23.11.15 Publication:

Terrorist atrocities are always a shock, whenever and wherever they happen. That is their purpose. On Friday November 13th I was in London attending a dinner discussion with executives from a major Japanese airline, and naturally the potential impact of terrorism on the travel business was a topic of our conversation. None of us could have imagined that even while the dinner was coming to a close, a shocking terrorist attack was taking place in Paris.

The difficulty, for an economist just as much as for a business executive, is to work out what effect terrorism might have on an economy or on a business. It is difficult because by its nature terrorism is a “one-off” event, designed to cause fear and panic. But we cannot know what the frequency of such events might be.

Experience of past acts of terrorism, including the Aum Shinrikyo sarin gas attack in Tokyo in 1995, the Irish Republican Army attacks in Britain during the 1970s, or the killings in January this year in Paris by Islamic State jihadis, tells us that the economic effect of such terrorism is minor. Businesses get on with their business, people get on with their lives.

However, the outcome can be somewhat different if the terrorist attack is of a sufficiently large and shocking nature that it is taken by the target country as being equivalent to an act of war. This was clearly the case with the attacks on New York, Washington and elsewhere on September 11th 2001, which are known as 9/11. The events since the November 13th attack in Paris imply that this time, again, the economic impact might be greater.

But how? With 9/11 there were two quite different sorts of economic and business impact. The first was one of a major short-term disruption. The closing of airports and other trading ports, the sudden increase in security in major cities which made logistics more difficult, the sudden jolt to consumer and business confidence all had a noticeable and negative effect on economic output during the months following the attacks. But it did not last long.

The second sort of impact did last a long time, however. It took the form not of any negative effect on output but rather of forcing a new allocation of resources, especially public resources, towards defence and security spending. Thanks to the wars in Afghanistan and Iraq, that effect endured for many years. In fact, it is probably still affecting US public finances and GDP.

So what will happen now, after Paris? And what might its effect be on other parts of the world, including Japanese businesses? We cannot be certain. But my guess is that, like after 9/11, there will be both some short-term disruptive impact and then a different longer-term impact.

The short-term disruption is unlikely to include much of an effect on consumer or business spending. But extra security in many European cities, and extra emergency border controls between European countries, will disrupt trade and raise costs for business. Probably this will not be a very large effect, but for businesses that depend on frequent, just-in-time deliveries of goods across European borders are bound to suffer.

The longer-term impact will likely include some long-term disruption as well as some re-allocation of resources. The long-term disruption will also take the form of extra border controls and so an increase in the costs of selling goods inside the European Union.

The arrangement that exists between 26 European countries, known as Schengen (which is the name of the place at which the arrangement was first agreed, in 1985), under which people can travel without showing passports and, crucially, trucks can cross borders without stopping for inspections, is likely either to be suspended or else abandoned altogether. One way or another, an extra cost will therefore be imposed on trade within the EU for Japanese and other foreign businesses that use factories in one member country to serve the whole continent.

That impact is likely to be negative. But the impact of the re-allocation of resources might end up being positive for the economy. France and other European countries will all spend more money on defence and security. This means that they are also likely now to break their own pact to restrict their budget deficits. Justified by being in a state of quasi-war, fiscal spending will now increase inside Europe.

From a macro-economic point of view, that extra fiscal spending might not be the most efficient use of resources. Border guards and armies are not associated with high productivity. But the broad effect on the European economy is nevertheless likely to be positive. The impact of terrorism is a complex matter, in economic terms, even if its human and emotional impact is much simpler.