The Role of Foreign Direct Investment in Post-Conflict Economic Recovery and Peace-Building

Abstract

Recently, post-conflict foreign direct investment (FDI) has garnered scholarly interest due to its potential for ending the “poverty-conflict trap” endured by many developing countries. However, few empirical studies have investigated whether FDI breaks such a vicious poverty-conflict cycle and, if so, how. Using intrastate armed conflict data from 1970 to 2019, where more than half the states experienced civil conflict recurrence, we test whether FDI curbs post-conflict onset through the mediation of economic recovery. Empirical results from two-stage generalized structural equation models appear to show that post-conflict FDI increases the magnitude of economic reconstruction and lessens grievances, indirectly decreasing the probability of conflict recurrence. Empirical findings also offer evidence in support of the mediation mechanism. We conclude that post-conflict FDI is a catalyst that could help war-torn countries escape the poverty-conflict trap.

Récemment, l'investissement direct à l’étranger (IDE) après un conflit suscite l'intérêt des chercheurs, car il pourrait mettre fin au « piège conflit-pauvreté » que connaissent nombre de pays en développement. Cependant, peu d'analyses empiriques ont cherché à déterminer si l'IDE cassait ce cercle vicieux conflit-pauvreté et, le cas échéant, de quelle manière. À l'aide de données sur les conflits armés intraétatiques entre 1970 et 2019, période durant laquelle plus de la moitié des États ont vu réapparaître un conflit civil, nous évaluons si l'IDE maîtrise les affrontements après un conflit par la médiation de reprise économique. D'après les résultats empiriques issus de modèles d’équations structurelles généralisés à deux étapes, l'IDE après un conflit accroît l'ampleur de la reconstruction économique et atténue les griefs, et donc réduit indirectement la probabilité de récurrence du conflit. Les résultats empiriques présentent aussi des éléments qui viennent appuyer un mécanisme de médiation. Nous concluons que l'IDE après un conflit est un catalyseur qui pourrait aider les pays déchirés par la guerre à échapper au piège conflit-pauvreté.

Durante los últimos años, la inversión extranjera directa (IED) que tiene lugar después de los conflictos ha suscitado interés académico debido a su potencial con relación a poner fin a la «trampa de la pobreza y el conflicto» que padecen muchos países en desarrollo. Sin embargo, se han realizado pocos estudios empíricos que hayan investigado si la IED contribuye a romper este círculo vicioso de pobreza y conflicto y, en caso afirmativo, de qué manera lo hace. Utilizamos datos procedentes de conflictos armados intraestatales de entre 1970 y 2019, en los que más de la mitad de los Estados vivieron algún tipo de repetición de conflictos civiles, con el fin de comprobar si la IED modera las probabilidades de ataques posteriores al conflicto a través de la mediación de la recuperación económica. Los resultados empíricos obtenidos de los modelos de ecuaciones estructurales generalizadas en dos etapas parecen demostrar que la IED que tiene lugar después de un conflicto aumenta la magnitud de la reconstrucción económica y disminuye los agravios, lo que reduce, de forma indirecta, la probabilidad de que se repitan los conflictos. Las conclusiones obtenidas de los datos empíricos también ofrecen evidencia que apoya el mecanismo de mediación. Concluimos, por tanto, que la IED que tiene lugar después de los conflictos funciona como un catalizador que podría ayudar a los países asolados por la guerra a escapar de la trampa de la pobreza y los conflictos.

Introduction

Post-conflict countries face many difficulties. One challenge is the lack of sufficient economic capacities, as substantial human and financial capital loss, coupled with the collapse of infrastructure and well-functioning economic institutions during unrest, weakens post-conflict economies. Worse, scholars warn that protracted economic instability causes post-conflict countries to plunge back into violence, inviting the so-called “poverty-conflict trap” (Collier 2003; Walter 2004; Collier and Hoeffler 2004b). Conversely, recent studies suggest foreign direct investment (FDI) could promote economic reconstruction and growth in post-conflict countries, lessening the grievances that precipitate conflict recurrence (Turner, Aginam, and Igbokwe 2010; Yelpaala 2010). FDI's possible benefits have led scholars to study the effects of post-conflict environments for attracting FDI (Flores and Nooruddin 2009a; Garriga and Phillips 2013; O'Reilly 2015; Joshi and Quinn 2020).

Despite the ample conflict and FDI work, few empirical studies have reversed the causal arrows and considered if FDI could reduce the likelihood of conflict recurrence in post-conflict states. Limited work has also examined if FDI might support economic recovery in post-conflict countries, potentially ending the poverty-conflict trap. The lack of scholarship is surprising as research has identified FDI as a critical factor that promotes interstate (Gartzke, Li, and Boehmer 2001; Lee and Mitchell 2012) and intrastate peace (Barbieri and Reuveny 2005; Mihalache-O'Keef 2018).

This study evaluates the indirect effect of FDI in post-civil conflict countries. Using intrastate armed conflict termination data from 1970 to 2019 (Kreutz 2010), where more than half the states endured conflict recurrence (Walter 2010), we find post-conflict FDI appears to increase the likelihood and magnitude of economic recovery. As the literature observes (e.g., Markusen and Venables 1999), FDI promotes jobs, improves employee productivity, and directly and indirectly raises tax revenues, likely fueling economic development. Economic recovery, in turn, helps to reduce the factors that cause grievances, decreasing conflict recurrence. The results suggest that post-conflict FDI may allow war-torn countries to escape the poverty-conflict trap.

Our study has several implications. First, although earlier studies assumed FDI supports economic development and eventually sustainable peace in post-conflict countries (Appel and Loyle 2012; Garriga and Phillips 2013; O'Reilly 2015), researchers have not empirically tested the relationship between FDI and conflict recurrence. Our work helps fill a gap in the literature. Second, recent studies have produced mixed findings on the impact of FDI on civil war onset. Some research suggests that FDI can suppress civil wars (Barbieri and Reuveny 2005; Bussmann and Schneider 2007) and reduce their intensity (Blanton and Apodaca 2007). Conversely, other studies argue that FDI has a weak effect or no significant effect on intrastate conflict (Hegre et al. 2003; Sorens and Ruger 2014). Additionally, some scholars contend that FDI may increase the risk of civil war onset (Pinto and Zhu 2022), or its effects may vary depending on the sector (Mihalache-O'Keef 2018; Brazys et al. 2023), or the mode of investment (Beuck et al. 2022). Although our focus is on conflict recurrence, our findings suggest how FDI helps to support economic reconstruction and lessens grievances, identifying the theoretical mechanism by which FDI promotes peace in post-conflict governments. Third, we find that not all foreign economic programs are alike. Many studies have documented the ineffectiveness of foreign aid in post-conflict countries (Collier and Hoeffler 2004a; Flores and Nooruddin 2009b), and particularly its negative effects in poorly managed nations—a situation that applies to most post-conflict countries (Collier and Dollar 2001, 2002). Our research shows the benefits of FDI and offers guidance to countries’ policymakers and government officials seeking to avoid post-conflict recurrence.

Civil Conflict Recurrence

Civil conflict recurrence is a common phenomenon, and the literature has identified its three broad determinants: structural, political, and economic conditions. Beginning with structural conditions, studies recognize that certain ones are conducive to durable peace. For example, if one group's decisive victory destroys the defeated group's organizational and military capacities after a previous civil war, it may raise the costs too high for challenging a new regime (Wagner 1993; Licklider 1995; Zartman 1995; Walter 2004). Another example of structural conditions is when civil wars end in negotiated settlements. Many studies find that the presence of peacekeeping forces enhances post-conflict peace duration (Fortna 2004, 2008; Doyle and Sambanis 2006; Hartzell and Hoddie 2007; Mross et al. 2022), while factors including external support to rebels (Karlén 2017), rebel fragmentation (Rudloff and Findley 2016), or transnational support for Islamist rebels (Nilsson and Svensson 2021) increase conflict recurrence risk. Scholars also show that previous conflict characteristics affect conflict recurrence risk (Walter 2004; Mason et al. 2011). Quinn, Mason, and Gurses (2007), for instance, find that countries that incurred prolonged conflict are less likely to suffer a recurrence because of the known high costs, while a high-casualty war is more prone to recur due to the distrust and hostility among protagonists.

The recurrence literature also suggests political conditions and particularly post-conflict governance influence the risk of civil war recurrence. Several studies find post-conflict political arrangements involving power sharing, such as the inclusion of former opponents in post-war governance or greater female representation, facilitate post-conflict peacebuilding and promote a durable peace (Hartzell and Hoddie 2003; Mukherjee 2006; Joshi and Mason 2011; Shair-Rosenfield and Wood 2017), while others argue a stable balance of power between the government and rebel groups is critical, as it discourages one or both parties from resuming armed conflict (Joshi 2010). Strong political institutions are another political determinant that impact civil war recurrence, as good post-conflict governance with strong political institutions significantly reduces recurrence, helping post-conflict countries escape the poverty-conflict trap (Walter 2015). Still others contend election timing matters, finding early elections, especially in new democracies, hasten recurrence (Flores and Nooruddin 2012), but favorable conditions (e.g., decisive victories, demobilization, peacekeeping, power sharing, etc.) can lessen this risk (Brancati and Snyder 2013).¹ Scholars also emphasize building post-conflict justice institutions that address grievances for keeping the peace (Loyle and Appel 2017).

Lastly, scholarship highlights economic development as a determinant of post-civil war peace (Paris 2004; Walter 2004; Collier et al. 2008; Collier, Hoeffler and Söderbom 2008; Kreutz 2010; Mason et al. 2011). Much post-conflict literature finds economic underperformance (including higher poverty) and low economic development lead to countries falling into a conflict trap (e.g., Collier and Hoeffler 2004b; Hegre and Sambanis 2006; Braithwaite, Dasandi, and Hudson 2016). Economic development is key because it creates jobs, raising government revenues and capacities to provide public services. Increased job and government assistance also promote citizens’ overall welfare, reducing grievances against the state, and upholding a socio-economic environment that is less susceptible to conflict resumption (Walter 2004).²

The literature indicates structural, political, and economic conditions influence civil war recurrence. In the next section, we discuss the role of FDI-induced economic development in creating jobs, indirectly increasing the government's economic capacities, and alleviating popular grievances, serving as possible intermediate pathways between FDI and civil war recurrence.

Effect of FDI On Economic Recovery and Civil War Recurrence

Before developing our theoretical arguments connecting FDI, economic recovery, and civil war recurrence, we assume prospective host countries do not necessarily attract initial FDI or added foreign capital following the cessation of civil conflict. Although the termination of civil wars presents opportunities for foreign capital to enter war-torn countries, post-conflict countries often receive differing levels of investor interest. As FDI studies show, many political, economic, and social factors affect foreign investors (e.g., Li and Resnick 2003; Jensen 2006). Some countries attract more FDI than do others, and the end of conflict may not trigger foreign capital flows in post-conflict countries (Appel and Loyle 2012; O'Reilly 2015; Bak and Lee 2021). While our study does not attempt to explain FDI determinants, the assumption that the end of civil conflict has varying effects on foreign capital flows reflects the reality in host countries.³

Unlike prior studies, our research focuses on FDI's impact on economic recovery and conflict recurrence once firms invest in post-conflict countries. Again, the literature has assumed FDI supports economic development, without empirically and systematically identifying the link between FDI in host countries and ending the poverty-conflict trap. Although there are studies that question the benefits of FDI on the economy, suggesting that the mode of entry (Aitken and Harrison 1999), investment sector (Chaudhury, Nanda, and Tyagi 2020), and the perceptions of economic insecurity produced in industries in which foreign firms operate (Scheve and Slaughter 2004) limit the gains from FDI, much research highlights the high demand for FDI in host states. The main task for us is to determine if foreign capital may positively influence economic recovery while imparting negative effects on conflict recurrence.

Although our focus is on FDI's indirect effect, we note that political economy scholars have long emphasized the direct link between economic globalization and intrastate conflict (Wager and Shulz 1995; Barbieri and Reuveny 2005; Blanton and Apodaca 2007; Beuck et al. 2022). Among several perspectives, we highlight two mechanisms where FDI can reduce the likelihood of conflict recurrence. First, we find that the opportunity costs that FDI generates against warring parties are greater in a post-war society, deterring conflict recurrence (Bussmann and Schneider 2007; Okafor and Piesse 2017). Civil wars deplete existing economic assets and lower national income (Collier 1999; Murdoch and Sandler 2002), and FDI is difficult to attract since foreign investors often view post-conflict countries as high-risk (Appel and Loyle 2012). Renewed civil war forces foreign firms to leave, causing both governments and rebels to forgo revenue needed for economic recovery and growth, reducing labor-force income. Moreover, the presence of foreign firms increases audience costs in global markets, discouraging governments from using repressive tactics against opposition groups because negative press abroad can harm future FDI flows (Blanton and Apodaca 2007). In essence, FDI makes the fruits of peace outweigh the expected benefits of renewed civil war for both governments and rebels (Barbieri and Reuveny 2005).

Second, we find that FDI-driven economic recovery can provide governments with revenues that deter or put down rebellions (Fearon and Laitin 2003; Collier and Hoeffler 2002). Studies on civil war recurrence suggest that weak governments are more susceptible to civil war (Mason and Krane 1989; Benson and Kugler 1998; Quinn et al. 2007). As Fearon and Laitin (2003, 75–76) explain it, “financially, organizationally, and politically weak central governments render insurgency more feasible and attractive due to weak local policing or incept and corrupt counterinsurgency practices.” Supporting this view, previous studies indicate that FDI increases tax revenues by broadening the available tax base and enhancing state resources (Becker et al. 2012; Kim 2022), while also promoting employment, balance of payments, and industrial base diversification (Garrett and Mitchell 2001; Ashraf et al. 2017). With increased revenue and resources, governments become more capable and efficient in deterring rebellions.

In considering FDI's indirect influence on economic recovery, we contend foreign investment has positive impacts on post-conflict economies. First, FDI provides capital that supports host country job growth (OECD 1995; Dunning and Lundan 2008; UNCTAD 2000). When FDI involves greenfield investment, multinational corporations (MNCs) directly create jobs and do so indirectly for local firms serving MNC supply chains (Rhee 1990). Job creation, in turn, may promote economic growth and alleviate grievances, as high unemployment often spurs unrest (Miaari, Zussman, and Zussman 2014). Indeed, a World Bank (2011, 80) survey reported that “forty percent of all respondents said they joined a rebel group because they were unemployed,” suggesting that rebels turn to soldiering to make ends meet (Hirshleifer 2001; Grossman 2002). MNCs also tend to pay higher wages than their domestic counterparts (UNCTAD 2000, 184), potentially limiting societal grievances. Thus, we posit FDI job creation can decrease grievances, helping to end the poverty-conflict trap (Collier et al. 2003; Fearon and Laitin 2003).

Second, MNCs provide technical and managerial expertise, and agglomeration opportunities that facilitate employee productivity, increasing domestic company competitiveness (Wang and Blomstrm 1992; De Mello 1997; Barry et al. 2003). According to Markusen and Venables (1999, 352), it is possible “for FDI to act as a catalyst, leading to the development of local industry, which may in turn become so strong as to reduce both the relative and absolute position of multinationals in the industry.” Although foreign companies could crowd out domestic industries (Aitken and Harrison 1999), preventing nascent domestic sector growth (Zhang et al. 2010), many empirical studies and case work show how FDI has a positive effect on domestic firms' productivity and export capacity (Blomström 1991; Blomström and Wolff; Hobday 1995; Blomström and Kokko 1998). Potential and active domestic employees who worked for foreign firms may eventually obtain local firm employment, transferring the skills they learned from the MNCs to domestic industries (Fosfuri, Motta and Ronde 2001). Such employment could result in domestic industries overtaking and forcing out FDI plants (Markusen and Venables 1999). Thus, FDI could help post-conflict economies indirectly achieve greater production efficiency and higher levels of development, spurring exports and economic progress.

Third, FDI can help revitalize economic activities and raise government revenues (Becker et al. 2012), indirectly aiding government capacities to rebuild devastated infrastructure (Blomström and Kokko 2003) and promote social programs (e.g., Gemmell et al. 2008). Much work has considered fiscal capacity and its effects on developing countries (see Flores and Nooruddin 2016; Queralt 2022). Bastiaens and Rudra (2018), for example, contend that trade liberalization has reduced (or eliminated) taxes and tariffs on trade, a primary source of government revenue, triggering a large fiscal hole in the developing countries’ budgets. Similarly, Flores and Nooruddin (2016) contend post-conflict governments need “fiscal space” (i.e., resources to fulfill popular demands and campaign promises) to legitimize fair elections and foreign aid or abundant natural resources to support the provision of public goods. Likewise, Queralt (2022) observes how easy access to foreign lending at early stages of state building contributes to chronic fiscal instability and weakens state capacity, a common concern for post-conflict countries. Unlike trade reform fiscal challenges, limited foreign aid or natural resource stocks, or extreme loan conditionality, FDI-sponsored job creation, and the economic growth it generates, likely provides positive direct and indirect effects on the state's fiscal space and ability to spend domestically via tax transfer, extending the provision of public goods and decreasing the root causes of grievance and conflict in host states (Gurr 1968; Regan and Norton 2005; Burgoon 2006; Heo and Ye 2019). Thus, FDI increases government revenue through reduced unemployment, balance of payments and taxes improvements, industrial base diversification, and expansion of related industries (Garrett and Mitchell 2001; Ashraf et al. 2017).

Fourth, FDI revenues indirectly bolster government capabilities to fund public services in health care and education, as MNCs need healthy workers with some education. While a lack of public services raises poverty, inequality, and grievances, increasing civil war likelihood (Burgoon 2006; Sambanis 2001; Thyne 2006), additions in such services improve citizens’ living standards and decrease incentives for organizing rebellions (Levi 2006; Taydas and Peksen 2012). Prior work has shown FDI positively affects health expenditures (Nagel et al. 2015), social spending (Gemmell et al. 2008; Soumaré 2015), and human capital development (Gittens 2006; Zhuang 2017). Hence, we posit that FDI is likely to indirectly increase social welfare spending, decreasing grievances and lessening incentives for individuals to join rebellions.

Although FDI could raise inequality and spark conflict, as MNCs are geographically concentrated, widening the intra-country wage gap (see Feenstra and Hanson 1997; Zhuang and Griffith 2013), many studies expect FDI to reduce inequality (e.g., Jensen and Rosas 2007; Chintrakarn, Herzer, and Nunnenkamp 2012; Raza, Tariq, and Sadiqa 2021; Topalli et al. 2021). Indeed, FDI could promote more employment for lower skilled workers, which may reflect rebels entering the workforce, helping decrease income inequality (Bogliaccini and Egan 2017). Thus, we expect FDI to indirectly benefits post-conflict economic recovery and peacebuilding.

Fifth, FDI might influence the development of more effective political institutions or governance structures in post-conflict societies. Previous studies have shown how FDI impacts local politics (Malesky 2008). An important element for host states in attracting FDI is respect for the rule of law and property rights protection to create more stable conditions (Li and Resnick 2003; Biglaiser and Staats 2010). Based on MNCs' local-level influence and their institutional preferences, it is plausible that MNCs directly or indirectly encourage host states to support more sound property rights during the peacebuilding processes, which help draw in greater FDI.

In sum, we argue FDI indirectly provides states with openings to address unemployment and poverty that scholarship identifies as primary factors causing civil conflict and its recurrence (Fearon and Laitin 2003; Collier and Hoeffler 2004b; Walter 2010; Hegre et al. 2017, 15).⁴ Given the well-established causal path from economic development to post-conflict peace, we contend FDI indirectly backs economic development and reduces post-conflict recurrence. Figure 1 summarizes our theoretical expectations.⁵

Research Design

For our unit of analysis, we use post-intrastate-armed-conflict-dyad-year from 1970 to 2019 drawn from the UCDP Conflict Termination Dataset version 3–2021 (Kreutz 2010). Each dyad-year consists of a pair of the government and a rebel group in a given conflict-year. While a post-conflict country's FDI and economic recovery are country-level variables, our dependent variable (recurrence) is a dyadic variable that can be measured only in the context of a particular armed conflict. Post-conflict-dyad-year as the unit of analysis inflates the number of observations in our sample because some countries experienced multiple armed conflicts simultaneously and the same country-level information appears redundantly. However, the country-year setup does not allow us to accurately identify recurrence cases for multiple reasons. First, the country-year unit of analysis makes it difficult to define post-conflict years. Many post-conflict years followed by conflict termination overlap with new or ongoing conflicts. For example, the Ethiopian government's conflict with Ethiopian People's Revolutionary Party (EPRP) ended in 1987. Yet, in the same year, there was an active conflict with the Tigrayan People's Liberation Front (TPLF), and a new conflict with Ethiopian People's Revolutionary Democratic Front (EPRDF) erupted in 1989. With respect to the conflict with EPRP, 1988 and subsequent years are post-conflict years. However, 1988 is not a post-conflict year in the context of the conflict with TPLF, and years between 1989 and 1991 are not post-conflict years with regard to the conflict with EPRDF. If we treat all these different conflict-dyads as the same conflict in a country-year setup, we would omit many post-conflict years and lose important conflict-specific information. Second, putting all different conflict-dyads in the general category of conflict would conflate conflict onset with recurrence. In the same Ethiopian example, two recurrence cases are recorded between 1975 and 1991, while seven different conflict episodes occurred. Counting all these conflicts as cases of conflict resumption would artificially inflate the number of recurrence cases. Third, disregarding dyadic conflict episodes would wipe out some critical predictors of recurrence, such as conflict duration, intensity, issues, and type of termination. Fourth and most importantly, recurrence is measured at the dyadic level in the UCDP dataset. The post-conflict-country-year unit of analysis would inevitably lead to measurement error. Thus, we choose post-conflict-dyad-year as the unit of analysis. Monadic analysis is also performed for robustness checks.

We include both minor (between 25 and 999 battle-related deaths) and large-scale (at least 1000 battle-related deaths) intrastate armed conflicts.⁶ Excluding conflicts below the 1,000 battle-death threshold drops not only low-intensity conflicts but also moderately high-intensity conflicts, in turn discarding about 85 percent of observations in the regression sample. Thus, we include all conflicts in the regression sample while controlling for the level of conflict intensity.

Model Specification

We summarize the empirical model in the following equations and explain in detail the variables in each equation below.⁷

In equation (1), the mediator (⁠|${{M}_{i,t}}$|⁠) is a linear function of FDI (⁠|${{X}_{i,t}}$|⁠) along with a set of control variables (⁠|${{C}_{i,t}}$| and |${{H}_{i,t}}$|⁠).⁸|${{\gamma }_1}$| in equation (1) shows the direct effect of FDI on economic recovery, which is equivalent to |$\overrightarrow {XM} $| in figure 1. Equation (2) estimates the probability of conflict recurrence as a function of the mediator and FDI.⁹|${{\beta }_1}$| in equation (2) shows the direct effect of the mediator on conflict recurrence (⁠|$\overrightarrow {MY} $|⁠), while |${{\beta }_2}$| represents the direct effect of FDI on recurrence (⁠|$\overrightarrow {XY} $|⁠). The nonlinear combination of |${{\gamma }_1}$| and |${{\beta }_1}$| yields the indirect effect of FDI on recurrence (⁠|$\overrightarrow {XMY} $|⁠).¹⁰ Equation (3) shows an FDI equation that addresses the endogenous relationship between FDI and conflict recurrence using an instrumental variable (⁠|${{I}_{i,t}}$|⁠).

Dependent Variable

The dependent variable (Y) in equation (2) is conflict Recurrence. This dichotomous variable is coded as one if a post-conflict country has experienced a recurrence of the same conflict (dyad) since termination, and zero otherwise. We obtain the data for this variable from the UCDP Conflict Termination Dataset version 3–2021 (Kreutz 2010).

Independent Variable

The independent variable (X) uses three indices of FDI: log of FDI per capita (FDI_pc), FDI as percentage of GDP (FDI_gdp), and log of FDI inflows in millions of U.S. dollars (FDI_inflows)¹¹ taken from the United Nations Conference on Trade and Development (UNCTAD) database (UNCTAD 2022). FDI per capita and FDI as a percentage of GDP appear to be more relevant to our theory because they capture the relative reliance of a post-conflict country's economy on FDI (Li 2009).¹² However, multiple other variables contain the redundant information about a country's GDP.¹³ Thus, we also use FDI net inflows as an alternative measure of FDI.

Mediator

We use economic Recovery as the mediator (M) in equation (1) comparing pre-conflict GDP per capita with post-conflict GDP per capita. We draw the information about a country's GDP and population from Penn World Table Version 10.01 (Feenstra, Inklaar, and Timmer 2015). One can use a dichotomous measure that shows whether a post-conflict country's GDP per capita returns to the pre-conflict level or higher. However, using a dichotomous variable loses information about the extent to which a post-conflict country's economic conditions improved compared to the pre-conflict period. In doing so, for example, a 1 percent increase in GDP per capita in post-conflict years would be treated as the same as a 100 percent increase. Instead of a dichotomous measure, we construct a continuous measure of the percentage change in GDP per capita relative to the level of GDP per capita in the previous year of conflict onset.¹⁴ Since it is difficult to pinpoint the exact pre-conflict period for comparison, we also use an alternative continuous measure by Recovery-3yr-MA measuring the percentage change in GDP per capita from the pre-conflict three-year moving average to the current GDP per capita. Additionally, we use three other measures for robustness checks: (1) Recovery-5yr-MA using the pre-conflict five-year moving average as the reference measure, (2) Recovery-3yr-Max comparing the post-conflict GDP per capita with the maximum level of GDP per capita during the three most recent pre-conflict years (Flores and Nooruddin 2009a,b), and (3) Recovery-5yr-Max using the maximum five-year pre-conflict GDP per capita as the reference measure.¹⁵

Control Variables

The control variables (⁠|${{C}_{i,t}}$|⁠) include: (1) Govt. Victory (coded as one if a government's decisive victory terminated a conflict and zero otherwise), (2) Territory (coded as one if the warring parties fought over a territory and zero otherwise), (3) PKO (coded as one if peacekeeping forces are present and zero otherwise) (Hegre, Hultman, and Nygard 2019), (4) Intensity (coded as zero for conflicts with 25 to 999 battle-related deaths; one for those with at least 1000 battle-related deaths), (5) Duration (the number of years in conflict), (6) log of Population (Feenstra, Inklaar, and Timmer 2015), (7) log of GDP per capita (GDPpc) lagged by one year (Feenstra, Inklaar, and Timmer 2015), and (8) Peaceyears (post-conflict peace-year polynomials to control for time dependence in binary response models) (Carter and Signorino 2010).

The mediator equation also includes four additional control variables (⁠|${{H}_{i,t}}$|⁠) that are correlated with both FDI and economic growth: Human Capital Index (HCI) (years of schooling and returns to education), Employment (logged number of employed people in millions) (Feenstra, Inklaar, and Timmer 2015), Trade Openness measured by the total volume of trade as a percentage of GDP (World Bank 2018), and Foreign Aid measured by the logarithm of the net official development assistance (World Bank 2018).¹⁶ These four control variables are lagged by one year. Country-specific fixed or conflict-specific fixed effects are not used because the regression models did not converge when we included them. The summary statistics for all variables in the regression models are presented in Table A1 in theonline appendix

Endogeneity

FDI is endogenous to the likelihood of conflict recurrence, as risk-averse investors are less likely to make investments in a post-conflict country where another civil war is set to resume. To address this endogeneity issue, we use an instrumental variable (⁠|${{I}_{i,t}}$|⁠) in Equation (3). The instrument is the sum of the inverse of distance between OECD countries and each of the post-conflict countries in the sample, weighted by OECD country's economy size: |$\mathop \sum \limits_{j = 1}^k \frac{1}{{\it{distance}ij}} \times GD{{P}_i}$|⁠, where k is the number of OECD countries, j each of the OECD countries, and i each post-conflict country. This instrument is created based on two stylized facts. First, OECD countries are responsible for the majority of global FDI outflows). Second, gravity models of investment and capital flows suggest geographical distance is negatively associated with foreign investment (Wei 2000; Carr et al. 2001; Loungani et al. 2002; Markusen and Maskus 2002). Prior research has used this instrument and it is a strong predictor of FDI (Bak and Moon 2016; Pinto and Zhu 2016). We take a logarithm of this measure.

This instrument is found to be significantly correlated with FDI with little theoretical reason for a causal link to the outcome variable (recurrence). The estimation result of the FDI equation shows this instrument has significant and positive effect on FDI, and the F-statistic for this instrument easily passes the thresholds suggested by Staiger and Stock (1997) and Stock and Yogo (2005) in all models.¹⁷ More importantly, there does not appear to be any direct theoretical linkage between geographical distance and OECD countries’ GDP on the one hand and the likelihood of civil war recurrence in a post-conflict country on the other.¹⁸ One possible indirect theoretical link between the instrument and the outcome (recurrence) is that major powers may have an incentive to start military intervention in a post-conflict country to serve their strategic and/or economic interests. In this scenario, the instrument may not be purely exogenous because major powers may be geographically proximate to a post-conflict country and are responsible for a large amount of FDI outflows. Such information within the instrument is theoretically linked to our dependent variable. To tackle this issue, we construct a new instrument using the same formula while excluding any information about major powers that are often involved in military interventions in civil war regions: the United States, the United Kingdom, France, Russia, and China. The result in the online appendix using this new instrument does not alter our main findings.

Estimator

Testing the causal mechanism in figure 1 is challenging for several reasons. First, the endogenous variable (FDI) should be estimated using the instrument to guard against simultaneity bias. Conversely, the FDI equation with the instrument should be integrated with the structural equation to control for error correlation caused by unobserved confounding factors. Second, the existing estimators for (causal) mediation analysis are designed for a dichotomous/categorical treatment variable and/or a continuous dependent variable, which is not suitable for our analysis. We find that a generalized structural equation model (GSEM) is flexible enough to address these challenges and to test the mediation mechanism (see, for example, Muthén 1984; Shipley 2000; Muthén and Asparouhov 2015;Bartus 2017).

Under the GSEM framework, we employ a two-stage residual inclusion (2SRI) GSEM in which the first stage residuals are controlled in the recurrence equation while the original FDI variable is used as the independent variable as it is. The whole system of equations is bootstrapped 3,000 times. This estimator is particularly useful in directly controlling for error correlation between FDI and recurrence equations. 2SRI estimators were found to yield asymptotically consistent estimates in nonlinear two-stage models (Wooldridge 2002; Terza, Basu, and Rathouz 2008). Additionally, both the mediation and outcome (recurrence) equations use the FDI measures rather than predicted values, which allows us to calculate the indirect effect of FDI using the same measure. An alternative estimator is a two-stage-predictor-substitution (2SPS) GSEM model that uses the predicted values of FDI from the first stage as the independent variable in the recurrence equation, which poses a challenge in the calculation of indirect effect. As a robustness check, we also report the results from 2SPS models in Table A3. In all models, we use robust standard errors clustered by conflicts.

Results

Table 1 presents the results of 2SRI GSEM models using two different measures of economic recovery as the mediator: Recovery and Recovery-3yr-MA.¹⁹  Figure 2 also presents the entire regression results using all five mediators using percentile-based confidence intervals. For each moderator, we run three two-stage models using different FDI measures: FDI_pc in Models (1) and (4), FDI_gdp in (2) and (5), and FDI_inflows in (3) and (6). The first row shows the effect of FDI on economic recovery. In all six models, we find FDI has a positive and significant effect on post-conflict economic recovery. This finding shows statistical evidence for the first part of the mediation path (⁠|$\overrightarrow {XM} $|⁠) in figure 1.

We also find statistically significant results for the second causal path from economic recovery to recurrence (⁠|$\overrightarrow {MY} $|⁠). Regardless of various FDI measures and two different mediators, the results show economic recovery has negative and significant effects on conflict recurrence likelihood. These two findings indicate that the mediation mechanism operates as expected in our theory. We report the results of FDI's direct effect in the third row. FDI is found to have a negative direct effect (⁠|$\overrightarrow {XY} $|⁠) on the likelihood of recurrence (not going through economic recovery), which is statistically significant in all models. This finding indicates that there exist other significant causal mechanisms for the positive influence of FDI on post-conflict peace.

Our theoretical expectations are most relevant to FDI's indirect effect on the likelihood of recurrence. The indirect effect (⁠|$\overrightarrow {XMY} $|⁠) estimates convey two pieces of information: (1) whether FDI promotes peace through economic recovery, and (2) whether the mediation mechanism is statistically significant. In all models, we find the indirect effect of FDI on recurrence is negative and statistically significant. This finding confirms that the proposed mediation mechanism is supported by consistent empirical evidence. We calculate the proportion of FDI's indirect effect out of the total effect²⁰ and find the indirect effect accounts for about 19.7 percent of the total effect of FDI on recurrence in models using FDI per capita, 7.7 percent using FDI as percentage of GDP, and 18.3 percent using FDI flows as the independent variable. While our finding on the peacebuilding effect of FDI in general is indicative of the positive role of FDI in post-conflict countries, the sizable mediation effect explains specifically how FDI promotes post-conflict peace durability.

Additional post-estimation analysis holding control variables constant at their mean values also reveals that the indirect pacifying effect of FDI is substantial. In Model (1), as the logarithm of FDI per capita increases by one standard deviation (1.9) from the mean (2.6), increasing from $37 to $245, we expect approximately a 33 percent increase in the extent of economic recovery. Given the same change in FDP per capita, we also expect that the direct effect of FDI amounts to a 70 percent decrease in the likelihood of recurrence and the indirect effect accounts for a 23 percent decrease. In Model (2), a one standard deviation increase (5.3 percent) of FDI as a percentage of GDP from the mean (2.8 percent) is expected to be associated with a 19.3 percent increase in the extent of economic recovery. The same change in FDI as a percentage of GDP directly contributes to an 83 percent decrease in the predicted probability of recurrence, and indirectly accounts for a 14.4 percent decrease. In Model (3), as the logarithm of FDI inflows in millions increases by one standard deviation (3.3) from the mean (5.3), or a $72 million increase from $544 million, we expect that the extent of post-conflict economic recovery increases approximately 33.4 percent and the likelihood of recurrence decreases about 86.4 percent because of the direct effect. The same amount of change in FDI is attributed to a 23.5 percent decrease in the likelihood of recurrence.²¹

Although we present bootstrapped standard errors and statistical significance tests of estimated effects, the bootstrapping results can be misleading because the sampling (bootstrap) distribution of these estimates may not be normal. To make sure that our results are not driven by normal-approximation significance tests, we also present percentile-based confidence intervals in figure 2. The results show that the 95 percent confidence intervals of the indirect effect of FDI are below zero in all models. Consistent with the findings in table 1, the 95 percent confidence intervals of the effect of FDI on recovery are above zero, and those of the effect of recovery on recurrence are below zero.

Although our theory focuses on the indirect effect of FDI on recurrence, the empirical results show that a significant pacifying effect of FDI is direct. However, the total direct effect of FDI on recurrence is not entirely direct because our model does not specify other potential linkages between FDI and recurrence, and these other indirect effects are masked under the direct estimation pathway. We believe that further empirical investigation is needed to fully understand the causal mechanism between FDI and recurrence.

Regarding the performance of other variables, we find conflict termination by government victory significantly decreases the likelihood of civil war recurrence and territorial conflicts are more likely to resume than other types of conflict (Kreutz 2010). We also see that the presence of peacekeeping forces decreases the likelihood of recurrence, but the coefficient estimate is statistically insignificant. The results also show the number of employed labor forces has positive effects on economic recovery while the statistical significance fluctuates across models. In the FDI equation, we confirm the relevance of the instrument: that is, it has a positive and significant impact on FDI in all models with sufficiently large F-statistics.

We present further robustness checks in the appendix regarding (1) alternative moderators, (2) an alternative instrument, (3) the effect of foreign aid on recurrence, and (4) monadic analysis.

Policy Implications and Conclusion

Although policy circles have found that FDI played a key role in revitalizing post-conflict countries’ war-torn economies and facilitating peacebuilding efforts, academic research has generally lagged behind. In this paper, we have sought to advance the FDI and civil war discussion and develop a theoretical mechanism about how FDI might indirectly contribute to post-conflict economic recovery and peacebuilding. Our empirical findings indicate that FDI seems to increase the probability (magnitude) of economic recovery and indirectly reduce the chance of civil war recurrence. Using a two-stage instrumental approach, we demonstrated that once FDI entered (and increased in) a dire post-conflict country, positive FDI spillovers and economic development appeared to occur that potentially increased government social spending. In short, we saw how FDI might indirectly break the poverty-conflict trap. In spite of the favorable effect of post-conflict FDI, we caution that post-conflict countries’ structural conditions are hardly homogenous and FDI may not be the panacea for all post-civil war states. Our findings serve as a starting point for discussions about FDI's impact in post-conflict countries.

The results of our study contribute to the conflict-onset literature in a few ways. First, our work complements previous scholarship indicating how FDI supports economic reconstruction and growth in post-conflict countries, offering rewards that lower grievances and reduce conflict recurrence (Turner, Aginam, and Igbokwe 2010; Yelpaala 2010). The study also builds on prior research noting how FDI promotes interstate and intrastate peace (Barbieri and Reuveny 2005; Gartzke, Li, and Boehmer 2001; Rosecrance and Thompson 2003; Lee and Mitchell 2012; Mihalache-O'Keef 2018), fueling economic development, and ultimately sustainable reconciliation (Flores and Nooruddin 2009a; Appel and Loyle 2012; Garriga and Phillips 2013; O'Reilly 2015). Further, our research highlights the benefits of FDI relative to other foreign capital sources. As noted earlier, much interdisciplinary scholarship identifies the ineffectiveness of foreign aid in post-conflict countries (Collier and Dollar 2001, 2002; Collier and Hoeffler 2004a; Flores and Nooruddin 2009b). Working within an interdisciplinary framework, our study suggests the advantages FDI provides to governments attempting to secure a lasting peace. What seems critical to the success of FDI and peacebuilding is the economic activities MNCs promote that broadly create jobs, reduce grievances, and lessen the factors that give rise to conflict recurrence.

We also propose several follow-up studies to better understand the role of FDI in post-conflict economic recovery and peacebuilding. First, post-conflict countries’ absorptive capacities are critical to translating positive FDI spillovers into economic productivity of host countries. Some post-conflict countries might have experienced an extremely devastating civil war in which a significant portion of the labor force has been lost. Without sufficient quality and quantity of human capital, no matter how much financial capital and technologies foreign investors deliver, post-conflict countries may be unable to transfer them into their local economies. Unless domestic businesses become self-sustainable in the domestic and global markets by assimilating and transforming FDI spillovers, post-conflict economies are likely to remain fragile and experience only a temporary economic boost. Second, future research should explore how governments and international organizations can effectively harness FDI for post-conflict recovery. Organizations as diverse as the IMF, the World Bank, and credit rating agencies have all recommended that countries take steps to attract FDI and lessen their capital costs. Lower-cost capital is critical to the political and economic success of countries. How international organizations help to facilitate the spreading of pro-FDI economic and political institutions and capital flows is a vital area for supporting post-conflict recovery and peace. Third, we note that FDI's pacifying effects through economic recovery may not be universally held. In future research, finding the conditions under which the proposed mediation mechanism does not work, such as the mode or sector of FDI or pre-existing political or economic conditions, would be able to reveal the more nuanced effect of FDI on conflict recurrence.

In sum, the findings indicate that FDI appears to play an indirect role in promoting economic reconstruction and reducing grievances, providing the possibility of lowering the probability of conflict onset. How states use resources generated by FDI will matter, but our work suggests FDI's potential benefits to post-conflict governments who seek to minimize conflict recurrence.

Author Biography

Daehee Bak is an associate professor in the Department of Political Science at Texas Tech University. His research interests include contentious interstate relations, foreign direct investment, authoritarian politics, and human rights.

Hoon Lee is an associate professor in the Department of Political Science at Texas Tech University. His work has appeared in journals such as International Studies Quarterly, Journal of Conflict Resolution, Legislative Studies Quarterly, Foreign Policy Analysis, Review of International Organizations, Studies in Comparative International Development, and International Interactions, and International Area Studies Review.

Glen Biglaiser is a professor in the Department of Political Science at the University of North Texas. He is the author/co-author of books at the University of Notre Dame and the University of Michigan Press and has published articles in journals including Comparative Political Studies, International Organization, International Studies Quarterly, and the Journal of Politics.

Footnotes

References