Thursday, July 27, 2006


Terror and Real Estate

A paper outlining the economic impact of worldwide terrorist activities on North American real estate markets.

In general lines, terror endangers life such that the value of the future relative to the present is reduced. Hence, due to a rise in terror activity, investment diminishes and in the long run income and consumption go down as well. This is, in a capsule, the experience of the countries where terror and its derivatives were the least aimed at: Islam.

To counter the negative effects of terrorism, Islamic Governments such as those of Saudi Arabia and Egypt have tried to offset terror by putting tax revenues into the production of security. Facing a rising tide in terror, so was the idea, a government that acts optimally increases the proportion of output spent on defense. Thus, when terror peaks, given the scarcity of available economic resources, the long run equilibrium is of lower output and diminished welfare. Which, as many Muslim countries have discovered later on, results in a drop of aggregate demand and a general economic slow down as well.

European Union members, on the other hand, have and are experiencing the economic impact of terror in a different fashion. Here too, as the massacres in Madrid and London have demonstrated, terror, among other things, endangers civilians’ lives. Fears, bewilderment, and different types of uncertainties proximately created by terrorist activities have been responsible in Europe for altering and redirecting individuals’ economic choices. Insecurity manifests itself in the daily life by increasing uncertainty such that, as terror or even just the threat of terror increases, life itself becomes less certain. In reaction to the rise of insecurity levels, European Governments too have tried to offset the threat of terrorism by increasing defense spending. Thus, the total cost of terror has emerged from both the individuals and governments response to terror. Individuals have changed their consumption and investment decisions in response to the change in their perceived sense of security. Governments have responded by increasing defense expenditures. And in many member States, counter-terrorism measures carry what economists call a “security tax” - higher costs associated with longer waiting times, additional shipping charges and other ways of making the economy less efficient.

By contrast, this is not what happened in North America. Whereas, in fact, defense spending in Europe has been kept down to minimal levels for decades, even during the times of the Cold War, defense spending has taken invariably a substantial portion of the American budget. As a result, therefore, European countries had to allocate resources ex novo to guarantee the security of their citizens and safety of their institutions, while instead all America simply had to do was to shift already existing and available resources for different purposes.

Surely enough, also in North America consumers had to redirect their economic decision-making processes, but to a far lesser extent. Besides the debate of a few years ago involving restrictions of civil liberties, a closer scrutiny on who is coming in and going out of the country, the plan announced by the Bush Administration of eavesdropping on people’s private telephone calls and the ‘infamous’ ban on carrying nail-clippers into aircraft, North American consumers cannot say they have been subjected to much else.

Since safety does not come for free, governments must use real resources to ‘produce’ security and, unless they run the risk of magnifying their defense budgets specifically to address security concerns, governments must take those real resources from the private sector. Therefore, the decision of governments about how much to spend on defense is based on comparing the social costs of resources, i.e the costs of forgone consumption and of forgone future consumption (investment), which are used to provide security, with the benefit that emerges from making life safer, that is the benefit of reducing terror. This decision, however, is much less drastic when the private sector already has plenty of resources that can be allocated for security purposes.

And, in fact, the privatization of security, always under government’s supervision, serves as a catalyst to domestic economic activity and growth. It is an undisputed fact that market economies, in Capitalism, are moved by the supply and demand for goods and services. Specifically as it relates to capital markets such as real estate, furthermore, the production of output depends essentially on the accumulation of capital. This is so because the propensity to invest in production (construction of new inventories) depends a lot on expectations of future profitability and on the present perceptions of market risk.

Growth is derived by the equilibrium of capital and investment with labor and employment. And since production is in direct function of consumer spending, which increases as unemployment falls, it follows that capital accumulation increases as employment rises and capital accumulation decreases as employment falls. The development of and privatization of security, therefore, has worked in North America as a stimulus to growth by increasing employment levels and subsequent consumer spending, as proven by the levels of the Index of Consumer Confidence reported by the Feds in recent years, which levels remain very high. Since Capitalism is commonly understood to mean an economic system in which the means of production are predominantly privately owned and operated for profit, and whose primary objective is to promote capital growth, North America’s response to growing terrorist threats has had a beneficial effect on capital markets, including real estate.

Luigi Frascati

As Featured On Ezine Articles Platinum Author

Real Estate Chronicle

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