Following the sad new terrorist events in Paris but also in other locations around the globe, I was astonished to see global stock markets rising on Monday the 16th (the CAC, the French stock market index fell a small 0.1%). Are markets really that insensitive or are they missing the economic impact of such barbaric acts? Indeed, looking at the data, the first piece of bad news is that terror is on the rise globally.
As more people lose their lives, I would expect the global economy to start being affected, either immediately or in the long run (the loss of lives detracting GDP as seen with the concept of value of life). I have looked at economic and financial markets studies on the impact of terror. Looking at financial markets is a good indicator of short term impact as markets usually over-react. For instance, Andrew Karolyi of Ohio State University looked at 75 terror events, including the 11/09/2001 in the US which saw the US financial markets closing down for a week. I was interested in the following findings:
Firms closely related to the terrorist attacks feel the largest impacts
In 2001, airlines’ share prices halved in the following month of 9/11 given the new restrictions on air travel. This week, shares in French hotels, airlines and luxury companies fell by a few percent. Some shares/sectors move the opposite way: for instance, defence or security companies exhibit gains as the markets expect higher revenues due to heightened security spending. Also, some companies’ shares gain at the expense of their hit competitors as it implies market share gains.
Durable economic losses are linked to asset losses
If you are an oil company with one oil platform and this one is damaged, your shares may never recover because your source of revenue is impaired. If a truck delivering Coke bottles is destroyed, the ability of Coca-Cola to generate profits will not change and its share price will not move. Looking at Paris last week, the Bataclan concert hall and the cafés owners should suffer temporary losses but these assets could be repaired.
Firm value impact remains modest
Another finding which was important in significance is the average market capitalisation impact. Market capitalisation is the value of all outstanding listed company shares. The study finds an average impact of $401m. If you compare to LVMH, a luxury goods maker, owning for instance Louis Vuitton, whose market value nears $90bn, we would talk about a 0.6% impact.
An explanation for the minor stock market impact could be that some countries and companies are diversified to withstand the effect of terrorism. For instance, while France tourism is a major sector of the economy, it represents only 7% of its GDP. In other words, the French economy is diversified and this is reflected in the stock market index being resilient.
The corollary to these findings is that it is unlikely that terrorism would impact the stock market decisively – other factors are more prominent. For instance, India is one of the worst-hit country from terrorism globally. Yet, Indian GDP growth is more affected by the lack of infrastructure, bureaucracy and corruption than terrorism. From that perspective, it is not surprising that bourses in the developed world did not blink.
Where financial markets can be wrong
Two important findings of many studies on the impact of terror on the economy is linked to the scale of damages and the protracted level of threat. In Iraq or Syria, the level of damages are colossal and these states have now failed. Looking at the Paris events, while the material damage is insignificant relative to the size of the economy, what now matters is the psychological damage.
A low-level of permanent threat can discourage investment, reduce consumer spending, frighten foreign capital and therefore reduce growth. There are numerous examples. Israel computed a 4% GDP loss due to the 2nd Intifada between 2000 and 2005 despite much higher security spending as consumer spending dived. Spain may have seen its GDP amputated by around 10% since the 1970’s due to the low-level terror in the Basque Country: many entrepreneurs curtailed investment faced with the revolutionary tax claimed by ETA, the local terrorist organisation. In Colombia, 1.2% of current GDP is spent annually compensating victims of the civil war.
To encourage ourselves, let me examine a positive example: in the US post 9/11, the feeling of security was restored quickly. Employment in tourism fell 3% in September and October 2001 before rallying the next months. Looking at the cost of hotels in New-York, I cannot see signs of low tourist demand. Let us be confident that our democratic governments are working to suppress threat levels and therefore ensure long term growth will not be affected.