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Economic Impact of Terrorism and the September 11 Attacks

Direct Economic Impact Was Less than Feared, but Defense Spending Rose by 1/3

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The economic impact of terrorism can be calculated from a variety of perspectives. There are direct costs to property and immediate effects on productivity, as well as longer term indirect costs of responding to terrorism. These costs can be calculated quite minutely; for example, calculations have been made about how much money would be lost in productivity if we all had to stand in line at the airport for an extra hour every time we flew. (Not as much as we think, but the line of reasoning finally gave me a rationale for the unreasonable fact that first class passengers wait less. Maybe someone is guessing, rightly, that an hour of their time costs more than an hour of mine).

Economists and others have tried to calculate the economic impact of terrorism for years in areas beset by attacks, such as Spain's Basque region and Israel. In the last several years, most analyses of terrorism's economic costs begin with an interpretation of the costs of the September 11, 2001 attacks.

The studies I examined are fairly consistent in concluding that the direct costs of the attack were less than feared. The size of the American economy, a speedy response by the Federal Reserve to domestic and global market needs, and Congressional allocations to the private sector helped cushion the blow.

The response to the attacks, however, has been costly indeed. Defense and homeland security spending are by far the largest cost of the attack. However, as economist Paul Krugman has asked, should the expenditure on ventures such as the Iraq war really be considered a response to terrorism, or a "political program enabled by terrorism."

The human cost, of course, is incalculable.

Direct economic impact of terrorist attack

The direct cost of the September 11 attack has been estimated at somewhat over $20 billion. Paul Krugman cites a property loss estimate by the Comptroller of the City of New York of $21.8 billion, which he has said is about 0.2 % of the GDP for a year ("The Costs of Terrorism: What Do We Know?" presented at Princeton University in December, 2004).

Similarly, the OECD (Organisation for Economic Cooperation and Development) estimated that the attack cost the private sector $14 billion and the federal government $0.7 billion, while clean-up was estimated at $11 billion. According to R. Barry Johnston and Oana M. Nedelscu in the IMF Working Paper, "The Impact of Terrorism on Financial Markets," these numbers are equal to about 1/4 of 1 percent of the US annual GDP--approximately the same result arrived at by Krugman.

So, although the numbers by themselves are substantial, to say the least, they could be absorbed by the American economy as a whole.

Economic Impact on Financial Markets

New York's financial markets never opened on September 11, and reopened a week later for the first time on September 17. The immediate costs to the market were due to damage to the communications and other transaction processing systems that had been located in the World Trade Center. Although there were immediate repercussions in world markets, based on the uncertainty engendered by the attacks, recovery was relatively swift.

Economic Impact of Defense and Homeland Security Spending

Defense and security spending increased by a massive amount in the aftermath of the September 11 attacks. Glen Hodgson, the Deputy Chief Economist for the EDC (Export Development Candada) explained the costs in 2004:

The US alone now spends about US $500 billion annually--20 percent of the US federal budget--on departments directly engaged in combating or preventing terrorism, most notably Defense and Homeland Security. The Defense budget increased by one-third, or over $100 billion, from 2001 to 2003 in response to the heightened sense of the threat of terrorism – an increase equivalent to 0.7 per cent of US GDP. Expenditures on defense and security are essential for any nation, but of course they also come with an opportunity cost; those resources are not available for other purposes, from spending on health and education to reductions in taxes. A higher risk of terrorism, and the need to combat it, simply raises that opportunity cost.

Krugman asks, regarding this expenditure:

The obvious, but perhaps unanswerable, question is to what extent this additional security spending should be viewed as a response to terrorism, as opposed to a political program enabled by terrorism. Not to put too fine a point on it: the Iraq war, which seems likely to absorb about 0.6 percent of America’s GDP for the foreseeable future, clearly wouldn’t have happened without 9/11. But was it in any meaningful sense a response to 9/11?

Economic Impact on Supply Chains

Economists also assess terrorism's impact on global supply chains. (A supply chain is the sequence of steps that suppliers of goods take to get products from one area to another.) These steps can become extremely costly in terms of time and money when extra layers of security at ports and land borders are added to the process. According to the OECD, higher transportation costs could have an especially negative effect on emerging economies that have benefited from a decrease in costs in the last decade, and thus on countries' ability to combat poverty.

It does not seem entirely farfetched to imagine that in some instances, barriers meant to safeguard populations from terrorism would actually amplify the risk: poor countries that might have to slow exports because of the cost of security measures are at a greater risk, because of the effects of poverty, of political destabilization and radicalization among their populations.

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