Tuesday, November 24, 2015

Economic impact of terrorist strikes

First published in The Korea Herald.

The recent dastardly terrorist attacks in Paris shocked the world, with countries scampering to tighten security in preparation for any eventuality.

Even countries like Korea that have had no terror attacks from Islamic jihadists have gone on high alert, and the administration is tightening measures to make sure that no untoward incident happens.

While the nation’s security, human casualties and material losses are important aspects of these inhumane attacks, what should also be considered is the economic impact of a terrorist strike -- especially on countries like Korea, which are highly dependent on a few sectors.

A study released last month by ratings agency Moody’s shows that terrorist attacks significantly weaken economic activity, with long-lasting effects on the economy.

The study measures the impact of terrorism on a country’s economic growth, investment growth, government expenditure and cost of government borrowing, according to the report “Terrorism Has a Long-lasting Negative Impact on Economic Activity and Government Borrowing Costs.”

“For example, in 2013 the 10 countries most affected by terrorism took an immediate and significant hit to growth, dampening GDP between 0.5 and 0.8 percentage points,” the report noted. “Even worse is that the negative impact continues for years after the attack, taking up to five years for the effects to peter out.”

Investment growth takes an even greater immediate hit, with Moody’s estimating for the same episodes that investment growth declines between 1.3 and 2.1 percentage points.

During the time period studied, terrorism was concentrated in a few countries. For example, more than 60 percent of all incidents in 2013 were in just four countries, with the majority of attacks occurring in Iraq (24 percent) and Pakistan (19 percent).

Terrorist events also materially dampen economic activity and investment in mature economies, the report noted. Moody’s analyzed the economic impact of the Sept. 11, 2001, attacks in the U.S., the 2004 bombings in Spain and the 2005 bombings in the U.K., all of which resulted in significant human casualties and infrastructure damage. In each case, the effect on economic activity and investment was significant and lasted several years.

Moody’s study consisted of a sample of 156 countries between 1994 and 2013.

In another interesting study published in the International Monetary Fund’s Finance & Development journal in June, the authors reach the same conclusion.

“The effects of terrorism can be terrifyingly direct,” it notes. “But terrorism inflicts more than human casualties and material losses. It can also cause serious indirect harm to countries and economies by increasing the costs of economic transactions.”

The article explores the economic burden of terrorism, focusing on three: national income losses and growth-retarding effects, dampened foreign direct investment, and disparate effects on international trade.

It notes that rich, large and diversified economies are better able to withstand the effects of terrorist attacks than small, poor and more specialized economies.

Unfortunately, Korea falls into the specialized category given its dependence on just a few engines of growth.

The article states that specialized economies may not have such resilience. Resources such as labor or capital may either flow from an affected sector to less productive activities within the country or move to another country entirely.

“A terrorist attack against such a nation is likely to impose larger and more lasting macroeconomic costs.”

Increased terrorism in a particular area tends to depress the expected return on capital invested there, which shifts investment elsewhere. This reduces the stock of productive capital and the flow of productivity-enhancing technology to the affected nation.

The authors analyzed 78 developing economies over the period 1984–2008 and found that on average a relatively small increase in a country’s domestic terrorist incidents per 100,000 people sharply reduced net foreign direct investment.

There was a similarly large reduction in net investment when the terrorist incidents originated abroad or involved foreigners or foreign assets in the attacked country.

The study suggests a troubling association between terrorism and foreign direct investment, both of which are crucial for emerging economies.

“It is generally believed that there are higher risks in trading with a nation afflicted by terrorism, which cause an increase in transaction costs and tend to reduce trade.”

Although terrorism may reduce trade in a particular product because it increases transaction costs, its ultimate impact may be either to raise or reduce overall trade.

Terrorism also influences immigration and immigration policy. The traditional gains and losses from the international movement of labor may be magnified by national security considerations rooted in a terrorism response, the authors note.

These above-mentioned studies hold useful lessons for Korea, which is highly dependent on trade, tourism and private consumption to sustain growth.

As recent history has shown, the impact of a local tragedy on consumer sentiment in Korea is huge.

In the aftermath of the Sewol ferry tragedy -- where more than 300 people died when it sank on April 16 last year, most of them students -- the economy suffered when private consumption dropped drastically.

It plunged the country into deep mourning, dragging down economic growth -- the slowest for more than a year -- partly because of sluggish consumption.

Consumer sentiment struggled to recover for months after the incident and the fallout lasted longer than expected.

With consumer sentiment remaining feeble, companies delayed investment due to uncertainty over the economic outlook, further depressing the economy.

More recently, the Middle East respiratory syndrome outbreak in Korea dealt a severe blow to the tourism sector and dampened consumer spending, almost crippling the economy.

Thirty-three people here died from MERS since it was first detected in May, making it the largest outbreak outside the Middle East.

South Korea’s export-led economy, which has been hit by slowing global demand for its goods, together with sluggish consumer demand at home, certainly does not need another tragedy.

It is right of the government to take rigorous steps to prevent terror attacks, even though many may consider it a little over the top. The Korean economy is currently very fragile and the administration is on the right path.