Exogenous shock—the term that economists use for events from outside the economy that affect economic activity—has a grim redundancy when applied to Tuesday’s attacks. The term literally means “a blow from outside the system.” Like a fuel-laden jetliner crashing into a skyscraper.
Exogenous shocks include things like wars, climatic events such as El Ninos or volcanic eruptions that affect crop yields. Resource discoveries such as the California and Alaska gold rushes also constitute external shocks. The 1973 OPEC oil embargo was a powerful shock to both industrialized and developing economies. And technological innovations, like the steam locomotive or the personal computer, are yet another category of exogenous shock.
They are different from endogenous shocks, which come from within economic or financial systems. Stock market crashes in 1929 and 1987, real estate price bubbles in Tokyo in the late 1980s, and adoption of suicidal economic policies such as the 1929 Smoot-Hawley tariff are examples of endogenous, or external, shocks.
Economic activity has undergone periodic fluctuations since the beginning of history. We call this the business cycle. While scholars and businesspeople have commented on it for decades, there were no good explanations for why it occurred until the 1980s.
A group of economists—including Dr. Ed Prescott from the University of Minnesota—devoted themselves to studying why cyclic patterns occur in output, growth and employment. They discovered that many, though not all, reversals in the trend of economic activity are caused by external shocks.
This week’s crashes into densely occupied buildings has certainly been a psychological and emotional shock to millions around the globe. These tragic events also shocked the economy. Air traffic halted, financial markets closed and panic buying drove gas prices above $5 a gallon in some areas.
However, it’s not yet clear what the longer-run effects will be. There are two plausible but contradictory scenarios.
The first is that of a negative shock.
The U.S. and world economies already were teetering on the edge of a garden-variety recession. Tuesday’s attacks will roil U.S. stock markets when they reopen, and prices will fall sharply. Consumer confidence may suffer, both from the attacks themselves, and from subsequent stock price slumps. Spending could shrink from such caution, further depressing demand and pushing the economy deeper into recession.
But a more positive outcome is also possible.
Except for destroying the offices of many major financial firms, there was little damage to U.S. productive capacity. The damage was psychologically shocking, but physical damage was nothing compared to German air raids on Coventry, Manchester or London; Allied bombing of Hamburg, Frankfurt or Regensburg; or American incineration of most Japanese industrial cities in World War II.
The psychological shock of the week’s events will certainly cause money to flow from federal coffers. There will be bipartisan support for vastly increased spending on anti-terrorist personnel and equipment. Airport authorities, states, cities and private property owners will spend further billions on guards, closed circuit cameras, metal detectors, bomb dogs, explosive sensors and all the rest.
Universities and think tanks will get fat contracts for research into anti-terrorist measures. And billions will be spent to clear the rubble and to rebuild.
A good local analogy would be the flooding in the Minnesota and Red River basins in 1997. Disasters such as floods or tornadoes wipe out net worth, but they stimulate output. People bounce back, get insurance and federal assistance checks and start to rebuild. Building tradespeople and material suppliers do booming business.
Which of the two scenarios is more likely?
It’s too early to tell. Perhaps both reactions will take place in sequence. The immediate pall cast by psychological shock and falling stock prices may cause additional short-term slowing with the reaction to increased federal and private security spending kicking in later on.
Whatever the specific outcome or sequence of events, one thing is sure: The U.S. economy is far too large and resilient to be affected over the long run by events such as this, tragic as they may be.
© 2001 Edward Lotterman
Chanarambie Consulting, Inc.