Impact of terrorism
The sheer unpredictability of terrorist attack on innocent people is what makes us gape and gasp, writes Dr Bhaskar Dasgupta.india Updated: Nov 18, 2005 20:10 IST
A few weeks ago, I wrote about resilient cities, such as New York, London, Madrid, Mumbai, Tokyo, Manchester, New Delhi, Dresden, etc. who have all bounced back after devastating attacks during war or terror campaigns. What I concluded was that cities are extraordinarily resilient, and try as they might, over time, the impact is minimal. The best analogy I can give is that it is like an ant bite or a bee sting. It hurts like nobody's business initially, but the effects disappear soon and in the vast majority of the cases, people forget about it. You swat the ant or bee, put ointment on the bite and then carry on as usual. In case of a terrorist attack, yes, it is singularly unfortunate for the victims and their relatives, but when one looks at the city as a whole, no impact whatsoever.
I am writing this sitting in a London underground tube carriage. The security has fallen off drastically, every station is working, the tube lines are ticking over, the same deadpan expressions, I am carrying my rucksack and nobody even glances at me when I unzip it and take my laptop out. It may well be because of the phlegmatic stiff-upper-lip nature of the British but I have seen the same reaction and state in all the above-mentioned countries. Time for a joke: The British are feeling the pinch in relation to recent bombings and have raised their security level from "Miffed" to "Peeved'. Soon though, security levels may be raised yet again to "Irritated" or even "A Bit Cross". Londoners have not been "A Bit Cross" since the blitz in 1940 when tea supplies all but ran out. Terrorists have been re-categorised from "Tiresome" to a "Bloody Nuisance". The last time the British issued a "Bloody Nuisance" warning level was during the great fire of 1666. Seeing this reaction the Americans have gone from "isolationism" to "find another oil-rich nation in the middle east ripe for regime change". Their remaining higher alert states are "attack the world" and "beg the British for help".
If cities are so resilient, how does the economy or the political system react to terrorist attacks? The evidence for the former is pretty clear but the latter has a different impact. In this column, we explore the economic impact in some greater depth and in a forthcoming column; we will explore the impact of terrorism on political systems. To see the impact of terrorism on the economy, we have to first define what we mean by the economy, what time period are we considering this impact over, how do we measure it and which terrorist events are we talking about. Please bear in mind that this analysis is, by design, very high level as we certainly cannot do a full econometric analysis within the constraints of a column.
Let us keep this simple. In so far as the economy is concerned, let's just talk about the GDP (gross domestic product) as a simple measure. We could have taken other measures such as the foreign exchange rate, the flow of portfolio and Foreign Direct Investment FDI funds, the state of the stock market, etc. but these elements are quite complex and are not really very easily measurable. Plus for very large economies such as India and USA, FDI is usually a very small component of their overall investment pattern. So while measuring the impact of terrorism on a country like Israel or Pakistan through FDI patterns is possible, you cannot do this for large economies.
Then we have to consider the time period. We can consider a normal business cycle of 7-10 years; we can consider a yearly time period, or a quarterly time period (which is usually the GDP reporting time period), a daily end of daytime period or an intra-day time period. The issue with the last two periods is that while we can capture the immediate impact of a terrorist attack through the impact on foreign exchange or stock market prices, we cannot measure the impact on the economy as a whole. So since we are taking the GDP figure, we stick to the business cycle/quarterly/yearly growth patterns.
The final point is to consider which terrorist events we are talking about. Well, this is where it gets a bit hairy and slightly illogical. Economic impacts are long term in nature, so picking up just one or two events will necessarily not make a difference. If we are talking about a reduction in the growth rate of GDP, then this means that people are not investing in products or production, economic activity has reduced or slowed or people are taking their money out of the economy and plonking it in some other economy or purchasing gold. As you can appreciate, one comparatively small blow-up of a power transformer in the wilds will not make a material difference to the entire economy. For that matter, as we will see, even the blowing up of the Baltic exchange, the Mumbai Stock Exchange, the Jakarta Stock Exchange, the Twin Towers, etc. major economic terrorist targets, did not make a difference to the economy.
If we take the following countries, India, Pakistan, USA, UK, Israel, Indonesia, Thailand, China and Russia as examples of countries which have been hit by terror attacks and compare their GDP growth rates over the past 20 years (which will cover at least one and in many cases two business cycles), the impact seems to be minimal. You can check that out at the World Bank site to see and judge for yourselves: http://www.worldbank.org/data/wdi2005/pdfs/Table4_1.pdf. Nice little table in here and will give you an overview of the economic growth rates.
Let us take some examples, 7/7 didn't do squat for the British economy, the markets actually rose, 9/11's impact was diffused in the general slowdown of the US economy, but 4 years on, the US economy is powering ahead, the Indian economy is remarkably resilient in the face of hundreds of terrorist attacks every year, Israel is a similar case (with some caveats - it's mostly public spending which keeps on priming the Israeli pump), Egypt shrugged off its Sinai bombings, terror in Pakistan seems to have some impact but it is still growing rapidly, and so are China, Thailand and Russia for various reasons.
So why do people get so excited about terrorist attacks and its economic impact? Well, for obvious reasons, terrorism does have a direct impact on certain aspects of the economy. Countries which are very heavily dependent on tourism get affected very badly. Take four examples, Indonesia, Egypt, Kenya and Tanzania. Each of them was attacked by Al Qaeda or its affiliates. Indonesia was directly impacted by the first Bali bomb, Egypt from the tender attentions of AQ or the brotherhood, Kenya and Tanzania impacted because of the US embassy bombings. In all the four cases, tourism was a relatively major part of their economies (ranging from 5% to 12% of the economy).
As it happens, the US, UK, German and other western (read rich tourist home countries) put in travel advisories or in some extreme cases, stop flights. This had a direct impact on the tourism sector. If the sector is large, then the overall economy takes a hit. How much of a hit is dependent upon how diversified the economy is, how well it wields its diplomatic stick and how quickly it can return confidence in the economy. In the case of Kenya, it did very well indeed, while Tanzania couldn't manage the impact and therefore suffered from a greater impact than Kenya. Same situation with Egypt, it took a hit after the Luxor massacre, but the recent Sinai bombings were shrugged off. On the other hand, Indonesia's huge Bali bomb had a negligible impact on its economy.
What are the lessons that public officials need to draw from this admittedly sketchy analysis? The first is that, over the business cycle, economies are remarkably resilient and can take huge number of terrorist knocks (with another caveat - this analysis does not hold for wars, which are far more destructive and resource consuming). Second, it pays to have a diversified economy - if your economy is very specific with respect to certain sectors such as Egypt with tourism, Saudi Arabia with oil etc., then this reliance on a single sector will make your economy extremely vulnerable to terrorist attacks. Third, keep on having a welcoming investment climate by low taxes, reduced corruption, easy investment processes, good resilient infrastructure, first-rate financial markets and no amount of terrorist attacks will materially shock the economy and people will keep on investing and producing goods.
So what are the lessons for the terrorists? It is simply impossible for them to wage a terrorist campaign with a view to destroy an economy. In other words, if all you are planning to make is a political statement, then there is no point in going after economic targets. That will fail. From an ideological perspective, it knocks away one of their core pillars; that the economic society of the infidels will fall apart after these bombings and attacks. It doesn't, it won't and it's of no use. Secondly, the state will almost always win a campaign, which is very intermittent in nature. If all that the terrorist groups do is to carry out spectacular but infrequent attacks, it will have an immaterial economic impact.
If they really want to commit economic mayhem, then both the frequency and the damage coefficient has to be drastically increased, which in turn increases the potential of being caught and so on and so forth. A case in point is Iraq where there are spectacular as well as very frequent terrorist attacks. The economy is suffering badly, but here's a prediction, over the economic cycle, the Iraqi economy will recover. Iraq, while being quite heavily dependent on oil, has a large educated population and can produce a diversified economy. Hence Al-Qaeda's attempts to destroy the economy will be in vain. But then, nobody said that these fundo's are analytical folks anyway. Anybody who has a medieval brain replacement done will keep on thinking that a big ball of fire equates to the economy in melt-down.
All this to be taken with a grain of salt!
(The opinion expressed herein are strictly the author's and do not reflect the positions, official or otherwise, of any firm or organisation, that the author is associated with at the present or has been in the past or may be in future. Dr Bhaskar Dasgupta, currently lives in the City of London and works there in various capacities in the Banking Sector.)