Critics have argued in recent years that financial counterterrorism is costly and ineffective. But a new Stigler Center working paper shows that it can reduce terrorist attacks and casualties.

A record number of terrorist attacks took place in the past decade all over the world, as reported by the Global Terrorism Database. Among the various factors responsible for this rise, a large consensus points toward extremist organizations improving their funding and recruitment activities. In line with this view, policymakers have empowered money laundering regulations and other laws to weaken extremist groups.

These initiatives, however, have come under scrutiny by various commentators and major outlets, such as The Economist in 2005 and Foreign Affairs in 2017, for two key reasons. First, the implementation of financial counterterrorism is costly: governments and financial institutions need to set up specific departments to go after terrorism financing, individuals see their bank accounts frozen without justification (and often for the wrong reasons), trials are long and have uncertain outcomes. Second, it is unclear what the returns on financial counterterrorism are, with some commentators claiming that the benefits to such regulations may be small, or even zero. In fact, it is often argued that “following the money” is insufficient to detect the activities of terrorist groups, as these organizations may be able to dissipate the money through their affiliates operating in various locations and use the funding when and where it is most relevant.

Yet there is a limited amount of quantitative research that seeks to understand how the financing and recruitment of terrorist organizations work. As a result, it is unclear whether “following the money” actually works. The lack of academic studies is due to the difficulty in observing the financing of terrorist groups and identifying relevant research designs to produce causal estimates of these channels. My new Stigler Center working paper offers a quantitative investigation into the relationship between terrorism financing, recruitment, and attacks. This research validates the hypothesis that “following the money” does allow authorities to uncover the activities of terrorist organizations and that changes in terrorism financing generate large effects on terrorist attacks and casualties. These effects are particularly intense when terrorist groups are successful in their recruitment.

The key contribution of this research is the study of a specific natural experiment in Pakistan, which offers exogenous variation in the amount, timing and location of terrorism financing across more than 1,500 Pakistani cities and over 20 years. The results of this research show that the timing and the location of terrorism financing correspond to the timing and the location of terrorist attacks. This result is consistent with terrorist organizations being unable to easily move financial resources over time and across locations.

Beyond identifying the quantitative effect of terrorism financing on attacks, the paper finds that when terrorist organizations receive more financing and are able to recruit more aggressively, then the effect of finance is twice as large as in other periods. This finding verifies the existence of a complementarity between finance and labor in producing terrorist attacks. Finally, in order to measure the potential gains of empowering financial counterterrorism, I estimate that a doubling of terrorism financing leads to a 25 percent increase in attacks and casualties.

The paper focuses on a natural experiment inducing a specific source of terrorism financing. In the Muslim world, the Zakat is a charitable donation that Muslims offer to the poor during Ramadan and is meant to literally “purify” the income and wealth of an individual by assisting the poor and vulnerable. It is typically administered through charities that specialize in offering these services during Ramadan. This type of “targeted donations” are ideal for studying this question, given that many charitable organizations involved in these payments are opaque and that some of them—in Pakistan, for example, as well as in the United States—have been accused of financing terrorism. It is important to clarify that the vast majority of charities (both Sunni and non-Sunni) are not associated in any way with terrorist groups and provide valuable goods and services to poor and vulnerable individuals. However, there is evidence that part of the Zakat funding does end up in the “wrong hands” and is used to finance terrorist attacks, as a Pakistani Minister reported in 2015. As a result, changes in Zakat donations alter the funding available to terrorist organizations and Pakistan offers a unique setting that generates unexpected changes in Zakat donations.

Specifically, the payment of the Zakat takes place through voluntary contributions going through charities and a mandatory government scheme, which is exclusive to Pakistan. This mandatory scheme obliges a certain segment of the population to give their donations to the government rather than charities, through a banking regulation that imposes a 2.5 percent levy on bank deposits above a specific threshold on the first day of Ramadan. Two institutional characteristics of this government scheme create unexpected changes in individual charitable donations, which affect the financing of terrorist groups and their attacks.

The first unique element is the definition of the threshold to pay the Zakat to the government in Pakistan. The threshold is defined as the monetary value of 600 grams of silver. Two days before the beginning of Ramadan, the Central Bank and Ministry of Religious Affairs check the price of silver, multiply it by 600 grams and announce the threshold. As a result, in years when silver prices are high, the threshold to pay the Zakat levy to the government increases, and as a result, fewer people pay the government and more is paid to private charities.

The second unique element has to do with the fact that this rule applies only to individuals belonging to the main religious confession in Pakistan, Sunni Islam, with other religious groups being exempted from the deposit levy. As a result, Sunni individuals donate more to charities during Ramadan when the price of silver is high and they are not subject to the levy. Therefore, as silver prices imply higher donations, there is a higher probability that larger amounts reach terrorist organizations and fund attacks. Consistently with this argument, the empirical analysis shows that cities with a Sunni majority population suffer from more terrorist attacks during Ramadan, but only in the presence of high charitable donations given by high silver prices.

Two additional findings help establish the hypothesis that “following the money” makes it easier to uncover terrorist organizations. First, terrorism financing affects the type of terrorist attacks being pursued. In fact, the violent escalation in the number of attacks that have taken place in Pakistan during Ramadan involved an increase in capital-intensive attacks (bombings, biological, chemical, and radiological attacks), compared to other attacks that require less capital (like hijackings and kidnappings et cetera). Second, the increase in attacks is linked to those terrorist groups that enjoy a funding boost. In fact, the paper collects data on the terrorist organizations responsible for the attacks and uncovers that Sunni terrorist groups are those responsible for the increase in attacks and casualties over this period, as they receive more funding.

The last part of the paper exploits an innovative measure of terrorist recruitment that combines data from Jihadist forums operating in the dark web, the work of two judges, and machine learning. I analyze data from Reddit-like forums operating in the dark web that have a clear Jihadi-friendly aim and are used by individuals to exchange messages and organize events. After sharing a random set of this data with judges that evaluated whether such messages contain the intent to recruit, I applied a standard machine learning algorithm to the remaining millions of scraped messages. This allowed me to measure the messages aiming at recruiting individuals. Combining this measure with the Zakat experiment, the paper finds that the positive effect of terrorism financing on attacks is much stronger in periods of intense terrorist recruitment. Such results suggest that financial counterterrorism can reduce terrorist attacks and casualties by “following the money,” particularly in periods of intense recruitment and radicalization.

Nicola Limodio is an assistant professor of finance at Bocconi University.

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