Terrorism the Effects of Terrorism

Terrorism

The Effects of Terrorism on the Global Economy since Sept. 11th

Without question, terrorism has dramatic and significant impacts. The human cost can be high, and the damage can be extensive depending on the target and the method. However, it is unclear to some degree whether or not terrorism has a palpable impact on the global economy. Certainly, there are immediate economic impacts at the site of the terrorist attack and these effects will be felt in that region. However, the degree to which a terrorist attack is capable of impacting the global economy is less certain. Commonsense tells us that major acts of terrorism will impact the global economy, but commonsense is not necessarily the best indicator of financial effects. Rather it is crucial to examine the state of the world economy both before and after major terrorist attacks and evaluate if there is a significant change after accounting for other, usual, economic factors.

The modern transnational economy depends on the free flow of capital -- people, goods, services, and ideas. As the national economies of the world become more interconnected and more integrated, ensuring the free flow of capital is of ever-increasing importance to ensure the health of all economies (Carafano 25). However, as national economies become more integrated, seemingly isolated events can have significant effects throughout the global economy as financial institutions, corporations, governments, and individuals change economic policy to adapt to these events. The Asian financial crisis of the late 20th century had global economic implications, even though the locus of that crisis was centered squarely on Southeast Asia. Thus, it is entirely plausible to posit that transnational terrorism, in taking advantage of the integrated global economy, can have tremendous impacts on that economy even when the acts of terrorism are highly localized.

A consideration of some significant terrorist attacks, and the state of the global economy before and after these events, should give us some indication whether or not there is any credence to this hypothesis. In particular, I will make mention of the September 11th attacks on the U.S. The discussion of these events will occur within a larger theoretical context in which I discuss that nature of the modern global economy and how that nature is conducive to feeling the effects of localized terrorism on a global scale. And though we will find that the absolute effects of terrorist events are small when contrasted with the global GDP, it is clear that there is a significant and tangible global impact on the economy. In particular, we shall find that in a relatively open and integrated global economy, terrorism induces shifts of capital away from sites of terrorism in order to minimize risk. Over time, then, the concentrated effects of localized terrorism can be significant as capital moves from sites of higher risk to those of slightly lesser risk.

Because trade and security can no longer be considered separate issues in the transnational economy, globalization provides opportunities for both economies to grow and for terrorists to mobilize their resources globally. Trade could be maximized at the expense of security, but would provide terrorists would significant opportunities to act globally. Contrariwise, efforts to control global trade strictly could theoretically limit terrorist activity, though this would come at the extreme expense of global economic health (Carafano 25). As such it is crucial that we understand the true costs imposed by terrorism on the global economy. If we have a sense of the significance of the impact, then we can begin to make judgments about how much of a burden -- through extra security measures -- that is warranted by the threat of terrorism. Much in the same way that insurance companies insure against potential damages, we must first understand the nature and extent of the threat and the maximum amount of harm that can be caused if a terrorist attack occurs. if, for example, the cost of security measures to reduce the economic impact of terrorism by $1 billion per year cost $50 billion per year, then obviously the cost of preventative measures far outweigh the benefits secured. Our first step must be to evaluate the global economic damage that can be wrought by terrorism.

Conventional analyses of the impact of terrorism tend to center on a few immediate effects. In "Terrorism and the World Economy," Abadie and Gardeazabal explain that there are four primary, conventional effects of terrorism from an economic standpoint. They are:

Reduction in capital resources, both human and physical from the attack itself.

An induced higher level of uncertainty in the market as corporations and individuals adapt to the possibility of warning-less terrorist attack.

The diversion of resources from productive economic to security-focused activities such as surveillance.

Terrorism tends to negatively affect specific industries such as tourism and travel (Abadie and Gardeazabal 1).

While these effects of terrorism are significant and real, they are nonetheless generally localized and generally short-term in duration. As soon as it is destroyed, new capital will be mustered to replace what was lost. Uncertainty fades as the time between terrorist attacks lengthens and routines re-emerge. Interest in heightened security will never be as high as immediately after the attacks, and even highly affected industries will eventually recover. These four effects cannot account for global economic effects that might occur as a result of terrorism. In fact, it is difficult to understand how a terrorist attack could have a global economic impact at all. The September 11th attacks on the U.S., one of the most significant terrorist events, only reduced the nation's productive assets by0.06% (Abadie and Gardeazabal 1). In other words, the terrorism's effects in that event on the U.S. productive resources were so low that we should barely be able to record an effect on the U.S. economy over the long-term, let alone an economic impact on the global economy.

In addition, other analysis has suggested three levels of impact of the September 11th terrorist attacks on the global economy. First, there was, naturally, the direct and primary damage that impacted the economy, much in the same way that any isolated natural disaster might impact the economy. Hurricane Katrina was devastating for the regional Gulf Coast economy; in this sense, the September 11th attacks were equally damaging to the economic health of the area directly hit by the attacks. Second, we can factor in the heightened perception socially, economically, and politically. This heightened perception will translate into higher spending on security vs. economic growth and more caution in producer and consumer behavior to account for the potential next attack. Finally, and this applies specifically to the case of the September 11th attacks, we must accept that those attacks instigated the U.S. global war on terrorism. This political and military machine has cost the U.S. economy hundreds of billions of dollars over the last six years and spawned a war in Afghanistan and one in Iraq (Nanto 2-3). All told, these economic impacts have drastically altered the U.S. economy, most notably in the case of increased spending on the war on terrorism.

The economic aftershocks of the September 11th terrorist attacks were, to some degree then, felt immediately. Foreign equity markets, tourism and travel industries, and consumers' attitudes were all affected almost immediately (Nanto 3). But these immediate effects don't necessarily speak to long-term impacts on the global economy. Yet despite these relatively conventional conclusions, there seems to be every indication that there was a tangible economic impact that stretched beyond the borders of the U.S. As an example, before the September 11th attacks, the total amount of FDI into the U.S. stood at 15.8% of the total Gross Fixed Capital Formation for the country. However, after the attacks, in 2003, the percent of FDI was a measly 1.5% (Abadie and Gardeazabal 2). True, there could have been other economic factors at work in this situation, but a reduction in FDI by a factor of 10 is a significant change in only two years. Since FDI is, by its own definition, foreign in origin, then it is reasonable to conclude that the September 11th terrorist attacks had an effect on the global economy. This dramatic change in FDI over such a short span of time indicates that the September 11th terrorist attacks were a significant contributing factor in changes in the global economy.

In fact, these findings seem to be consistent with general economic principles that we can assume operate at the level of an open, integrated global economy. Namely, capital in all its forms will naturally be shifted from high-risk areas to low risk areas of the world (Abadie and Gardeazabal 2). Consider that most economies operate on basic market principles: maximize profits while minimizing costs. The perceived threat of terrorist attacks will naturally then suggest that costs may be higher for investing capital in regions of the world that have persistent terrorism problems or that have recently been the target of terrorism. The end result would be the shifting of capital -- people, goods, services, and ideas -- away from parts of the world that are more susceptible to terrorism and towards places that are safer from this threat. No matter the actual cost of terrorism in terms of the economic damage, the perception that investment is going to incur higher risk will inevitably lead to the conclusion that it will also incur higher costs. Since higher costs are generally an anathema to transnational business, it stands that capital would move away from areas that have experienced terrorism. In fact, this is born out by the numbers. As already mentioned, FDI in the U.S. dropped by a factor of ten following the September 11th terrorist attacks. No one person, business, institution, or government had to organize this shift; rather it occurred organically as a function of the market itself. In the aftermath of the attacks, the U.S. suddenly seemed like a riskier place to do business and capital would have been shifted towards areas of the world that had the perception of being safer.

In fact, surveys conducted among major international corporations found that, with regard to FDI, the presence or absence of a significant terrorist threat was cited as a significant factor in determining where to invest capital (Abadie and Gardeazabal 3). In an open, yet integrated, global economy where capital can easily be shifted from one locus to the next it is not surprising that it would move from areas of high risk to areas of low risk -- whether or not terrorism represents a significant long-term threat to doing business. From this we see that terrorism does have an impact on the global economy because of the perception that it will negatively impact business. In the aftermath of September 11th, FDI evaporated from the U.S. And was shifted to other parts of the world. Whether or not that capital will eventually be shifted back to the U.S. seems to be largely a matter of perception. As the perceived risk of doing business in the U.S. diminishes, it will become more likely that investment will return and be shifted away from other parts of the world that are perceived to be at greater risk from terrorism.

Despite the fact that terrorism does, then, have an impact on the global economy, it would appear that said impact is largely a function of perception rather than of actual cost. Fortunately, other analyses have been conducted in the last few years to calculate the actual financial impact of terrorism on the global economy that use the September 11th attacks as case examples. These studies illustrate that there has been an actual global financial cost to the world economy because of major terrorist attacks, though the cost seems to be significantly less than perception of danger leads many to believe. In other words, the dramatic shifting of capital and investment away from perceived danger sites is not commensurate with the actual financial cost of doing business in those areas.

Of course, at first brush, the numbers do not seem to confirm this point. For instance, when comparing world economic growth in 2000 versus 2001, we find that it dropped by almost 3%, from a modest 4.1% growth rate to a recessionary 1.4% growth rate (Nanto 3). However, these numbers do not tell the whole story. In fact, it had already been predicted that world economic growth rates were going to drop around the time of the September 11th attacks. Economists had already predicted a slowdown in the economic growth rate of the world economy. However, the actual rates that manifested were significantly lower than what had been anticipated. After September 11th, actual global economic growth averaged about 1% below where it had been expected (Nanto 4). While this is not unequivocal proof that the terrorist attacks were behind this larger-than-anticipated slowdown, it is suggestive that there was a global economic response to the terrorist attacks.

While the economic effects of September 11th were large and varied, they were incredibly small when weighed against the total productive capacity of the world economy. The global GDP currently hovers around $40 trillion. If the attack caused a global economic slowdown of roughly 1%, then the total cost to the world economy should be somewhere between $300 billion and $400 billion (Nanto 4-6). This amount of financial loss is certainly impressive considering it rippled through the global economy as the result of a single coordinated terrorist attack. Nonetheless, when spread across the entire global economy, the total loss to any one government, corporation, or even individual would have been incredibly minute. In other words, the actual economic cost of the terrorist attack was not commensurate with the significant shift in capital that occurred away from the U.S. In the immediate aftermath of the attack. The perception of danger, risk, and cost was significantly higher than the actual danger, risk and cost. Regardless, it is apparent that perception is a powerful factor in the global economy. The idea that terrorism represents an incredible economic risk is a strong incentive to shift capital away from regions that are afflicted with terrorism.