World markets had a serious attack of nerves recently. Just as a consensus was building that the global economy had got off mercifully lightly from the terrorist atrocities of September 11, the dollar, Wall Street and the FTSE 100 all took a hammering.
They were reacting to a persistent trickle of bad corporate news and finally letting go of the idea that the United States has shaken off the effects of the dotcom implosion and is already roaring up the second arm of an economic V.
But there is something else going on. Mistrust and insecurity are back. People in the West feel life — and livelihoods — are threatened, but are not sure by whom. Which is one reason the markets have reacted so strongly to intelligence warnings that the US could be the target of further large-scale attacks; to mounting military tension between India and Pakistan; and to the Middle East crisis.
A new paper by the Organisation for Economic Cooperation and Development (OECD), Economic Consequences of Terrorism, suggests the change in the political mood could damage the global economy long after the more tangible effects of the attacks on New York and Washington have gone.
Most analysts believe the worst is over in terms of the immediate hit to world growth. The depreciation in the dollar in recent weeks shows there are doubts about the fundamental strength of the US economy, but initial predictions of a prolonged global recession now look too pessimistic.
Discussion now is of when and not whether the main central banks will begin reversing the huge round of monetary loosening they put in place to keep consumers spending in the aftermath of the attacks.
Meanwhile, with worries about terrorism still strong, governments are wary of undoing the security measures they put in place at home and across international borders and the OECD fears border checks and extra security restrictions could create a drag on world trade, by imposing extra barriers on transporting goods across international borders.
”For international sea shipments, this has included notification requirements, more frequent coastguard inspections and tugboat escort obligations, which have resulted in increased costs and longer waiting times. For air freight, higher security-related costs at airports led to the application of security charges, higher commercial insurance premiums and war surcharges for sensitive regions.”
The motivation for imposing these hurdles is understandable; but industry estimates the price of negotiating them at 1% to 3% of the cost of the goods being transported. The OECD says that makes them as costly as the reductions in tariffs that developing countries managed to win from the rich nations at the Uruguay round of trade negotiations. The increased fear inflicted by terrorists risks undoing advances made through years of careful international negotiations to open up the global marketplace.
Trade flows are strongly responsive even to small movements in the cost of doing business, and the report calculates that, even if transportation costs rise by only 1%, international trade could fall back as much as 2% to 3%. ”Reversing the trend towards higher affordability of transportation and tightening border crossing indiscriminately would risk scaling back openness and could have a long-lasting negative impact on growth both OECD-wide and among non-member countries.”
There is a strong risk, too, that the countries that will suffer most will be the poorest, least trusted trading partners — those most in need of the export-led growth that participation in the global trading system can give them.
Protectionism has long been another knee-jerk response to insecurity. The motivation for Washington’s decision to slap tariffs on steel imports was as much to do with domestic politics as international concerns; but the fact that it is so willing to opt out of the rules of the international market shows how little concerned it is with multilateralism. With a new round of World Trade Organisation talks coming up, it is a bad time for the recriminations going on between the parties to the steel dispute. So much for September 11 forcing Americans and their president to look beyond their borders.
The second drag on the world economy singled out by the OECD is the risk that governments respond by pumping billions more dollars into military and security spending, reversing the post-Cold War dividend by boosting their defences against the ”axis of evil”.
US government expenditure rose by more than 10% in the final quarter of last year. President George W Bush has asked for an extra $48-billion for national defence in the 2003 budget, and is seeking congressional approval for a huge new department of security, which would probably lead to extra money being spent on the home front. Britain’s Ministry of Defence has put in a bid for new funds in next month’s Treasury spending review to fulfil its role in the Afghanistan conflict and elsewhere.
In the short term, these extra shots of public spending are a fillip to growth, one badly needed in the US at the end of last year as the full effects of the dotcom crash began to feed through to the real economy. In the long term, they divert resources away from more productive civilian uses and act as a drag on growth, by increasing government borrowing and boosting interest rates.
The OECD reckons extra public and private spending on security could knock as much as 0,7% off gross domestic product in the US seven years from now and warns Bush to exercise public spending restraint if he is to avoid damaging the US economy.
The third drag on the global economy highlighted by the OECD report is the effect of September 11 on the insurance industry. When the World Trade Centre crumbled, taking about 30% of office space in the lower Manhattan financial district with it, that was by far the largest insurance event in modern history. Insurers sustained huge losses, estimated at $30-billion to $58-billion. Fortunately, the cost was shared widely, with about half of it being borne by European reinsurance firms. Amazingly, there were no bankruptcies among big insurers.
The scale of losses has forced the insurance industry to reassess how it predicts the risk of terrorist attack. The OECD estimates that commercial property and liability insurance have been raised by 30% on average.
Insurance lubricates the economy by allowing companies to share risks they cannot afford to shoulder directly, so higher premiums hit their bottom line, making it more expensive to do business. Cash-strapped British manufacturers were signalling early this year that they were paying the price for greater insecurity in higher insurance costs. The OECD believes that in the short-term governments may have to step in to help the insurance industry while it learns to calculate the true risks of further terrorist attacks.
Governments will have to work hard in the months ahead to ensure that when terrorists struck at the symbolic heart of world trade, they did not also score an indirect hit on the global trading system itself.