The effects of terrorism on trade: a factor supply approach

The conventional view of terrorism is that it raises risks and, as a result, reduces trade. The authors use a factor supply approach to show that this hypothesis is not necessarily correct. They use a two-good, two-factor, small open economy model to show that terrorism can either reduce or raise trade depending on critical factors, such as the impact of terrorism on the intensive factor of the export or the import sector. They then extend the analysis to models with several goods and factors and identify conditions under which trade may rise or fall with a greater incidence of terrorism. Finally, they provide an analysis of the effects of terrorism on trade in the presence of an optimal counterterrorism policy. The authors find that a nation’s adjustment of its counterterrorism level in response to a greater terrorist threat may moderate the impact of terrorism on trade.