are doubly penalized: their lack of outside options makes them tempting targets for terror. Our findings have implications for other forms of violent and nonviolent political tactics which affect multinationals and for understanding how foreign investment reacts to heightened risk in host markets.

Literature Review and Outlook on Geopolitical Risks of Overseas Investment

“…Jiang also argues that economic factors moderate the relationship between geopolitical risk and overseas investment, and that geopolitical risk has less deterrent effect on overseas investment when the country's GDP is low, GDP growth rate is high, and infrastructure stock is low [36]. Osgood and Simonelli argue that terrorism does not affect overseas investment behavior when the marginal return to investment in the host market increases relative to the available return in the rest of the world [37]. Ma points out that cooperation with SOEs reduces geopolitical risk and attracts more overseas investment [38].…”

Does terrorism hamper FDI inflows? A pre and post 9/11 analysis

“…In the same vein, Ouyang and Rajan (2017) also noted that if the host country has a good institutional infrastructure, it can mitigate the negative impact of terrorism on FDI inflows. Recently, Osgood and Simonelli (2020) investigated the effect of terrorism on FDI on the inbound FDI. They confounded that foreign investments are less reactive to political violence when the host country contains attraction immobile factors of productions, matching firm requirements or substituting host economy.…”