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THE U.S. ECONOMY IN THE AFTERMATH OF TERRORISM

By Richard J. Cebula, Shirley and Philip Solomons Eminent Scholar

The U.S. still is trying to comprehend the unspeakable acts against God and humanity that were perpetrated on September 11, 2001 by terrorists. However, there also appear to be serious additional near-run and longer-run implications of these acts of horror for the U.S. economy.

Prior to the catastrophe of September 11th, the U.S. economy was already faltering on the brink of a recession. In my view, we would very likely have avoided an outright recession nationally, but just barely. Unfortunately, the outlook for the economy’s future is very different now. Indeed, there are increased risks not only of recession but also increased risks of inflation.

The problems exist on many fronts, far too many to describe here. But to begin with, consumer confidence in the U.S. economy and in the general state of security has been shaken. Since it has been spending by the household sector of the economy that has kept us out of recession, this is a serious development.

Surely, despite temporary financial support from the federal government, the airline industry is destined to face a much less rosy future than before. Security issues will at least temporarily, if not permanently, limit the volume and growth in the customer base of commercial airlines. The many forms of increased of proper security and the diminished customer base, along with very high fixed costs in the industry, will ultimately mean higher ticket prices, as well as longer and more tedious waits and delays at airports and increased delays in arrival time. Naturally, the problems faced by the airlines will lead to a diminished rate of growth of orders for new aircraft, although private aircraft orders conceivably could increase somewhat.

The tourism industry, especially in destinations such as Florida and even Las Vegas, will suffer at least in the short run but also very likely in the long run, largely due to declining air traffic. People will tend to take shorter vacations and more often drive to destinations closer to home. Not only will destination hotels, motels, restaurants, and special attractions suffer, but even cruise lines will. The latter industry will in turn also be forced to quickly come to grips with security issues as well.

The problems in the airline industry will be accompanied by increased auto traffic and hence increased demand for gasoline and motor oil, which naturally threatens to be inflationary to at least some degree. This is certain to create upward pricepressure in the energy sector for all forms of fossil fuel. Naturally, environmental issues such as exploiting Alaska resources will also become more controversial.

The issue of security impacts on all industry and all forms of service provision, even public and private education. The steps taken in certain public school systems to date will likely prove inadequate and require major rethinking and innovation. This of course will raise taxes and private school and university tuition as well as public university tuition. All forms of enterprise will be forced to re-evaluate surveillance, security measures, and personnel. Wages paid security personnel must be increased to ensure hiring of the most qualified and best trained people. This fact too will raise the cost of doing business and running the government, further increasing the likelihood of increased future inflation.

Other complications for the economy have already been experienced. Witness, for example the bottlenecks in shipping parts required for manufacturing. Observe the temporary halting of production at certain North American plants by Ford Motor Co., General Motors Corp., and Honda Motor Co. because of heightened security at the US-Canadian border.

In addition, insurance company exposure from the September 11th terrorism alone will run an estimated $20 billion. Furthermore, to account for increased future risk and uncertainty from terrorism and related problems, insurance premiums across the industry in many categories will not only rise but increase more rapidly over time, further contributing to inflationary potential.

The costs of security reform will ultimately be borne by the U.S. consumer. This burden will take many forms. For example, although it impossible to know with absolute certainty, consumer wealth and income, and therefore consumer confidence, will be shaken by stock market reactions to the new challenges to the economy. In jeopardy are stocks in many sectors of the economy, including airlines, airplane manufacturers, tourism and travel services, hotel/motel, insurance, entertainment, and food service sectors.

Given the already somewhat anemic earnings of so many publicly traded firms represented in the stock markets, the added security costs, time delays, bottlenecks, increased energy costs, increased costs of personnel training reform, and other challenges faced by so many firms, will likely turn from bad to worse and lead to increased costs and inefficiencies, and hence to further earnings reductions for many industries. Lowered consumer confidence lowers stock prices, but more importantly it lowers demand for final goods and services and hence pushes the economy towards recession. In addition, the numerous upwards pressures on costs in so many areas of life will tend to be inflationary and ultimately will lead to expectations of increased future inflation. Ironically, security-systems firms may be among the few bright spots in the market.

In the end, a complex variety of higher costs and energy prices will be experienced. These will create higher prices and inflation for consumers. The many assaults on consumer confidence will raise the prospects for recession. Furthermore, in this new environment of increased risk and uncertainty, firms are even less likely as a group to invest in new plant and equipment. Since investment was already a weak link in the economic chain before the terrorist attack, we cannot rely on firms’ investment to bolster the economy and prevent recession.

In closing, the events beginning on September 11th have introduced more questions to be answered, more problems to be addressed, and more risk to be recognized. In the absence of remarkably well executed monetary and fiscal policies, recession coupled with inflation will be our next economic news.

What can be done to soften the blow of recent and related future events? Clearly the President and Congress will be spending more to protect certain industries and to carry out massive security reform and military action. But that will not be enough. The Federal Reserve must at last inject a serious increase in liquidity into the economy to provide reduced costs of borrowing to business that can raise earnings and reduce interest rates that will encourage consumer spending. Beyond, that, we need tax cuts and we need them now. Real tax cuts, not tax rebates and not tax cuts that will disappear automatically in the future. We need substantial and fair long term tax cuts that the consumer will believe will remain in place and that the consumer will find large enough to actually be able to spend on big ticket items.



Dr. Cebula is ranked in Who’ Who in Economics, 1700-1996, as among the 1500 major economists of the past three centuries. He is incoming President of the Academy of Economics and Finance, editor or associate editor at more than a dozen professional journals, author of 20 books and over 300 articles in scholarly journals. He also was an advisor the U.S. Senator Sam Nunn on tax reform and to U.S. Congressman Elliott Levitas.

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