We show that regional instability, defined as political instability in neighboring countries, has a strong negative effect on a country's economic performance. The magnitude of this negative externality is similar in size to that of an equivalent increase in domestic political instability. We also identify two main channels through which regional instability lowers economic performance. First, regional instability disrupts trade flows. The shares of merchandise and manufactured trade are lower in countries with high regional instability. Second, regional instability leads to increased military outlays. Defense expenditures are higher in countries with high regional instability. In contrast, the share of government expenditures allocated to education is lower in countries with politically unstable neighbors. Our results suggest the existence of negative spillovers among politically unstable neighboring countries. These adverse regional influences should be taken into account when projecting the future economic performance of countries. The evidence presented also suggests that the gains from reducing regional instability extend far beyond the welfare of the country experiencing political unrest. Policies directed at settling current territorial disputes in a peaceful and orderly manner can have large beneficial effects for parties not directly involved in the conflict.