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Bomb and the Bill: Economic Impact of Terrorism

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A year after 9/11, the Comptroller of the City of New York gave a report on economic consequences of the attack. The report pegged the property losses at $21.4 billion – otherwise a huge amount but actually just 0.2% of US GDP. The report, however, observes that there was a large economic loss in terms of diversion of business, which is difficult to quantify. Direct cost of a terror attack – in terms of lives lost or property damage – is undoubtedly the most spectacular part of it but often proves to be the tip of the iceberg in terms of its economic consequences.

Terrorism by definition is asymmetric warfare. An individual terrorist or a group tries to inflict maximum damage during an attack but the strategy of any terrorist organization is to bleed its perceived opponent through thousand cuts – therefore they try to maximize the long term/indirect cost. Through recent (i.e., post-9/11) research, three distinct components in terms of economic consequences have been identified – direct, indirect and frictional. It is however important to remember the context of such analysis – Western world has so far witnessed only isolated cases of violence. Violence due to long term militancy obviously produces a different set of patterns.

The Western Template

Direct Cost is similar to accidents/natural calamities. The key components are loss of lives, damage to property and the cost of rescue, relief and immediate dislocation. Airlines, travel and tourism are also affected immediately. Indirect cost has also been described as terror tax. To prevent recurrence of such attacks, a state/society invests heavily in deterrent mechanisms. As the resources are limited, the concerned state is compelled to divert resources from other areas, more often from social sector like health and education. But it is difficult to draw the line. If we look at the post 9/11 scenario of businesses moving out of downtown New York, it could also be because of high property prices or broken infrastructure or a combination of such factors. Even if we assume businesses moved out post 9/11 then the loss is only for the city economy and not the national economy. Afghan war was a direct consequence of 9/11. But for war in Iraq, 9/11 just made the justification easier. Though it cannot be counted solely as an indirect cost of 9/11 but between 2001 and 2011, Washington spent a mind-numbing 7.2 trillion dollars for defence and homeland security – and this was after all just one attack.

In a widely read cover story in 2002, Fortune concluded that the real cost of 9/11 should be measured in terms of response to terrorism, how it has generated frictions all over the great American economic machine. Fortune estimated a loss of 1.5% of GDP per annum due to these frictional costs. Firstly there was a massive hike in insurance premium (there was no template of terror insurance in most of the western economies before 9/11). Fortune claimed that the attacks have compelled businesses to review their supply chain management and in place of just-in-time delivery they have been forced to stock up supplies, which, in turn, had significantly slowed down US productivity. Most subsequent studies have rejected this contention though they have agreed on enhanced transaction cost due to heightened security.

Terrorism in South Asia

Terrorism in South Asia is a long term issue, resulting in significant loss of lives and damage to property and infrastructure. Two important indices to analyze the economic impact of such losses are the number of casualty per million populations and material loss in proportion to the country’s GDP. As per the Global Terrorism Database, between 1968 and 2004, India was the second most vulnerable country after Israel. But for Israel this translates into 258 terrorist attacks/million population as against just one incident/million population in India. Israel suffered 1502 casualties/million population, in case of India it was just 7. In terms of number of incidents per billion dollars of GDP – tiny Lebanon tops the chart and in case of India – despite far higher casualties – it hardly makes an impact. In South Asia, it is difficult to arrive at a correct estimate of property losses due to lack of insurance penetration.

India is witnessing considerably less violence in recent years in trouble-spots like the North-East and Kashmir (though incidents outside these areas have gone up). In our understanding, terrorism so far has not become a large enough problem for the Indian economy as a whole. On the other hand, recent wave of terror in Pakistan has seriously dented the country’s economy. The cost for anti-militancy operations went up from US$2.72 billion (2001-02) to US$17.82 billion (2010-11). Travel ban along with general insecurity led to a precipitous fall in investment and trade. In North-West Frontier Province (Khyber Pakhtunkhwa) and FATA, millions were displaced, infrastructure was destroyed and tourism came to a virtual halt leading to massive job losses. The result was best summarized in Pakistan’s Economic Survey (2010-11), which had a special chapter on economic impact of war on terror: “Pakistan has never witnessed such devastating social & economic upheaval in its industry, even after dismemberment of the country by direct war”.

Economic impact of long term terrorism can only be understood by analyzing its debilitating consequences at different levels. Kashmir and in recent times NWFP-FATA are examples of prosperous provincial economy destroyed due to long and intensive period of terrorism. Between 1989 and 2011, Kashmir has witnessed as many as 17 years of high density violence (more than 1000 fatalities a year). This resulted in sharp increase in both direct (destruction of property, infrastructure and displacement of people) and indirect cost (policing cost, terror tax on business/individuals). This long phase of violence virtually destroyed Kashmir’s tourism and fruits and handicraft industries. There was no dearth of fund flow into Kashmir during this period but due to terror-induced distortions these funds could not be used for productive purposes. Similarly, militants in NWFP-FATA have inflicted massive casualties and deliberately targeted business and infrastructure. They also destroyed or damaged 65% schools in Swat alone. As tourism collapsed, most of the 800 plus hotels in Swat employing 40000 people went out of business. Violence has displaced more than 3 million people in these two areas – putting a huge strain on the entire Pakistan economy.

Terrorists always target congested urban areas where density of both population and productivity is highest. Globally three South Asian cities have been hit most number of times – Kabul, Karachi and Mumbai. Here we will limit ourselves to Mumbai and Karachi. Since the Babri Masjid demolition in 1992, Mumbai and every sphere of Mumbai life has been under the shadow of terrorism. Every time there was a serial blast or isolated blasts in Mumbai, regular targets included suburban railway, which is the lifeline of Mumbai, stock market and diamond trading centres. Bombay Stock Market came to a standstill when it was attacked in 1993 but since then stock trading has largely moved on to computer screens and has become location-neutral. Bombay diamond hub, centered around Zaveri Bazaar-Opera House has also been targeted repeatedly. A large number of diamond traders have already shifted to Gujarat (Surat, Ahmedabad), which they consider a safer option. Some are in the process of shifting to Bharat Diamond Bourse in Bandra-Kurla, leaving the South Mumbai diamond hub bereft of its former glory. It is however important to remember that security is not the sole factor, businesses may be shifting out of Mumbai due to various reasons, including very high cost of real estate. Mumbai in economic terms is no longer the sole growth engine of a resurgent Indian economy. Pune, apart from its manufacturing focus, appears to have claimed the pole position in terms of new economy in the region. As Pune emerged as a new economy destination, terror followed on close heels – German bakery blast on 13 February 2010 killed 17 people and injured at least 60, including foreigners.

Karachi, Pakistan’s most populous city, is more important to Pak economy compared to what Mumbai is to Indian economy. Karachi alone accounts for more than 50% of Pakistan’s total revenue collection and contributes more than 20% to the nation’s GDP. Karachi and Port Qasim together handle more than 90% of Pakistan’s cargo traffic. In 2011, all the terror-related casualties in Sindh were reported from Karachi. As per the SATP database, the total casualty in 2011 in Karachi was 1048. There are many shades of violence in Karachi – political, ethnic and routine criminal violence. Entire Pakistan appears to be paying a very high economic cost for terrorism but Karachi seems to be worst affected simply because more business has traditionally been concentrated here.

Indirect Cost in South Asia

Indirect cost needs to be seen in two categories – tax to the government and tax to individuals /businesses – most of the frictional costs come under this category. There has been a huge increase in India’s internal security (Home Ministry) budget in recent years (Rs 13037 cr in 2002-03 to Rs 48920 cr in 2011-12). As policing is a state subject so the hike in central government budget alone does not represent the full picture. In case of central government spending the key elements are: Para-Military forces, cost of building new institutions like NATGRID, NIA, NCTC and expansion of existing units like regional NSG hubs, providing funds for capacity building of state police forces and vastly enhanced cost of digital security. In Pakistan, it is far more difficult to investigate the actual amount of resource diversion. There has been a little change in terms of internal security budget but defence budget has predictably gone up sharply post 2006, when the army launched its offensive against the militants.

For individuals, the chief cost is due to displacement – we have already mentioned massive internal displacement in Pakistan. In India also, Kashmiri Pandit community represents a case for systematic targeting by terrorists resulting in displacement of the entire community. Rising insurance premium is a concern for the organized sector. But organized or unorganized, every business/office establishment today is forced to invest considerable resources for security. Indian security market, valued at around US$1 billion in 2009 and is estimated to be US$9.7 billion by 2016. There are as many as 5000 companies in Indian security market today with more than 5 million private guards. Metro in Delhi and Kolkata, premier private offices (like Infosys in Bengaluru) and research institutions (following blast at IISc, Bengaluru) are now being protected by CISF. All the important temples and courts around the country are being protected by central forces/state police commando units. NSG commandoes are deployed in every domestic flight. Need for tracking terror financing has added to transaction cost in the financial system. Terror –Mobile nexus has brought security at the centre of telecom policy debate. Rising trend of segregated and community-centric housing in metropolitan India is also an unfortunate fall out of security concerns.

Bomb and the Bill

Terrorism is typically seen as a political and law and order problem and responses are designed from that perspective. But the total cost of terror is an aggregate of individual and government responses. Terror forces an individual to modify investment and consumption patterns. Terror also forces a government to change its priorities, very often which means curtailing funds for socio-economic development. This is the actual cost terrorism imposes on any society. After 9/11, the USA launched three operations, ostensibly to make both the USA and world a safer place – Operation Enduring Freedom in Afghanistan, Operation Iraqi Freedom and Operation Noble Eagle to make US military bases and homeland more secure. Operation Noble Eagle is the least known among the three and Washington has spent least amount on it (total allocation came down from $8 billion in 2003 to $100 million per annum beginning 2008). Though Boston again brought terror back into US mainland, yet Op Noble Eagle has been the most successful in achieving its objectives. Contribution of two other high-profile campaigns in securing American life – despite much higher cost – remains highly questionable. The basic policy challenge for governments therefore – more so in developing countries like India and Pakistan – is to avoid the traps of asymmetric war and allocate resources judiciously and effectively.

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