October 17, 2001

Sometimes, simple economic questions lead to complex answers. Most economists acknowledge that temporarily grounding the airlines, shutting malls for a day, putting fear into flying, and creating a TV demand that supplanted shopping has lowered economic activity in September.

Many also understand that recovery from these shocks probably will push fourth quarter economic growth below what would have occurred if the attacks never happened. We are still working on quantifying the magnitude of these distortions . (My own guess is that employment temporarily will plunge another half to three quarters of a million jobs and then gradually rebound as the shock effects slowly wear off.)

The more difficult question is what will happen to economic growth in 2002 and beyond.

Surprisingly, many economists are raising their growth rates for 2002, albeit from lower 2001 economic levels than were expected before the September events.

Some of the reasoning for stronger growth is as follows:

First, psychological shocks do wear off. The first time you walk past a cemetery at night, you might be very fearful. The second time you are cautious. By the tenth time, you do not notice the cemetery. Unless continuous attacks buffet our psyche, we will learn to overcome our fears.

Second, we must repair and replace what was damaged and destroyed. We are poorer because of the attacks, but more of our resources will be put to work. If we had been at full employment, activity would have needed to be diverted, probably through higher prices. However, the economy’s softness means that an actual job stimulus will develop once the replacement work begins.

Third, we were under-insured for terrorist attacks. Resources now will be needed to make up that deficiency. Again, a softening economy makes that conversion to defense and security easier than if the economy were at peak efficiency.

Economists will debate when the fear falls and the additional spending for replacement and defense begins, but the case for stronger growth has merit.

However, I said that the answer about 2002 growth was complex. Before adding the stimuli, we must ask if any collateral damage has been created by the terrorist shocks. Some companies with weak balance sheets have declared bankruptcy because they could not absorb the economic shocks. Loan difficulties are rising in bank portfolios as rising costs and falling revenues are simultaneously hitting some customers.

Under-utilized aircraft and low hotel occupancies already are altering future needs for additional capacity. Thus, economic weakness does not diminish when the fear factor does. The shock waves still are spreading.

Fortunately, our financial institutions are in strong shape to handle higher loan losses. Even the insurance industry is prepared for the higher claims that they will process because of what happened in New York and Washington. Our financial shock absorbers are in good shape and the economic shock waves should diminish quickly.

Nevertheless, the new economic measure of normal is different from what existed before September 11. Higher security costs mean that capital will return less to investors. Thus, capital growth will be less and equity values will be lower in the new "normal" economy.

Also, transactions costs, especially for flying, are now higher. I am not talking about security surcharges, though they surely will surface. Instead, I am talking about the increased time to negotiate flying.

This will probably be small for the leisure traveler. The added airport wait is small relative to the value of the trip for them. However, the business traveler will be much more reluctant to make trips. Those long security lines at airports probably are stimulating the demand for telephonic board meetings.

Thus, the mix of leisure to business travelers will be permanently altered. This is not to say that security lines should not be long, but their length will impart a long term cost to the travel industry.


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