Chapter 41 The Economics of Terrorism Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

41-2 Chapter Outline ECONOMIC IMPACT OF 9/11 AND TERRORISM IN GENERAL MODELING THE ECONOMIC IMPACT OF THE ATTACKS TERRORISM FROM THE PERSPECTIVE OF THE TERRORIST

41-3 You Are Here

41-4 The Economic Impact of September 11th and Terrorism in General September 11th Costs –World Trade Center ($4 billion) –Pentagon ($1 billion) –Planes ($50-$100 million per plane) Lost Income/Business –$10 billion; –unemployment claims rose –100,000 airline layoffs

41-5 Reconstruction Homeland Security –Actual increases in security –Wasted time in airports Defense Spending –Increased from $300 billion to $400 billion excluding the war –War in Iraq ($400 billion at minimum) Lives (more than 3000) The Economic Impact of September 11th and Terrorism in General (continued)

41-6 Value of Human Life Present Value of future earnings (often used in wrongful death suits) PV of $75,000 over 30 years is $1.7 million

41-7 Modeling the Economic Impact: Aggregate Demand Shock AS PI RGDP AD 9/10 RGDP* PI* AD Shock AD post-9/11

41-8 Modeling the Economic Impact: Aggregate Supply Shock AS 9/10 PI RGDP AD RGDP* PI* AS Shock AS post 9//11

41-9 Insurance Aspects of Terrorism With uncertainty people buy insurance to minimize the financial consequences of a foreseeable, but not necessarily predictable, problem. (auto insurance, home owners insurance etc.) With 9/11 there was uncertainty about how bad it could get Insurance companies were uncertain whether they could survive financially

41-10 Reinsurance Reinsurance: like insurance except it is bought by insurance companies from other larger insurance companies (or from consortiums of insurance companies). Reinsurance allows for large losses to be shared among insurance companies. Reinsurance works well when the uncertainty to the insurance company is large but is manageable to a reinsurance company. Reinsurance markets failed post-9/11 and the federal government stepped in to be the reinsurer of last resort.

41-11 Buy Insurance or Self-Protect or Both If you want to prevent a car from being stolen you can –Buy Insurance –Buy self-protection Lo-Jack, the Club Self-Protection encourages thieves to steal other cars –This amounts to a negative externality

41-12 Protection and Terrorism Increasing security at U.S. airports makes –U.S. airports safer –Other targets less safe (because they become relatively more attractive to terrorists Non-U.S. airports are less safe Other targets (bus terminals, subways, water treatment facilities) are less safe

41-13 The Rational Terrorist Terrorists seek to –Maximize impact –Minimize costs and risks Terrorist vs “Freedom Fighter” –Like beauty, its in the “eye of the beholder” The rational terrorist does not necessarily stop when faced with increased costs –Substitution effect: terrorist finds next best alternative to secure target

41-14 Targets of “Rational Terrorists” World-wide newsmakers Easy Target –Recent Targets Bali (2003) Madrid Trains(2004) London Subways (2005)