Economic Concerns in the Aftermath of Terrorism

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Table of Contents

Introduction
Analysis
Local and Foreign Direct Investment (FDI)
Financial market
Impact on supply chains
Conclusion
Recommendations
Reference List

Introduction

Terrorism is one of the major challenges threatening the existence of societies in different parts of the world. Acts of terror have been in existence for centuries. Currently, governments are facing terrorism from domestic and transnational sources (Gaibulloev & Sandler, 2009). Various scholars have tried to define the term terrorism, thus leading to numerous definitions.

Gaibulloev and Sandler (2009) define terrorism as “premeditated use or threat to use violence by individuals or sub-national groups in order to obtain a political or social objective through the intimidation of a large audience beyond that of the immediate victims” (p. 362).

Gaibulloev and Sandler (2009) further opine that modern terrorism is intended to cause harm to a particular society in order to compel the targeted government to give in to their demands. Therefore, terrorists try to achieve their goal by circumventing democratic processes.

Acts of terror may result in adverse economic and or human losses. For example, the al-Qaeda terror network advocates its supporters to attack critical economic centers. Gaibulloev and Sandler (2009) are of the opinion that such losses expose governments’ incapability to protect their citizens and assets.

As a result, the public may lose confidence on their government. In addition to social impacts, terrorism has significant economic impacts on society. Therefore, it is imperative for the government to integrate effective mechanisms to curb this social ill. This paper focuses on the economic dimension of terrorism by describing and critically analyzing the economic concerns due to terrorism.

Analysis

Direct economic costs

According to Johnston and Nedelescu (2005), terrorism has undergone significant changes over the past few years. Terrorists are targeting civilians and business activities leading to substantial destruction of property and loss of life. The Organization for Economic Cooperation and Development (OECD) estimated the direct cost of the 9/11 terrorist attack to be $ 27.2 billion, which represents 25% of the country’s Gross Domestic Product.

Local and Foreign Direct Investment (FDI)

Local and Foreign Direct Investment (FDI) are some of the major avenues through which governments stimulate their countries’ economic growth and development. According to Alfaro (2003), both the developed and developing economies are increasingly offering incentives to foreign investors in order to attract them to invest in their countries.

FDI has positive impacts on the host country’s growth and development efforts (Carkovic & Levine, 2004). First, FDI results in the transfer of knowledge and technology to the host country, thus jumpstarting its economy.

Terrorist attacks diminish the attractiveness of a particular country to investors, which arises from an increment in the degree of uncertainty with regard to foreign direct investments. Terrorism may result in the destruction of essential infrastructure. For example, the attack on London’s financial district in 1992 by the IRA terrorist group resulted in damages worth £ 800 million.

Additionally, the attack conducted on London’s railway network in July 2005 resulted in damages whose cost was estimated to be £ 1 billion (Gaibulloev & Sandler, 2009). Such destructions may lead to increment in the cost of operation. Moreover, investors may be forced to integrate private security measures in order curb terrorism, which may affect the productivity of a company adversely.

Terrorism may also increase the cost of doing business, thus hindering a country’s economic growth. For example, companies may be forced to pay higher insurance premiums (Gaibulloev & Sandler, 2009). The aviation industry is one of the industries that have been greatly affected by insurance premium hikes.

However, other sectors such as tourism, transportation, and the energy sector have also been affected (Organization for Economic Development and Cooperation, 2002). Secondly, firms may experience a challenge in their efforts to recruit the necessary workforce, which arises from lack of incentives to work in a country that is prone to terrorism.

Therefore, the performance and productivity of companies may be affected adversely by terrorism. Considering the fact that investors are risk averse in their investment process, they may decide to redirect their local and foreign direct investments to countries that are not prone to terrorism. For example, the success of the European Union depends on the extent of the developed investor confidence.

Disruption of investor confidence is likely to lead to the member states experiencing low Gross Domestic Product (GDP) due to change in investment behavior. Moreover, lack of investor confidence may also lead to a decline in asset prices.

Johnston and Nedelescu (2005) further opine, “Falling investor confidence may trigger a generalized drop in asset prices and a flight to quality that increases the borrowing costs for riskier borrowers” (p.32). This aspect may adversely affect a country’s economic growth.

Public spending

Government spending is another major macroeconomic element that is influenced by terrorism. Government spending refers to the expenditure that is incurred by a particular government in the process of providing goods and services to the public.

According to Gaibulloev and Sandler (2009), terrorism increases government spending in a number of ways. Governments are forced to increase their expenditure in an effort to implement various defensive and proactive actions to counter terrorism. Such campaigns may entail an effort to capture the terrorists.

Herendeen (2008) asserts that investments on such security measures may crowd investment in some economic sectors such as health, infrastructure [canals, bridges and highways], and education. The 2001 terrorism attack in the US stimulated the US government to invest a substantial amount in research and development on military projects.

Similarly, member states of the Organization for Economic Cooperation and Development (OECD) increased their investment on counter-terrorism mechanisms. Therefore, governments shift their focus from economically productive sectors.

According to a survey conducted by the Organization for Economic Development and Cooperation in 2002, a 1% increment on military security spending, reduces a countries spending by 0.7% within five years.

Terrorism in the less developed countries may also limit the amount of grants and donations received from the developed countries. This aspect arises from the fact that donors may develop a perception that their donations will be diverted to finance military projects rather than projects aimed at alleviating poverty (Gaibulloev & Sandler, 2009).

In an effort to raise the funds necessary to counter terrorism, the less developed countries may adopt measures that might increase the rate of inflation. For example, governments might produce their domestic currency. According to Bruck (2007), public spending during the conflict period increases significantly.

This trend continues during the years preceding acts of terror. As a result, a country’s macroeconomic stability is affected by the high rate of inflation and increase in the budget deficit (Bruck, 2007).

Financial market

According to Bruck (2007), financial markets play a critical role in a country’s economic growth as it stimulates the flow of investment capital and savings. As a result, production of products and services and continuous restructuring of a country’s economy are enhanced despite the fact that their financial markets are facing a major threat due to terrorism.

According to Johnston and Nedelescu (2005), terrorism affects the operations of financial markets in a number of ways. One of these ways entails disruption of the financial market infrastructure such as the communication systems.

For example, J.P Morgan Chase and the Bank of New York are some of the major clearing financial institutions in the US. The two institutions were forced to relocate their operations to their backup sites after the 2001 terror attack. Their relocation was occasioned by the fact that their headquarters were located near to the World Trade Center, which was hit by terrorists.

Disruption of operations in the two financial institutions forced the firms to resort to manual processing of securities and other financial transactions. This move led to significant delays in the process of clearing various financial transactions. Consequently, the degree of uncertainty in the financial institutions’ ability to address the customers’ liquidity needs was increased.

Mueller and Stewart (2011) assert that terrorism affects the stability of financial markets, and this aspect has adverse effects on stock prices. The 9/11 terrorist attack led to heavy disturbance in the global stock exchange market. For example, stock prices in the European stock market declined with a 9% margin. The decline in stock prices arose for the insurance, tourism, and the airline industries were affected adversely.

The European stock market was also adversely affected by the Madrid bombings. The insurance industry is greatly affected by terrorism compared to the stock exchange market and the banking industry.

For example, it is estimated that the US insurance industry incurred a loss of $ 30 and $ 50 billion following the 9/11 terrorist attack. Such huge financial losses may result in some companies going into bankruptcy, as the parties affected by terrorism may claim compensation, which the insurer might not be in a position to cover.

Impact on supply chains

Developing an effective supply chain is imperative in a country’s economic growth and the government should focus on three main facets of supply, which include information, material, and funds (Organization for Economic Development and Cooperation, 2002). After the 11 September 2001 terrorist attack in the US, the US government halted the country’s air transport system for four days.

The decision to halt the air transport hinged on the need to tighten the country’s security measures. Immediately after the terror attack, the US government closed the border between Canada and the US. It is estimated that approximately 500,000 vehicles cross the border daily. Moreover, the volume of trade conducted through the border between Canada and the US is estimated to be $ 1.4 billion daily.

Traders incurred opportunity cost due to the long waits. The automobile companies were the worst affected, which arises from the fact that the just-in-time supply chain was broken down. Moreover, companies that deal with perishable goods experienced huge losses due to the long wait during security checks.

The terrorist attack did not only affect the US firms, but also firms in other countries that conduct bilateral trade with the US. For example, a number of companies in Canada were shut down following the 2001 terrorist attack (Organization for Economic Development and Cooperation, 2002).

Terrorism disrupts the cost of supply chains by increasing transportation cost. Most air and water transportation companies have increased the cost of transportation. For example, the US government requires all international shipments to be subjected to inspection by the Coast Guards.

Additionally, the ships are required to be escorted by tugboats and on the other hand, airfreight companies have incorporated high commercial insurance premiums. Additionally, the cost of airfreights in some terrorist prone regions is also increased by war surcharges.

Sandler and Enders (2008) assert that exports are affected adversely by terrorism due to increment in the cost of transaction. Sandler and Enders (2008) further opine, “A first terrorist incident reduces bilateral trade by 8%” (p.5). If a country becomes vulnerable to terrorism, the volume of bilateral trade is adversely affected.

Conclusion

The paper ranks terrorism as one of the major challenge faced by all governments around the world. Currently, terrorism has undergone significant changes and the perpetrator’ targets have also changed. Terrorists are not only targeting major installations, but also civilians. Therefore, it is essential for governments and other stakeholders to address this social ill conclusively.

In addition to addressing the social impacts associated with terrorism, it is imperative for governments to take into account the economic aspects highlighted in this paper. The analysis shows that terrorism has adverse effects on a country’s economic growth and development. First, terrorism leads to substantial loss in governments’ effort to clear and reconstruct critical infrastructures that are damaged by terrorist acts.

Additionally, terrorism diminishes the attractiveness of a country to investors, which arises from the fact that investors lose confidence on the security of their investment. Lack of confidence may force investors to shift their investments to other countries that are less prone to terrorism and have a high degree of certainty. Terrorism also results in an increment in the volume of government spending.

Governments spend a lot of money in developing and implementing mechanisms aimed at countering terrorism. As a result, funds are shifted to activities that have a low economic value. Financial markets, which are a critical component in a country’s economic growth, are also affected by terrorism through disruption of communication systems.

Terrorism may also force some financial institutions such as insurance companies into bankruptcy. The supply chains are also affected adversely by terrorism. Such effects may limit a country’s ability to achieve its macroeconomic goals.

Recommendations

In order to address the negative economic effects associated with terrorism, it is imperative for governments to integrate effective counter terrorism mechanisms. Some of the issues that governments should focus on are outlined below.

Governments should integrate tighten their security mechanisms. For example, governments should conduct a comprehensive background checks on the parties involved in the supply chain. Such measures are important despite the fact that they may increase the cost of doing business. This aspect arises from the fact companies will be forced to shift from just-in-time inventory management model to just-in-case buffers to minimize disruptions in the operation of companies due to lack of raw materials.
It is imperative for governments to collaborate with one another in their quest to counter terrorism, as terrorism does not only affect the target country but also the country’s trade partners.

Reference List

Bruck, T. (2007). The economic analysis of tourism. New York, NY: Routledge.

Carkovic, M., & Levine, R. (2004). Does foreign direct investment accelerate economic growth. Retrieved from https://piie.com/publications/chapters_preview/3810/08iie3810.pdf

Gaibulloev, K., & Sandler, T. (2009). The impact of terrorism and conflicts on growth in Asia. Economics and Politics, 21(3), 359-370.

Herendeen, J. (2008). Issues in economics: an introduction. Lanhan, MD: University Press of America.

Johnston, R., & Nedelescu, O. (2005). The impact of terrorism on financial markets. New York, NY: International Monetary Fund.

Mueller, J., & Stewart, G. (2011). Terror, security and money: Balancing the risks, benefits and cost of homeland security. Oxford, UK: Oxford University Press.

Organization for Economic Development and Cooperation. (2002). Economic consequences of terrorism. Retrieved from https://www.oecd.org/eco/outlook/1935314.pdf

Sandler, T., & Enders, W. (2008). Economic consequences of terrorism developed and developing countries: an overview. Retrieved from http://www.utdallas.edu/~tms063000/website/Econ_Consequences_ms.pdf

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