30 November 2015

How strong are economies in the face of terrorism?


13th November 2015 marked a day filled with loss and devastation for many Parisians. As following many past terror incidents, finance professionals cautiously watched Eurozone markets open, speculating over the immediate market impact of the attacks. Historical studies on terrorism’s economic effect generally conclude that ‘after an initial drop, the innate resilience of consumers and investors will stabilize markets’. Survivors swiftly resume normal economic activity, protecting markets and the wider economy from long-lasting disruption and economic diversion. This conclusion is certainly valid with regard the impact of terrorism on diverse, developed economies – however its relevance to less differentiated economies and those experiencing protracted terror campaigns must be questioned through consideration of the economic effect of terror in nations like Pakistan and Nigeria.

The initial Eurozone market movements witnessed were consistent with those experienced following terror tragedies in developed economies. Risk aversion prompted the movement of investors away from riskier equity markets into safe havens such as gold, ‘safe’ currencies and government bonds. The Euro fell as investors moved into the US dollar and the Japanese yen, yields of 10-year commonwealth government bonds dropped on safe haven buying, and gold rocketed to $1096.90 per ounce. Travel and leisure predictably suffered selloffs – on Monday alone investors wiped more than €2.5bn off the total value of Europe’s most prominent tourism firms. Defence and security rallied as public sentiment favoured increased state observation to avert future attacks and European leaders promised increased security spending.

Considering the historical record for market recovery following terror incidents, French markets will recuperate. When US exchanges reopened on 17th September 2001, the DJIA and S&P 500 sank 7.1% and 5% respectively. These losses were recovered within a month and by the years end, the S&P was up 5.1% from close on 10th September and yearly GDP growth was just 0.5% under predictions. Subsequent attacks in Spain (2004), the UK (2005) and Mumbai (2008) saw the IBEX, FTSE 100 and Sensex finishing the year significantly higher than closing levels prior to the attacks.

These examples appear to demonstrate a temporary and short-lived negative market impact of what could be described as ‘black swan’ terror events, their unpredictable nature demonstrated in the utter shock and disbelief amongst whole populations following these incidents.

However, in Brussels at the moment, we are seeing evidence of the detrimental economic effect pure speculation of terror attacks can have. With businesses closed in the usually busy run up to Christmas and countless tourists cancelling visits due to anticipation of attacks, some commentators claim the economic impact on Brussels is already more significant than that experienced by Paris. Due to the recent increasing prevalence of terrorism, it is possible the psychological power of terrorism will be able to inflict an economic impact, separate from a physical attack.

However, as Adam Klein from the Center for a New American Security has noted: “Sporadic attacks don’t alter macroeconomic trendlines, but frequent attacks, over the long-term…significantly depress consumer expectations and business investment”. Protracted terror campaigns in the past have driven both national and international investors and consumers to direct assets to safer markets and economies. Analysis of the economic impact of the twenty-year terror campaign in Spain’s Basque region revealed each attack dissuaded approximately 140,000 tourists from visiting the country. Other studies estimated per capita GDP by the campaign’s end was 10% lower than expected.

The maturity of an economy will significantly affect the economic impact of terrorism. Fiscal institutions in developed economies are generally more responsive and able to rapidly apply stimulating monetary policy to combat negative market reaction. Many believe the ability of the Fed to make quick decisions regarding macroeconomic policy, such as sharply cutting the Federal Funds rate to stimulate borrowing, cushioned the US economy from investors’ demand for highly liquid assets following the suspension of trading. Similarly, following the Paris attacks, there is speculation of increased ECB QE to protect Eurozone markets from terrorism-induced changes in investor confidence and risk perception.

Developing economies are generally less diversified and thus are more significantly affected by reductions in specific sectors as a result of terror activity. In the Swat District in northern Pakistan, agriculture provided the main source of income for 80% of the regions households, with advanced farming systems and efficient infrastructure supporting large scale harvesting and exporting of agricultural products. However, since 2007 the area has been bombarded – roads have been destroyed or blockaded, curfews enforced and cultivation scaled back, with 76% of Swat valley land shelled into obsolescence. A government survey in 2014 estimated the loss incurred to the national economy as 35 billion rupees.

The regions of northern Nigeria are characterised by poverty in comparison to the prosperous south, where oil exports and foreign investment have made Lagos a haven for Nigeria’s expanding middle classes. Many northern and northeastern areas of Nigeria are terrorised by Boko Haram, whose increasing activity in the early 2010s saw foreign direct investment into Nigeria drop 21% in a year – from $8.9 billion in 2011 to $7 billion in 2012. The less varied economies of the north failed to recover, afflicted by a prolonged campaign of terror.

This year, Kano State’s chamber of commerce estimated business activity in Kano has fallen 80% since 2012. The owner of a textile business in Kano, stated: “Lots of projects are being cancelled in the region because people are scared. They are scared that factories can become targets; commuters to work can also become targets”. Agriculture is a major commercial activity in the north, and unstable and reduced production is both limiting cross border trade with Cameroon, Chad and Niger and raising national food prices. Accredited banks have closed some northern branches in response to the widespread decrease of economic activity and employees of national firms are migrating to safer areas, further polarising the economies of the terror ridden north and the globalised south.

Recent claims by French media place the cost of the Paris attacks (through loss of tourism and faltering consumer confidence) at around €2billion (0.1% of annual GDP). However, consideration of past terror strikes suggest that the French economy will not endure long-term economic ramifications. Studies of particularly vulnerable sectors to terrorism, such as a Deloitte report on the durability of the hotel industry, suggest even these areas see rapid recovery in western nations. The French economy is well diversified and mature, and short-term losses in certain sectors are unlikely to significantly affect the overall economy. After a short period of investor and consumer caution, economic activity and behaviour will return to that followed prior to the attacks. As part of the Eurozone, the economic effects will be further diminished by ECB intervention to loosen fiscal and monetary policy. However, the statement that terrorism has a limited economic impact is by no means universally applicable.

Sustained terror campaigns spread longer-term investor and consumer fear, and necessary economic diversion into defence and security inhibits economic growth. Economies with undiversified commercial offerings can see whole sectors diminish, with reduced production and trade spreading unemployment, migration, deprivation and national economic stagnation.

Olivia Townsend is a graduate in History from the University of Oxford, providing fresh perspectives on current trends and issues