Crime and Finance: Evidence from Colombia By Rony Pshisva and Gustavo A. Suarez Harvard University Second Workshop of the Latin American Finance Network Cartagena, 2004

Motivation “Who wants to invest money and effort in building a business if their reward is to risk losing their life and/or their money?” The Economist, “Fear of Captivity,” June 2004

Suggestive evidence Some studies argue that fear of crime may explain: –Individual housing decisions (Katz et al., 2001) –Firms’ location (Porter, 1995) Terrorism is costly for economic activity (Abadie and Gardeazabal, 2003)

Cross-country studies Find that political instability reduces: Growth Barro (1991) Investment and savings Alesina and Perotti (1996)

Limitations of cross-country studies Reverse causation: Fajnzylber et al. (2002) suggests that crime rates are countercyclical Unobserved variables causing both low investment and high crime/terrorism Crime reporting standards vary across countries  Micro data can help.

Outline I.Why Colombia? II.Firms and crime in Colombia III.The effect of crime on investment IV.Conclusions and further research

I. Why Colombia? 1. High crime rates Country Population (million) Colombia42 South Africa44 Venezuela24 Russia146 Mexico98 United States282 Denmark5 Source: United Nations Homicides per 100,000 pop. ( )

2. Regional and time-series variation Homicides per 100,000

3. Different types of crime Kidnappings Homicides Guerrilla Attacks Not all crime targets firms Not all crime has economic motivations

II. Crime and Firms in Colombia 1. Crime and terrorism

Distribution of kidnappings Kidnappings per 100,000 More than 25 Between 9 and 24.9 Between 5 and 8.9 Between 1 and 4.9 Fewer than 1

2. Firms

The Effect of Crime on Investment 1. Baseline Regression: i indexes firms, j departments, t years, k industries. Investment:  PPE TA: Total Assets X: Firm-specific controls (Size, Cash holdings, ROA) Z: Regional characteristics (GDP pc, Primary school enrollment, poverty index, extension of paved roads)

1. Baseline results I: kidnappings that do not target firms

1. Baseline results II: kidnappings that target firms

2. Direct effect vs. indirect effect I: firms directly affected

2. Direct effect vs. indirect effect II: firms not affected

3. Kidnappings in the same industry vs. other industries

4. Unobserved demand variables? Not likely

IV. Conclusions Firms invest less when crime targets them Unlikely to be driven by unobserved variables that drive both overall crime rates and investment Unlikely to be driven by unobserved demand variables

Conclusions (contd.) Higher conditional probability of kidnapping  larger effect Fear of crime may reduce investment Possible explanation: human and physical capital are complements

Further Research What is the channel? Possible explanations: 1. Lower demand 2. Higher costs 3. Tighter financial constraints 4. Human and physical capital are complements Do Banks charge larger premia to violent regions?

Appendix

Terrorism decreases capital formation

Terrorism decreases FDI

Distribution of firms, 2000 More than 1,000 firms Between 200 and 999 firms Between 100 and199 firms Between 1 and 99 firms Departments with no firms

Descriptive statistics: firm characteristics

Descriptive statistics: high vs. low kidnappings

Firm-related kidnappings of Colombians and foreign citizens

Asset tangibility and the effect of kidnappings on investment

Firm-related kidnapping and firm borrowing

Firm-related kidnapping and firms’ costs