Economy Likely Won't See Gain From War Against Terrorism

Greg Ip and John D McKinnon / Wall Street Journal 25sep01

WASHINGTON -- As in previous wars, the U.S. is gearing up to spend billions of dollars on its war against terrorism. But unlike past conflicts, this one isn't likely to pump up the economy.

While earlier conflicts occurred overseas, terrorism damages Americans' sense of well-being, hurting the civilian economy in ways that purely military engagements like the Vietnam or Persian Gulf wars didn't.

Successfully attacking a military target as prominent as the Pentagon would have had great symbolic value, but little economic impact, says Alberto Abadie, an economist at Harvard's Kennedy School of Government. By contrast, he said, the destruction of the World Trade Center affects "the spinal cord of any favorable business environment" -- the ability of business and workers "to meet and communicate effectively without incurring risks."

Most economists expect the terrorist attacks to drive the U.S. into recession -- albeit a short one. Even Treasury Secretary Paul O'Neill, who initially played down the economic impact of the attacks, said Monday they had hit the economy in a "resounding way," though the underlying future of the U.S. economy is "very good." Indeed, most economists expect growth to resume in the first quarter of 2002, helped by aggressive interest-rate cuts and a big boost in federal spending.

That is unless, of course, there are more terrorist attacks. President Bush has warned of a prolonged fight, raising the risk of more attacks. If that is the case, the experience of other countries suggests business investment and economic growth could be hurt for some time to come, though how much is hard to measure.

After the separatist group ETA began an intense terrorist campaign targeting business in Spain's Basque region in the mid-1970s, the region's per capita income fell 10% from what it otherwise would have been, according to a study co-written by Prof. Abadie. Investors aren't likely to abandon the U.S. as they did the Basque region, he said. Still, when civilian business activities are targets, Prof. Abadie said, terrorism is "likely to create lower private investment" while boosting security costs.

Because of its global scale and long-term nature, the war on terrorism probably will cost more than the Persian Gulf War, which totaled about $80 billion in constant fiscal-year 2002 dollars. The Vietnam War, by contrast, cost $572 billion in 2002 dollars. U.S. government spending as a percentage of gross domestic product peaked at 43.7% in 1944 during World War II and was only 20.5% at the height of the Vietnam War in 1968. It is currently about 18%.

"In relation to the size of the overall economy, the increase [in government spending] this time will not be sufficient to compensate for the dampening effect of the threat itself," said Loren Thompson, chief operating officer with the Lexington Institute, a military think tank in Arlington, Va. "On balance, I think this is an economic negative rather than a positive."

Furthermore, the money expected to be spent as a result of the attacks overstates the stimulative impact of fresh government spending, since much of it will simply go to replace lost incomes, notes UBS Warburg economist Maury Harris.

Overall, the economic spinoffs from direct spending related to the conflict are likely to be quite small. Some security activities might even drain economic energy by slowing commerce and discouraging travel. Some high-technology activities -- such as cracking encryption devices to track down terrorists and their assets -- could produce considerable new skills and technology, but they might not translate readily to a bigger market.

One of the big costs will be intelligence-gathering on the whereabouts of terrorists and their assets. Government spending for security measures also will soar, not only for airlines and buildings but also for telecommunications infrastructure and computers. "It's also a war against cyberterrorism," said David E. Baker, managing director, Schwab Washington Research Group.

The effects of a prolonged terrorist campaign may prove difficult to measure. When the Irish Republican Army launched several bombings in London's financial district between 1991 and 1994, "it led to fears that were uttered quietly, that London would lose business to other European locations," said Brendan O'Leary, a political scientist at the London School of Economics who has studied the Northern Ireland conflict. "Almost by definition these things are impossible to quantify. But there's not much doubt that it was a factor affecting policy makers' thinking."

Israel's growth has come to a standstill in the past year, hit by a combination of the Palestinian intifada and the Nasdaq collapse, which has hurt Israel's high-tech sector. The security response has added to costs everywhere, said Ephraim Kleiman, professor of economics at Hebrew University in Jerusalem and a visiting professor at the Massachusetts Institute of Technology. Even coffee houses now post guards at their entrances, he said.

But over the years Israelis have learned to live with both the constant threat of terrorist attack and the intrusiveness of extreme security measures. Once the initial horror of the Sept. 11 attacks wears off, the same is likely to be true of Americans, Prof. Kleiman said.