# FDI position by 5%.

Our work however is more closely related to papers investigating the links between international trade in goods and transnational terrorism<sup>2</sup> . In the aftermath of September 11, the OECD was particularly concerned by the extent to which the world economy would be hit by the observed increase in security surcharges emanating from airlines, maritime transport companies or insurers due to the increase in terrorism threat (OECD (2002a), OECD (2002b)), although without giving a particular estimate of the impact on trade. Walkenhorst and Dihel (2002) use a CGE modelling to assess more analytically that impact on trade and welfare. The authors model the costs from a terrorist attack in the same way as an increase in tariffs with the only exception that the former is not accompanied by an additional revenue for the importing government. Where the transaction costs born from terrorism are uniform across regions, the results show that highly opened regions and industries with high import price-elasticities would bear a non negligible adjustment in trade and welfare losses. Another study by Nitsh and Schumacher (2004) uses a gravity model to assess the impact on trade between two countries which have experienced terrorism attacks. They find that a doubling of terrorism attacks in those countries affect their trade by around 4%. Fratianni and Kang (2006) extends the analysis of Nitsh and Schumacher (2004) to a different time period (1980-1999) and investigate how the terrorist impact on bilateral flows interacts with geographic distance. Using the ITERATE database for the period 1968-1999, Blomberg and Hess (2006) estimate the cost of violence on bilateral trade flows, considering as well other sources of violence like external conflicts, revolutions, and inter-ethnic fighting. They find that a country which has a terrorist accident is associated with a 7.6 % decline in its bilateral trade. While significant, this is less than half the magnitude of the negative impact on trade from external and inter-ethnic All these papers however, do not deal with the impact on bilateral trade of a targeted country whose main interests and citizens have been hit in a foreign country. As it will be shown below, a significant proportion of the incidents targeting rich countries is actually perpetrated either locally (in the country of origin) or in a third location. Besides, although all these studies emphasize the transaction cost impact of terrorism on trade, most of them do not address the possible endogeneity between trade, terrorism and security measures neither in theory nor in the data.

As well, though not directly related to terrorism, Anderson and Marcouiller ( (1997), (2002)) focus on the impact of insecurity on trade. In the first paper, insecurity arises endogenously from the choice of agents to allocate their labor between production and predatory activities, the latter hindering international trade at the borders. In the second paper, the authors model alternatively insecurity as a hidden tax on trade. They find that poor institutions in terms of government transparency and commercial legal systems hinder trade at least as much as tariffs. Instead, our paper model together, the probability of terrorism occurrence (i.e. insecurity), the governments’ choice of (counter)-security measures and trade. Less trade in such a framework does not directly come from insecurity but from counter-terrorism security measures at the borders.

> 2In another paper, Mirza and Verdier (2006) provide a recent survey on these issues.

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