This paper analyzes the causal effects of aggregate income changes on the incidence of violent conflicts. We adopt a novel approach by leveraging a country’s commodity terms of trade as a source of exogenous income variation. We find that income changes stemming from commodity terms-of-trade affect conflicts significantly and persistently. The impact of a 1% GDP loss is an increase equivalent to 1.6% of the average conflict incidences. The magnitude is twice as large for low-income countries. Our results also show that the shocks create more violence in countries with higher inequality and less fiscal space, suggesting the transmission channels in play. While prior studies have reported mixed results on the impact of economic shocks on conflicts, we discuss how our novel approach resolves the discrepancies in their findings. Furthermore, we show that there is a second-round effect through spillovers to neighboring countries. Put together with the literature that emphasizes the economic cost of conflicts, our empirical results imply the presence of a vicious feedback loop between weak economic performance and conflicts in a country’s development.
JEL classification: D74, E32, O11.