Thy Neighbor's Curse: Regional Instability and Economic Growth

Abstract

We show that regional instability, defined as politicalinstability in neighboring countries, has a strong negative effecton a country's economic performance. The magnitude of this negativeexternality is similar in size to that of an equivalent increasein domestic political instability. We also identify two mainchannels through which regional instability lowers economic performance.First, regional instability disrupts trade flows. The sharesof merchandise and manufactured trade are lower in countrieswith high regional instability. Second, regional instabilityleads to increased military outlays. Defense expenditures arehigher in countries with high regional instability. In contrast,the share of government expenditures allocated to education islower in countries with politically unstable neighbors. Our resultssuggest the existence of negative spillovers among politicallyunstable neighboring countries. These adverse regional influencesshould be taken into account when projecting the future economicperformance of countries. The evidence presented also suggeststhat the gains from reducing regional instability extend farbeyond the welfare of the country experiencing political unrest.Policies directed at settling current territorial disputes ina peaceful and orderly manner can have large beneficial effectsfor parties not directly involved in the conflict.