factors are not correctly accounted for. This, however, is usually well undertaken in the literature, although without being sufficiently documented.

But, what the literature does not usually account for, is the relation between terrorism and the degree of specialization of countries. In fact, it is interesting to see that most of the economies that are source or host of incidents are developing countries that are mainly specialized in agriculture, natural resources and manufacturing employing intensively those resources (ITERATE). Whereas countries like Saudi Arabia, Iran or even Colombia are specialized in oil production and oil related products like plastic (especially Saudi Arabia), Latin American countries in general (including Colombia) exploit intensively some natural resources from agriculture and fishing (Argentina, Cuba, Colombia, Chile, Puerto Rico) to mineral resources (Peru) and mining (Chile). As differences in specialization between developing and developed countries represent another important factor to trade, this is then another reason why one could retrieve a relationship between terrorism and bilateral trade if the degree of specialization of countries is not controlled for in the trade regression.

This underlines the importance of relevant controls in gravity regressions like (1) and it emphasizes the importance of robustness checks to disentangle the true causality link from transnational terrorism to bilateral trade

# **B/ Income Effects**

A second aspect has to do with the channel through which terrorism is affecting trade. All papers in the above literature describe the effects of transnational terrorism on trade through an increase in trade costs. Therefore, they assume as exogenous GDP and GDP per capita and do not take into account the potential effect of terrorism on trade through the impact on GDP and GDP per capita as suggested for instance in equation (6). This may in principle, underestimate the effect of transnational terrorist activities on bilateral trade How big could be the underestimating bias? To get an idea of this, one may start from the literature on the macroeconomic effects of terrorism. Using again the ITERATE data from 1968 to 2000, for instance, Blomberg, Hess and Orphanides (2004) investigate the effect of terrorism on economic growth. In their panel growth regressions with time and country fixed effects, they find that terrorism has a small negative and statistically significant effect on growth rates: a terrorist attack reduces growth by about 0.5 percent in a given year<sup>7</sup> . Interestingly, they note that the impact is associated to a shift from investment expenditures to government spendings and that the negative impact of terrorism in advanced and democratic economies is smaller than in developing countries.

This result is somewhat confirmed by Tavares (2004) using the dataset of IPIC (the _International Policy Institute for Counter-Terrorism_ (2003)). Under a shorter period 1987-2001 and measuring the incidence of terrorism by the number of terrorist attacks divided by absolute population, Tavares finds that one standard deviation of that variable tends to decrease GDP growth by 0.2%. After controlling for extra growth determinants, however the incidence of terrorism on growth becomes insignificant.

> 7Internal conflicts and external conflicts have much higher impacts (respectively reductions of about 1,4% and 4% of growth in a given year).

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