Drugs and Violence in Afghanistan: A Panel VAR with Unobserved Common Factor Analysis

This paper addresses the relationship between the level of violence and the opium market in Afghanistan’s provinces. We first provide an overview of the nature and extent of the Afghan drug trafficking. This is followed by a VAR analysis of the nexus opium-insurgency activities using monthly time-series data on opium prices and the number of security incidents for 15 Afghan provinces over the period 2004-2009. We use a multifactor error structure, the Common Correlated Effect (CCE), to include unobservable common factors; Impulse Response functions to describe the time path of the dependent variables in response to shocks; and the Mean Group Estimator to summarize our results across the provinces. Results suggest a conflict-induced reduction in opium prices, while the reverse opium-violence mechanism is mostly negligible. Moreover, unobservable common factors are the main drivers of opium prices and violence.