By Martin Wolk
msnbc.com
updated 7/8/2005 6:27:34 PM ET 2005-07-08T22:27:34

Friday’s big global stock market rebound offers some reassurance that investors believe Thursday's terrorist attack on London will not cause serious economic damage. And indeed, economists expect the immediate impact to be relatively small and fleeting — provided the bomb blasts turn out to be an isolated incident rather than the beginning of a new wave of attacks across Europe.

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But some researchers caution that the indirect economic effects of terrorism may be more significant than many people realize, both because they are so pervasive and because the likelihood of such attacks has been priced into financial markets long before this week’s events.

While true cost of terrorism with its appalling loss of life may be incalculable, a growing body of research since the 9/11 attacks on the United States has tried to accounting of the direct and indirect economic consequences of terrorism.

The cost of the 9/11 attacks, for example, has been estimated at $28 billion in the loss of pure physical assets plus the initial cleanup and rescue efforts. But that was only the beginning, according to a 2002 assessment by the Paris-based Organization for Economic Cooperation and Development.

The attack was the greatest insurance disaster in history, with insured losses of about $32 billion for business interruption, workers compensation, loss of life and other liabilities.

New security requirements could add 1 to 3 percent to the cost of international trade transactions indefinitely, reducing productivity and eliminating some business entirely, the OECD estimates. Increased spending on the military and private security measure diverts resources from more productive uses and could cut gross domestic product by 0.7 percent over five years, according to the OECD.

Other effects are hard to quantify, but many researchers say terrorism has a long-term negative effect on economic growth, similar to other types of political instability.

“I think the evidence is that in countries where there is ongoing terrorism there is a meaningful impact on the economy and financial markets,” said Nouriel Roubini, associate professor at New York University’s Stern School of Business.

He points to the case of Israel, where the so-called second intifada beginning in 2000 caused tourism to collapse, triggered a long stock market slump and contributed to a painful economic recession from which the country is still emerging.

In the Basque region of Spain, a decades-long campaign of political terror beginning in the 1970s reduced per capita economic output by 10 percent and continues to have an effect, according to Harvard economist Alberto Abadie.

"The effect of terrorism on the economy dies very slowly with time," he said in an interview. "It's something you have to take into account when you are dealing with long campaigns of terrorism."

In a forthcoming study, Abadie and a Spanish colleague find that even without a steady campaign of attacks, even a perceived risk of terrorism can have a  “substantial” effect by reducing foreign direct investment. A sharp rise in the risk of terrorism can reduce foreign direct investment by 5 percent, according to the study by Abadie and Javier Gardeazabal of the University of the Basque Country.

In a global economy that is more open than ever, the authors argue, some investors will choose to redeploy their funds into countries where they believe the risk of terrorism is lower.

“Even if the terrorism attack isn’t realized, the perception that one may occur may be having an anticipated impact on the economy," Abadie said.

Abadie’s study has some weaknesses. Its calculations are based largely on a global terrorism risk index that was published once in 2003 and never updated. The authors measure foreign direct investment in 110 countries and control for a number of factors, finding correlations with national wealth, demographic factors and openness to investment as well as terrorist risk.

But while it may be hard to quantify with precision, the new reality of a persistent terrorist threat in some of the world’s richest nations clearly has an impact. Just look at the high price of oil, for example, which is being pushed up by a risk premium stemming in part from terrorist attacks that are threatening the Saudi regime and preventing expected oil flows from Iraq.

While the U.S. economy recovered quickly from the 9/11 attacks, that was due partly to a massive government response in terms of fiscal and monetary stimulus, creating economic imbalances that still need to be addressed, said Roubini of NYU, who served on President Clinton’s Council of Economic Advisers.

Roubini said this week's attack in London is likely to have an impact on consumer confidence and possibly on business confidence. Potentially more damaging is the evidence that al-Qaida is operating with confidence in Europe and may be planning attacks against other countries, especially those allied with the United States in Iraq.

“That may have a negative effect on business and consumer confidence,” he said. “I don’t want to exaggerate those effects, but we don’t know.”

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