Economic Responses to Terrorism

Murray Weidenbaum

      Murray Weidenbaum is a visiting scholar at the Center for Strategic & International Studies, on leave from Washington University in St. Louis where he holds the Mallinckrodt Distinguished University Professorship.

      The terrorist attack on September 11 and its aftermath is causing the American people to reexamine and revise their expectations of the future, both short term and long term. Under the circumstances, some economic perspective is needed. First of all, the United States remains the world's economic and financial superpower. There is no close second. Moreover, even during the terrorist attacks, the basic infrastructure of the country as well as that of the immediate regions directly affected continued to function effectively-electric and gas utilities, radio and telecommunications, banking etc.
      The direct damage was dramatic and substantial (an estimated $40 billion in the vicinity of the World Trade Center), but localized. The initial effects were readily contained, except for traveling by air. Most Americans maintained their regular activities. In striking contrast, the indirect repercussions of the unprecedented attack on the United States continue to reverberate and to generate a variety of economic impacts and challenges. One measure of those reverberations is that the U.S. gross domestic product for the year 2001 is likely to be about 1 percent lower than it otherwise would have been (a reduction of approximately $100 billion).

Macroeconomic Policies
      In view of the long-term nature of the struggle against terrorism, it is vital to maintain the capacity of the economy to function at a high level and in an increasingly competitive global marketplace while supporting the expensive new commitments involved. Given the high degree of globalization that has been achieved in recent years, the effects of a weak U.S. economy are quickly transmitted around the globe. Reductions in U.S. imports and new overseas investments mean that the already vulnerable economies in East Asia and Latin America will be hit particularly hard.
      The short-term economic effects of September 11 did not occur in a vacuum. They were superimposed on an economy that already was on the brink of recession, if not in actual decline. The negative impacts did not have to be substantial in order to tip the economy into the actual downturn that occurred. Consumer spending had been the mainstay of the economy before September 11. The new uncertainties unleashed by the event (which included lack of knowledge about the U.S. military response as well as terrorist counter actions) were sufficient to deter enough postponable consumer purchases to constitute the decisive change.
      Fortunately, the key financial agencies of the Federal government-the Federal Reserve System, the Treasury Department, and the Securities and Exchange Commission-responded quickly and with an unusual display of cooperation. Thus, ample supplies of liquidity were injected into the financial system, while investors learned that the regulatory authorities were closely monitoring the status of the stock exchanges and the other key financial market mechanisms.
      Simultaneously, government policy makers in the United States, Western Europe, Canada and Japan, were closely coordinating their activities, notably reducing interest rates at about the same time.
      This timely display of intergovernmental coordination was especially helpful in view of the unfortunate coincidences of economic weakness that had been occurring in many parts of the world, including Europe, Japan, Korea, and Southeast Asia, as well as the Western Hemisphere. In the absence of an obvious engine of economic growth, weak economic conditions can be expected to linger at least through the middle of 2002.
      The major continuing uncertainty facing economic decision makers in both the public and private sectors relates to the nature of the U.S. response to the terrorist attacks. Normally, a major military operation provides an economic stimulus, with new production contracts for a host of goods and services plus an expansion of the size of the armed services. The struggle against international terrorism, in contrast, is likely to be far more complex. Most of the actual military actions will use forces and equipment already on hand. Thus, in the current environment the economic effects of military strikes against targets in nations that harbor terrorists-and their responses-could be destabilizing. The resultant interruptions of the usual flows of international commerce and finance could offset the positive stimulus resulting from higher levels of defense orders. These adverse repercussions could include interruptions in the flow of oil from the Middle East-provoking sharp rises in price as well as substantial reductions in available supply.
      Of course, U.S. strategy should not be and will not be determined by the nature of economic repercussions. Nevertheless, these concerns reinforce the need for comprehensive economic contingency planning. In any event, the uncertainty that arises from the public's inevitable lack of knowledge of future terrorist and counter terrorist actions may interfere with the normal recovery that occurs in the economy following a national disaster of comparable magnitude (such as Hurricane Hugo or the Northridge earthquake).
      This underscores the need for expansionary monetary and fiscal policies to promote economic growth during this difficult period. To a significant degree, these policies are underway, especially in the case of the Federal Reserve System, which has been actively and progressively reducing interest rates.
      Achieving a strong and effective fiscal policy is a far more difficult undertaking. In good measure, the process requires resisting pressures from powerful interest groups seeking support for activities that do not particularly contribute to the larger objectives. Unfortunately, examples abound, ranging from overly generous farm subsidies to tax cuts unrelated to the current need to stabilize the economy.
      Over the next several years, fiscal policy decision makers will be focusing on a changing combination of increased federal spending (hopefully on productive endeavors) and carefully designed reductions in taxation. This may involve a temporary shift from budget surpluses to deficits, but the latter will do less damage in the short run than would a stagnant economy that lingers for too long.
      The added spending can finance a substantial variety of worthy undertakings, such as combating terrorism, enhancing homeland security, improving the U.S. infrastructure for ground and air transportation, and helping to rebuild lower Manhattan. Tax cuts should initially focus on stimulating consumer purchases to get the economy out of recession. Subsequently, action on taxation should shift to encouraging a greater flow of productive investment via such measures as accelerating the write-off of new investments for income tax purposes. The latter is the most effective way of promoting long-term economic growth and hence creating growing employment opportunities in a period where there is no obvious backlog of business or consumer demand.
      In the short run, an upturn in the U.S. economy can result from a variety of sources: the repeated reductions in interest rates, the substantial sums that are being spent to repair and rebuild the damaged areas, the added procurements by the Federal government for defense and other security-related matters, the lower price of imported oil that results from weaknesses in the global economy, and the need to replenish low business inventories.

Microeconomic Policy
      The effects of September 11 and subsequent events have been very uneven as they have been percolating through the American economy. Some industries have been particularly hard hit, notably airlines, insurance companies, and travel-related businesses. The latter cover a wide range of large, medium and small enterprises, including makers of jet airliners, hotels, travel agencies, car rental agencies, and airport-based restaurants. Many companies in these industries are not likely to regain their pre-September 11 market positions for a long time. Other businesses, notably financial institutions, are recovering as investors return to the financial marketplace. However, some of the most lucrative parts of the investment banking business-notably issuance of new public offerings of corporate stocks and assistance with mergers and acquisitions-are still at historically low levels. Some of the negative effects will be felt in the future. For example, as insurance companies sell off their assets and reduce their reserves in order to pay the huge claims that face them, the nation will see a shift from investment capital to current consumption. The loss of funding for new capital projects will be a negative factor in long-term growth. Moreover, the role of government in the insurance business is likely to increase with private carriers unwilling (and often financially unable) to include acts of terrorism in the coverage of new policies that they write. Directly or indirectly, the Federal Government will be underwriting a major portion of such risks.
      On the bright side, we should not underestimate the demonstrated ability of Americans to improvise in the face of new challenges. Unless squashed by excessive bureaucratic restrictions, the private sector has strong incentives to devise innovative responses to enable businesses to operate effectively in the new environment. In contrast, too much propping up of weak sectors by government assistance would end up wasting resources and sending the wrong signal to private enterprises.
      Not all of the recent changes will be negative for American businesses. Clearly, the market for antiterrorist equipment and systems (especially high tech electronics) is expanding rapidly, both in government and in the private sector. A significant, albeit measured, upturn in the military budget is now taking place and it is likely to extend over a substantial period of time. Rising expenditures for what is now called "homeland security" will cover far more than conventional military outlays. A new array of growth industries is in the offing. These include providing protection against biological and chemical attacks against the population of the United States and guarding basic infrastructure, notably the facilities that produce and distribute electric power as well as vital telecommunications systems. Stepped up internal security will also mean more detailed background reviews of new employees-both expanding the market for a small specialized industry and also adding to business overhead expenses.
      To a substantial degree, the reduction in air travel (or surely the slowdown in its growth rate) may be offset by increased use of bus and railroad transportation as well as automobile travel unless Americans respond to recent events by staying closer to home. The producers and providers of teleconferencing equipment are benefiting as a portion of conventional conferences are replaced by "virtual" meetings where the participants hear and see each other without leaving their localities. Although not a total replacement for face-to-face encounters, these virtual meetings have the added benefit of economizing on peoples' time and company costs. Nevertheless, there are limits to the use of such relatively new technology. Many people may be agreeable to long distance communication with those they know. However they may be reluctant to enter into serious discussions via telephone or television with newcomers, such as potential new hires or those marketing new products.
      Simultaneously, an acceleration is underway in the tendency of top management to bypass commercial airlines and the delays at major airports by more widespread use of company-owned or leased executive aircraft. These smaller planes use secondary airports that have not been the focal point of terrorist activity and frequently are easier to get in and out of.
      On balance, the cost of doing business in the United States will be rising to cover such factors as increased security precautions, higher insurance premiums, and delays in delivering component parts and finished products. The latter will mean that many producers and distributors will have to maintain larger inventories than they were accustomed to under "just in time" procedures. In recent years, about one-eighth of U.S. gross domestic product, approximately one trillion in goods, has been transported by air annually. The potential for change is quite substantial.
      Combating terrorism also will mean reducing the openness of borders and restricting or at least slowing down businesses and financial activities that cross national boundaries. The efforts to reduce the flow of funds to terrorist organizations inevitably involve more stringent regulation of global financial flows.

Global Factors
      Building and maintaining a global coalition to combat terrorism has important economic dimensions, which can be both positive as well as negative. At a minimum, policymakers should avoid actions-such as restricting access to U.S. markets-that would harm coalition partners who are trying to cope with the economic repercussions of terrorist actions. Given the weak economy that characterizes so many parts of the world, a protectionist policy by the United States-which would be the equivalent of economic isolationism-would be counterproductive in the extreme.
      Going beyond the need to reject trade protectionism, the present time presents an important opportunity to push forward with trade negotiations, both at the global level in the World Trade Organization and in the Western Hemisphere. Opening markets would stimulate the American economy, as it would those of cooperating nations. A new round of trade negotiations would also send the message that the United States is truly open for business, thereby enhancing confidence both at home and abroad.
      This message is of particular importance to developing countries that need new market opportunities for their exports if they are to develop the ability to deal with the difficult combination of economic and development problems that they face. Opening our markets to their products in an off-budget action that does not require any outlays from the Treasury. However such an enlightened international trade policy would enhance the receptiveness of these nations to cooperate more fully in the antiterrorist struggle.
      Nevertheless, on balance the events following September 11 will most likely result in a lower pace of globalization. Many companies in the United States and abroad will review and quite a few will likely reduce their dependence on global supply chains. Cross border movements of people, goods, and services will continue to be important, but the rate of growth-after the painful short-term adjustments are complete-is likely to be significantly less than in the recent past. The repercussions on domestic economies will be substantial. For example, during the strong growth period of the 1990s, the United States had been buying about 22 percent of Europe's exports; international trade is thus a key mechanism for transmitting domestic economic weakness to the nations that we trade with by curtailing the amount of goods and services that we buy from them.
      Professional analyses of business risk, both at country and industry levels, will constitute a new "cottage-sized" growth industry. These analyses, in turn, will often result in changes in both perceptions and actions on the part of business decision makers. Thus, the increased vulnerability of imported energy and minerals will elicit substantial changes in the modes of business operation as well as in governmental policies. In the case of fuel, greater efforts at conservation as well as at domestic production of both new and conventional energy sources can be expected. The vulnerability of our energy supply requires a multifaceted and long-term response.
      Conservation can be promoted by such means as eliminating "caps" on energy prices and terminating tax subsidies that keep the price of conventional fuels below their true economic costs. Simultaneously, the United States could encourage a greater diversity of the sources and types of fuels that are used. Specific action could include reducing regulatory barriers to the production and distribution of energy, promoting the development and use of nonconventional fuels and constructing pipelines to transport natural gas from Canada. The latter point is a useful reminder of the strategic importance of America's special relationship with its long-term friend and neighbor-Canada.
      Also, we may see a renewal of metal and mineral stockpiling. That was characteristic of the Cold War period when government agencies and business enterprises alike were concerned about the stability of specific developing countries that were often major sources of these vital materials.

Longer Term Impacts
      Some of the developments in response to the extended struggle against terrorism, by creating new business opportunities, will generate a positive effect on the overall level of economic activity. This will be so to the extent that such new activities add value to the economy and generate new sources of employment. The stepped-up security measures are likely to reduce the flow of immigration into the United States, which will increase job opportunities for some Americans-but likely reduce the overall economic growth rate.
      The exact new economic policy measures that will be necessary or even desirable in the future will vary depending on events in the intervening periods. The terrorists have demonstrated great imagination and skill in developing innovative ways of attacking the United States. Similarly, the responses by the United States and its allies are not likely to all follow conventional paths.
      These future events have the potential of changing the national policy agenda once again. This underscores the need to remember that our economic base of production and our financial system are critical assets on which the future of America rests. The way security measures are developed and carried out must take adequate account of this powerful reality. In the words of Secretary of Defense Donald Rumsfeld, "The uniforms of this conflict will be bankers' pinstripes and programmers' grunge just as assuredly as desert camouflage."
      More fundamentally, finding and punishing the terrorists and, even more importantly, destroying the major terrorist networks will generate far more positive attitudes on the part of business executives and consumers alike. That in turn will stimulate a much more positive economic outlook.

Conclusion
      The terrorist attack on the United States has set in motion forces that are generating important and lasting effects on the functioning of the American economy in general and on the private enterprise system in particular. The sensible response is neither to despair nor to react passively, but to take the initiative in developing new ways of conducting economic activity. In the long run, the result may well be a more resourceful and resilient business system that functions more effectively in a constantly changing global marketplace. In any event, the spirit of patriotism and national unity that developed in the aftermath of the events of September 11 will help in dealing with an economic future that may be more difficult and surely more uncertain than the relatively golden years of the late 1990s.