Estimation and Results

We first estimated the growth equation in Equation (1) for our entire Asian sample. The Hausman test between two-way fixed-effects and two-way random-effects specifications rejected the null hypothesis of no correlation between the explanatory variables and the unobserved effects; hence, the standard random-effects estimation was not appropriate. We also performed F-tests for the presence of country-specific and time-specific effects and found the presence of both effects, thereby supporting our two-way fixed-effects estimations.⁵

In Table 3 [ PDF 14.8KB | 1 page ], Models 1–4 sequentially introduce the four conflict variables—transnational terrorist events, all terrorist events (as recorded by GTD), external conflicts, and internal conflicts—one at a time to three standard growth explanatory variables that appear in all six models. Models 5 and 6 include conflict variables together with transnational terrorism and all terrorism, respectively. Consistent with the growth literature, the log of lagged GDP per capita had a negative influence on income per capita growth, which reflects convergence. The lagged investment share has the anticipated positive effect on income per capita growth. Across all six models, the impacts of these two variables were robust. The log of lagged openness was not a positive determinant of growth, which agrees with Rodrik's (1999) view that the influence of openness on growth is overstated, especially for developing countries, which comprise most of our sample. In fact, the openness variable was negative, but not significant.

For the political violence variables, transnational terrorism and internal conflicts have the expected negative impact on growth; however, all terrorist events and external conflicts are statistically insignificant. These results hold for all six models. In particular, the coefficient of transnational terrorism is about –0.015, indicating that, on average, an additional terrorist event per million persons lowers GDP per capita growth by about 1.5% in a given year. Thus, a populous country with 100 million people would have to experience 100 more transnational terrorist events to have this kind of impact. Ten additional events would reduce growth by 0.15% for this hypothetical country. The estimated influence of internal conflicts is around –0.02, which implies that an intrastate conflict cuts a country's income per capita growth by approximately 2% in a year. For populous countries, internal conflicts understandably pose a greater growth worry than a small level of transnational terrorism.

There are a number of potential reasons for why terrorism and other types of conflict influence a country's economy. One scenario is that terrorism and conflict crowd out growthpromoting investment for less productive government spending in terms of national security. We investigated this possibility by estimating investment and government spending models, given by Equations (2) and (3). A positive impact of terrorism and conflict on government spending and a negative influence of terrorism and conflict on investment would be consistent with this crowding-in/crowding-out hypothesis. We perform specification tests for these two equations. F-tests indicate that both time-specific and country-specific effects are significant for the investment models, whereas only country-specific effects are significant for government spending models.⁶ The Hausman test for the investment regression and the Wald statistic (an equivalent to the Hausman test) for the government spending regression indicated a correlation between the unobserved effects and the regressors for all models; thus, we employed two-way, fixed-effects estimators for the investment models and oneway, fixed effects estimators for the government spending models.

Table 4 [ PDF 20.9KB | 2 page ] reports the results for the investment regressions where the dependent variable is investment share (in percentage). Economic openness strongly stimulated investment. Lagged GDP per capita and transnational terrorism were not statistically significant. For all terrorism attacks, an additional incident per million persons led to a reduced investment share of about 0.1 percentage points. External and internal conflicts are associated with a fall of the investment share by 0.73 and 0.66 percentage points, respectively. These results were weakly significant at the .10 level and were sensitive to the inclusion of other conflict variables. External conflict was not significant when included with other types of conflict (Models 5 and 6), while internal conflict was not significant when included with all forms of terrorism (Model 6).

For government spending models in Table 5 [ PDF 15.2KB | 1 page ], lagged income per capita decreased the percentage of government spending share, which may be attributable to automatic stabilizers. That is, government spending contracted during good times when income per capita was high, while it expanded during bad times when income per capita was low. Lagged openness, however, stimulates government spending, consistent with Rodrik (1998) who argued that open economies are more vulnerable to external shocks. To cushion such shocks, government expenditures play a stabilizing role in open economies, so that government spending and openness moved together. An increase in transnational terrorism by one incident per million persons raised the share of government expenditures by approximately 1.5%, consistent with crowding-in; however, aggregate terrorism was not statistically significant. External conflicts augment the government spending share by approximately 1.4%, while internal conflicts increased this share by about 1%. The results were robust across all government spending models.⁷

To compare the relative impact of transnational terrorism with that of external and internal conflicts on growth and government expenditure shares, we transformed transnational terrorism into an indicator variable, analogous to the two conflict variables. This comparison could not be accomplished when terrorism is a continuous variable and the conflict variables are dummies. We dropped the GTD variable because it was typically insignificant. Moreover, we did not present comparable estimates for the investment regression, because results were not robust across models. Table 6 [ PDF 15.2KB | 1 page ] displays the political violence estimates for models 1 and 5 for the growth and government share regressions when transnational terrorism is a dummy variable. The adverse impact of internal conflict on growth is over twice that of transnational terrorism. Thus, internal conflict is a greater growth concern than transnational terrorism. Similarly, the impact of transnational terrorism on the share of government spending is much less than half of that of external conflicts and just over 60% of that of internal conflict. External conflict contributes more than internal conflict to crowding-in of government spending.

Until now, we assumed that the influence of terrorism is the same across sample countries and periods; however, terrorism may have a stronger effect on countries with less-developed economies. Advanced economies are more resilient and recover faster from shocks associated with terrorist incidents (Sandler and Enders 2008). To explore this possibility, we divided our sample into seven developed and 35 developing countries (see footnote 3 and repeat the analysis). For brevity, we focused on the coefficients of the political violence variables. For developed countries, we excluded internal conflicts because there were almost no such conflicts.

As anticipated, the terrorism variables were never significant for developed countries in Table 7 [ PDF 20.7KB | 2 page ].⁸ External interstate conflicts that reduced investment shares was just under 4% and increased government spending shares by about 1.2%. These results were highly significant and robust across models. Development is no firewall against the adverse effects of interstate wars on investment and government spending.

A different picture emerged for developing countries, which were adversely affected by conflicts and terrorism.⁹ According to Table 8 [ PDF 17KB | 2 page ], transnational terrorism had a statistically significant impact on growth and government spending, consistent with the entire sample. Transnational terrorism's effect on growth was marginally significant and was insignificant when combined with conflict variables. The general terrorism variable was statistically significant only in investment models, while external conflict was only significant in the government spending models. Finally, internal conflict was statistically significant in all relevant models. The signs of all significant coefficients were as expected. An additional transnational terrorist incident per million persons resulted in a reduced growth of 1.4% and a rise in the government spending share of about 1.6%. An additional general terrorist incident per million persons caused investment shares to fall by less than 0.1 percentage points. External conflicts led to an increase in the government spending share of about 1.7%, which was similar to transnational terrorism. Internal conflict lowered growth and investment shares by about 2% and 1%, respectively, and raised the government spending share by approximately 1%.

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