Introduction

Modern-day terrorists are bent on causing sufficient harm to a society so as to force its government to concede to the terrorists' demands. The harm may be in terms of human and/or economic losses—e.g., the al-Qaida training manual invokes followers to attack “vital economic centers” (WorldNetDaily 2003). Both kinds of losses expose a government's inability to protect its people and property, thereby causing a loss in citizen confidence and government legitimacy. When terrorist attacks are sufficiently deadly, costly, and persistent, an atmosphere of fear and terror may pervade the society, making virtually everyone feel at risk, which is the terrorist group's aim. If a besieged government views the anticipated costs of future terrorist actions as greater than the costs of conceding (including lost reputation) to terrorist demands, then the government will grant some accommodation. A determined terrorist organization may obtain its demands quicker by augmenting the economic consequences of its terrorist campaign. Thus, Euskadi Ta Askatasuna (ETA), the Basque group, targeted hotels and resorts in the 1980s to hurt tourism in Spain (Mickolus, Sandler, and Murdock 1989). Jemaah Islamiyah's car-bombing attack on a Bali nightclub on 12 October 2002 was intended not only to kill Westerners but also to cripple Bali's lucrative tourist industry. A subsequent JI attack on a Marriott hotel in Kuningan, Jakarta, in 2003 had economic ramifications on tourism. Although Abu Sayyaf is based on the southern Philippine islands of Sulu and Basilan, a few high-profile attacks by Abu Sayyaf in Manila caused the Philippine government to reallocate some expenditure to security, thereby crowding out growth-promoting public projects. Much of these security expenditures address the bulk of Abu Sayyaf's activities in the south. On 11 September 2001 (henceforth, 9/11), the al-Qaida attack against New York City's World Trade Center, an icon of the capitalist world, created US$80 to US$90 billion in direct and indirect economic losses and temporarily impacted stock markets worldwide (Chen and Siems 2004; Kunreuther, Michel-Kerjan, and Porter 2003).

Terrorism can potentially affect economic growth in the short run through a number of channels. Such attacks can increase uncertainty which limits investments and diverts foreign direct investment (Abadie and Gardeazabal 2003, 2008; Enders and Sandler 1996; Enders, Sachsida, and Sandler 2006). For developing countries, foreign direct investment is an important source of saving to fund investment. Terrorism campaigns lead to government expenditures on defensive actions to strengthen targets and proactive measures to capture terrorists and their assets. This increased government spending on security can crowd out more growth-enhancing public and private investments (Blomberg, Hess, and Orphanides 2004; Gaibulloev and Sandler 2008). Public investment in the form of social overhead capital (e.g., canals, highways, and bridges) is especially important to bolster growth in developing countries. Terrorism also hinders growth by raising the cost of doing business in terms of higher wages, larger insurance premiums, and greater security expenditures. These higher costs result in reduced profits and, thus, smaller returns on investment. Terrorist attacks can also destroy infrastructure, thereby leading to business disruptions. The Irish Republican Army attacks on London's financial district at the Baltic Exchange (10 April 1992) and Bishopsgate (24 April 1993) resulted in £800 million and £350 million in direct damages, respectively. The 7 July 2005 attacks on the London transport system resulted in over £1 billion in damages. Finally, terrorism can impact some key industries—the airline, tourism, and export sectors—which can reduce gross domestic product (GDP) and growth (Drakos 2004; Drakos and Kutan 2003; Enders, Sandler, and Parise 1992; Ito and Lee 2005; Nitsch and Schumaker 2004).

Similarly, internal (i.e., intrastate or civil wars) and external conflicts can also reduce growth by destroying human, private, and public capital. Civil wars result in a flight of capital; the amount of private wealth held abroad more than doubles during intrastate conflicts (Collier et al. 2003). Conflicts, like terrorism, increase uncertainty thereby decreasing investment. In addition, internal conflicts almost double the share of GDP devoted to defense—from about 2.8% to 5%—which limits spending on social overhead capital and health (Collier et al., 2003). Such diversion of public spending not only crowds out more productive forms of investment but also makes a conflict-ridden country prone to diseases (Ghobarah, Huth, and Russett 2003). Conflict-torn developing countries may experience decreased growth from reduced aid as donor countries worry that aid may be channeled to finance military activities rather than to alleviate poverty. As in the case of terrorism, internal and external conflicts raise the costs of doing business. Nearby conflicts can reduce economic growth by disrupting supply lines, creating refugee inflows, causing border skirmishes, and increasing security spending. Murdoch and Sandler (2002, 2004) showed that each war in a country's borders as nearby countries divert resources to defense to ward off the spread of conflict (Murdoch and Sandler 2004). This heightened risk augments uncertainty region-wide and reduces investment and growth.

This study has six purposes. First, and foremost, we present panel estimates for a sample of 42 Asian countries to quantify the impact of terrorism and conflicts on income per capita growth for 1970–2004. Panel estimation methods control for country-specific and timespecific unobserved heterogeneity. Second, we distinguish the influence of terrorism on economic growth from that of internal and external conflicts. Third, these influences are investigated for cohorts of developed and developing countries to ascertain whether development can better allow a country to absorb the impact of political violence. Fourth, econometric estimations relate violence-induced growth reductions to two pathways— reduced investment and increased government expenditures. Fifth, a host of diagnostic and sensitivity tests to support our empirical specifications. Last, we draw some policy conclusions.

Earlier studies on the economic consequences of terrorism growth have focused either on the world (Blomberg, Hess, and Orphanides 2004; Tavares 2004) or on Europe (Gaibulloev and Sandler 2008). For a much smaller Asian sample and a different time period, Blomberg, Hess, and Orphanides (2004) did not uncover any significant effect of terrorism on economic growth. Our larger sample also allows us to distinguish the growth consequences of terrorism between developing and developed countries.

For the entire Asian sample, transnational terrorism and internal conflict have significantly adverse consequences for growth, with the largest impact coming from internal conflicts. Developing Asian countries are much more affected by political violence than their more developed counterparts, suggesting that development greatly cushions the impact of terrorism and conflicts. Not surprisingly, political violence adversely affects investment, while it increases government spending. Transnational terrorism and conflicts have a particularly strong influence in augmenting government spending, with internal and external conflicts exerting the stronger impact.

The remainder of the paper contains five main sections. Section 2 presents a background for the discussion, including definitions, the primary influences on income per capita growth, and a brief review of the related literature. Section 3 includes the empirical specification and data. Estimations and results then follow in Section 4. In Section 5, we present estimates where regime type is taken into account and the general terrorism variable is dropped. Concluding remarks and policy implications are presented in Section 6.

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