The behaviour of foreign investors is difficult to predict and depends on several factors, including conventional wisdom, prior experience, perception and tolerance of economic and political risk, and long-term objectives.

Acts of terrorism could be expected to have a negative impact on FDI flows to affected countries. Common sense dictates that the loss of foreign investor confidence following terrorist attacks would prompt large outflows of capital from the affected countries and that once a country is branded a terrorist target, it would attract reduced levels of FDI.


Although academic studies have demonstrated that sometimes this is the case, foreign investor sentiment is not always dictated by common sense. The lure of profit and the desire to establish trade partnerships is often a stronger motivational force than perceived political risk is a disincentive to invest.

FDI trends

Although the growth of global terrorism is on the minds of some corporate decision makers when contemplating whether or not to invest abroad, it has not deterred many of them from deciding to invest in the post-9/11 developing world. According to the United Nations Conference on Trade and Development, FDI flows to the developing world surged 200% between 2000 and 2004, up from 18% to 36% of global FDI. During the same period, FDI flows to developed countries plunged 27%, from 81% to 59% of global FDI. In every category of developed country cited, inward investment declined significantly, while in every developing country category, the inflows rose sharply. The vast majority of terrorist attacks take place in developing countries, yet the FDI trend is clear.

Does this mean that perceived terrorism risk negatively effects FDI decision making? That undoubtedly depends on where an investor intends to put his money. Clearly, a company considering investing in Iraq would have far greater concerns about terrorism than one investing in Canada.

Proof on both sides

Empirical studies examining the link between perceived political risk, terrorism and FDI flows have yielded contradictory results. Those that have found linkages have tended to be older studies.

Among the newer studies, consulting firm AT Kearney’s annual FDI Confidence Index has revealed some surprising conclusions. For the index, top decision makers in the world’s largest 1000 companies are asked about their opinions on a range of FDI-related issues. Although AT Kearney’s do not focus on specific countries, among the respondents, economic concerns outweigh political concerns by a large margin.

A Harvard study published in October 2005, however, found that higher levels of terrorism risk are associated with lower levels of net FDI. In an integrated world economy, in which investors are able to diversify their investments, terrorism may induce large movements of capital across countries.

In a recent study undertaken at Pennsylvania State University (PSU), the effect of economic globalisation on transnational terrorist incidents was examined statistically using a sample of 112 countries during the period 1975 to 1997. The results show strongly that FDI, trade and portfolio investment have no direct positive effect on the number of transnational terrorist incidents among countries, and that the economic development of a given country and its trading partners reduce the number of terrorist incidents in that country. To the extent that FDI and trade promote economic development, they have an indirect negative effect on transnational terrorism.

Development role

Perhaps the decision makers polled in the AT Kearney studies knew intuitively what the PSU study proved statistically: that development deters terrorism.

PSU also produced an interesting empirical study recently, examining the impact of political violence on FDI. The study posits that terrorist incidents do not produce any statistically significant effect on the likelihood that a country will be chosen as an investment destination, or on the amount of FDI it receives. Further, it states that unanticipated acts of terrorism do not generate any changes in investor behaviour, either in terms of investment location choice or the amount of investment.

However, a study done on the impact of terrorism and FDI in Spain and Greece arrived at a different conclusion: that acts of terrorism had a significant and persistent negative impact on net FDI. They concluded that one year’s worth of terrorism discouraged net FDI by 13.5% annually in Spain and 11.9% annually in Greece. On this basis, it was concluded that smaller countries that face a persistent threat of terrorism may incur economic costs in the form of reduced investment and economic growth.

Related to this, the authors of the previously cited Harvard study produced a case study on the economic costs of the Basque conflict and concluded that there is evidence of a negative economic impact associated with terrorism in the Basque region of Spain. On average, the conflict resulted in a 10% gap in per capita GDP between the Basque region and a comparable region without terrorism over a two decade period. Moreover, changes in per capita GDP were shown to be associated with the level of terrorist activity.

Image versus reality

An interesting corollary is the research done by the Asian Development Bank (ADB) when it created a terrorism insurance facility for investors in Pakistan. ADB learned that in nearly every instance, acts of terrorism in Pakistan were directed at government and/or military targets, and that commercial loss (if any) was nearly always the result of collateral damage.

A survey of local insurance companies in Pakistan revealed that the incidence of commercial loss due to acts of terrorism was almost zero. This is in sharp contrast to the image of Pakistan that prevails in the global media, where it is portrayed as a poor place to invest because of perceived terrorism risk.

Yet 9/11 produced more than $50bn in commercial losses in the US, and the US remains one of the top FDI destinations. This demonstrates just how flawed common perceptions of risk can be.

Perceptions of terrorism risk have a great deal of influence on some investment decisions and very little on others. Among the factors that influence decision makers are the economic health of the investment destination, the difficulty associated with doing business there, the existence of rule of law and good corporate governance, the existence of corporate and government connections, and the cost of production.

Investors may also distinguish between perceptions of the existence of a terrorism threat in a given FDI destination and acts of terrorism, or between domestic acts of terrorism and international acts of terrorism.

Short-term corporate costs directly or indirectly linked to acts of terrorism can be substantial, but the potential long-term costs of terrorist threats to national economies can be devastating. The developing economies of east and south-east Asia are deemed to be the most vulnerable. Australia’s Department of Foreign Affairs and Trade estimates that economic growth in the region could decline by 3% after five years of ongoing terror threats and by 6% over 10 years.

The attacks of 9/11 are estimated to have cost the US $660bn in 2005 and have significantly reduced global investment levels. The IMF has estimated that the loss of US output from terrorism-related costs could be as high as 0.75% of GDP – $75bn per year in the future.

Conflicting theories

Does perceived terrorism risk negatively affect FDI decisions? Some theorists maintain that democratic political systems are a breeding ground for terrorism, while others claim the opposite. Some earlier studies have concluded that corporate executives consider political and terrorism risk to be among the most important factors influencing the decision-making process, while later studies minimise their importance.

Existing theories and arguments fail to explain the rationale behind what motivates many foreign investment decisions. Also yet to be addressed is the question of whether certain sectors of an economy are more sensitive to the negative effects of terrorist attacks than others. And why do some countries experience protracted terrorism over time, and what is its impact on FDI decision making?

A lengthy history of terrorism has not prevented foreign oil companies from making, and continuing to make, long-term investments in Colombia or Algeria. And Angola continued to receive huge foreign investments in its energy industry at the height of its civil conflict.

Counting the cost

Investment in all these countries might have been much higher in the absence of recurring terrorism or civil conflict. The US continues to be one of the world’s top foreign investment destinations, even though it is Al Qaeda’s number one target. Although the level of FDI is down significantly in the US post 9/11, it is hard to determine whether this is due primarily to a changed perception of the US as a ‘safe haven’ destination or to the prevalence of low interest rates prompting capital investors to seek more lucrative alternatives.

Some companies are concerned primarily with profit maximisation while others are more concerned with risk management and loss minimisation. The impact of government-to-government relations on the FDI equation can be an important factor motivating FDI flows, as can the desire to establish and maintain international trade links. Experienced foreign investors may discount terrorism risk automatically because they will have had good experience or strong corporate and government relationships locally.

Non-experienced foreign investors may never pursue cross-border investment opportunities because of the absence of prior experience or meaningful corporate and governmental relationships.

Unwise speculation

The question of what would happen in the event of a catastrophic terrorist event must also be considered. Would new construction-related investment flow in, as is the case when natural disasters occur? Would the explosion of a dirty bomb make a city so dangerous that the replacement of damaged buildings would not be possible? It is questions like these that serve to re-emphasise the limited value of generalising about terrorism’s impact on FDI.

Theorists can speculate all they want about what may happen if such an event were to occur, but theories and complicated forecasting models have been proven wrong many times in the past.

Depending on the investment destination, terrorism either already is, or has the potential to become, a primary consideration in formulating investment decisions. Much will depend on the motivations, experience and resources of a given foreign investor. As the Pakistan example demonstrates, it is vital not to rely solely on widely held perceptions about the nature of terrorism risk in a particular country. A wise foreign investor will separate fact from fiction to arrive at an investment decision based on reality on the ground that is consistent with their investment objectives.

Daniel Wagner is senior cofinancing specialist (guarantees) at the Asian Development Bank in Manila. The views expressed here are the author’s and do not necessarily reflect the views of the ADB.