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Gambling on Conflict: Profiling Investments in Conflict Countries
Unformatted Document Text:  Andreea Mihalache Updated: March 20, 2008 au-Prince, despite repeated losses due to political violence. This mango and peppers processing plant has lost $434,110 in 1993 and $305,900 in 1994, because of the trade embargo that followed the coup against Aristide, but its parent company has not sought to relocate it. Aggregate figures tell a similar story: foreign investments continue to flow to countries facing political violence. Figure 1 depicts the variation in aggregate FDI inflows in Haiti, throughout both peace and conflict years. Figure 2 includes graphs of FDI inflows to a set of other countries that, like Haiti, underwent several periods of conflict. Figure 1 and Figure 2 here The fact that developing countries facing such high probabilities of political violence continue to receive FDI inflows is surprising. As conventional wisdom has it, all foreign investors should avoid countries where political violence is present or highly probable. This belief is based on two assumptions. First, the investment environment in developing countries is relatively homogenous, with low labor costs and, more often than not, foreign investor-friendly legislation. Second, the presence of political violence increases the risks associated with investments, which results in higher costs for the investors. Given that developing hosts are interchangeable for many firms, and also given the high costs resulting from political violence, rational foreign investors select conflict-free locations. The data, however, tell a different story. It is true that overall levels of FDI are lower in periods surrounding incidences of political violence. It is also true that FDI inflows to countries undergoing conflict do not cease completely and, in some industries, remain unchanged or even increase. But how can this be? Relaxing the second 7

Authors: Mihalache, Andreea.
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background image
Andreea Mihalache
Updated: March 20, 2008
au-Prince, despite repeated losses due to political violence. This mango and peppers
processing plant has lost $434,110 in 1993 and $305,900 in 1994, because of the trade
embargo that followed the coup against Aristide, but its parent company has not sought to
relocate it. Aggregate figures tell a similar story: foreign investments continue to flow to
countries facing political violence. Figure 1 depicts the variation in aggregate FDI
inflows in Haiti, throughout both peace and conflict years. Figure 2 includes graphs of
FDI inflows to a set of other countries that, like Haiti, underwent several periods of
conflict.
Figure 1 and Figure 2 here
The fact that developing countries facing such high probabilities of political
violence continue to receive FDI inflows is surprising. As conventional wisdom has it,
all foreign investors should avoid countries where political violence is present or highly
probable. This belief is based on two assumptions. First, the investment environment in
developing countries is relatively homogenous, with low labor costs and, more often than
not, foreign investor-friendly legislation. Second, the presence of political violence
increases the risks associated with investments, which results in higher costs for the
investors. Given that developing hosts are interchangeable for many firms, and also
given the high costs resulting from political violence, rational foreign investors select
conflict-free locations.
The data, however, tell a different story. It is true that overall levels of FDI are
lower in periods surrounding incidences of political violence. It is also true that FDI
inflows to countries undergoing conflict do not cease completely and, in some industries,
remain unchanged or even increase. But how can this be? Relaxing the second
7


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