New Research in Economics: Terrorism and the Macroeconomy: Evidence from Pakistan

This is from Sultan Mehmood. The article appears in the May edition of Defense and Peace Economics, which the author describes as "a highly specialized journal on conflict":

Terrorism and the Macroeconomy: Evidence from Pakistan, by Sultan Mehmood, Journal of Defense and Peace Economics, May 2013: Summary: The study evaluates the macroeconomic impact of terrorism in Pakistan by utilizing terrorism data for around 40 years. Standard time-series methodology allows us to distinguish between short and long run effects, and it also avoids the aggregation problems in cross-country studies. The study is also one of the few that focuses on evaluating impact of terrorism on a developing country. The results show that cumulatively terrorism has cost Pakistan around 33.02% of its real national income over the sample period.

Motivation: Studies on the impact of terrorism on the economy have exclusively focused on developed countries (see e.g. Eckstein and Tsiddon, 2004). This is surprising because developing countries are not only hardest hit by terrorism, but are more responsive to external shocks. Terrorism in Pakistan, with magnitude greater than Israel, Greece, Turkey, Spain and USA combined in terms of incidents and death count, has consistently hit news headlines across the world. Yet, terrorism in Pakistan has received relatively little academic attention.

The case of Pakistan is unique for studying the impact of terrorism on the economy for a number of reasons. Firstly, Pakistan has a long and intense history of terrorism which allows one to capture the effect on the economy in the long run. Secondly, growth retarding effects of terrorism are hypothesized to be more pronounced in developing rather than developed countries (Frey et al., 2007). Thirdly, the Pakistani economy is exceptionally vulnerable to external shocks with 12 IMF programmes during 1990-2007 (IMF, 2010, 2011). Lastly, the case study of terrorism for a developing or least developing country is yet to be done. Scholars of the Copenhagen Consensus studying terrorism note the ‘need for additional case studies, especially of developing countries’ (Enders and Sandler, 2006, p. 31). This research attempts to fill this void.

Main Results: The results of the econometric investigation suggest that terrorism has cost Pakistan around 33.02% of its real national income over the sample time period of 1973–2008, with the adverse impact mainly stemming from a fall in domestic investment and lost workers’ remittances from abroad. This averages to a per annum loss of around 1% of real GDP per capita growth. Moreover, estimates from a Vector Error Correction Model (VECM) show that terrorism impacts the economy primarily through medium- and long-run channels. The article also finds that the negative effect of terrorism lasts for at least two years for most of the macroeconomic variables studied, with the adverse effect on worker remittances, a hitherto ignored factor, lasting for five years. The results are robust to different lag length structures, policy variables, structural breaks and stability tests. Furthermore, it is shown that they are unlikely to be driven by omitted variables, or [Granger type] reverse causality.

Hence, the article finds evidence that terrorism, particularly in emerging economies, might pose significant macroeconomic costs to the economy.