Dodging the Bullets: An industry-level analysis of MNEs in

conflict countries

Caroline T. Witte, Martijn J. Burger, Elena I. Ianchovichina, and Enrico Pennings


The views expressed in this paper are entirely those of the authors; they do not necessarily represent the
views of the International Bank for Reconstruction and Development/World Bank and its affiliated
organizations, or those of the Executive Directors of the World Bank or the governments they represent.

Caroline T. Witte is PhD Candidate at the Department of Applied Economics, Erasmus University, Rotterdam,
Erasmus Research Institute of Management (ERIM), P.O. Box 1738, 3000 DR Rotterdam, the Netherlands, Tel:
+31 (0) 10 4088907. Email: witte@ese.eur.nl.

Martijn J. Burger is assistant professor at the Department of Applied Economics, Erasmus University,
Rotterdam, Tinbergen Institute and Erasmus Research Institute of Management (ERIM), P.O. Box 1738, 3000
DR Rotterdam, the Netherlands, Tel: +31 (0) 10 4089579, Fax: +31 (0)10 4089141. E-mail: mburger@ese.eur.nl.
URL: http://www.mjburger.net.

Elena I. Ianchovichina is lead economist at the Chief economist Office, Middle East and North Africa Region,
the World Bank, 1818 H Street NW, Washington, DC 20433, USA, Tel.: +1 202 458 8910, E-mail:
eianchovichina@worldbank.org.

Enrico Pennings is full professor at the Department of Applied Economics, Erasmus University, Rotterdam,
Tinbergen Institute and Erasmus Research Institute of Management (ERIM), P.O. Box 1738, 3000 DR
Rotterdam, the Netherlands, Tel: +31 (0) 10 4082166, Fax: +31(0)10 4089141, Email: pennings@ese.eur.nl.
Abstract

This paper examines the effect of political violence on aggregate, resource-related, and non-

resource-related greenfield Foreign Direct Investment (FDI) in developing countries using

predictions from real options theory. We find that political violence is negatively associated

with aggregate FDI inflows as violence increases uncertainty and operating costs. Greenfield

FDI in the natural resource sector is least sensitive to political violence because of the

geographic restrictions on such investments and the high economic rents associated with

extractive activities which offset to some extent the negative effects of political violence on

profits. We find some support that while non-seccesionist conflicts are associated with a

decrease in non-resource related FDI, there is no correlation between secessionist conflicts

and aggregate or non-resource FDI.

Key words: Political violence, conflict, foreign direct investment (FDI), greenfield FDI,

sectoral FDI, natural resources

JEL codes: D74, F21, F23, P48, O13

2
1. Introduction

Over the years political violence has led to major human suffering, loss of lives, destruction of

infrastructure, increased political risk, threats to international security and massive economic

decline (Bodea & Elbadawi, 2008). It is increasingly recognized that the exploitation of natural

resources can play an important role in violent conflicts in developing countries (European

Commission, 2013; Collier & Hoeffler, 1998; Ross, 2004: U.S. Securities and Exchange Commission,

2010). Several studies have documented that resource dependency is likely to increase the length

and probability of conflict, particularly if the quality of institutions is poor (Collier, 1998; Fearon &

Laitin, 2003; Hodler, 2006; Ross, 2004). 1 Collier (2007) argues that the best way for developing

countries to break free from this so-called “resource-conflict” trap is through the diversification of

the economy and the realization of economic growth. Foreign Direct Investment (FDI) can be an

instrument to catalyse such growth, as it is associated with additional capital formation, technology

transfer, managerial know-how, access to international markets, and productivity spill-overs (Jensen

et al., 2012). In addition, it has been argued that the presence of multinational enterprises (MNEs)

reduces the likelihood of conflict (Barbieri & Reuveny, 2005; Gartzke & Li, 2003; Gartzke et al., 2001;

Rosecrance & Thompson, 2003). Hence, it can be beneficial for conflict countries to attract FDI.

However, conflict is generally thought to decrease aggregate FDI inflows (e.g. Dai et al., 2013; Li &

Vashchilko, 2010). As a result, a resource-rich country experiencing political violence might end up in

a vicious cycle where resource dependency is positively related to conflict and conflict, in turn,

deters FDI flows.

Yet, empirical research examining the effect of political violence on FDI remains

inconclusive. Brunetti and Weder (1998) demonstrate that war casualties and political executions

are negatively associated to the average rate of investment, but find no significant relationship

between FDI flows and the incidence of assassinations, strikes, riots or armed attacks. Dai et al.

1
Sachs and Warner (1991) were the first to describe this resource curse, stressing that resource-rich countries
grow slower than resource-poor ones. They inspired an academic debate on whether and how resource
abundance affects a broad set of economic and political indicators (Brunnschweiler & Bulte, 2009).

3
(2013) obtain that Japanese subsidiaries are more likely to exit if they are located in a conflict area

and Asiedu (2006) finds that in African countries the number of coups, riots, and assassinations is

negatively associated with the ratio of net FDI flows to Gross Domestic Product (GDP). Yet, in an

earlier paper on determinants of FDI to developing countries, she infers that the average number of

assassinations and revolutions does not have a significant influence on FDI inflows (Asiedu, 2002). Li

(2006) also concludes that the occurrence of unanticipated interstate wars has a negative influence

on FDI, but he finds no significant association between FDI and intrastate wars or terrorist incidents

which has made up most of the political violence incidents since the end of the cold war

(UCDP/PRIO, 2014). Contrary to Li (2006), Busse and Hefeker (2007) find that interstate war has no

effect on FDI, while civil war negatively affects FDI. Several other scholars find no relationship

between political violence and FDI (Biglaiser & DeRouen, 2007; Li & Vashchilko, 2010), while Biglaiser

and DeRouen (2006) and Asiedu and Lien (2011) even found a positive relation between FDI and

conflict.

One explanation for the heterogeneous and sometimes contradictory findings in the

literature is that the relationship between political violence and FDI depends on the type of conflict.

Another explanation for the inconclusiveness of the empirical literature is that most empirical

studies have examined total aggregate FDI flows, neglecting the sectoral heterogeneity of these

flows. Burger et al. (2013) is one of the few studies which examine the association between political

instability and sector-specific FDI showing that the increase in political instability during the Arab

Spring discouraged greenfield FDI in the tradable manufacturing and service industries, while

investments in natural resource sectors and non-tradable activities appear insensitive to such

shocks. In addition, Guidolin and La Ferrara (2007) show in a firm level study that firms active in the

diamond sector profited from the Angolan war, suggesting that under certain circumstances FDI

flowing to the natural resource industry can increase rather than decrease if political violence

increases. Finally, Driffield, Crotty and Jones (2013) combine the Corporate Social Responsibility

framework with international business theory in a study on the firm-level determinants of FDI to

4
conflict zones. They find that MNEs active in mining and agriculture are more likely to invest in

countries that experienced an intrastate conflict.

This paper is linked to the literature on FDI and political instability (Schneider and Frey,

1985; Brunetti and Weder, 1998; Busse and Hefeker, 2007; Meon & Sekkat, 2012; Burger et al.,

2013) and the one on MNEs and political institutions (Daude & Stein, 2007; Li & Resnick, 2003;

Mauro, 1995). It builds on the work of Burger et al. (2013), but extends it to a set of 93 developing

countries and focuses particularly on political violence, an extreme form of political instability,2

defined as ‘collective attacks within a political community against the political regime, its actors –

including competing political groups as well as incumbents – or its policies’ (Gurr, 1970, p. 3-4).

Political violence or conflict includes civil wars, territorial disputes, acts of terrorism and genocides,

but excludes criminal violence (Kalyvas, 2013). The concept is closely linked to political instability as

both lead to uncertainty concerning government policy. Yet, they differ as political violence is not

only associated with unexpected changes in policy, but also leads to the destruction of physical and

human capital.

This study contributes to the existing literature as it tests several hypotheses which help

explain the mixed results in studies on FDI and political violence. We establish that there is

considerable heterogeneity in how MNEs react to political violence, reflecting differences in industry

characteristics, notably limited investment options and high rents, as well as differences in the

exposure to conflict. We find empirical evidence that (i) separatist conflicts have a smaller effect on

MNEs than non-separatist conflicts and (ii) conflicts have the least effect on FDI in natural resources

and much larger effect on FDI in manufacturing and services. Hence, this article emphasizes the

importance of disaggregating sectors and distinguishing between different types of conflicts when

analysing FDI to developing countries. Secondly and most importantly, this study suggests that FDI to

politically violent countries can make it harder to escape the conflict-resource trap as resource-

driven FDI flows deepen resource dependence and thus threaten prospect for peace building success

2
Political instability refers to the risk that a sovereign government may change ‘the rules of the game’ to which
firms ought to adhere (Butler & Joaquin, 1998).

5
(Doyle and Sambanis, 2000). Hence, it can be argued that developing countries experiencing

violence need to be cautious when promoting total FDI.

2. Theoretical Framework

Many studies apply Dunning’s eclectic paradigm (1988) to explain firms’ foreign investment

decisions. Dunning argued that three conditions must be met for a firm to undertake FDI and thus

acquire a lasting management interest (10% or more of voting stock) in another firm located abroad

(Barba Navaretti & Venables, 2004). The foreign investment must allow such a firm to gain certain

ownership advantages and to derive a degree of market power; the foreign investment enables the

firm to exploit location advantages from its position abroad; and the firm achieves internalization

advantages allowing it to benefit from keeping the ownership of the new venture within the same

organization rather than selling it to a foreign firm. Another popular theoretical approach to FDI is

Markusen’s (2000) knowledge-capital model. It distinguishes between horizontal FDI, mainly driven

by the desire to locate close to consumers, and vertical FDI, motivated by differences between the

source and host countries’ factor endowments.

However, both the eclectic paradigm and the knowledge-capital model have been criticized

for not taking into account strategies for reducing downside risk and coping with political instability

(Altomonte, 2000; Jensen, 2003). As an extreme form of political instability, political violence can

pose a serious downside risk for firms investing in developing countries. Since neither the OLI

framework nor the knowledge-capital model explicitly addresses the influence of uncertainty, it is

doubtful whether Dunning’s eclectic paradigm or Markusen’s knowledge capital model provide

sufficient insights into the nature of the FDI-political violence link. In contrast, real option theory is

acknowledged for its ability to model irreversible investment decisions under (political) uncertainty

and has been used repeatedly to model firms’ entry in foreign markets (e.g. Altomonte, 2000;

Belberbos & Zou, 2009; Brouthers et al., 2008; Kogut, 1991; Kogut & Chang, 1996; Pennings &

Altomonte, 2006; Pennings & Sleuwaegen, 2004) and decisions to invest in the natural resource

industry (e.g. Insley, 2002; Paddock et al., 1988; Slade, 2001).

6
 Real options theory asserts that an investment decision can be modelled as if it concerns

the purchase of a financial put or call option (Dixit & Pindyck, 1989). A possibility for investment is

equivalent to a financial option in so far as it provides a firm the right but not the obligation to act

upon a business opportunity. The real option approach to strategic investment relies on three

notions (Altomonte, 2000; Dixit & Pindyck, 1989). First, there is some uncertainty about the

outcomes of the investment in terms of the costs associated with the investment or the value of the

investment. Uncertainty raises the critical value at which it is optimal to invest. Second, the

investment is at least partially irreversible because sunk costs are involved. These costs negatively

affect the likelihood that a firm invests in risky projects since the investment cannot be reversed if

conditions become unfavourable. Third, there is some flexibility in the timing of the investment. In

many cases, firms can delay their investment decision until uncertainty resolves (Smit & Trigeorgis,

2004). By postponing an investment a firm increases the available information which could decrease

the riskiness of the investment. This means that waiting for uncertainty to resolve has a positive

value. While according to traditional models a firm should make an investment when the Net

Present Value of investing is positive, real option theory posits that it is only optimal to invest when

the expected earnings stream is equal to the Net Present Value plus the value of postponing the

investment, which is positively related to uncertainty. Hence, uncertainty increases the value at

which it is optimal to invest, also called the trigger value, and as such it decreases the likelihood of

the investment being made.3

In a country marred by political violence, the pay-off of an investment is subject to great

uncertainty due to a variety of risks, including expropriation, asset destruction, supply chain

disruptions, extreme currency and price volatility, disorder in market systems, and violence against

employees (Dai et al., 2013; Li & Vashchilko, 2010). In addition, during a conflict the host

government is more likely to change existing regulations or impose new ones raising the cost of

doing business once the MNE enters a market and incurs certain sunk costs. These regulations can

3
Details on the mathematical specification of the trigger value at which investment is optimal can be found in
the work of Dixit & Pindyck (1994).

7
include for example a breach of contract, limiting repatriation of profits, exchange controls,

embargoes, and other restrictive trade policies (Li & Vashchilko, 2010). Finally, during an interstate

or internationalized conflict consumers may be reluctant to purchase products from a firm that

originates from a hostile country as a result of nationalistic sentiments. In brief, these factors

associated with political violence increase the riskiness of an investment and decrease the expected

payoff of the investment. Therefore, political violence raises the critical trigger value for investment

and reduces the probability that this trigger is hit as the expected rate of return on an investment

declines. Accordingly, it can be expected that political violence is associated with a decline in FDI

flows to a country.

H1: Political violence in the host country is associated with a decline in FDI inflows.

Recent models of real options also take into account pre-emption effects or first-mover

advantages (Mason & Weeds, 2010; Smit & Trigeorgis, 2004). Pre-emption occurs in situations

where the firm that invests first has a considerable advantage over firms that invest at a later point

in time (Lieberman & Montgomery, 1988). Such a first-mover advantage can arise from three

sources: technological leadership, buyer switching costs, and pre-emption of assets. The latter are an

important source of advantages for MNEs active in the natural resource industry. These firms have

limited opportunities for investment due to the geographical concentration of natural resources

(Driffield et al., 2013). Because these resources are generally scarce and valuable - although there is

considerable price volatility associated with global commodity booms and busts - acquiring a

location rich in resources can provide MNEs with a considerable first-mover advantage (Lieberman &

Montgomery, 1988). If these first-mover advantages are large, a firm might forego the value of

waiting in order to become the first-mover and to acquire the rents associated with the first-mover

advantage (Mason & Weeds, 2010; Smit & Trigeorgis, 2004). In the remainder of this article the

8
effect of limited investment opportunities will be referred to as the limited opportunities

mechanism.

In addition, the economic rents that a MNE, active in the natural resource industry, can

obtain by investing can be particularly high, especially during times of commodity booms (Kolstad &

Wiig, 2009). For example, at the peak of a commodity boom in 2011 a barrel of oil was valued at

$80, while the extraction costs of this barrel in Saudi Arabia where little over $2 (Barma et al., 2012).

For a MNE active in the natural resource industry the value of waiting may therefore be relatively

small compared to the foregone resource rents, triggering investments in politically violent regions.

This effect is expected to be dependent on the size of the rents and would hence be most prominent

during resource booms. Stated differently, the size of the resource rents increases the probability

that the trigger value for optimal investment is hit. In the remainder of this article the effect of

resource rents on the responsiveness of natural resource FDI to political violence will be referred to

as the rents mechanism.

In contrast to the rents and limited opportunities arguments, the irreversibility of

investments may discourage MNEs from investing in the natural resource sector. These investments

tend to be less reversible than investments in most other sectors, as the physical assets needed for

both exploration and exploitation are often specific to the geographic location of the natural

resource and cannot be easily transferred to another location in case of conflict. This so-called sunk

cost effect may play a smaller role for the investment decision of non-resource MNEs. Nevertheless,

investments in these industries can also be considered fundamentally irreversible as the acquired

physical assets and human capital cannot easily be transferred when political violence erupts. Thus,

we expect that the limited opportunities and rent mechanisms are the main factors distinguishing

the sensitivity to political violence of resource and non-resource FDI. We therefore formulate the

following hypothesis:

H2: FDI in natural resources is less affected by political violence than FDI in other sectors.

9
 Hitherto the focus of the discussion has been on how political violence affects the

investment decisions of MNEs in resource and non-resource industries, but the effect of conflict

might also depend on the nature of the violence, specifically on the extent to which fighting is

spread throughout the country. A conflict that is concentrated in only one part of the country is

likely to pose a lower risk to a multinational wanting to invest in that country than violence that is

spread through the entire country as the adverse consequences of a concentrated conflict can be

avoided by locating its subsidiary in a different part of the country. This is particularly relevant for

large countries such as India and Thailand, which experience conflicts concentrated in the border

regions.

In the political science literature the distinction between conflicts contesting incumbent

national governments and separatist (or secessionist) conflicts has received considerable attention.

Buhaug & Gates (2002) showed that separatist conflicts are more likely to be geographically

contained than non-seperatist conflicts, as secessionist groups are often active in specific areas of

interest, typically located in border regions, whereas conflicts contesting national governments show

a wider geographic spread and are disproportionally concentrated in capital cities (Buhaug & Gates,

2002). Literature on the consequences of the two different types of conflict on business is still

limited. Given that multinationals can avoid investing in the areas which secessionists are fighting

over, the risk of secessionist conflict is lower than the risk of extended national conflicts. As a result,

the trigger value of optimal investment is lower for secessionist conflicts than for conflicts contesting

national governments. The following hypothesis is formulated:

H3: The type of conflict, that is secessionist or non-secessionist, moderates the relationship

between political violence and aggregate GFI.

10
 As argued above, MNEs active in the natural resource sector are more constrained in making

their location choice than MNEs operating in services and manufacturing as the investment options

of a resource firm are restricted to those sites where natural resources are present. Hence, the

opportunities to circumvent the areas where separatist fighting is concentrated might be limited.

Moreover, in the regions where extraction sites are located and where natural resource MNE’s can

establish a subsidiary, separatist conflict is relatively more likely, because these sites are more often

positioned in rural areas, which are in turn more likely to experience secessionist conflict (Buhaug &

Gates, 2002). The following hypothesis is formulated:

H4: The type of conflict, that is secessionist or non-secessionist, has a weaker moderating

effect on the relation between political violence and resource-related FDI than on the relation

between political violence and non-resource related FDI.

3. Data and Methodology

As in real options theory our economic model departs from the assumption that decision to make

greenfield investments abroad is a function of both expected returns and perceived uncertainty (e.g.

Wheeler and Mody, 1992; Meon and Sekkat, 2012). The following sector-specific, reduced-form,

dynamic investment model:

links the foreign direct investment FDIist flowing to country i in sector s at year t, with a range of

variables underpinning perceived uncertainty and expected returns, including lagged FDI in the

sector s, Pi, t-1 - the political violence indicator for country i lagged one year, Xi, t-1 – a set of control

variables, capturing conditions that might confound the relation between political violence and FDI,

is – a set of country dummies capturing time-invariant country characteristics, and t – a vector of

11
time dummies. The control variables include GDP in US dollars, inflation, exchange rates, and

regulatory quality. In addition, we control for exchange rates volatility as increases in political

violence and revolutions often coincide with macroeconomic uncertainty. The country fixed effects

capture between country variations, such as country size, resource endowments, culture and

policies that do not change in the sample period. Hence, we consider only the within country

variation, that is whether a country attracts less FDI when political violence rises. The time dummies

capture time dependent effects such as global FDI waves, global commodity price fluctuations, and

global economic phenomena. The lagged FDIis variable enters the equation to minimize the risk of

omitted variable bias, as the amount of FDI received in the past is one of the best predicators of FDI

to be received in the future. In addition, this variable makes it possible to estimate the long run

effects of our variables. To reduce the problem of reverse causality, all independent variables are

lagged. However, ultimately this model cannot determine causality and the results should therefore

not be interpreted as causal relations, but as conditional associations.

Data on FDI flows into developing countries for the period 2003-2012 is obtained from the

fDi Markets database, a Financial Times databank tracking cross-border investments in new projects

and expansions of existing ventures. The data is collected through Financial Times newswires and

internal information sources, other media sources, project data acquired from industry organisations

and investment agencies and data purchased from market research and publication companies. Each

project is cross-referenced against multiple sources. The dataset includes a total of 51,800 greenfield

investments in developing countries, amounting to a total of US$4.62 trillion. For each year, FDI

flows are aggregated to the country-sector level. We focus on greenfield investments, because this is

a relatively homogeneous group of investment in new facilities and excludes investments resulting

from fire-sales (Krugman, 2000). This eliminates concerns that heterogeneity of FDI is driving the

results and the possibility that investments reflect repairs of facilities associated with prior

investments rather than investments in new projects. In developing countries the inflow of

greenfield investments is also considerably larger than the inflow of brownfield investments

12
(Markusen & Stähler, 2011). Comparing the number of greenfield investments in our dataset to all

mergers and acquisitions (M&As) registered by Thomson One in the same time period, 81.6% were

Greenfield investments. Moreover, many policy makers are particularly interested in attracting

greenfield FDI and some countries even restrict M&As (UNCTAD, 2013). Finally, data on greenfield

investments is more detailed than data on M&As. Although the Thomson One data service includes

information on M&As, the size of the investment is missing for approximately 50% of the

observations in developing countries for the period under study.4 To test hypotheses two and four,

we split FDI flowing to the natural resource sector and FDI flowing to non-resource sectors, including

manufacturing, construction, distribution, and commercial services. FDI is measured in millions of US

dollars, and because the distribution of FDI is skewed, the inflows are log-transformed.5

Following the political science literature, we measure political violence using the number of

battle-related deaths (BRD) in a country in a year, obtained from the World Bank World

Development Indicators. BRD are all deaths in battle-related conflicts between warring parties in a

conflict. Though this indicator has some limitations – e.g., it does not measure non-fatal casualties or

damage to property – it is widely available for conflict countries and can be considered to be a good

proxy for political violence. In addition, this variable is less likely to be endogenous to FDI than most

subjective measures of conflict, as the investment of a MNE is unlikely to directly cause battle-

related deaths. Because the battle-related deaths variable is highly skewed, we take the natural log

of the inverse hyperbolic sine function. For our third and fourth hypothesis concerning the

heterogeneous nature of political violence we code political violence as secessionist when one of the

parties in the conflict has the primary aim of seizing a part of the territory from the government.

Data on the classification of secessionist conflicts comes from the UCDP/PRIO dataset (2014)

4
In fDi Markets some of the data on the size of investment is estimated by fDi Markets rather than directly
observed. Therefore, we repeated our estimations with the number of projects (ln) as a dependent variable.
The results were qualitatively the same as those reported below. They are available from the authors on
request.
5
As FDI inflows are zero for some observations, we take the logarithm of the inverse hyperbolic sine:
√ .

13
collected by the Uppsala University. Secessionist is a dummy which is 1 if a conflict can be regarded

as secessionist and zero otherwise. If a country experienced several conflicts in a year, we coded

political violence as secessionist only if all conflicts could be considered secessionist.

Data on our control variables comes primarily from the World Bank World Development

Indicators. We control for GDP in millions 2013 USD and inflation measured as the annual growth

rate of the GDP implicit deflator. In addition, we control for the nominal exchange rate and daily

exchange rate volatility6 using the OANDA dataset, the level of democracy using the polity index

developed by Marshall et al. (2013), and regulatory quality as quantified by Kaufman’s World

Governance Indicator. The polity index ranges from -10 to +10, where low negative numbers indicate

autocracies and high positive numbers correspond to democracies. The Kaufman’s World

Governance indicator measures perceptions of the ability of the government to formulate and

implement sound policies and regulations that permit and promote private sector development on a

scale of approximately -2.5 and 2.5, with higher values corresponding to better governance. We do

not control for trade costs, as an increase in trade costs is part of the theorized mechanism of the

political violence-FDI relation. Appendix 1 shows the descriptive statistics and correlation matrix.

4. Estimation and Empirical Results

To estimate the dynamic model specified above, a fixed effects estimator is used. In panels with a

large number of countries, but a small number of time periods, the standard fixed effects estimates

are inconsistent, because the transformation process creates a correlation between the regressor

and the error (Nickell, 1981). We use the least square dependent variable estimator developed by

Bun and Kiviet (2003) to correct for this bias. The bias correction is initialized by a system GMM

estimator.

6
Following the literature, exchange rate volatility is operationalized as the standard deviation of the first
difference of the natural logarithm of daily bilateral exchange rates vis-a-vis the U.S. dollar.

14
Table 1 Effect of Political Violence on Total, Resource, and Non-resource Related Greenfield FDI, with Battle-Related
Death Proxies for Political Violence
Dependent Variable: Log GFI (in USD millions), LSDVC Estimation.
(1) (2) (3)
Total FDI Resource FDI Non-Resource FDI
BRDt-1 (ln) -0.105** 0.013 -0.131**
(0.052) (0.073) (0.052)
FDIi,t-1 (ln) 0.207*** 0.079** 0.144***
(0.041) (0.040) (0.040)
GDPt-1 (ln) -0.308 -1.437* 0.247
(0.528) (0.739) (0.527)
WGI regulatory qualityt-1 0.372 1.338 0.005
(0.630) (0.882) (0.629)
Polity Indext-1 0.001 -0.056 0.019
(0.048) (0.067) (0.048)
Nominal Exchange Ratet-1 (ln) 0.079 0.684 0.013
(0.339) (0.474) (0.336)
SD Exchange Ratet-1 -27.123*** -11.020 -22.743***
(7.242) (10.186) (7.228)
Inflationt-1 0.005 0.010 0.007
(0.009) (0.012) (0.009)
Observations 731 731 731
Number of countries 93 93 93
Country FE Yes Yes Yes
Year FE Yes Yes Yes
Bootstrapped standard errors in parentheses.
*** p<0.01, ** p<0.05, * p<0.10

Table 1 shows the results of the baseline model, the Bun and Kiviet LSDVC model with

bootstrapped standard errors. Three different specifications are estimated, where the dependent

variable represents total FDI (column 1), non-natural resource FDI (column 2) and natural resource

FDI (column 3). Battle-related deaths are negatively related to total FDI flows and are significant at

the 5% level. A 10% increase in the number of Battle-Related Deaths decreases total Greenfield FDI

flows with approximately 1%. This is on top of a decrease of FDI that might result from an decrease

in economic growth due to the reduction of violence.7 The first hypothesis is hence supported. In the

second specification, which includes only investments in the resource sector, political violence has a

positive but insignificant effect on FDI flows to this sector. In the third specification, the effect of

political violence is negative and statistically significant. The effect is even slightly greater than in the

first specification. A 10% increase in the number of battle-related deaths increases greenfield FDI in

the non-resource sector by 1.3%., ceteris paribus. Hence, we find support for the second hypothesis.

7
The effect of political violence on FDI is slightly larger in a model in which GDP is not controlled for.

15
 With respect to the control variables, FDI flows are mainly influenced by previous

investments. GDP does not significantly affect total FDI flows or flows to the non-resource sector,

but has a negative effect on FDI in the natural resource sector. This coefficient is however only

significant at the 10% level which is consistent with the fact that low-income developing countries

depend on resource-related FDI to a greater extent than high-income developing countries.

Regulatory quality, the level of democracy measured by polity, inflation and the exchange rate do

not significantly affect FDI in any of the models. This could be explained by the fact that there is little

within variation for these variables during the years under study. Exchange rate volatility, our proxy

for macroeconomic uncertainty, has a strong negative effect on FDI flows, thought this effect is not

significant for resource-related FDI. None of the results changed meaningfully when a non-corrected

LSDV estimator was used, suggesting that the Nickell bias is small.8

Table 2 Effect of Political Violence on Total, Resource, and Non-resource Related Greenfield FDI, including moderating
effects.

Dependent Variable: Log GFI (in USD millions), LSDVC

Estimation.
(1) (2) (3)
Total FDI Resource FDI Non-resource FDI
BRDt-1 (ln) -0.134** -0.020 -0.175***
(0.057) (0.081) (0.057)
BRD (ln)*secessionistt-1 0.140 0.157 0.213**
(0.088) (0.125) (0.088)
FDIi,t-1 (ln) 0.201*** 0.073* 0.134***
(0.040) (0.040) (0.040)
GDPt-1 (ln) -0.309 -1.441* 0.251
(0.528) (0.741) (0.525)
WGI regulatory qualityt-1 0.442 1.409 0.107
(0.634) (0.889) (0.631)
Polity Indext-1 0.011 -0.045 0.036
(0.049) (0.069) (0.049)
Nominal Exchange Ratet-1 (ln) 0.057 0.663 -0.021
(0.340) (0.478) (0.337)
Exchange Rate Volatilityt-1 -27.118*** -11.172 -22.712***
(7.235) (10.204) (7.203)
Inflationt-1 0.005 0.010 0.008
(0.009) (0.012) (0.009)
Observations 731 731 731
Number of iso3n 93 93 93
Country FE Yes Yes Yes
Year FE Yes Yes Yes
Bootstrapped standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.10

8
The results of the non-corrected LSDV are reported in the appendix, together with an OLS-model and a
Random effects model. All support our hypotheses (1) and (2).

16
 Table 2 column 1-3 shows the results when the secessionist moderator is added to the

model. The main effect of the type of conflict is not included in the model, because conflicts rarely

evolve from a secessionist conflict into a conflict for national power or the other way around and

hence the type of conflict is largely absorbed in the country fixed effects.9 In addition, the variable

indicating the type of conflict is quite strongly correlated with the number of battle-related deaths.

The first column shows the results for total FDI, the second for resource FDI and the third for non-

resource FDI. The moderator is positive for both total FDI, resource FDI and non-resource FDI, but is

only significant for non-resource FDI. Hence, there is no support for our third hypothesis that

secessionist conflicts have a different effect on aggregate greenfield FDI than conflicts for national

power, but there is evidence that the effect of battle-related deaths on non-resource FDI is smaller

for secessionist conflicts than for conflicts concerning national power. In the case of a conflict for

national power, a 10% decrease in the number of battle-related deaths increases greenfield FDI

flows to the non-resource sector with 1.8%, ceteris paribus. The effect of a decrease of battle-

related deaths in a secessionist conflict is however not significantly different from zero. For total FDI

flows or FDI flows to the natural sector such a moderator effect is not found. There is thus support

for hypothesis 4; i.e. the type of conflict, has a weaker moderator effect on the relation between

political violence and resource-related FDI than on the relation between political violence and non-

resource related FDI.

Additional analysis

One concern might be that the results are driven by the longer gestation period for greenfield FDI in

the natural resource sector compared to that of FDI in the services and manufacturing sector. Some

natural resource extraction activities might need years of planning before the investment is

implemented on the ground. Hence, investments in extraction might be less affected by short-term

9
In our dataset a total of five out of the ninety-three countries experienced both a secessionist and a non-
secessionist conflict (Eritrea, Pakistan, Nigeria, Mali and Turkey).

17
fluctuations and more affected by changes in long-term conditions. Stated differently, there might

be a greater lag between changes in conditions and effects on investments in the resource sector.

Therefore, we estimate a model where the political violence indicator is the three-year moving

average of Battle-Related deaths. The results are reported in Table 3.

Table 3 Effect of Political Violence on Total, Resource, and Non-resource Related Greenfield FDI, with moving average of
Battle-Related Death as a proxy for Political Violence.

Dependent Variable: Log GFI (in USD millions), LSDVC Estimation

Total FDI Resource FDI Non-resource FDI
(1) (2) (3) (4) (5) (6)
BRD (ln) -0.165** -0.162** -0.043 -0.006 -0.230*** -0.198**
(0.074) (0.077) (0.104) (0.110) (0.074) (0.077)
BRD (ln)*secessionistt-1 0.024 0.114 0.034
(0.113) (0.161) (0.113)
Observations 668 668 668 668 668 668
Number of countries 93 93 93 93 93 93
Economic Controls Yes Yes Yes Yes Yes Yes
Country FE Yes Yes Yes Yes Yes Yes
Year FE Yes Yes Yes Yes Yes Yes

Bootstrapped standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.10

The results confirm the first hypothesis as the negative relationship between total greenfield

FDI and Battle-related deaths holds even for changes which occur in more distance periods in the

past. The second hypothesis also holds as political violence in the more distant past affects non-

resource-related FDI, but not resource-related FDI. The moderator is positive but insignificant in all

three models. Hence, the results of the model using three year moving averages do not support the

hypothesis that secessionist conflicts have a smaller effect on Greenfield FDI inflows than conflicts

for national power.

As a proxy for political violence, the battle-related deaths indicator has the advantage of

being a rather objective and widely-available measure. However, one disadvantage is that the data

are collected by searching for keywords in newspapers, newswires, books, case studies, and journals

and as a result, the death count may be biased. Moreover, it only takes into account the loss of

human lives and does not take into account the destruction of physical capital. Unfortunately, there

is no worldwide database for conflict-related capital destruction indicators. The International

Country Risk Guide of the Political Risk Service (PRS) group provides two subjective measures of

18
political violence - the internal conflict and the external conflict indicators that are intended to

capture both the loss of human lives and extent of physical capital destruction. The internal conflict

indicator assesses the presence of internal conflict in the country and its actual or potential impact

on governance. The external conflict indicator measures the risk to the incumbent government from

foreign action, ranging from non-violent external pressure (diplomatic pressures, withholding of aid,

trade restrictions, territorial disputes, sanctions, etc.) to violent external pressure (cross-border

conflicts to all-out war). These two components are rated on a scale of 1 to 12, where a rating of 12

indicates a very low risk of conflict and 1 indicates a very high risk of conflict.

As a robustness check, we take the minimum of the two measures to measure political

violence and to ease interpretation, we transform the index so that a score of 12 indicates a very

high risk of political violence and 1 indicates a very low risk. It should, however, be taken into

account that the ICRG indicator measures the risk of political violence rather than violence itself. In

addition, since the indicators are based on the perceptions of violence rather than violence itself, the

measure can be influenced by the personal opinion of the country experts. Finally, the ICRG index is

available for a smaller set of countries and shows considerably less variation than the number of

Battle-Related Deaths. Table 4 shows the complete model for total, resource-related, and non-

resource related FDI when the ICRG-variable is included as a proxy for political violence.

Table 4 Effect of Political Violence on Total, Resource, and Non-resource Related Greenfield FDI, with ICRG conflict
indicator as a proxy for Political Violence

Dependent Variable: Log GFI (in USD millions), LSDVC Estimation

Total FDI Resource FDI Non-resource FDI
(1) (2) (3) (4) (5) (6)
ICRG Conflictt-1 -0.281** -0.294** -0.091 -0.127 -0.265** -0.286**
(0.127) (0.130) (.1877) (0.192) (0.128) (0.131)
ICRG Conflict*secessionistt-1 0.093 0.244 0.145
(0.107) (0.159) (0.108)
Observations 640 640 640 640 640 640
Number of countries 81 81 81 81 81 81
Economic controls Yes Yes Yes Yes Yes Yes
Country FE Yes Yes Yes Yes Yes Yes
Year FE Yes Yes Yes Yes Yes Yes
Bootstrapped standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.10

19
 The ICRG conflict variable is negatively and significantly related to Total FDI and Non-

Resource FDI, but does not have a significant effect on Resource FDI. This is in line with the results

found when measuring political violence by means of the number of Battle-Related Deaths. Hence,

the results support both the first and second hypothesis. The secessionist conflict moderator is not

significant in any of the three models. A reasonable explanation for this could be that the ICRG

measures the risk of political violence faced by a firm, it accounts for the fact that the risk is higher

when a conflict concerns bids for national power than when a conflict is secessionist as well as for a

possible link between FDI and secessionist conflicts.

The Case of Oil and Gas: Real Options Mechanisms

Finally, we test whether the irresponsiveness of natural resource FDI to political violence is indeed a

result of the mechanisms derived from the real options framework, i.e. the size of the resource rents

and the existence of limited investment opportunities. As no data are available on rents and

investment opportunities for the entire natural resource sector, we focus here on the oil and gas

industry. The BP Statistical Review of World Energy provides a large dataset containing information

on global oil and gas reserves and prices. Statistics are obtained from government sources and

published data. We use proved global reserves – i.e. oil and gas that with reasonable certainty can

be recovered in the future from known reservoirs - as a proxy for investment opportunities for

multinationals active in the oil and gas industry. Because gas and oil reserves are measured in

different units, we first standardize the oil and gas reserves data and subsequently take the average

of the two to obtain a z-score. This score is then interacted with battle-related deaths to test the

mechanism of limited investment opportunities. The main effect of global oil and gas reserves is

excluded as it does not vary over countries and is hence absorbed by the time fixed effects. In

addition, a global price index of oil and gas prices (2003=100) is used as a proxy for oil and gas rents.

We interact this price index with battle-related deaths to the effect of rents on the responsiveness of

natural resource FDI to political violence. The main effect of our global oil and gas price measure is

excluded as similar to global reserves it does not vary over countries and is hence absorbed by the

20
time fixed effects. It is possible that both oil and gas related FDI flows and political violence are the

result of the discovery of one of these valuable resources. Therefore, we also control for large oil

and gas field discoveries within a country using a dataset obtained from the BP Statistical Review of

World Energy. The variable discovery is a dummy variable which is one if either a major oil or gas

field was found in the country. A major discovery is a discovery of a field that contains at least 500

million barrels of oil or 79 million m3 of gas (Halbouty, 2001).

Table 5 Effect of Political Violence on Greenfield FDI in the oil and gas sector, including moderator effects for type of
conflict.

LSDVC estimations, GFI in USD millions

(1) (2) (3) (4)
BRDt-1 (ln) -0.006 -0.032 -0.412** -0.417**
(0.077) -0.085 (0.194) (0.194)
Ln(BRD)*secessionistt-1 0.117 0.065
(0.133) (0.133)
Ln(BRD)*gasoilindext-1 0.002** 0.002**
(0.001) (0.001)
Ln(BRD)*gasoilreservest-1 -0.145*** -0.143***
(0.048) (0.048)
Major Gas/Oil field discoveriest-1 -0.018 -0.057 -0.136 -0.153
(0.414) (0.418) (0.414) (0.417)
FDIt-1 (ln) 0.114*** 0.110*** 0.102*** 0.101**
(0.040) (0.040) (0.039) (0.040)
GDPt-1 (ln) -0.945 -0.952 -0.976 -0.977
(0.783) (0.786) (0.778) (0.780)
WGI regulatory qualityt-1 1.100 1.153 0.800 0.830
(0.933) (0.941) (0.932) (0.941)
Polity Indext-1 -0.059 -0.052 -0.052 -0.048
(0.071) -0.952 (0.074) (0.075)
Nominal Exchange Ratet-1 (ln) 0.661 -0.952 0.712 0.704
(0.502) (0.786) (0.503) (0.507)
Exchange Rate Volatilityt-1 -7.364 1.153 -9.034 -9.055
(10.740) (0.941) (10.709) (10.715)
Inflationt-1 0.009 -0.052 0.010 0.010
(0.013) -0.952 -0.976 (0.013)
Observations 731 731 731 731
Number of countries 93 93 93 93
Country FE Yes Yes Yes Yes
Year FE Yes Yes Yes Yes
Bootstrapped standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.10

Columns (1) and (2) of table 6 show the baseline models without and with the secessionist

conflict moderator, respectively. The results suggest that the effect of political violence on oil and

gas FDI is rather similar to the effect on total natural resource FDI. Neither battle-related deaths nor

the moderator of the secessionist dummy has a significant effect on oil and gas FDI. Columns (3)

21
shows the results in the presence of moderator effects of oil and gas reserves and the oil and gas

price index. The moderator effect of gas and oil prices is positive and significant, indicating that the

effect of battle-related deaths on FDI flowing to the oil and gas sector depends positively on the

price of gas and oil. During commodity booms when prices are high, MNEs are more likely to enter a

country marred by political violence than when prices are low. When the prices of oil and gas

doubles relative to 2003, the effect of battle-related deaths becomes negligible. Hence, we find that

the responsiveness of oil and gas FDI flows indeed seems to be negatively related to the profitability

of oil and gas extraction. The moderator effect of global oil and gas reserves on the relation between

battle-related deaths and oil and gas FDI is negative and significant, indicating that when new oil and

gas reserves are discovered, MNEs active in the oil and gas sector are less willing to invest in

countries marred by political violence. If global reserves increase with one standard deviation

relative to the mean amount of reserves in our dataset, the effect of a 10 percent increase in battle-

related deaths decreases greenfield FDI in oil and gas with approximately 5.5%. This supports the

hypothesis that within the natural resource sector the effect of political violence on FDI flows

increases as investment opportunities become more limited.

In Column (4) the moderator effect of secessionist and battle-related deaths is added to the

model. The effect of this moderator is positive, but insignificant. This is in line with the limited

opportunities argument. If MNEs active in the oil and gas industry have limited investment options

and as a result are more likely to invest in an area affected by political violence, then there is no

reason to expect that the effect of a secessionist political violence is lower than that of national

secessionist violence. The moderator effects of the oil price index and global reserves on the relation

between battle related deaths and oil and gas FDI still have the expected sign and remain significant.

6. Conclusion

This study makes several contributions to the research on conflict and FDI, with a specific focus on

sectoral investments and investments in natural resources. First, earlier studies on political violence

and FDI mainly focussed on how aggregate FDI is influenced by political violence. Although it is

22
frequently claimed that political violence increases downward risk and as a result decreases FDI in

conflict countries, these studies report mixed empirical results. We disaggregate FDI into different

sectors and limit our analysis to greenfield FDI to create a homogenous set of investments and to

exclude investments that are the result of fire-sales. Our results affirm that greenfield FDI in

different sectors is heterogeneously affected by political violence. This might explain why earlier

studies found ambiguous results.

Secondly, many studies emphasize how dependence on natural resources can fuel conflict,

largely neglecting the effect political violence has on a country’s dependence on natural resources.

This paper is one of the first attempts to fill this gap, as we analyse how FDI flows in the natural

resource sector respond to changes in political violence. We show that while total greenfield FDI and

greenfield FDI in the non-natural resource sectors is on average negatively affected by political

violence, resource-related greenfield FDI does not significantly decrease when political violence

intensifies. In addition, we show that the insensitivity of MNEs active in the oil and gas sector to

political violence can be explained by the profitability of resource extraction, especially during

periods of commodity booms, and limitations on the number of available investment opportunities.

These results are robust across all our specifications.

Thirdly, this study does not only analyse the effects of conflict on different sectors, but also

addresses the heterogeneous nature of political violence itself. Previous studies found that

separatist conflicts are commonly geographically concentrated further from the capital city and

closer to the borders of a country than non-separatist conflicts, which is more likely to affect the

entire country. It can therefore be argued that the two types of political violence affect investments

differently, as in the case of a separatist conflict it might be easier to evade political violence by

locating a subsidiary outside of an affected region. We find that in the short-term non-separatist

conflicts have larger effects on MNEs in non-resource sectors than separatist conflicts, but we find

no evidence that FDI in the natural resource sector is more affected by non-separatist than

separatist conflicts. An explanation for this finding is that natural resource MNEs’ only have limited

23
investment options and might hence not have the option to invest in another region of the same

country. When the ICRG is used to measure political violence, no significant difference between the

two types of conflict is found.

The main limitation of this research is that it cannot establish a causal relation between FDI

and political violence and as a result, the results should be interpreted as conditional associations.

Finding sources of exogenous variation in political violence that can be exploited in a panel set up is

particularly challenging. Although it is unlikely that aggregate FDI flows have a direct effect on the

number of battle-related deaths, it might be that FDI in the natural resource sector affects political

violence - particularly violence with separatists motives - by intensifying grievances or increasing the

perceived gains of a secession. We tackle this problem by including a fixed effects and a large set of

control variables, including income and the quality of institutions. In the robustness analyses we also

control for the discovery of large oil and gas reserves, as it is likely the discovery of valuable

resources rather than the involvement of a MNE fuels conflict. This additional control variable does

not change our main results.

Political violence is most detrimental to non-resource greenfield FDI that are most essential

for job creation and economic diversification. Conflicts are often ascribed to a lack of economic

opportunities; the Arab Spring is a well-known example. In addition, it is often asserted that FDI in

services and manufacturing can create positive spill-overs and as such enhance economic growth.

We show that MNEs that are active in these industries are deterred by political violence. This not

only adds to the damage of political violence itself, but also exacerbates its economic consequences,

which might make it more difficult to create peace.

This study explores the effect of political violence on greenfield FDI flows to developing

countries and considers how the characteristics of a host country and the political violence there

affect MNEs location decision. Further research could examine sectoral FDI and conflict at the sub-

national level. As such, it is possible to take into account the distance from epicentre of a conflict,

the exact location of a MNE within the country, and the role of oil-rent sharing between subnational

24
and national governments. In addition, the interaction between political violence and characteristics

of a MNE can be considered to study what makes a MNE more likely to invest in an affected region.

25
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 Appendix 1: Descriptive Statistics and Correlation matrix

Variable Mean S.D. Min Max (1) (2) (3) (4) (5) (6) (7) (8) (9

(1) BRD (ln) 1.459 2.760 0 9.731 1

(2) Secessionist 0.065 0.247 0 1 0.374 1

(3) GDP current USD (billions) 142 520 0.409 7320 0.046 0.110 1

(4) Exchange Rate 4.324 2.804 -0.352 16.022 0.156 -0.096 -0.149 1

(5) Exchange Rate volatility 0.008 0.013 0.000 0.247 0.067 -0.035 -0.055 0.102 1

(6) Inflation 8.522 9.349 -32 102 0.041 0.016 -0.032 0.082 0.037 1

(7) WGI Regulatory Quality -0.482 0.608 -2.260 1.210 -0.176 0.047 0.140 -0.324 -0.081 -0.232 1

(8) Combined Polity Score 2.743 5.478 -9 10 0.008 -0.002 -0.060 -0.039 0.036 -0.075 0.506 1

(9) Major oil/gas discovery 0.0787 0.270 0 1 0.031 0.043 0.410 -0.049 -0.024 0.041 -0.071 -0.014 1

(10) Global oil & gas reserves (std) -0.002 1.049 -0.995 2.022 0.0143 -0.0159 0.0888 0.0277 -0.0496 0.0307 0.0307 0.06

(11) Oil/gas price index 187 48 100 266 0.017 0.027 0.064 0.015 -0.062 0.141 0.020 0.081 0.0

Appendix 2: Results of a Fixed Effects model (LSDV), Random Effects model and an OLS-model.

Total FDI
FE RE OLS
BRDt-1 (ln) -0.141*** -0.065** -0.065**
(0.052) (0.030) (0.030)
Ln(BRD)*secessionistt-
1 0.148** 0.063 0.063
(0.058) (0.040) (0.040)
Observations 731 731 731
Number of countries 93 93 93
Country FE Yes Yes Yes
Year FE Yes Yes Yes
Bootstrapped standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.10

Resource FDI
FE RE OLS
BRDt-1 (ln) -0.023 0.013 0.013

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 (0.093) (0.041) (0.041)
Ln(BRD)*secessionistt-
1 0.154 -0.026 -0.026
(0.117) (0.057) (0.057)
Observations 731 731 731
Number of countries 93 93 93
Country FE Yes Yes Yes
Year FE Yes Yes Yes
Bootstrapped standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.10

Non-Resource FDI
FE RE OLS
BRDt-1 (ln) -0.180*** -0.084** -0.084**
(0.045) (0.035) (0.035)
Ln(BRD)*secessionistt-
1 0.222*** 0.098** 0.098**
(0.056) (0.045) (0.045)
Observations 731 731 731
Number of countries 93 93 93
Country FE Yes Yes Yes
Year FE Yes Yes Yes
Year FE Yes Yes Yes
Bootstrapped standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.10

33