The Costs of Terrorism
and the Benefits of Cooperating to Combat Terrorism
Paper presented by Dr Geoff Raby, Deputy Secretary, Department
of Foreign Affairs and Trade to APEC Senior Officials Meeting, Chiang Rai,
21 February 2003 and submitted by Australia to the Secure Trade
in the APEC Region (STAR) Conference, 24 Feb 2003. Economic Analytical
- The increased risk and prevalence of global terrorism looms as a
major threat to regional development.ï¿½ Terrorist acts have already
imposed significant increased costs on all economies.
- The immediate costs of terrorist acts including loss of life, destruction
of property and depression of short term economic activity are compounded
by the costs associated with the continuing threat of terrorism.
- Terrorism unchecked creates uncertainty, reduces confidence and increases
risk perceptions and risk premiums leading to lower rates of investment
and lower economic growth.ï¿½ Terrorist acts can severely disrupt international
trade and the continuing threat of terrorism imposes costs on international
- Given their greater reliance on trade and capital inflows, developing
APEC economies may incur higher costs relative to GDP from unchecked
- The costs of implementing counter-terrorism measures should be viewed
as an investment that, by reducing the threat of terrorism, will reduce
risk premiums and the bias against longer term, productivity raising
activities that uncertainty and risk create.
- New technologies introduced to strengthen security can increase efficiencies
in trade and reduce trade costs.
- Due to regional and international economic linkages, terrorist events
in one economy can impose significant costs on other regional economies.ï¿½ All
economies have an economic interest in cooperating to reduce the threat
of terrorism.ï¿½ Economies which fail to combat terrorism and ensure
the safety of trade and people movement could expect to incur significant
costs in terms of lost investment and trade opportunities.
- The positive spill-overs from anti-terrorism activities, with all
countries benefiting from a more secure trading and investment environment,
as well as the negative spill-overs from inaction, make collective
international action the most efficient response.
Unchecked Terrorism Undermines Trade
The threat of terrorism reduces trade flows.
study of over 200 countries from 1968 to 1979 found a doubling of the
number of terrorist incidents decreased bilateral trade between targeted
by about 6 per cent (Nitsch and Schumacher, 2002).
A shutdown of major ports or airports due to terrorist attacks could result
in high costs, particularly for those economies more reliant on trade.
two week lockout at 29 US West Coast ports in late 2002 delayed the unloading
at port of more than 200 ships, carrying 300,000 containers. Railcars
and inter-modal shipments were parked all over the country as US and
exports filled warehouses, freezers and grain elevators. Costly diversions
were made to other ports and many businesses laid-off workers or cut
back production (Gooley and Cooke, 2002).
estimate the month long disruption at US West Coast ports cost Asian
economies 0.4 per cent of nominal GDP. The negative impact in Hong
and Malaysia was estimated to be as high as 1.1 per cent of nominal
GDP (Saywell, 2002).
The continuing threat of terrorism raises the cost of undertaking trade
through a range of mechanisms:
increases insurance costs for cargoes and passengers.
creates the need to carry higher levels of inventory (due to the potential
for terrorism to cause bottlenecks in delivery systems) thus reducing the
benefits of just-in-time manufacturing processes and undermining supply
chain management. International information technology and automobile production
chains, which have a major presence in APEC economies, are particularly
vulnerable to supply chain disruption from security threats.
estimates indicate that if the United States has to carry 10 per cent
more in inventories and pay 20 per cent more for commercial insurance
as a result of the increased terrorism threat, it would cost 0.1 per
cent and 0.3 per cent of GDP or US$7.5 billion and US$30 billion
per year, respectively
(UBS Warburg, 2001).
APEC economies, particularly those with internationally integrated production
chains, would face relatively higher costs as a result of the fact that
trade is a more important component of GDP.
Piracy and Terrorism
The costs piracy imposed on international shipping and trade are analogous
to those of terrorism. Between 1814 to 1860, mainly due to the European
powers eliminating piracy, international shipping costs fell by over
80 per cent and the industry's total factor productivity rose by about
500 per cent. Improvement in management also contributed. By allowing
ships to dispnse with cannon and reduce their manpower, shippers could
introduce faster, cargo-specific ships dramatically reducing costs and
boosting productivity. This fall in shipping costs significantly expanded
international trade flows in the nineteenth and twentieth centuries.
Source:ï¿½ North, 1968.
The Threat of Terrorism Reduces Investment and Economic Growth
Terrorism and the spectre of future terrorist acts creates uncertainty
which increases perceived risk.ï¿½ This increases costs through several channels
and dampens economic activity.
risk perceptions undermine investor confidence, reducing their willingness
to commit to new projects. Over time, higher risk premiums increase required
rates of returns on investments, reducing equity prices and biasing investment
decisions against riskier, potentially higher return and long term investments
towards lower risk, lower return and shorter term investments. The cumulative
effect is to reduce overall investment and retard economic growth. Higher
risk premiums impact mostly on economies with substantial external financing
requirements, which must pay more for their capital, lowering investment
and output growth.
the impact of security on private investment and growth in 53 developing
countries from 1984 to 1995 shows economies can achieve significant
benefits from reducing their security risks. In the short to medium
term, this study
found measures that increased economic security in relatively insecure
developing countries to levels in best practice regions raised private
investment by 0.5 to 1 percentage point of GDP. In the long term, these
measures boosted economic growth by 0.5 to 1.25 percentage points per
year. Political terrorism was found to be one of the most important
factors undermining economic growth in the short to medium term (Poirson,
analysis estimates the fall in US investment due to ongoing terrorism
threats is about 0.2 per cent of GDP (Becker and Murphy, 2001, cited
in Joint Economic
Committee, 2002). This drop in investment and hence income is transmitted
to other economies through lower US demand for imports.
in major long term energy and infrastructure projects that require large
scale networks and coordination across several countries are highly sensitive
to increased perceptions of security risk.ï¿½ Terrorists attacks on pipelines
in Pakistan have disrupted natural gas supplies to business, compounding
fiscal problems and deterring investors in future pipelines (stratfor.biz,
travel, tourism, accommodation, restaurant, postal services and insurance
industries are particularly susceptible to increased terrorism risks. Regions
and economies where these industries are concentrated are likely to suffer
most from output and employment falls. Resulting discounting to attract
travellers reduces the return on capital and undermines future investment.
2001, international tourist arrivals fell by 0.6 per cent, the
first year of negative growth since 1982.
reflecting the Bali tragedy, Indonesia's 2002 tourist arrivals fell by
2.2 per cent. As tourism accounts for 3.4 per cent of Indonesia's
GDP, financial market analysts place the expected cost of lost tourist
receipts at around 1 per cent of Indonesia's GDP (Euroweek, 2002).
of tourism activity in Greece, Israel and Turkey also shows sensitivity
to terrorist incidents (Drakos and Kutan, 2001).
terrorism risks and associated uncertainty also reduce consumers' willingness
to spend, particularly on discretionary items and major consumer durables,
thereby reducing investment in consumer goods industries and depressing
major concern, particularly for developing economies, is that those economies
which markets perceive as failing to deal effectively with terrorism will
face higher risk premiums and the cost of protecting assets will rise,
reducing foreign direct investment (FDI) inflows.
study showed that from 1975 to 1991, heightened terrorism reduced average
annual net FDI inflows to Spain by 13.5 per cent and to Greece
by 11.9 per cent (Enders and Sandler, 1996).
of economies seen as carrying higher risk premiums may experience exchange
rate volatility and sudden depreciation in response to terrorist events,
as investors switch to reserve currencies like the US dollar; this could
impose significant costs on such economies.
11 September, the US dollar strengthened at the expense of many emerging
market currencies. Exchange rate depreciation may make exports more
competitive but it also increases domestic inflation and raises foreign
obligations, while exchange rate volatility can discourage foreign
investment and encourage capital flight.
fear of depreciation and inflation also can adversely affect the process
of financial deepening by undermining confidence in the domestic currency
(Addison, et. al., 2002).
are responding to the increased risk of terrorism by increasing premiums
and reducing terrorism risk coverage; in the medium term this could significantly
lower investment and output in affected sectors and economies. While insurance
markets may learn to price for large terrorist risk events, the unpredictability
and potential size of terrorism events will make this difficult and premiums
for risky activities are likely to be high.
The Overall Economic Costs of Terrorism Are High
IMF estimates that the loss of US output resulting from terrorism related
costs could be as high as 0.75 per cent of GDP or US$75 billion per year
(International Monetary Fund, 2001).ï¿½ The cost to the regional and world
economy would be significantly higher.
comparison, US benefits from the Uruguay Round are estimated to be
between 0.4 and 0.6 per cent of GDP per annum.
2002 US Congressional Budget Office study estimated terrorism directly
cost the United States about 0.3 per cent of non-farm GDP and also reduced
total factor productivity by around 0.3 per cent (Congressional Budget
study of the Spanish Basque country shows terrorism reduced the Basque
region's per capita GDP by 10 per cent, with the gap between expected
and actual per capita GDP appearing to increase in response to spikes
activity (Abadie and Gardeazabal, 2001).
The threat of terrorism may hurt developing economies more
While the costs of unchecked terrorism are significant for all economies,
terrorism could impose a disproportionately high cost on developing APEC
economies' trade and income growth because:
developing APEC economies depend more heavily on trade flows, particularly
with the United States and OPEC economies.
regional developing economies rely on receiving strong FDI inflows.ï¿½ The
recent increase in world and regional terrorism activity could raise risk
premiums, reducing FDI inflows to economies considered at risk.
premiums may be higher on cargoes and vessels travelling to and from
developing economies because of insurers' uncertainty about the adequacy
Counter-terrorism measures: an investment against future attacks
Implementation of new counter-terrorism measures will require one-time
investments in new infrastructure and may, in some cases, lead to short-to-medium
term increases in the costs of doing business internationally.
trade security measures taken in response to the 11 September attack
cost from 1 to 3 per cent of North American trade flows, equivalent to
increasing traders' annual costs from between US$5.6 and US$15.8 billion
(Organisation for Economic Co-operation and Development, 2002). If such
measures were applied to total 2001 world merchandise trade, they would
cost between US$60 billion and US$180 billion.
study estimates world welfare would decline by about US$75 billion
annually for a 1 per cent increase in the costs of trade. North America,
Western Europe and North Asia face the highest losses, while agriculture
and food products, textiles and leather, non-metallic minerals and machinery
are the most affected sectors (Walkenhorst and Dihel, 2002).
These costs should, however, be viewed as an investment that will, by
reducing the threat of terrorism, pay future dividends through reduced
risk premiums and increased trade efficiency.
Security measures can facilitate trade
APEC's trade facilitation and improved security objectives are mutually
reinforcing.ï¿½ Regardless of the benefits of reducing exposure to terrorism,
technological advances to increase security are likely to increase the
efficiency of cargo handling and people movement, lowering trade costs
and making trade flows more efficient.ï¿½ For example:
passenger information systems and other electronic identification techniques
at airports should speed up passenger movements and, over time, lower
business costs, as well as providing increased security at the border.
the electronic manifests system at all ports would save time and reduce
costs through quicker processing of cargo, faster vessel turnaround,
a more consistent approach to cargo and vessel data reporting, increased
confidence in the reporting system and more timely responses for importers
and exporters. All these benefits should lower freight and handling
reducing final prices of traded goods; hence increasing demand.
compatible electronic systems to handle trade also will reduce businesses
costs.ï¿½ For example, after introducing an electronic supply chain and logistics
system, a US manufacturer with a turnover of US$1.2 billion per year
who buys US$100 million in imports now takes only 20 minutes with
half as many people to produce a manifest that formerly took two to
three days to prepare (Chabrow, 2003).
presentation by the US delegation at the APEC Committee on Trade and Investment
meeting in Chiang Rai, Thailand, on 17 February, showed how the US Customs' Automated
Commercial Environment (ACE) project will increase security by enabling
US Customs to more readily identify and intercept high risk cargo,
while at the same time reducing costs to business and facilitating
processing of goods.
related study estimates that the ACE system will save US importers
US$22.2 billion in costs over 20 years
will also save the US government US$4.4 billion in administrative costs
over 20 years.
With international trade expanding rapidly, global logistics systems already
are becoming a necessity. Thus, expenditure on these new systems represents
an investment which will deliver considerable efficiency returns in the
future, regardless of their added benefits in countering terrorism.
APEC economies need to be creative in working together to find innovative
ways, using new technologies, to both strengthen security and facilitate
Cooperating to achieve trade security
The public good nature of anti-terrorist activities means all economies
can benefit from a more secure international environment and have an interest
in achieving it. Reducing terrorism creates increased international security
benefits from which no economy can be excluded; also individual economies
can benefit from this increase in security without diminishing other economies' ability
to enjoy these benefits.ï¿½ On the other hand, any individual country's failure
to take action will impact negatively on global, regional and domestic
welfare. Economies which fail to cooperate in multilateral counter terrorist
measures run the risk of marginalising themselves from many international
By taking coordinated joint action to counter terrorism, APEC economies
will increase the effectiveness and reduce the costs of their efforts to
ensure the security of their citizens, trade and investment. Without regional
and multilateral cooperation, individual economies are likely to face higher
public and private spending on security and trade requirements and regulations
and measures to combat terrorism in individual economies may need to be
Due to complex cross border linkages between financial institutions and
new banking technologies, for instance, actions to counter money laundering
and combat terrorism financing require all economies to work together.
Those economies that do not take counter measures could face a loss of
investor confidence and boycotts by other banks. Financial institutions
involved in terrorist financing also will face criminal charges and reputation
Effective action to combat terrorism will generate significant benefits
for the global economy, preventing losses from reduced trade flows and
investment undermining economic growth. Since international goods and financial
markets transmit terrorism's costs well beyond the country where acts occur
and terrorist groups operate across borders, any economy's actions to curb
terrorist activities should produce global and regional benefits. Similarly,
failure to counter terrorism will produce costs for all economies and populations.
Given their active participation in international trade and high investment
requirements to promote growth, developing APEC economies have at least
as much to gain from countering terrorism as industrial economies.
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