Top 5 Ways Terrorism Impacts the Economy

The high-profile terrorist attacks in the United States, Bangladesh, Iraq, France and Istanbul, are only some of the more than 1,000 known terror attacks between the Nov. 13, 2015 attack in Paris and July 2016. Investors and businesses in the United States have dealt with the realities and tragedies of global terrorism since at least 2001, and the threat has only increased. While the human cost is devastating, the economic impact may be larger than most realize. The following are five ways that terrorism has an impact on the economy.

The most immediate and measurable impact of terrorism is physical destruction. Terrorists destroy existing plants, machines, transportation systems, workers and other economic resources. On smaller scales, acts of terrorism may blow up cafes, churches or roads. Large-scale attacks, most infamously the World Trade Center bombings on Sept. 11, 2001, can destroy billions of dollars' worth of property and senselessly kill thousands of productive workers.

The impact of terrorism and war is always negative for the economy, and physical destruction is a large reason why. Productive resources that might have generated valuable goods and services are destroyed, while other resources are almost invariably diverted from other productive uses to bolster the military and defense. None of this creates wealth or adds to the standard of living, even though military spending is often erroneously cited as a stimulant; this is the "broken window fallacy" sometimes mentioned by economists.

Even if you do not live anywhere near terrorist attacks, you might still be negatively impacted indirectly. This is because all kinds of markets hate uncertainty, and terrorism creates a lot of it. The financial markets literally shut down after Sept. 11, and did not really recover until months after the 2003 invasion of Iraq.

There is plenty of debate about the depth and pervasiveness of the actual impact on financial markets. As the threats and publicity of global terrorism continue to rise, markets appear to be more and more resilient. Stock market indexes did not decline much after the terrorist attacks in France killed at least 129 people in 2015. However, the deadly attack in Nice, France in 2016 only adds to the sentiment that France may be an increasingly unstable place to live and do business in. The real threat of global terrorism from an investor's perspective is about the broader picture, not individual incidents. International investment and cooperation are lower in a world full of terrorism.

There are two obvious industries especially vulnerable to the effects of terrorism: insurance and tourism. Not all insurance companies pay out in the event of international terrorism or foreign wars, so the impact is likely less than you might first expect. Nevertheless, terrorism is risky business for everyone, and insurance companies hate risk as much as anyone else.

Tourism is even more concerning. In France, for example, tourism accounts for approximately 7 to 8% of total gross domestic product (GDP). Vanguelis Panayotis, a director of MKG tourism consultancy, told Reuters that he expected a 30% decline in visitors to France in the month after the Nice attacks.

On a broader scale, terrorism hurts international trade. This may be due to imminent threats, such as compromised trade routes and distribution systems, or because of the psychological and physical reactions to terrorism. This also means less foreign direct investment (FDI), especially in unstable countries.

There is an old saying in the study of political economy that reads "war is the health of the state." It means that during times of conflict, reactive governments and nervous citizens are far more inclined to give up economic and political freedoms in exchange for security. This could result in higher taxes, higher government deficits and higher inflation. During wartime, the government often implements price controls and sometimes even the nationalization of industries.

Governments are less effective at managing resources for productive economic activity than private individuals, especially when those resources are co-opted to achieve a strategic military objective. When governments militarize, the private economy suffers. As economist and historian Robert Higgs demonstrated in his book "Crisis and Leviathan," many government controls stay in place long after military campaigns end.

The final risk to the economy is political risk. This is already on display in the United States and Europe in 2016, where there has been a rise in skepticism of foreign cultures, businesses, immigrant workers and refugees. Populist movements already won a victory of sorts in the United Kingdom, where anti-globalist and anti-trade sentiments helped pass Brexit. These kinds of major political events have an uncertain economic fallout on everything from currency to trade and diplomacy.

Closing down borders to trade and immigrant workers reduces the size and diversity of economic transactions and limits productive resources. Economists as early as Adam Smith contended that the division of labor and gains from trade are limited to the size of available factors of production. Just as a single household or town is less productive if it only relies on internal resources, so too do national economies limit themselves to the extent that they wall off external producers and consumers.