The burden of terrorism and war

The burden of terrorism and war
Oct 16th 2001
From The Economist Global Agenda


Amid a relentless stream of bad news, economists are still trying to assess the damage done to the global
economy by the terrorist attacks on America. But it is difficult to know how much worse things will get

In Depth: America's fiscal shock

THERE can be no quick fixes. That much was clear even before the terrorists struck on
September 11th. The world economy, led by America, had been in trouble long before then.
Now economists are trying to assess how much worse global economic prospects are as a
result of those events. But as the bad news piles up relentlessly, disentangling the
causes of the downturn is, if anything, getting more difficult. So too is framing the
correct policy response.

The latest American figures for industrial output, published on October 16th, illustrate
this dilemma all too clearly. Output fell by 1% in September, compared with August: the
twelfth monthly slide, making it the longest since October 1945. Figures released on
October 12th revealed a sharp slide in retail sales in September, down by 2.4% (in value
terms) compared with the previous month, a much sharper drop than had been expected, and
the biggest fall in nine years. Much of this weakness is probably explained by the
response to the attacks on New York and Washington.

But some of the drop reflected the downturn which was well established before then. The trouble is, nobody knows
how much weight to apply to each cause, nor how long economic uncertainty will be affected by the aftermath of
the terrorist attacks. New data released on October 12th showed an unexpected pick-up in consumer confidence in
the early part of this month; but this was before fears of bioterrorist attacks in America took hold.

After the boom years of the 1990s, pessimism is firmly back in fashion. During a decade-long expansion-the
longest peacetime boom in its history-the world's biggest economy went into a sharp reversal towards the end of
last year. The rate at which the American economy deteriorated took many economists-and policymakers-by
surprise. The speed at which America's economic problems spread around the world also confounded many. In the
first few months of this year, European policymakers were still confident that the euro-area economies would
remain largely immune from America's problems.

But it soon became clear that almost nowhere in the world would be unaffected, and that
the global slowdown could be the worst for decades. The International Monetary Fund (IMF)
recently argued that the global economic linkages had been underestimated because when
America last went into recession in 1991, Japan had been enjoying relatively buoyant
growth and economic performance in Europe was distorted by the process of German
unification. As the IMF also pointed out in its World Economic Outlook, things are very
different this time around: Japan, for instance, is now in its fourth recession in a
decade. That America's high-tech sector was, initially at least, the worst-affected also
made the global impact of America's problems greater.

By late summer it was clear how far the effects of the American slowdown were spreading.
Mexico, on America's doorstep, was in recession. Several economies in South-East Asia,
heavily dependent on high-tech exports to America, were either already in or were sliding
towards recession. And the turnaround in Europe's fortunes caught policymakers off-guard.
As yet, the euro area still looks likely to avoid an actual contraction, but by nothing
like as comfortable a margin as the language at the beginning of the year had suggested.

Long before September 11th, the policy response of the American
authorities had been aggressive. That was the term used by Alan
Greenspan, chairman of the Federal Reserve-America's central
bank-to describe the long run of interest rate cuts over which he
has presided: nine since the beginning of the year, and seven of
those before the terrorist attacks. As part of President George
Bush's ten-year programme of tax cuts, Americans were sent a tax
rebate over the summer which was intended, by the president at
least, to help kickstart the faltering economy.


Shopping confidence

It might have been faltering before September 11th, but since then most economists are convinced America is
headed for recession, if it is not already in one. The attacks dealt a further blow to consumer confidence, just
when it already looked as if the valiant American shoppers-for most of this year the mainstay of what little
growth America had managed-were finally losing heart in the face of declining business confidence, falling
industrial production and investment, and rising unemployment.

The short-term economic impact in America has been catastrophic. Industries already in serious trouble suddenly
found themselves in crisis-the airlines in particular, who saw their passenger numbers collapse in the wake of
the terrorist attacks. More than 100,000 jobs have already been lost among American carriers in the past few
weeks, and more may be on the way. The government was forced to provide emergency funding and loan guarantees
just to keep planes flying. Now a fiscal stimulus package is being negotiated on Capitol Hill, urged on by Mr
Bush who wants to see a combination of extra government spending and tax cuts of more than $100 billion,
including the emergency funding already approved.

America's government is not the only one trying to mitigate the impact of the global slowdown. Singapore is now
facing its worst recession since independence in 1965, with GDP expected to shrink by 3% this year. On October
12th, the island's government unveiled its second stimulus package since July. Hong Kong, Taiwan, South Korea
and the Philippines are all in serious economic difficulties.

The Japanese government under prime minister Junichiro Koizumi, who was elected earlier this year on a reform
platform, has still failed to deliver convincing evidence that it is committed to taking the necessary measures
to deal with long-standing structural problems, particularly in the banking system which remains plagued by bad
loans. But the Ministry of Finance has been trying to push down the value of the yen in the wake of September
11th, recognising that a weaker currency is an essential ingredient of recovery from recession.

The Bank of Japan has taken further steps to relax monetary policy. But in a reminder of the scale of Japan's
problems, the Bank warned on October 15th that the country still faces "severe adjustment" partly because of the
heightened uncertainty after the terrorist attacks on America. And on the same day, new figures showed a surge
in corporate bankruptcy and a further decline in exports.

So too has the European Central Bank (ECB), which followed the Fed's lead on September
17th and cut interest rates in an effort to bolster international economic confidence.
But the ECB resisted pressure to make further cuts when it met on October 11th, in
spite of fears that German growth, in particular, continues to be alarmingly sluggish.
The ECB President, Wim Duisenberg, argued that because the outlook remained so
uncertain, the bank needed to "keep its powder dry" for the time being.

Many economists believe that the ECB has been far too slow to cut interest rates during
the whole of this year, and that its reluctance is now especially odd, given that the
balance of risks seems so clearly weighted towards further economic weakness rather
than inflation. But Mr Duisenberg does have a point. Economic policymakers around the
world now face a dilemma. With American and British forces engaged in military action
against Afghanistan, and continuing threats of further terrorist action in America or elsewhere, no one can
predict how long the period of intense business and consumer uncertainty will last, or how significant its
effects will be.

This makes it difficult to frame the appropriate policy response. Too much fiscal stimulus now could stoke up
inflationary pressures and create long-term budgetary problems for governments-especially in America which has
seen its projections of vast government surpluses over the coming decade shrink dramatically in just a few
months. Whether or not to bail out failing industries is also a difficult question. It is one thing to help
airlines over a temporary crisis, for example, as the authorities in America and Europe have done. But it is
quite another to assume-wrongly in the case of the airlines-that all the industry's troubles stem from the
events of September 11th, and so to provide help on a scale which actually prevents the much-needed
restructuring of an industry that had already been in trouble.

Economic policymaking has always been a difficult balancing act, a case of trying to avoid listening too closely
to vested interests while recognising when policy intervention might make sense. Since September 11th, and for
the foreseeable future, steering the right course has become even more difficult.