Financial Development and Conflict Mitigation: Can Finance Combat Conflict?

Abstract

We investigate whether a given economic intervention can mitigate domestic conflicts of different types, regardless of their different origins and characteristics, without government intervention. The intervention that we consider is financial development, measured either as an increase in bank credit supply or an increase in the number of bank accounts, in a conflict-affected area. Using a model as well as extensive empirical tests with district-level data from India comprising different types of conflicts over a long sample period, we find consistent evidence that supports our model's prediction that financial development mitigates conflict, and that this negative relationship holds for conflicts of all types. We also find that employment growth due to financial development and economic expansion serves as a beneficial channel from financial development to conflicts. The findings suggest that all conflicts share common economic underpinnings, in particular low opportunity costs of conflict participation for most insurgents. Employment growth raises their opportunity costs, inducing some of them to exit conflict. The findings are new contributions to the literature.

Keywords: conflict, credit supply, number of bank accounts, economic growth, channel tests

JEL Classification: G21, O16