January 1, 2014
This paper constructs a theoretical model to investigate the relationship between the two major forms of terrorism and foreign direct investment (FDI). We analyze with various estimators how these relationships are affected by foreign aid flows by focusing on 78 developing countries for 1984–2008. Both types of terrorism are found to depress FDI. Aggregate aid mitigates the negative consequences of domestic and transnational terrorism, but this aid appears more robust in ameliorating the adverse effect of domestic terrorism. However, when aid is subdivided, bilateral aid is effective in reducing the adverse effects of transnational terrorism on FDI, whereas multilateral aid is effective in curbing the adverse effects of domestic terrorism on FDI. For transnational terrorism, there is evidence in the literature that donor countries earmark some bilateral aid to counterterrorism. Aid’s ability to curb the risk to FDI from terrorism is important because FDI is an important engine of development.