GLOBAL ISSUES BRIEF

The Economic Costs of Terrorism

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The increased risk and prevalence of global terrorism looms as a major
threat to regional economic prospects. Terrorist acts already impose
significant n e w costs o n all economies.

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Longer term costs associated with the continuing threat of terrorism
compound immediate costs of terrorist acts including loss of life, destruction
of property and depression of short term economic activity.

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Unchecked terrorism creates uncertainty, reduces confidence and incre ases
risk perceptions and premiums, reducing investment and economic growth.
Terrorist acts can disrupt international trade severely and terrorism threats
impose ongoing costs on traders.

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Given their greater reliance on trade and capital inflows, unchecked
terrorism may impose higher costs on developing economies relative to
GDP.

•

Due to regional and international economic linkages, terrorist events in one
economy can impose significant costs on other regional economies. Hence all
economies have an economic interest in co operating to reduce terrorism.

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The positive spillovers from anti terrorism activities and negative spillovers
from inaction make a collective international approach the most efficient
response to terrorism.

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Economies which fail to combat terrorism and its financing could incur
significant costs in terms of lost investment and trade opportunities and
even become marginalised from many international transactions.

Report No. 01/2003

7 April 2003

Box 1

Terrorism increases trade costs, undermines trade growth

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The OECD estimates extra trade security measures taken in response to
11 September cost from 1 to 3 per cent of the value of North American
trade flows, equivalent to increasing traders’ annual costs from between
US$5.6 and US$15.8 billion. If such measures were applied to total 2001
world merchandise trade, they would cost between US$60 billion and
US$180 billion.

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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 incur the highest costs,
while agriculture, food products, textiles, leather, non-metallic minerals
and machinery traders are the hardest hit.

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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).

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The two week lockout at 29 US West Coast ports in late 2002 illustrates
the potential costs of terrorist attacks on ports. It delayed more than 200
ships carrying 300 000 containers and railcars and inter-modal
shipments were parked across the United States as US and Asian
exports filled warehouses, freezers and grain elevators. Ships made costly
diversions to other ports and many businesses laid off workers or cut
back production (Gooley and Cooke, 2002).

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The month long disruption at US West Coast ports cost Asian
economies an average of 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.

Box 2

Piracy and Terrorism

The costs piracy imposed on international shipping and trade could be
equivalent to the costs of terrorism today. 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 dispense 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,
contributing to rapid world growth.

Increasing national and transnational terrorism is looming as a significant threat
to regional and global growth. As international goods and financial markets
transmit terrorism’s costs well beyond economies where terrorists are most active,
failure to counter terrorism will generate costs for all economies.

AVOIDING COSTS OF UNCHECKED TERRORISM

The costs of unchecked terrorism already are high. Terrorism increases direct
costs for traders and producers and raises risk perceptions, depressing
international trade and investment and lowering growth.

Terrorism undermines trade

The threat of terrorism directly increases the cost of undertaking international
trade transactions (Box 1). To avoid loss of life, productive assets and cargoes
through terrorist actions and cap insurance premiums, many individual traders
and governments have increased security precautions since 11 September. The
OECD estimates these new security measures cost between 1 and 3 per cent of
the value of North American trade flows, roughly 5 to 20 per cent of trade profits
or US$60 to US$180 billion for world trade flows. Shippers pass the costs of
direct security measures and higher cargo, vessel, transport infrastructure and
passenger insurance premiums into higher shipping and aviation cargo freight
rates and fares (Box 2). Many producers also now carry higher inventory levels to
maintain supply chains in the event of terrorist disruption; the electronics and
auto industries are particularly vulnerable. A shutdown of major ports or airports
due to terrorist activities obviously would impose major costs on most economies,
particularly ones with a high ratio of trade to GDP.

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Diversion of trade flows and product substitution spread the impact of these
costs well beyond economies which are immediate targets of terrorist attacks.

Avoiding such costs is a major benefit of reducing terrorism.

Terrorism risk reduces investment

Terrorism and threats of ongoing insecurity also increase risk perceptions,
undermining inve stors’ confidence and reducing their willingness to commit to
new projects. For example, analysts estimate ongoing terrorism reduces
investment leading to a loss of about 0.2 per cent of long run GDP; in Spain,
Greece, Israel and Sri Lanka, terrorism reduces investment dramatically (Box 3).

H

igher risk premiums increase required rates of return on investments, biasing

investment decisions against long term, riskier and potentially higher return
investments, reducing overall investment and economic growth. Economies which
markets perceive fail to deal effectively with terrorism face higher risk premiums,
lower foreign direct investment inflows and higher borrowing costs.

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Airline, travel, transport, tourism, accommodation, restaurant, postal service
and insurance industries are particularly susceptible to terrorist threats, as
are large scale, cross border energy and transport projects. If terrorism goes

unchecked, regions and economies specialising in these industries and
projects will suffer the highe st outpu t and employment falls.

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For example, from 1996 to 1999, terroris m in Greece, Israel and Turkey
reduced their share of world tourism by between 0.7 and 1.4 per cent.

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Box 3

Terrorism risk reduces investment and growth

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From 1975 to 1991, heightened terrorism reduced average annual net
investment inflows to Spain by 13.5 per cent and to Greece by 11.9 per
cent.

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The estimated 0.2 per cent fall in long run US GDP resulting from
declining US investment due to ongoing terrorism leading to higher
terrorism risk premiums transmits to other economies through lower US
import demand.

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Terrorism in Spain’s Basque country reduces the region’s per capita GDP
by 10 per cent; the gap between expected and actual per capita GDP
increases in response to spikes in terrorist activity.

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From 1983 to 1988, Sri Lanka’s armed conflict cost about $4.2 billion or
68 per cent of 1988 GDP; for the period 1983 to 1996, another study
found the conflict cost about twice Sri Lanka’s 1996 GDP.

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The first 15 months of the Intifada cost Israe l 4 per cent of GDP.

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The IMF estimates the loss of US output from all terrorism related costs
could be as high as 0.75 per cent of GDP or US$75 billion per year. By
comparison, US benefits from the Uruguay Round are estimated to be
between 0.4 and 0.6 per cent of GDP.

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A 2002 US Congressional Budget Office study estimates 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. An
extensive study of US terrorism related bu siness costs including extra
logistics, insurance, workplace security, information technology, travel,
transport and employee costs estimated these totalled 1.5 per cent of
GDP or US$151 billion in 2001.

Box 4

Higher costs imposed on developing economie s

Terrorism could impose a disproportionately high cost on developing
economies because:

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increased risk premiums and security costs impact most on economies
with high trade exposure and external financing requirements

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most developing economies depend heavi ly on trade and investment
inflows

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if uncertain about local security procedures’ adequacy, insurers may

raise premiums on cargoes and vessels travelling to and from developing
economies.

A study of 53 developing economies found lifting economic security to
international best practice levels could raise short term private investment
by 0.5 to 1 percentage points of GDP and long term economic growth by 0.5
to 1.25 percentage points per year.

Insurers are responding to higher terrorism risks by increasing premiums and
reducing terrorism risk coverage, potentially lowering investment and output in
riskier sectors and economies. While insurance markets may learn to price for
terrorist events, their unpredictability and potential size will make this difficult; if
offered, premiums are likely to be high. While some governments are establishing
schemes to provide cover, this merely passes risks on to taxpayers.
Increased terrorism uncertainty also reduces consumers’ willingness to spend,
particularly on discretionary items and costly consumer durables. This reduces
consumer goods industry investment, further undermining growth.
Currency depreciation and volatility in economies carrying high terrorist risk
premiums also impose significant economic costs. While depreciation may boost
export competitiveness it exacerbates domestic inflation and blows out foreign
currency debt repayment costs. Exchange rate volatility also can discourage
foreign direct investment and encourage capital flight.
Developing economies suffer at least as much as developed economies from the
costs terrorism imposes and possibly more (Box 4).

Cooperating to achieve security

The spillover costs of terrorism mean an individual country’s failure to take
action impacts negatively on global and regional welfare. The public good nature
of anti-terrorist activities, which enable s all economies to benefit from a more
secure international environment, provides governments with incentives to
cooperate in countering terrorism, but also could encourage some free loading.
By taking coordinated joint action, economies will reduce the costs and increase
the effectiveness of counter terrorism activities. Without regional and multilateral
cooperation, individual economies are likely to face higher public and private
security spending and more stringent trade security measures. Important areas
for cooperation are trade and shipping security and terrorism financing.
Economies which fail to cooperate in multilateral counter terrorist measures run
the risk of marginalising themselves from many international transactions.

Security measures can facilitate trade

Trade facilitation and improved security objectives can be mutually reinforcing.
Technological advances to increase security also should increase the efficiency of
cargo handling and people movement, lowering trade costs. Such technologies
include face and eye scanners, electronic transmission of quarantine data and
electronic shipping systems. With international trade expanding rapidly, global
logistics systems are increasingly necessary. Thus, investment in these new
systems should deliver considerable future efficiency returns, regardless of their
benefits in countering terrorism.

Summing Up

All economies have a significant economic interest in reducing the threat of
terrorism. Effective action to combat terrorism will generate major benefits
including maintaining trade and investment levels and economic growth rates. If
all economies act cooperatively to deal with this problem, costs will be minimised
and benefits for all maximised, strengthening regional and global security and
prosperity.

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