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The Costs of Terrorism

Category
News, speeches and media

and the Benefits of Cooperating to Combat Terrorism

Speech

Chiang Rai

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
Unit.



Photo of Dr Geoff Raby

Main Points

  • The increased risk and prevalence of global terrorism looms as a
    major threat to regional development.� 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.� Terrorist acts can severely disrupt international
    trade and the continuing threat of terrorism imposes costs on international
    trade.
  • Given their greater reliance on trade and capital inflows, developing
    APEC economies may incur higher costs relative to GDP from unchecked
    terrorism.
  • 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.� All
    economies have an economic interest in cooperating to reduce the threat
    of terrorism.� 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.

  • A
    study of over 200 countries from 1968 to 1979 found a doubling of the
    number of terrorist incidents decreased bilateral trade between targeted
    economies
    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.

  • The
    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
    Asian
    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).
    • Analysts
      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
      Kong, Singapore
      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:

  • It
    increases insurance costs for cargoes and passengers.
  • It
    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.
    • Recent
      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
      premiums
      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).
    • Developing
      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:� 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.� This increases costs through several channels
and dampens economic activity.

  • Increased
    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.
    • Modelling
      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
      security
      factors undermining economic growth in the short to medium term (Poirson,
      1998).
    • One
      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.
    • Investments
      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.� Terrorists attacks on pipelines
      in Pakistan have disrupted natural gas supplies to business, compounding
      fiscal problems and deterring investors in future pipelines (stratfor.biz,
      2003).
  • Airline,
    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.
    • In
      2001, international tourist arrivals fell by 0.6 per cent, the
      first year of negative growth since 1982.
    • Partly
      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).
    • Modelling
      of tourism activity in Greece, Israel and Turkey also shows sensitivity
      to terrorist incidents (Drakos and Kutan, 2001).
  • Increased
    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
    growth.
  • Another
    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.
    • One
      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).
  • Currencies
    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.
    • After
      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
      currency debt
      obligations, while exchange rate volatility can discourage foreign
      investment and encourage capital flight.
    • The
      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).
  • Insurers
    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

  • The
    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).� The cost to the regional and world
    economy would be significantly higher.
    • By
      comparison, US benefits from the Uruguay Round are estimated to be
      between 0.4 and 0.6 per cent of GDP per annum.
  • A
    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
    Office, 2002).
  • A
    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
    in terrorist
    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:

  • Most
    developing APEC economies depend more heavily on trade flows, particularly
    with the United States and OPEC economies.
  • Many
    regional developing economies rely on receiving strong FDI inflows.� The
    recent increase in world and regional terrorism activity could raise risk
    premiums, reducing FDI inflows to economies considered at risk.
  • Insurance
    premiums may be higher on cargoes and vessels travelling to and from
    developing economies because of insurers' uncertainty about the adequacy
    of local
    security procedures.

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.

  • Extra
    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.
  • Another
    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.� 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.� For example:

  • Advance
    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.
  • Standardising
    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
    costs
    reducing final prices of traded goods; hence increasing demand.
    • Introducing
      compatible electronic systems to handle trade also will reduce businesses
      costs.� 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).
  • A
    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
    the faster
    processing of goods.
    • A
      related study estimates that the ACE system will save US importers
      US$22.2 billion in costs over 20 years
    • And
      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
trade.

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.� 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
transactions.

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
more stringent.

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
damage.

Summing Up

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.

References

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    A Case-Control Study for the Basque Country
    , NBER Working Paper 8478,
    National Bureau of Economic Research, Cambridge Massachusetts, September
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    Reduce Financial Development', WIDER Discussion Paper No. 2002/48, World
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    , 29 October, cited in Joint Economic Committee, 2002, The
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    , United States Congress, Washington DC,
    May.
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    Manhasset, Jan 6.
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Last Updated: 19 September 2014
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