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

• DOI: 10.1177/0022002720908314
• Published date: 01 October 2020
• Date: 01 October 2020
• Author: Iain Osgood,Corina Simonelli
• Subject Matter: Articles

Article

Nowhere to Go:

FDI, Terror, and

Market-specific Assets

Iain Osgood

1

, and Corina Simonelli

1,2

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.

Keywords

terrorism, game theory, trade, political economy

1

Department of Political Science, University of Michigan, Ann Arbor, MI, USA

2

The Gerald R. Ford School of Public Policy, University of Michigan, Ann Arbor, MI, USA

Corresponding Author:

Corina Simonelli, Department of Political Science, University of Michigan, Haven Hall, 505 S. State St., Ann

Arbor, MI 48104, USA.

Email: csimonel@umich.edu

Journal of Conflict Resolution

2020, Vol. 64(9) 1584-1611

ªThe Author(s) 2020

Article reuse guidelines:

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DOI: 10.1177/0022002720908314

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Foreign investment in the developing world is repelled by terrorism and political

violence (Abadie and Gardeazabal 2008; Bandyopadhyay, Sandler, and Younas

2018; Braithwaite, Kucik, and Maves 2014; Witte et al. 2016; Powers and Choi

2012). Terrorism raises costs for multinationals for security (Busse and Hefeker

2007), insurance (Jensen 2008), and recruitment (Bader and Berg 2013) and makes

it harder to manage supply chains and ensure predictable operations (Gaibulloev and

Sandler 2009; Johns and Wellhausen 2016). Multinationals’ defining characteris-

tics—their international profile, mobility, and choices among potential host mar-

kets—may enable them to avoid these costs by eschewing host markets suffering

from political violence. However, despite the growth in terrorist attacks on foreign

firms (Brandt and Sandler 2010; Enders and Sandler 2000), the literature lacks a

systematic account of heterogeneity across industries in their responsiveness to

terrorism. Are all industries equally averse to operating in markets with terrorism

and other political violence? If multinationals’ negative response to terrorism in host

markets is driven by their ability to redeploy investments internationally, what

happens to firms which cannot easily move investments or have no viable alternative

sites for their overseas activities?

In answer to these questions, we argue that there is significant unexplored hetero-

geneity across industries in their response to terrorism and that this heterogeneity is

driven by the quality of alternative investment options available to firms interna-

tionally. Where alternative options are good, foreign investment will be highly

responsive to terrorism. When the abil ity to redeploy investment outside a h ost

market is lacking, multinationals must remain and operate under the suboptimal

conditions—heightened costs, heightened risk—generated by terrorism (see Frieden

[1994] and Steinberg [2018] on site-specific assets).

We consider several explanations for the ability of firms to locate their in vest-

ments outside of developing markets facing greater risk of terrorism. First, the

inputs employed by firms may be a good match for particular host markets, and

those firms may lack other markets that are similarly good matches. It is harder to

turn away from a market that is a “good fit” if political violence spikes. Second,

firms may control country-specific assets—exclusive copyrights or real estate, for

example—that can only be exploited in that market. These assets are inherently

nontransferable. In a similar vein, we also consider relatively immobile forms of

capital investments: fixed capital expenditures among manufacturing firms, and

investments in the purchase, exploration, and development of mineral or land

rights among mining firms.

To examine these ideas, we develop a formal model of the strategic interaction of

multinational firms and terrorists, extended to include a host government under-

taking counterterrorism.

1

We prove our main contention on the responsiveness of

foreign investment to terror and its interaction with outside options. Where marginal

returns on investment in a host market increase relative to returns available in the

rest of the world, firms are more willing to stay put in the face of terror. This result

holds under a variety of assumptions about terrorists’ motivations.

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