The impact of conflict on the shadow economy and FDI : evidence from causal and spatial inference

Alfar, Abdelrahman J. K.

Business; Economics
March 2022

Thesis or dissertation

© 2022 Abdelrahman J K Alfar. All rights reserved. No part of this publication may be reproduced without the written permission of the copyright holder.

Conflict affects governance policies, rendering them fewer effective tools, which motivates people to move into the informal sector. The shadow economy activities are labour intensive and suitable for adoption with low-return capital and small-scale production. They inefficiently use the factors of production, and distort the investment environment. Moreover, the shadow economy affects official macroeconomic measurements such as of gross domestic product, consumption expenditure, the unemployment rate, and the labour force. This motivates researchers and policymakers to pay more interest to study the phenomena of the shadow economy. Therefore, this study uses the event study approach to infer whether contemporaneous conflict affects the size of the shadow economy in subsequent years. Further investigations using the difference in differences approach are conducted to test the impact of Intifada, a political conflict event that has harmed the Palestinian and Israeli economies, on the size of the shadow economy in both countries.
While conflict is one phase of political unrest, it harms economies, and diminishes capital stock when armed forces and rebels target infrastructure, which is either damaged or demolished. Moreover, armed conflict increases the depreciation rate, encourages capital flight, deters new investment opportunities, and accelerates loss for businesses. Motivated by these facts, this thesis also tests the hypothesis that conflict could have an impact on FDI in the mining sector. To do that, an event-study approach is implemented that focuses on the possible dynamic and spatial spillover effects of conflict on FDI.
The study finds that conflict has had a dynamic impact on the shadow economy that remains statistically significant over a span of three years. Moreover, its impact becomes higher when conflict turns out to be more intensive, yet it loses dynamism. Additionally, Intifada is found to have affected the Palestinian economy, but not the Israeli one.
The results show inconsistency across different groups of countries for the dynamic impact of conflict on FDI in the mining sector. Furthermore, the study does not find significant spillover effects across neighbouring countries.

Business School, The University of Hull
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