Economic effects of terrorism

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Terrorism imposes a significant economic effects on societies and will not only lead to direct material damage, but also to long term effects on the local economy. The identification and the estimation of these economic effects of terrorism has received broad attention in economic literature and research, especially since the events around 9/11.

Relevance

Considerable costs are incurred in relation to terrorism. Terrorist events not only leads to material and immaterial costs for those who have become victimised, but also forces local and national authorities to spend billions on the prevention of terrorism and the detection, prosecution and punishment of terrorists. The economic impact of the 9/11 events, for example, are estimated between USD 25 - 60 billion[1].

Measuring the economic impact of terrorism

Economists use various definitions and terminology for categorising the economic impact of terrorism. The two main categories are the primary and secondary economic impact of terrorism, also referred to as direct and indirect economic effects[2].

This relationship is illustrated below:

Terror eventPrimary economic impactSecondary economic impactEconomic impactEconomic impact terrorism v2.jpg
About this image

Primary economic impact of terrorism

Primary economic impact of terrorism “refers to the effects arising from the immediate aftermath of a terrorist event” . These effects include the physical destruction of urban objects, and the human casualties (injuries and losses of human life). Primary economic impact of terrorism refers to the effects arising from the immediate aftermath of a terrorist event[3]. These effects include the physical destruction of urban objects, and the human casualties (injuries and losses of human life).

Micro-economic impact

On a micro-economic[4] level, terrorist events influence three main types of economic actors, namely:

  1. individual households,
  2. the private sector (companies), and
  3. the public authorities (see table below).
Household level Companies Public sector
There is not much available literature when it comes to the primary costs that households experience due to terrorism itself[3]. Surveys in France, the Republic of Ireland and the UK illustrate that terrorist attacks have a negative effect on reported life satisfaction[5]. Other empirical research found out that terrorism will produce more fear than other, more probable risks[6]. Businesses and firms, especially the ones operating to or from insecure countries, are frequent victims of terrorist events. According to the German security economists Schneider, Brück and Meierrieks (2010), this is also due to the fact that public buildings are better protected in general. The actual direct losses of terrorism depend on the nature of the attack (property damage or ransom payments for hostages), but overall, Enders and Sandler (2008)[7] conclude that most sectors recover quickly, given that the economy does not face sustained terrorist attacks, like in Israel and Northern Ireland. There is not much literature available on this subject. The costs arising from physical destruction from small-scale terrorist events are not structurally measured, except for major events like 9/11 and the terror events in London and Madrid. Costs for the public sector arise whenever public infrastructure or buildings are destroyed (including military structures and equipment), but are generally considered to be relatively small[3]. Moreover, terrorism forces local and national authorities to spend billions on the prevention of terrorism and the detection, prosecution and punishment of terrorists.

Due to a terrorist event, these economic agents suffer from impact through losses in physical and human capital, and, at the same time, they themselves may influence the economy through their immediate responses to the violent shock that occurred[3].In general, the direct economic losses of terrorism do not bulk very large[8], with an exception for the unprecedented magnitude of the 9/11 attacks[9]. Terrorism in general, and especially in Europe, can, according to Schneider et al. (2010), be characterized as small scale, but frequent events, more focused on objects with a symbolic or political value and not so much on economic symbols like the World Trade Centre in New York.

Secondary economic impact of terrorism

Terrorism will not only cause primary economic impact, but will also produce considerable secondary (or indirect) impact. This secondary economic impact is the result of an interdependent economic system in which terrorist attacks cause the disruption of economic entities which have not been direct targets of the attack[3]. A survey review by the Swiss economists Frey et al. (2004)[10] describes the following indirect economic aspects of terrorist events:

Types of secondary economic impact Description
Effects on tourism Terrorism systematically influences tourists' choice of destination and can, therefore, substantially negatively affect a host country[10].The American economists Enders and Sandler (1991)[11], for example, conclude that a typical terrorist act in Spain scares away over 140,000 tourists. Moreover, the effect is long-lasting and has also an impact on the demand for tourism in neighbouring countries.
Foreign direct investment Enders and Sandler (1996)[12] also found out that countries like Spain and Greece saw their foreign direct investments(FDI) decrease in the period 1975 - 1991 due to a series of terrorist events[13]. The impact on FDI in three larger European countries (France, West-Germany and Italy), however, was zero, implying that the impact of structural terrorism on FDI also depends on the size of the economy.
Savings and consumption Consumption and saving rates, may be affected by terrorism, but according to Frey et al. (2004), it is still unclear if this effect is positive or negative[14].
Investments Next to (macro)economic stability, political stability is generally recognised as the most important factors that determine investments in a local economy[15]. Not only the amount of investments are influenced by terrorist events, but also the investment composition (in particular the investments in machinery and equipment)[10].
Stock markets The impact of terrorist events on financial markets is a famous phenomenon. Since share prices reflect (in theory) expected future gains of a company, a terrorist attack will negatively influence the share prices since: Expected profits will decline if security measures increase the costs of production and trade costs, and consumers will decrease their consumption. The risk premium will increase due to the increased uncertainty about a firm's prospects on the market[10].On the other hand, share prices already reflect expected terrorist attacks before any actually occurs. So, the conclusion is that only single unexpected events or an unexpected intensification will lead to negative effects.
Foreign trade Terrorist events not only increase the sense of insecurity and uncertainty for foreign traders, but will also increase transaction costs (due to augmented security measures) and can lead to the destruction of export goods (oil pipes for example)[10]. Nitch and Schumacher (2004) illustrate that countries that are targeted by terrorism, will trade less with each other than countries not affected by terrorism. Moreover, these effects are large: a doubling of the number of terrorist events reduces the bilateral trade flows by 4%[10].
National income & growth The overall effect of terrorism on the economy can only be determined when it is known how an economy would have developed without the terrorist event. Attempts to illustrate these differences by Blomberg et al. (2004)[16], conclude that the effects of terrorism on the economic growth are small and only statistically significant for development countries, and not for the more advanced OECD countries[17].

Related subjects

Footnotes and references

  1. Brück, T., M. Karaisl and F. Schneider (2008): A Survey of the Economics of Security. Economics of Security Working Paper Series.
  2. Primary economic impact (or direct effects) are generally defined as the initial, immediate economic output generated by a specific cause (in this case terrorism). Secondary economic impact (or indirect effects) are generated each time a subsequent transaction is made, for example, the impact of terrorism on tourism in the region.
  3. 3.0 3.1 3.2 3.3 3.4 Schneider, F., T. Brück and D. Meierrieks (2010): The Economics of Terrorism and Counter-Terrorism: A Survey. DIW Berlin. Discussion Paper No. 1049
  4. "Micro economics is the branch of economics that analyses the market behaviour of individual consumers and firms in an attempt to understand the decision-making process of firms and households". Source: Investopedia. Online: http://www.investopedia.com/terms/m/microeconomics.asp
  5. Frey and Luechinger (2005) and Frey et al' (2009). In: Schneider, F., T. Brück and D. Meierrieks (2010): The Economics of Terrorism and Counter-Terrorism: A Survey. P. 36.
  6. E.g. Viscusi, W., K. and R.J. Zeckhauser (2003): Sacrificing Civil Liberties to Reduce Terrorism Risks. Journal of Risk and Uncertainty. No. 27(1), p. 5-76. In: Schneider, F., T. Brück and D. Meierrieks (2010): The Economics of Terrorism and Counter-Terrorism: A Survey. DIW Berlin. Discussion Paper No. 1049, p. 36.
  7. Enders, W., T. Sandler (2008): Economic Consequences of Terrorism in Developed and Developing Countries: An Overview. Terrorism, Economic Development, and Political Openness. P. Keefer and N. Loayza, Cambridge University Press: New York: 17-47.
  8. Source: Krugman, P. (2004): The Costs of Terrorism. What do we know? Princeton University.
  9. The 9/11 attacks caused for over USD 25 Billion physical damage to buildings, equipment and infrastructure. Source: Carter, S. and A. Cox (2011, September 8): One 9/11 Tally: $ 3.3 Trillion. Net York Times. Online: http://www.nytimes.com/interactive/2011/09/08/us/sept-11-reckoning/cost-graphic.html
  10. 10.0 10.1 10.2 10.3 10.4 10.5 Frey, B.S., S. Luechinger, A. Stutzer (2004): Calculating Tragedy: Assessing the Costs of Terrorism. Institute for Empirical Research in Economics. University of Zürich. Working Paper Series ISSN: 1424-0459.
  11. Source: Enders, W. and T. Sandler (1995): Terrorism: Theory and Applications
  12. Enders, W and T. Sandler (1996): Terrorism and Foreign Direct Investment in Spain and Greece.
  13. This decrease in FDI inflow was worth around USD 0.5 Billion for each country, which can be considered substantial. Source: Enders, W and T. Sandler (1996): Terrorism and Foreign Direct Investment in Spain and Greece.
  14. According to Frey et al. (2005) the way saving and consumption is affected by terrorism depends on the local situation: If people are afraid they are going to lose their savings, they will consume more. If they expect a decline in income, on the other hand, they will increase their savings and decrease their consumption
  15. Source: United Nations & WAIPA (2007): Worldwide Survey of Foreign Affiliate. United Nations Conference on Trade and Development. Occasional Note.
  16. Blomberg, S. Brock, Gregory Hess and Akila Weerapana (2004): Economic Conditions and Terrorism. European Journal of Political Economy 20(2): 463-478. In: Frey, B.S., S. Luechinger, A. Stutzer (2004): Calculating Tragedy: Assessing the Costs of Terrorism. Institute for Empirical Research in Economics. University of Zürich. Working Paper Series ISSN: 1424-0459.
  17. Negative economic effects are especially present when a small country/region like the Basque country or Israel face a long and intense era with terrorist events. Source: Blomberg et al (2004) In: Frey, B.S., S. Luechinger, A. Stutzer (2004): Calculating Tragedy: Assessing the Costs of Terrorism. Institute for Empirical Research in Economics. University of Zürich. Working Paper Series ISSN: 1424-0459.