Your war, my problem: How conflict in a neighbour country hurts domestic development

Abstract

This paper explores the transmission mechanisms of the impact of civil conflict in the neighbourhood on the economic development of the domestic country. We study a set of endogenous relations linking growth and its fundamental causes, domestic conflict and conflict in the neighbourhood. Methodologically, we go beyond a reduced-form single equation model to estimate a system of four equations where neighbourhood conflict affects domestic civil conflict, institutions and economic integration. Civil conflict in the neighbourhood significantly increases the probability of domestic conflict, lowers the quality of domestic institutions, and reduces the degree of economic integration with the rest of the world. The dollar value of this damage cumulates over time depending on the frequency/duration of spatial conflict. Our simulations show that the cost to the domestic economy ranges between $506 and $14,165 in lost per-capita GDP over a period of fifteen years.