Terrorism Financing, Recruitment and Attacks: Evidence from a Natural Experiment

Updated: Jun 9, 2019

By Nicola Limodio, Bocconi University; - IGIER - Innocenzo Gasparini Institute for Economic Research; Baffi Carefin Centre, Bocconi University.

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I present empirical evidence showing that terrorism financing and recruitment promote terrorist attacks. Pakistan offers an ideal setting for this research due to a natural experiment inducing exogenous variation in terrorism financing. In line with terrorist organisations facing financial frictions, I find a correspondence between the timing and location of finance and the attacks by organisations exposed to this transfer. The effect of financing on attacks increases in recruitment, measured by combining dark web data and machine learning. These results suggest that financial counter-terrorism lowers attacks, which I quantify by estimating the elasticity of terrorist attacks to financing (0.25).

Keywords: Terrorism, Finance


Threats to national security can weaken institutions and the rule of law (Shleifer and Vishny (1993), Besley (1995), Acemoglu et al. (2001)) beyond resulting in large human and economic costs. The past decade has seen an unprecedented rise in the number of terrorist attacks all over the world, as the solid line in Figure 1 shows. Among the various factors responsible for this surge, the financing of terrorist organisations is considered one of the most important (Feldstein (2008)). In fact, policy makers have been trying to curb this link for decades by placing an increasing number of funding sources under strict scrutiny.1

However, despite such global effort, there is a lack of studies exploring whether the funding of terrorist groups affects their attacks, over which horizon and through which mechanisms. This is due to the inability to quantify the funding flows and to identify sources of exogenous variation in terrorism financing. Such absence of quantitative evidence leads to challenges regarding the scope of regulation(2) and the existence of financial counter-terrorism.3

This research investigates the relation between terrorism financing, recruitment and attacks and seeks to address the following question: do the timing and location of finance affect attacks? From a theoretical standpoint, the answer is definitely negative in a frictionless world, as terrorist groups smooth financial resources over time and across locations. However, if terrorist organizations face frictions in storing or transferring funding, there then emerges a correlation between the timing and location of financing and attacks. In such cases, local conditions can have key effects on the success of an attack, for example the availablility of recruits and the technology of attacks. As a result, documenting the relation between the timing and location of financing and terrorist attacks can be crucial for two aspects. First, it sheds light on the financial frictions faced by terrorist groups and the effectiveness of financial counter-terrorism in lowering attacks and casualties. Second, it offers insights on the technology of terrorism and the relation between capital and labour in producing attacks.

In this paper I present causal evidence on the impact of terrorism financing and recruitment on terrorist attacks, assisted by two methods. The empirical test takes place in Pakistan, where I build a unique dataset that follows a panel of 1,545 cities over 96 quarters between 1992 and 2015 and contains the universe of terrorist attacks over the corresponding period (around 12,000 events). This dataset is combined with a natural experiment that generates exogenous variation in terrorism financing over time and across cities, allowing me to address the research question posed above.

Two methods contribute to identifying the increase in attacks due to the additional funding available to terrorist organisations. First, I build a panel that follows a set of terrorist organisations operating in multiple cities over time. By exploiting variation both within an organisation and a city, I can disentangle the effect of the natural experiment on the demand and supply of terrorist attacks. This shows that the supply is key: as terrorist organisations become more active in the aftermath of a positive funding shock, they increase their attacks when and where they receive funding. In addition to this city-level analysis, I also study a higher level of geographic aggregation (Pakistani divisions, equivalent to counties in the United States), and beyond confirming the city-level results at this higher aggregation, such variation also allows me to estimate a novel parameter: the elasticity of terrorist attacks to terrorism financing. The second method offers an innovative measure of terrorist recruitment by combining data from Jihadist fora operating in the dark web with the work of two judges and a machine-learning algorithm. Such measure allows the exploration of a mechanism through which the funding shocks to extremist groups can transmit and amplify.

Pakistan is the ideal country to conduct this study for two reasons. First, the country exhibits an evolution of terror attacks in line with the rest of the world (Figure 1, dashed line), which makes it a convenient case study. Second, it presents a unique natural experiment, the Zakat levy, which induces exogenous variation in a particular source of terrorism financing over time and across cities: charitable donations. When Ramadan arrives, Muslims are expected to give a charitable donation to the poor, the Zakat. While this is an individual choice in most countries, the Pakistani government imposes a mandatory contribution on its citizens through a 2.5% levy on bank deposits.4

I exploit the institutional features of the Zakat levy that create exogenous variation in the number of taxed individuals and the size of the tax. I show that when there is an increase in tax exemptions, there is then an increase in both charitable donations and attacks in the location and at the time of the donations.5 Such variation in the Zakat levy is given by the existence of an eligibility threshold on taxable deposits. Individuals below the threshold are not taxed and give their contribution through charities or personally, while those who exceed the threshold face the 2.5% tax on their overall deposits, which lowers their disposable income and donation amount. The legal definition of the threshold stems from a local interpretation of the Sharia law and is specified as the monetary value of 600 grams of silver.6 As a result when silver prices are high, the threshold increases; fewer individuals are taxable and people donate more to private charities, with the opposite occurring for low silver prices. Therefore, the variation in the international price of silver is key to verifying how individual donations and attacks evolve over time. To identify this effect, it is key that Pakistan is neither a top 20 producer nor consumer of such commodity,7 therefore allowing me to take the price of silver as being exogenously determined to the Pakistani economy. I also show that only the price of silver before Ramadan affects donations and attacks, while those of other religious celebrations do not (for example Eid Adha, acting as a placebo). This source of time-series variation is combined with a fundamental cross-sectional heterogeneity provided by another institutional feature of the Zakat levy. As Pakistan is a Sunni Islamic Republic (the Sunni sect is closer to the Saudi Arabian interpretation of Islam), this levy only applies to Sunni Muslims, while other religious groups are exempt (including the Shia sect closer to the Iranian interpretation of Islam). As a result, changes in the international price of silver affect donations heterogeneously for Sunni (treated) or non-Sunni (control) cities and the financing of Sunni (treated) and non-Sunni (control) terrorist organisations. These cities and organisations are coded using a religious map of this country and various reports on intelligence and security.

This paper consists of four parts. In the first part I introduce a theoretical framework to guide the empirical analysis and present the source of exogenous variation in terrorism financing. In the framework, I solve the capital allocation problem of a terrorist group, which characterises the mechanism through which an increase in local terrorism financing and recruitment affects attacks. I show that in the presence of financial frictions to capital transfers within the group and a partial complementarity between labour and capital, there then emerges a correspondence between the timing and location of financing and attacks, with terrorist recruitment being key. I also offer some institutional details on the exogenous variation in terrorism financing and illustrate the relation between silver prices and Zakat donations, focusing on the differential effect in Sunni areas and individuals who are marginally exempt. Finally, I show the opacity of Pakistani charities and their contiguity with terrorist organisations, which makes Pakistan an ideal environment to address this research question

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Suggested Citation:

Limodio, Nicola, Terrorism Financing, Recruitment and Attacks: Evidence from a Natural Experiment (April 2019). Chicago Booth Research Paper No. 32, 2019. Available at SSRN: https://ssrn.com/abstract=3384109 or http://dx.doi.org/10.2139/ssrn.3384109

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