PRB 01-8E

TABLE OF CONTENTS

NEGATIVE ECONOMIC CONSEQUENCES

   A.  Weakened Consumer Confidence/Reduced Consumption

   B.  Border Delays

   C.  Higher Energy Prices

   D.  Slowdown in Tourism/Losses at Airlines and Aircraft Manufacturers

   E.  Credit Crunch

ECONOMIC GROWTH CONSEQUENCES

   A.  Increased Spending on Rebuilding

   B.  Increased Spending on the Military

   C.  Additional Liquidity/Lower Interest Rates

   D.  Higher Raw Material Prices   

POTENTIAL ECONOMIC CONSEQUENCES
OF THE TERRORIST ATTACK OF 11 SEPTEMBER 2001

It is extremely difficult to predict the overall economic impact of the terrorist attack of 11 September 2001 on the United States.  This involves determining to what degree the economic growth consequences might or might not outweigh two factors:  what appears to be a nascent recession, and the negative economic consequences.   It is perhaps more useful, then, to look at the various consequences individually.

NEGATIVE ECONOMIC CONSEQUENCES

   A.  Weakened Consumer Confidence/Reduced Consumption

In previous times of war and crisis, especially after events as unexpected and sudden as the terrorist attack on New York and Washington, consumers tended to hoard food and energy supplies (oil and gas especially) owing to concern about further disruptions or supply restrictions.  Although this could provide temporary stimulus to the economy, the overall impact of the attack will likely be to diminish consumer confidence.  Partly out of concern over their jobs, partly out of concern over a possible war, consumers may delay purchases of consumer durables such as stoves, washing machines and automobiles.  Thus, there is likely to be little replacement buying, especially in the United States, where consumers have acquired a large number of these items during the past five or six years. This is slightly less true in Canada, where real incomes have stagnated relative to the U.S. and, for example, the average vehicle is older than it is in the United States.(1)

   B.  Border Delays

Following the terrorist attack, the Canadian and U.S. governments imposed increased security at all border crossings, resulting in delayed shipments of manufactured goods and parts and agricultural products between Canada and the United States.   A few days after the terrorist attack, for example, General Motors Corp. shut down an Ontario car plant(2) and Ford Motor Co. said that its third-quarter earnings would be less than expected because of border delays and flight cancellations. Other manufacturing firms (automotive and others) are expected to face similar problems.

The economic impact of the border delays, however, extends beyond the more immediate impact of plant closures, layoffs, and reduced consumption.  The delays also could lead to lower productivity, which is measured as output per hour worked.  Productivity gains in Canada and the United States during the latter half of the 1990s have been due at least in part to just-in-time delivery, smaller inventories, and shorter production runs.   Border delays make it much more difficult to guarantee on-time delivery, which means firms may have to hold larger inventories, which could exacerbate the economic slowdown, especially at a time when most manufacturers have been trying to reduce their inventories.  At a very minimum, border delays are likely to decrease the economy’s overall efficiency.  Border delays could possibly lead to some price increases for fresh fruit and vegetables that can’t be grown in Canada and have short shelf lives.  Ultimately, however, the negative effects of increased border security depend on how long enhanced security measures are in force:  if they are short-term, the impact could likewise be fleeting.

   C.  Higher Energy Prices

The prices of energy – and especially oil – surged immediately after the terrorist attack, although they fell back somewhat in the following days.  Again, the market is betting the United States will take potentially destabilizing military action in the Middle East, which continues to be a major supplier of oil to the world.  Although Canadians and Americans are far less reliant on oil than they once were, an increase in energy prices:  would almost certainly reverberate through the economy in the form of generalized price increases; and could slow the pace and magnitude of interest rate adjustments otherwise planned by the Bank of Canada and the U.S. Federal Reserve to shore up a faltering economy.  If growth were to slow markedly, however, energy prices could stabilize or even fall due to weakened demand.

   D.  Slowdown in Tourism/Losses at Airlines and Aircraft Manufacturers

Travellers will likely delay travel plans or cancel them altogether for several reasons:  fear of another terrorist attack; frustration with the increased security; or worries about their ability to afford the flight (airfares are likely to increase as insurers demand higher premiums from airlines).  Already, the airline industry has felt the repercussions of the attack, with one small U.S. airway – Midway Airlines – suspending all flights, returning its airplanes to leasing firms, and laying off its pilots.  The slowdown could be particularly painful for Air Canada, which is already facing a significant loss this year, and Air Transat, which was already contending with passenger concerns about the safety of its aircrafts.(3) To the extent that tourism travel suffers, there could be a secondary effect on the airplane manufacturing industry and companies such as Bombardier and Boeing.

   E.  Credit Crunch

There is some chance that banks may be reluctant to extend credit to their customers because of concern about a recession or, perhaps, further terrorist attacks.  This, however, is perhaps the least likely of the negative consequences of the crisis, if only because the Bank of Canada and the U.S. Federal Reserve have both pledged to provide all necessary credit, just as they did following the 1987 stock market crash.

ECONOMIC GROWTH CONSEQUENCES

   A.   Increased Spending on Rebuilding

Standard measures of economic growth do not discriminate between new spending on factories or homes and replacement spending for items that have been destroyed.  On 14 September, the U.S. government committed $40 billion in spending to assist areas affected by the attack as well as to fight terrorism and increase various forms of security (including that of the transportation sector).  From a purely accounting perspective then, rebuilding downtown New York City will add to measured output in the United States and therefore create demand for Canadian goods, especially building materials.  The destruction of the New York buildings will not affect growth to the extent that the services that had been delivered by firms in those buildings can be delivered elsewhere.   Overall, however, this stimulus should be relatively minor and of a short-term, “one-off” nature.

   B.  Increased Spending on the Military

Similarly, additional military spending by the United States to finance an attack or build up its military could provide a shot in the arm to the U.S. economy, although military spending is qualitatively different from investment expenditures because the equipment generated (tanks, aircraft, etc.) are generally not used to produce more goods.  In other words, military equipment ties up potentially scarce resources (many of which may end up being destroyed) and its production adds little to society’s productive capacity, at least insofar as consumer goods are concerned.(4) Military expenditures, therefore, have the potential to be inflationary because they use resources without creating a commensurate increase in society’s ability to produce goods.

   C.  Additional Liquidity/Lower Interest Rates

In the immediate aftermath of the attack, the U.S. Federal Reserve (and other central banks, including the Bank of Canada) announced that it would meet all demands for funds from the banking community.  In so doing, it was fulfilling the lender-of-last-resortrole that many argue is the raison d’être of central banks:  without this kind of stabilizing policy, there very easily could have been a run on the commercial banks most affected by the crisis, leading to panic and closures.(5) The end-result of this policy, however, is an increase in the money supply, as banks demand emergency credit (on behalf of themselves and their customers) to get through the crisis.(6) Although it is difficult to say how these funds will be used, possible scenarios include:  being used to meet debt commitments, in which case the increased money supply may be “neutralized”; or being used for investment or consumption, which could add to growth.

There are also expectations that the central bank will lower interest rates in the aftermath of the crisis, especially if it believes the attack could hasten a recession.  Already, the yields on two-term U.S. government bonds are near 50-year lows, suggesting the market believes interest rate cuts are inevitable and necessary. They also suggest that most market participants believe an increase in the inflation rate is unlikely in the near future.

   D.  Higher Raw Material Prices

During crises such as the terrorist attack on the U.S., raw material prices tend to rise as investors seek to invest in assets that are considered safe.  For example, immediately following the crisis, gold prices rose sharply.  There could, therefore, be some largely short-term gains for Canadian mineral producers.  Energy prices also increased following the attack, as investors assumed the United States would launch military attacks in the Middle East, a key oil-supplying area.  Not only could these attacks prove politically destabilizing, they could also lead to retaliatory action in the form of reduced output by OPEC nations.  All things being equal, higher energy prices at the world level would benefit Canadian energy producers.

(1)  Bank of Canada Monetary Policy Report, May 2001, p. 10.

(2)   Bill Koeing, “General Motors Shuts Ontario Plant Because of Parts Shortages,” Bloomberg, 14 September 2001.

(3)  Allan Swift, “Ailing airlines face more pain:  Carriers facing more losses to pay security costs, passenger drop,” The Edmonton Journal, 13 September 2001, p. G7.

(4)   That is not to say that military expenditures are useless from an economic perspective.  National security is an important part of the overall economic context, as the September 2001 events clearly show.  Moreover, military expenditures in the past have led to scientific breakthroughs that have had important economic ramifications; nuclear technology, computers, and the Internet are three examples.  Arguably, however, these discoveries could have been attained through any concerted spending effort on research and development, civilian or military.

(5)   The closure of the stock markets is another important “stabilizing” policy that some argue should be considered at the global level in times of crisis.

(6)   The media have reported that in the three days immediately following the attack, the U.S. Federal Reserve injected as much as $188 billion into the U.S. economy.  See Marian Stinson, “Fed Injects Record Cash Into System,” The Globe and Mail, 15 September 2001.