Terror's long-term cost to the economy

By Stephen King

People have all sorts of views on globalisation but there can be no doubt that, last week, we saw a series of atrocities carried out against one, particularly enlightened, version of globalisation. London, like other major international cities, is an ethnic and cultural melting pot, a place that derives much of its vibrancy from its cosmopolitan nature. The roll-call of the dead and injured demonstrates, in its all too grim way, that London is a magnet for people from all over the world, a place where opportunity abounds. Last week's atrocities, like those in New York four years ago, were particularly repugnant for their lack of discrimination: not targeted attacks, but attacks on humanity in its widest sense.

As an economist, there's little to be said of any relevance in the immediate aftermath of these attacks. There's always the danger of some kind of financial fallout but, by the end of last week, British markets had shown the "stiff upper lip" resolve that's become almost a caricature of our behaviour.

Compared with 9/11, financial markets took the latest attacks in their stride: it's as if people recognised that, despite the scale of the atrocities, it was still possible to carry on with business as usual. And getting back to work may even have been a therapeutic process, an act of defiance in the face of savage hostility. Even 9/11 proved to be less eventful for economic activity than originally feared.

International terrorism can, however, be seen as an attack on the more positive aspects of globalisation. As transport costs have come down, and as people's knowledge of opportunities in other parts of the world have increased, so both people and capital have upped sticks and gone elsewhere. As they have done, patterns of life have changed. It may be a cliché, but the London restaurant scene has been transformed, in part, because of the "internationalisation" of our cuisine. President Chirac's attack on British food revealed a remarkable ignorance about the positive changes brought on by immigration and cultural diversity. The same is true of capital flows: whatever one thinks about multinationals, there can be no doubt that capital flows into countries such as China and India over the past decade have provided at least part of the impetus behind their now phenomenal growth rates.

Terrorism threatens these benefits, notably the particular brand of international terrorism spread by Osama bin Laden and al-Qa'ida. Terrorism increases the costs of doing business, through heightened security costs and possible disruption. It also reduces the willingness of capital to move to areas of the world that might bring the most economic and human benefits and changes attitudes towards immigration: it moves us, if you like, from a climate of opportunity towards a climate of fear.

Take, for example, the 2003 Yearbook of Immigration Statistics, published by the US Department of Homeland Security. In its section on Refugees, the Yearbook states that "the terrorist attacks of September 11, 2001 continued to have a lagging effect on the number of refugee approvals in fiscal year 2003 (61 per cent below fiscal year 2001 level) and admissions (59 per cent below fiscal year 2001 level). Approvals continued to be slowed by enhanced security procedures for the applicants ... Admissions remained well below 2001 levels because safety concerns prevented refugee processing at some overseas locations and security requirements postponed the travel of already-approved applicants".

Al-Qa'ida's desire - if there is a collective plan at all, given the diversity of the groups that make it up - is to re-establish a Caliphate in the Middle East, thereby creating a fundamentalist Islamic movement that is purposefully at loggerheads with the West. Its philosophy is one of separation, not of integration, and consequently it is, by its very design, inimical to all forms of globalisation. Its terrorist actions are a deliberate attempt to turn back the clock, to choke off all the progress in recent years towards freedom and opportunity for all, regardless of ethnic or religious background.

In that sense, al-Qa'ida's attitudes have a resonance with more traditional forms of protectionism, which seeks to reduce levels of trade, migration and capital flows to try to protect one country's interests, even if that protectionism comes at the expense of others. The irony, though, is that protectionism eventually becomes self-destructive.

If you want extreme proof of this claim, you need to go back to 1434. Then, China decided that ocean-going trade was no longer a desirable form of commerce and closed itself off from the rest of the world. That left China economically isolated and its economy found itself facing ongoing relative decline against the West. Only in the past 20 years, as China has opened up to trade and to capital flows, has that relative decline been placed in reverse. Autarky is the surest route towards economic decline.

At this stage, it is impossible to place any numbers on the longer-term effects of the al-Qa'ida version of international terrorism. Obviously, one can look at the opportunity costs of more expensive security arrangements - money that would be better spent on education, health or improved infrastructure, for example. But additional security arrangements are small fry relative to a possible overall reduction in capital and labour mobility. Factor mobility has both its positive and negative effects. Ultimately, though, reductions in factor mobility will, as China found out after 1434, lead to economic performance atrophying, with huge costs placed on future generations.

Sadly, if factor mobility does decline in response to terrorist fears, it's likely to mean that capital stays closer to home. Already, it appears that too much capital stays in the industrialised world and too little flows elsewhere. If risk aversion rises as a result of heightened terrorist attacks, this unequal distribution of the world's savings will get still worse - and, with it, so will the lives of the world's poor, those who are least able to get on the first rung of the ladder that eventually leads to economic success.

Stephen King is managing director of economics at HSBC

stephenking@hsbcib.com