Friday, November 20, 2015

Terrorism has little economic impact

The attacks on Paris in recent days have raised concerns about the potential impact of such acts on economies and markets. Don't take the prophets of gloom seriously. Terrorism has little impact on the economy.  I have always argued thus and was happy to see an article in the FT corroborating my view.

Terrorism involves attacks on some places in a city. The city may shut down for a few days, some economic centres may suffer damage, there could some loss of output. However, this is an insignificant fraction of national output and registers merely as a blip. Terrorism could have some impact on tourism and it could affect foreign investment. But for this to happen, it has to be sustained and widespread. This is not common.

The modern economy has two great strengths. First, it is greatly decentralised. Secondly, growth depends more on knowledge capital, embodied in people and published work, than on physical capital. Both these make for enormous resilience in economies.

The effect of decentralised production was best exemplified in the ability of Germany to maintain production in the face of savage bombing in the dying months of World War II. By spreading out production and thanks to the genius of Albert Speer, the armaments minister in the Third Reich, Germany war production remained not very far from its peak despite daily bombing raids mounted by the Allies. It was not aerial bombing but boots on the ground- and mostly Russian boots- that brought Hitler's Germany to its knees.

In the more modern period, Sri Lanka's economy grew at a brisk pace even when the LTTE's ability to strike was formidable. India itself has known insurgencies in various parts for long spells but this has had little impact on the economy. The 9/11 attack in the US was shrugged off by the markets despite the large damage it caused. The fear at that time was that global economic integration brought about by the spreading out of the production chain would be imperilled. This did not happen. Any risk of terrorism simply gets priced into costs and the premium is not large.

The current bout of militancy is bound to impact migration into the west. But world labour flows have been largely controlled, so the incremental impact will not be much. Over a long time frame, adverse demographics makes greater migration into the west inevitable. The west will be selective about whom it lets in, screening will be tighter but, finally, large flows of people will happen.

More importantly, growth is driven overwhelmingly by increases in efficiency brought about knowledge capital as economist Solow showed decades ago. The destruction of physical capital and even the deaths of large numbers of people does little to degrade the availability of knowledge capital. This was true even in past centuries when marauding conquerors burnt down cities - only for these cities to rise from the ashes. Think also of Somnath being rebuilt umpteen times after the raids by Mohammed Ghazni. If this could happen in the past when knowledge was largely embodied in peiopel, think of the possibilities today when knowledge is diffuse and universally accessible at the click of a mouse.

If wars waged on a titanic scale could not stop the growth of economies, terrorist acts are no more than mosquito bites on the surface of the world economy. We will live in fear, human rights will be encroached upon, the quality of life may suffer. But material well being will not be affected by terrorism. There is, of course, one exception. That is terrorists getting hold of a seriously dirty bomb. We must fear terrorism because of that one possibility. Random attacks, with all the sorrow they cause, the world can take in its stride.


Anonymous said...

Dear Prof
It is very hard to accept the idea that Terrorism cannot obstruct the economic growth.It is well known fact that geo- political dynamics plays a crucial role in economic development,more over economic well being becomes worthless if the citizens had to live in an insecure & panicking environment. Terrorism &battles ,forces the government to introduce stringent measures like emergency,deportations thereby making the economy less liberated which further means a change in the trade equations amongst nations.The classic example is that of India& Pakistan where frequent terror attacks& infilteration disintegrated our fragile bonhomie. Some experts says that,the liberation of Bangladesh was the prime reason for our Internal Emergency since India had to spend terribly on Defence. During that time,migration was severe& India had to feed lakhs of migrants which ruined our economy .Even though it is said that need for 1991 reforms was triggered by faults in our economic structure,one cannot overrule the problems created by iraq's invasion on Kuwait. In his book "Restart" Mihir Sharma,portrays Jim O Neill who after witnessing 9/11 attacks thought about a new economic order driven by developing countries abbreviated as BRIC. Moreover,as the book puts forward,the exuberance of the self obsessed clinton era became a dim& distant memory.The Israel- Palestine issues,the war torn Afghanistan etc shows how geo- political issues are intertwined with economic development.Thus the Idea of a Cloistered economy is doubtful at present.Terrorism may not make Tsunami but it is much dreadful than a mosquito bite ,at least it can make tides,that can drown us.

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