Sunday, March 28, 2004
Recession and other terrorist myths
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

Whenever anybody gives a view on the prospects for the economy or the markets, there is usually a big caveat attached, along the following lines. If there is another big terrorist attack — which those who are supposed to know say is inevitable for London — all bets are off.

Terrorist anxiety comes in cycles. After the appalling Madrid bombings of March 11, fears of imminent attacks elsewhere have been heightened. That may be illogical — there is no statistical evidence that outrages are bunched (if only because the terrorists may choose to wait until complacency has set in) — but it is understandable.

Economists and market pundits feel obliged to lodge terrorism as a caveat because it is unknowable. Before the September 11, 2001 attacks on America, nobody could have really factored in an attack on that scale. Who knows whether Al-Qaeda or other groups will acquire dirty bombs, or even fully-fledged nuclear weapons? But if we stick to dealing with what we do know, a few things are clear. There is no evidence that the number of international terrorist incidents is increasing. In fact US State Department figures show an average of just over 330 separate terrorist “events” a year between 1998 and 2002, half the annual number in the mid to late 1980s.

There is evidence, on the other hand, that attacks are becoming more deadly. Deaths in the three years 2000, 2001 and 2002 matched those in the previous 14. Whereas in the past terrorists often preferred to destroy the symbols of western prosperity and power, for example by blowing up empty airliners, now they glory in the taking of human life, usually without warning.

Even that would not be a clear-cut conclusion were it not for the huge 9/11 death toll which skewed recent averages upwards. But it is reasonable to operate on the basis that we are dealing with a more callous generation of terrorists than in the past. The 9/11 attacks raised the stakes.

What do we know about the economic effects of terrorism? With the passage of time, many have come to believe, first, that the 9/11 attacks pushed America’s economy into recession and, second, that they gave us the equity bear market.

Neither is true. America’s recession began a year before the terrorist attacks, in the third quarter of 2000. The third quarter of 2001 was, perhaps surprisingly, the last one in which the US economy shrank. America embarked on growth in the fourth quarter of 2001, when the 9/11 shockwaves were compounded by a justified panic over anthrax. Britain grew through the attacks, our gross domestic product rising by 0.3% and 0.4% respectively in the third and fourth quarters of 2001.

This is not to argue that there were no economic effects from terrorism. The airline and tourism industries were hard hit, as was business confidence, leading to a corporate caution that is only now lifting.

But there were also countervailing economic factors. Policymakers responded, while central banks cut interest rates to “emergency” low levels in response to the attacks. Without 9/11 I doubt we would have had a 3.5% base rate in Britain. There was also a big fiscal response, particularly in America. To give an example, the budget of the US Department of Homeland Security jumped 60% to $36 billion (19.5 billion).

The same was true for the stock market. While the immediate effect of the 9/11 attacks was a slump in share prices — which had already been falling for months — the recovery was quite quick. A bigger and more lasting crisis came when the Enron and WorldCom debacles hit home a few months later. The Private Eye cover that said Osama Bin Laden should have trained as an accountant had a grain of truth.

What about the vulnerability of London, which houses the lion’s share of the financial-services industry, and accounts for nearly a fifth of Britain’s gross domestic product? The lesson of New York was that cities can bounce back quickly.

The future is unknowable, but London has faced terrorism before.

None of this is intended to argue for complacency, merely a bit of perspective. And if economics can help to provide that, it can also provide a way forward in the fight against terrorism. Professor Todd Sandler of the University of Southern California, who last year delivered a Leverhulme globalisation lecture at Nottingham University, is an expert in the economics of terrorism. His latest paper, Controlling Transnational Terrorism: Co-operation Dilemma, sets out a key problem.

Many readers will be vaguely familiar with game theory, if only through Russell Crowe playing the game theorist John Nash in the film A Beautiful Mind. The classic game theory is the prisoner’s dilemma, when two prisoners are being separately questioned for jointly committing the same offence. If one confesses while the other stays silent, the former is let off for honesty, the latter gets a long sentence. If both confess, or stay silent, they get locked up. Each individual’s strategy depends on what the other does.

In the case of terrorism, things are more transparent, but similar dilemmas apply. The best way to deal with a global terrorist threat is global co-operation. That may mean that individual countries abandon autonomy — sharing and in some cases combining intelligence operations, operating the same regime when it comes to arresting terrorist suspects, and so on. United, the world is stronger.

The trouble is that each individual country has an incentive not to co-operate too much, in order to maintain national independence, not be seen as America’s ‘poodle’, and hope (probably in vain) to deflect terrorist attention elsewhere. This, which economists would call the “free rider” strategy, appears to be the approach of the new Spanish government.

The task has to be to persuade countries to engage fully in a global coalition against terrorism. As Sandler put it: “Networked terrorists present a formidable threat to a globalised and technologically sophisticated world where targets still act largely independently to curb transnational terrorism . . . All solutions require collective action by rich, developed countries that is not easy to achieve.”

Building an international coalition against terrorism may be beyond the Bush White House, loaded down with Iraq baggage. It has to be the urgent task of the next US administration.

PS Sir Donald MacDougall, who died last week aged 91, had a distinguished career as an economist in academia, government — he rose to become the Treasury’s chief economic adviser — and business. He was instrumental in wartime planning, and rebuilding the British and European economies after the war.

Less successfully, he was associated with Labour’s failed attempt at economic planning, when he was the civil servant put in charge of the short-lived Department of Economic Affairs under George Brown in 1964.

His lasting legacy, however, could be work he did after leaving government. As chief economic adviser to the CBI, he was asked by the European commission to head an inquiry into how big a central budget would be needed for a fully integrated, single-currency EU. The verdict was between 20% and 25% of gross domestic product, roughly 20 to 25 times the existing budget, and too much fiscal federalism for most people.

Whether it was because of this, MacDougall became one of several ex-Treasury mandarins to sign up to the “No” campaign against UK membership of the single currency. Last week the campaign more or less shut up shop, on the ground that the budget kicked entry prospects into the very long grass. They’re probably right, although Tony Blair remains as keen as ever to pull it off before he rides off into the sunset.

From The Sunday Times, March 28 2004

Comments

Building an international coalition is beyond the Bush Administration? How clever. Is France in? Well no it actively worked against the liberation of Iraq because it was more interested in sweet heart oil contracts. Is Germany in? Well no, too many export dollars would go away. How about Russia? Well no, it was arming Iraq. How about the UN? No again. It would have to give up it's cut of the oil for palaces program.

Ever hear of the list of the bribes given by Saddam via oil vouchers? It's long and only proves how cheaply the sophisticates of Europe are nothing more than common whores.

The baggage of Iraq is rich. Would that baggage include a budding Democracy in the heart of the repressive middle-east? Or are you referring to the mass-graves and human paper schredders of the Bathists?

Waiting on the next American administration to usher in the golden age of diplomacy? Your boy Kerry is certainly up to the task. After claiming he has the support of many world leaders, he quickly ran away from his statements. He can't even get the new Spanish prime minister to rethink his commitment to withdraw from Iraq.

Exactly what world do you live in? Iraq is moving toward democracy, the Taliban are gone, Libya has shipped it's WMD's to the US, Libya has turned on and is providing info on the shadow underground trade in nuclear technology, Iran is stumbling toward inspections, Syria is pleading for Austrialia's help to get out from under the glare of US actions against this terror state, the nations around North Korea are working in tandum against this threat. Give George Bush another term and he might run the table. Can you provide me with some accomplishments of mulit-lateral and diplomatic action that actually solved problems? The first Gulf war is a classic case of the coalition defining the goals rather than the reverse. And what did we get, another ten plus years of Saddam rather the another ten plus years of a possible democracy in Iraq. Yes, I blame Bush, the first Bush.

Oh, and bye the way, the US economy is proving to be the strongest in the world. And you conviently forget the other element of fiscal policy that kick shoved the economy, marginal tax cuts.

Posted by: Gary B at March 28, 2004 05:36 PM

The problem with the reassuring statistics about the recovery of the American economy after 9/11 is that the next big event might be on a different scale. If Chicago is leveled by a nuclear weapon, or just has to be evacuated due to a dirty bomb, the economy (and the stock market) might not be as resilient. And we know that chemical attacks on London were being planned, that Pakistan and North Korea willingly trade all kind of weapons, and that Al-Qaeda and co. have no compunction about mass murdering as many westerners as they possiblly can.
So it's a bit presumptuous to say terrorism will not have a significant effect on the economy.

Posted by: Me at April 16, 2004 04:23 AM
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