Modeling and Estimating the Macroeconomic Consequences of Terrorism

Transcription

1 CREATE Research Archive Current Research Project Narratives Modeling and Estimating the Macroeconomic Consequences of Terrorism Brock S. Blomberg Claremont McKenna College, Follow this and additional works at: Part of the Behavioral Economics Commons, and the Macroeconomics Commons Recommended Citation Blomberg, Brock S., "Modeling and Estimating the Macroeconomic Consequences of Terrorism" (2013). Current Research Project Narratives. Paper This Article is brought to you for free and open access by CREATE Research Archive. It has been accepted for inclusion in Current Research Project Narratives by an authorized administrator of CREATE Research Archive. For more information, please contact

2 National Center for Risk and Economic Analysis of Terrorism Events University of Southern California Modeling and Estimating the Macroeconomic Consequences of Terrorism October 2012 to September 2013 S. Brock Blomberg Claremont McKenna College "This research was supported by the United States Department of Homeland Security through the National Center for Risk and Economic Analysis of Terrorism Events (CREATE) under Cooperative Agreement No ST-061-RE0001. However, any opinions, findings, and conclusions or recommendations in this document are those of the authors and do not necessarily reflect views of the United States Department of Homeland Security or the University of Southern California." Cooperative Agreement No ST-061-RE0001 Department of Homeland Security December 31, McClintock Avenue, RTH 314 ~ Los Angeles, CA ~ (213) ~

3 ABOUT CREATE Now in its tenth year of operation, the National Center for Risk and Economic Analysis of Terrorism Events (CREATE) was the first university-based Center of Excellence (COE) funded by University Programs of the Science and Technology (S&T) Directorate of the Department of Homeland Security (DHS). CREATE started operations in March of 2004 and has since been joined by additional DHS centers. Like other COEs, CREATE contributes university-based research to make the Nation safer by taking a longer-term view of scientific innovations and breakthroughs and by developing the future intellectual leaders in homeland security. CREATE's mission is to improve our Nation's security through research and development of advanced models and tools to evaluate risks, costs and consequences of terrorism and natural and man-made hazards and to guide economically viable investments in homeland security. We are accomplishing our mission through an integrated program of research, education and outreach that is designed to inform and support decisions faced by elected officials and governmental employees at the national, state, and local levels. We are also working with private industry, both to leverage the investments being made by the Department of Homeland Security in these organizations, and to facilitate the transition of research toward meeting the security needs of our nation. CREATE employs an interdisciplinary approach merging engineers, economists, decision scientists, and system modelers in a program that integrates research, education and outreach. This approach encourages creative discovery by employing the intellectual power of the American university system to solve some of the country s most pressing problems. The Center is the lead institution where researchers from around the country come to assist in the national effort to improve homeland security through analysis and modeling of threats. The Center treats the subject of homeland security with the urgency that it deserves, with one of its key goals being producing rapid results, leveraging existing resources so that benefits accrue to our nation as quickly as possible. By the nature of the research in risk, economics, and operations, CREATE serves the need of many agencies at the DHS, including the Transportation Security Administration, Customs and Border Protection, Immigration and Customs Enforcement, FEMA and the US Coast Guard.. In addition, CREATE has developed relationships with clients in the Offices of National Protection and Programs, Intelligence and Analysis, the Domestic Nuclear Detection Office and many State and Local government agencies. CREATE faculty and students take both the long-term view of how to reduce terrorism risk through fundamental research, and the near-term view of improving the cost-effectiveness of counterterrorism policies and investments through applied research. In 2011, the University of Southern California (USC) and a team of 23 partner institutions were awarded a new 5-year Cooperative Agreement resulting from a recompetition of the Center s charter. This annual report covers the third year under Cooperative Agreement 2010-ST-061-RE0001, the ninth year overall of CREATE s DHS funding, from October 2012 to September ii

4 Table of Contents 1. Executive Summary Research Accomplishments Research Products Publications Conference and Outreach Presentations Education and Outreach Products Executive Summary This study continues to provide contributions for our understanding of underlying macroeconomic consequences of terrorism. This has been a continuation of years on working on projects under this theme. The study estimates the long run economic growth effects associated with terrorism and includes impacts due to behavioral influences as specified via social capital networks. To accomplish this task, we extended a panel data set that incorporates the World Bank data on national income and growth, IMF data on financial conditions, RAND and START data on domestic and international terrorism incidents, and data on external and internal conflict. Using this unique dataset, which spans over 40 years for 180 countries, we examine the dynamic effects of terrorism on economic growth, consumption growth, as well as possible effects on capital accumulation and macroeconomic instability. The panel dimension of this data is particularly useful as it allows identification of the effects of terrorism on economic activity, growth and stability that may be evident in long-run trends that cannot be detected absent long-horizon cross-country comparisons. With these added degrees of freedom across the globe, we can then extract the impact on the United States economy. This project continues to develop a research program to estimate the economic impact of terrorism using a myriad of macroeconometric techniques. To estimate the long-term impact of terrorism the project will employ cross-sectional estimation, to estimate the short- and medium-term impact of terrorism the project employ dynamic panel and VAR analysis. To augment these estimates, the project will include estimates from the impact due to psychological and behavioral factors. This project continues to be of the three modeling and research analyses of CREATE Economic Assessment which includes the estimation of direct and indirect economic impacts and cost-benefit analyses of counter-terrorism options. Last year s project resulted in a macroeconomic-model and data construction of over 16,000 terrorist events over 40 years in the United States and abroad. In 2009, it provided macroeconomic estimates on the average loss of GDP growth, which aided in a definitive estimate of the cost of 9/11 of $60 billion. The research was well-received by policy-makers, think-tanks and academia, as the research associated with the funding led to 4 publications and 2 presentations to date. The work for year 9 augments these earlier estimates by comparing costs over a longer historical context and providing predictions for the longer term future. In addition, I explored developing new research ideas with a more applied focus. The purpose of this research is to improve methods for assessing likely targets of terrorism. Our goals are to investigate three economic avenues of terrorism (democratization, globalization, and resource allocation), to better predict when and which countries and organizations would be the most likely sources of terrorism in a Web- Based Global Warning System. This model can be used to pinpoint likely sources of attack from terrorist groups abroad on American soil (see map above). Knowledge of probable attacking countries would enable DHS to better protect air and sea ports. This work builds on efforts to develop threat assessments designed to help DHS optimally allocate resources to stem likely avenues of terrorism. Page 3 of 9

5 2. Research Accomplishments The results from the research program fit nicely into several papers published during Some of the results follow directly from research developed specifically for the project and others are more indirect off-shoots from this research program. 2.1 The Economic Welfare Costs of Conflict In The Twentieth Century Scorecard: How Much Did Global Problems Cost the World? -Progress Since 1900, Prospects to 2050 (Cambridge) Gregory Hess, forthcoming. Conflicts, of various sizes and purported purposes, cast a long and dark shadow on the lives of many and on the histories of nations and peoples. Theories of conflict abound for wars between nations, internal civil conflicts, and terrorist operations primarily based on national or group leaders convincing followers to take up a fight for some purpose, noble (to advance an idea, a religion, a culture, a form of government) or otherwise (to appropriate). While leaders, on occasion, do profit from conflict, they do so less often than they might ever imagine. Indeed, leaders, depending on institutional constraints, can separate the spoils of war (land, resources) from the dim costs of war. Despite the inherent wastefulness of conflict, we continue to observe it in all its infinite manifestations. And there should be no doubt that we will certainly continue to observe it throughout this century. As he remarked in his speech in accepting the 2009 Nobel Prize for Peace, U.S. President Barrack Obama stated We must begin by acknowledging the hard truth: we will not eradicate violent conflicts in our lifetimes, and that There will be times when nations acting individually or in concert will find the use of force not only necessary but morally justified. Violent conflict is thus wasteful and inevitable a cheerless combination. But this odd coupling, perhaps surprisingly, may help us to understand how to create a less violent world. Indeed, the key to reversing the inevitability of violent conflict may lie in our better understanding and coming to grips with its wastefulness. In other words, by better understanding the costs of war we may be able to chip away at the existence of conflicts, and build institutions to better insure against their return. In our paper, we will provide an empirical analysis of data to better understand the effect of conflict, as measured by military spending, on economic activity and the consumption alternatives that a society faces. In other words, how would the present day mix of Butter and Guns consumed by a society change if we were to return to a more war-like time in history. We will then use standard economic theory to answer the question, How much would you pay to consume the current level of Guns and Butter rather than consume the level required to sustain a more violent environment that we experienced in the past. Our answer is that an average person would permanently pay no less than 8% of their current consumption to avoid returning to such a systemic conflict world such as we saw in World War II. That violent, systemic conflict is such a large tax leads us to believe that domestic and international institutions can and should be better designed to realize the benefits to peace. 2.2 Terrorism and the Invisible Hook with Ricardo Fernholz and John-Clark Levin. Southern Economic Journal (2013) Vol 79. Number 3: For much of the 1990s and early 2000s, piracy existed off Somalia in a sporadic, opportunistic form. Usually that would be gangs of pirates boarding ships very close to the coast, and robbing the sailors of valuables. In 2008, though, for reasons that are still murky, this local piracy problem spiraled out of Page 4 of 9

6 control. Somali pirates began preying on large merchant ships far out to sea, including in the strategically vital Gulf of Aden. International navies sent three major task forces to the region, but despite naval escalation, the problem continued to worsen. Then, starting in late 2011, a combination of private security forces, naval patrols, and precautions by merchant ships turned the tide. Somali piracy has now receded to manageable levels, but those gains are fragile. A parallel threat has been menacing the same waters. In 2000, a terrorist suicide boat packed with explosives severely damaged the destroyer USS Cole, and in 2002, a similar attack gravely damaged the French tanker Limburg. In 2010, the Japanese tanker M. Star was hit by a similar attack. In the last few years, al-qaeda s center of gravity has been shifting from Afghanistan, Pakistan, and Iraq to Africa through its affiliates there -- al-qaeda in the Islamic Maghreb in Algeria, Boko Haram in Nigeria, and al-shabaab in Somalia. That trend suggests to many analysts that suicide attacks on shipping in the waters around Africa may increase in the near future. The existence of these parallel threats raises thorny economic and legal questions. Private companies and governments must devise security plans that are cheap enough to deploy widely, thereby deterring profit-motivated pirates. But defenses must also be strong enough to physically stop ideology-motived terrorists. This paper examines how rational actors can balance the risks of piracy and terrorism in formulating response strategies. We do this in a strategic framework that investigates the benefits and costs to potential state and non-state actors. We find that the pay-offs to terrorism are in fact different with regards to terrorism and piracy. In doing this, we find that direct incentives for prevention are significantly stronger with regards to terrorism than piracy suggesting that counter-measures are more effective in piracy. Probably the best way of preventing shootings of civilians is through stringent rules for the use of force. Generally, this takes the form of a graduated escalation from non-lethal countermeasures to warning shots to lethal force. This is a serious challenge for security forces, because in the waters off Somalia, pirates, terrorists, and innocent fishermen may look and behave very similarly. Thus, it is hard to sort friend from foe until an attack is actually initiated. Yet the need for graduated escalation must also be balanced against the need to protect merchant ships. If security forces are too tightly restricted, pirates can exploit those rules to their advantage. For example, if security can only fire when fired upon, pirates can make it all the way to the merchant ship safely as long as they don t use their weapons. The case of the Enrica Lexie is of particular interest to Italians. Two active duty Italian marines serving as a protection detachment aboard an Italian tanker shot and killed two Indians who turned out to be innocent civilians. India wishes to treat this murder, while Italy wants to protect its marines, who could face the death penalty if convicted. This caused a serious international incident, and demonstrates the real-world impact of rules for the use of force. 2.3 Lines in the Sand: Border Effects, Economic Integration and Disintegration of Post-War Iraq Journal of Law and Economics with Roz Engel, (2012): The Obama and Bush administrations decision to improve security in Iraq and Afghanistan by increasing the number of troops has been labeled the surge. Is one consequence of the increased troop presence increased market integration by lowering transportation costs and enforcing rule of law? In this paper, we Page 5 of 9

7 analyze weekly price data for approximately 250 goods from eighteen Iraqi cities between 2005 and Our paper suggests four empirical regularities associated with price dispersion and market development in post-war Iraq. First, the degree of intra-governorate price dispersion across Iraq is higher than the intrastate dispersion reported for industrialized countries such as the United States or Japan. Second, the degree of price dispersion fell significantly during 2007, coincident with the surge. Third, the economic impact of the surge is geographically uneven but loosely follows patterns of U.S. deployment decreasing by roughly one-third in areas targeted during the surge but remaining relatively static in the Shia south and in the eastern regions bordering Iran, where the surge was nearly nonexistent. Finally, we find the effect of internal borders to be relatively modest, though clean interpretation of these border effects is difficult. Taken together, our results suggest that the shift in U.S. security policy in 2007 did bring higher levels of economic integration to the majority of post-war Iraq. In the midst of the ongoing violence in Iraq and Afghanistan, scholarly debate about the economic costs of conflict often focuses on long-term security and rebuilding considerations, human capital and infrastructure losses, the viability of the All-Volunteer Force, and many other direct and indirect costs of war. An area that has received less attention, however, is the effect of violence on local market development and the prospects for economic integration in a post-conflict country. We aim to provide such an analysis for the case of post-war Iraq. With six years in theatre and an average of 130,000 to 160,000 U.S. military personnel on the ground at any given point in time, Iraq may be the best documented post-war reconstruction project ever witnessed. Using a rich data set from Iraq s eighteen governorates, we investigate the costs of market inefficiencies stemming from price volatility across intra-national borders. This paper considers the extent to which these price differences are driven by U.S. security strategy, ethnic differences, fixed geographic factors, and patterns of violence. We are able to consider the extent of regional integration and disintegration during the period from June 2005 through May 2008, a span over which significant shifts in U.S. security strategy are evident. In particular, we consider the effect of the surge in 2007 and find evidence that its timing is negatively correlated price dispersion. Controlling for other relevant factors, average price dispersion across Iraq appears to have declined by 2 percentage points (approximately one-tenth of average price dispersion) from January, the date marking the shift in U.S. policy, to October 2007, when U.S. troop levels associated with the surge peaked. For areas specifically targeted during the surge, such as Baghdad and the Baghdad belt of Anbar, Diyala, Salah Ad Din, and Wasit, the drop is significantly higher with price dispersion declining by as much as 6 to 8 percentage points. We also present results showing that major ethno-religious fault lines are associated with higher levels of price dispersion. In particular, we show that the surge caused Sunni regions and Kurdish regions to become more economically integrated during the surge. However, Shia regions in the south and those bordering Iran, which lay outside the U.S. strategy, did not experience any significant change in economic integration. Although the results suggest that market integration across differing ethno-religious regions remains incomplete, we find that these lines in the sand between Kurdish, Shia, and Sunni regions are smaller than the typical border effects found between sovereign nations, though standard border dummies must be interpreted carefully. 2.4 The Economic Welfare Cost of Conflict: An Empirical Assessment. In Garfinkel and Skaperdas (ed.) Oxford Handbook of the Economics of Peace and Conflict, (Oxford), with Gregory Hess, War, whether external or internal, large or small, is a costly endeavor. Loss of life, loss of close friends or family, and the destruction of material possessions all play a part in the costs of war. The purpose of this Page 6 of 9

8 paper is to capture only the material, economic welfare costs of conflict stemming from the altered path of consumption resulting from conflict. As such, the measure is quite a lower bound for the true and more encompassing welfare loss from living in a non-peaceful world. But how much would an individual be willing to pay to avoid just the economic costs of conflict? Remarkably, even these pure economic welfare losses from conflict are quite large. We find that, on average, individuals who live in a country that has experienced some conflict during the sample would permanently give up to approximately 9 percent of their current level of consumption to live in a purely peaceful world. Such large potential welfare gains from reducing warfare should make economists and policy-makers take note, and continue to investigate and advocate for domestic and international institutions to realize such gains. In this paper, we provide a lower bound estimate for the welfare costs of conflict by exploring only the forgone consumption from being mired in a world of conflict. We demonstrate how one can theoretically `price' the effect that war has on consumption's growth and volatility. Intuitively, these consumption growth costs from war would be avoided in a perpetually peaceful world, which allows us to calculate the equivalent variation of how much individuals would be willing to give up in order to live in a peaceful world. It is worth noting that implicit in the methodology is the assumption that obviating conflict is possible. Further, the peaceful world we consider removes the effect of war from all participants. That is the cost estimates that we provide are not those from choosing a peaceful path when others have not (i.e., the costs of `turning the other cheek'). Rather, the cost estimates are an individual country's net economic benefit from a peaceful world. This paper estimates the potential economic gain from peace as the certainty equivalent of how much individuals would be willing to give up of their current consumption up in order to live in a peaceful world. Using panel data (unbalanced) for 184 countries, we calculate a synthetic path of consumption that removes the effects of war on the mean and volatility of consumption growth. From these estimates, the cost of conflict is calculated. The main finding is that a lower bound estimate of the average benefit from eliminating war is about 9 percent of per capita annual consumption. In addition, though many of the poorest countries stand to benefit greatly from peace, the benefits to developed economies can often be substantial. The results are robust to regional effects and possible reverse causality. Further, both data limitations and the nature of this technique suggest that the calculation represents a lower bound estimate of the possible gain from eliminating conflict. In an attempt to assign an actual dollar value to this lower bound estimate of the cost of war, at an admitted loss of generality, multiply each country's calculated cost of conflict by their actual per-capita and total consumption in 2000 international dollars. By this measure, the average (world) cost of conflict is $224 per person for the 184 countries who appear in our sample. The countries whose citizens would be willing to pay the most to avoid conflict are Iraq ($1,428), the United States ($1,070), the United Kingdom ($903), Cyprus ($872), and Israel ($851). Recall that these are not one-time payments, but a permanent per-capita payment, so that the simple present discounted value is twenty-one times higher for a risk free rate of 5 percent. Similarly, the total world cost of conflict in 2000 dollars and for the year 2000 population is $918 billion, and this permanent payment would grow at the rate of population growth. The magnitude of the potential consumption welfare and dollar gains from eliminating conflict should make economists, political scientists, and policy-makers continue to investigate and advocate for domestic and international institutions to realize such gains. Page 7 of 9

9 Resear ch Area Referre d Not Referre d 3. Research Products Research Product Metrics # # of peer-reviewed journal reports published 3 # of peer-reviewed journal reports accepted for publication 1 # of non-peer reviewed publications and reports 0 # of scholarly journal citations of published reports 5 # of scholarly presentations (conferences, workshops, seminars) 3 # of outreach presentations (non-technical groups, general public) Publications CREATE PUBLICATIONS Blomberg, Brock Claremont McKenna College 1. The Economic Welfare Costs of Conflict In The Twentieth Century Scorecard: How Much Did Global Problems Cost the World? -Progress Since 1900, Prospects to 2050 (Cambridge) Gregory Hess, forthcoming. 2. Terrorism and the Invisible Hook, Southern Economic Journal, with Ricardo Fernholz, Lines in the Sand: Border Effects, Economic Integration and Disintegration of Post-War Iraq Journal of Law and Economics with Roz Engel, The Economic Welfare Cost of Conflict: An Empirical Assessment. In Garfinkel and Skaperdas (ed) Oxford Handbook of the Economics of Peace and Conflict, (Oxford), with Gregory Hess, Conference and Outreach Presentations Conference Presentations Economic Analysis Economic Analysis Economic Analysis Economic Analysis X X X X 1. Terrorism and the Invisible Hook, Terrorism and Policy -- University of Texas at Dallas (May 2013). Outreach Presentations 1. CMC-UCLA Inland Empire Forecast Conference Citizens Bank Area (October 2012). Page 8 of 9

10 4. Education and Outreach Products Education and Outreach Initiatives (Please detail entries below) # # of students supported by CREATE funds 2 # of students involved (whether funded by CREATE + any other programs) 2 # of students graduated 0 # of contacts with DHS, other Federal agencies, or State/Local (committees) 0 # of DHS committees served or Congressional testimony provided 0 # of existing courses modified with new material 0 # of new courses developed 0 # of new certificate programs developed 0 # of new degree programs developed 0 Page 9 of 9