The terrorist attacks on the World Trade Center and the Pentagon on September 11, 2001 signaled a turning point in US history. The attacks impacted the nation on multiple levels, ranging from the effect on people’s moral psyche to redefining the country’s international relations and major policies. In the months following the attacks, one of the foremost areas of concern was the downturn in the US economy. The decline in average real income, increasing unemployment, and recession within most industries, were widely attributed to the 9/11 episode. This paper aims to present an objective analysis of the nature and extent of the macroeconomic effects of 9/11, taking into consideration the existing state of the economy during that period, the major economic areas affected, and the overall short term and long term effects of these factors on recession.
Existing State of the Economy in 2001
The US economy was undergoing a transition during 2000-2002. The growth rate had spiked sharply after 1997, and between1999 and the first half of 2000 the U.S. economy was growing at between 3% and 5% per year. The unemployment rate at 3.9% was the lowest in 30 years, suggesting excessive demand in the market (Makinen 12). However, such growth rate is not sustainable, and the US economy was expected to decline and settle to a lower-growth, but more stable, environment.
But the combined effect of rising oil prices, decreasing investment in the hi-tech sector, and the US’s constantly widening trade deficit caused a decline in stock prices and subsequently affected consumer confidence. In order to curb inflation risk and to reduce GDP growth to a more sustainable rate, the Federal Reserve began to tighten credit and reduce interest rates on Federal funds in 1998. By early 2001, the interest rate had dropped 2 percent, clearly indicating the slowdown in the economy. The federal interest rate was now 4 ½ percent, the lowest level since 1994 (“The World Economy” 35).
Percentage Change from previous year
|Consumption peaked in 1999-2000, and then increased by only 2.7% in 2001.||Consumption||3.6||4.7||5.3||5.3||2.7|
|Investment peaked in 1999, in 2001 it increased by only 4.2% from previous year||Investment||5||5||8.8||6.2||4.6|
|Total domestic demand||4.7||5.6||5.2||5.8||2.1|
|Abrupt % decrease in GDP growth||GDP||4.4||4.4||4.2||5||1.6|
|Private consumption deflator||1.9||1.1||1.8||2.4||2.1|
|% Increase in unemployed||Unemployment, %||4.9||4.5||4.2||4||4.5|
|Federal Govt. balance as % of GDP||-0.7||0.5||1.2||2.4||2.5|
|General Govt. debt as % of GDP||70.1||67||63.5||58.5||54.5|
|Current Account deficit is still high||Current account as % of GDP||-1.7||-2.5||-3.6||-4.4||-3.9|
|Net Overseas Assets as % of GDP||-11.4||-12.4||-11.3||-12.9||-12.4|
Table 1. Percentage Change (YoY) in Economic Indicators, 1997-2001
(“The World Economy” 35)
According to the Federal Reserve Board, “The drag on demand and profits from rising energy costs, as well as eroding consumer confidence, reports of substantial shortfalls in sales and earnings, and stress in some segments of financial markets suggest that economic growth may be slowing further” (Siddiqui 14).
Clearly, at this juncture, the US economy was bracing for a possibly severe recession, and the government was taking measures to minimize the negative effects as the economy descended to settle into a more stable state. The terrorist attacks on September 11 therefore occurred at an especially unfortunate time, and following the weeks after the attacks, the US economy definitely suffered a significant setback. Some of the areas that were the worst hit and consequently affected the nation on a greater level included the airline industry, insurance, financial markets, and the labor market.
Sectors Heavily Affected in the Short Term
The Airline Industry
The use of commercial airplanes as the main weapons of attack resulted in the airline industry being the worst hit by the events of 9/11. Immediately following the attacks, a complete shutdown of air travel across the US, although temporary, served to increase perceived risk associated with air travel. At the time of 9/11, the global airline industry was already facing financial difficulties.
Rising oil prices and lowered demand had adversely affected industry revenue, despite strong cost-cutting measures. The 9/11 attacks exacerbated the global airline industry’s troubles, and the US airlines suffered the majority of the slack. The federal government immediately granted an aid package with $5 billion in short term assistance, and $10 billion as loan guarantee. However, this did not prevent companies like US Airways and United Airlines filing for Chapter 11 bankruptcy (Makinen 9).
Figure 1. Monthly US Domestic Airline RPMs, January 1980 – December 2003
Ito and Lee have analyzed US airline industry revenue and the effect of major national and international events on air travel demand (5-6). Figure 1 depicts monthly U.S. domestic airline industry revenue passenger miles (RPMs) in addition to its 12-month moving average, from January 1980 through December 2003.
Although air travel is seasonal and cyclical, the moving average clearly depicts the impact of events such as the 1981 air traffic controllers’ strike and the 1991 Gulf War on US airlines. Understandably, the September 11 attacks caused a sharp decline in airline revenue, however, it is also evident that the industry was already experiencing recession at the time. The difference was that in this case, the negative effects did not dissipate even after the crisis situation had ended. According to Ito and Lee:
There are a number of reasons to suggest that September 11th and its aftermath may have imposed a more lasting impact on the demand for airline services. First, September 11th likely caused more consumers to be unwilling to travel because of an increased fear of flying. Another significant factor impacting demand has been the increased security measures that have made traveling by air post-September 11th more time-consuming and far less convenient than before the terrorist attacks. (5)
It is certainly true that the terrorist attacks plunged the already declining industry revenues further, and in the short and medium term, the US airline industry was the one that was most adversely affected.
The Insurance Industry
Besides the US airline industry, the other industry to be significantly impacted by 9/11 was the insurance sector. The attacks on the World Trade Center and the Pentagon gave rise to the largest property/casualty claim in history, with total insured losses of about $34.7 billion (Insurance Information Institute). Although the US insurance sector as a whole had the reserves to settle these claims, the individual companies undertaking the settlements posted huge losses. Berkshire Hathaway and St. Paul Companies suffered $2.2 billion in losses each, and CNA Financial Corporation suffered losses totaling $304 million. Other insurance companies posting significant losses included AIG ($820 million), Citigroup, Inc. ($502 million), and Allstate Corporation ($32 million), the combined losses being the largest in US insurance history (Dhooge).
Following the attacks, most insurance companies increased their premiums, adversely affecting several key industries. The strongest impact was on aviation, but other sectors, including transportation, construction, and tourism and energy generation were also affected. Overall, it is estimated that commercial property and liability insurance rates were raised by 30 percent on average (Looney para. 10). In addition, major re-insurers announced that they would no longer cover acts of terrorism in their re-insurance contracts with primary insurers. The combined effect of these events resulted in a large number of smaller insurance companies going out of business, unable to survive the high risk, high premium environment.
The terrorist attacks of 9/11 were aimed at the very core of the US financial markets. The World Trade Center and surrounding buildings are the major operating locations for the world’s foremost banks, financial institutions, trading houses, and brokerage firms. The initial impact on the US financial markets was massive. As noted in Wikipedia:
The attacks had a significant economic impact on the United States and world markets. The New York Stock Exchange (NYSE), the American Stock Exchange, and NASDAQ did not open on September 11 and remained closed until September 17. NYSE facilities and remote data processing sites were not damaged by the attack, but member firms, customers and markets were unable to communicate due to major damage to the telephone exchange facility near the World Trade Center.
When the stock markets reopened on September 17, 2001, after the longest closure since the Great Depression in 1929, the Dow Jones Industrial Average (“DJIA”) stock market index fell 684 points, or 7.1%, to 8920, its biggest-ever one-day point decline. By the end of the week, the DJIA had fallen 1369.7 points (14.3%), its largest one-week point drop in history. U.S. stocks lost $1.2 trillion in value for the week. (5.1)
To guard against panic and loss of confidence in the financial markets, the Federal Reserve and other central banks took immediate steps to ensure that the financial system was supplied with sufficient liquidity. On the three days following the attack, the Federal Reserve infused over $100 billion per day into the financial system.
In addition, the Federal Reserve arranged swapping dollars for foreign currency in order to support foreign financial institutions operating in the United States, thus pulling in an additional $90 billion into the financial system (Makinen 15). These measures were instrumental in shielding the US financial system from the worst effects of the terrorist attacks.
The labor industry was well into a recession since March 2001, with the unemployment rate already above the 3.9% low reached during the early 1990 (Makinen 53). Predictably, the events of 9/11 immediately affected the already weakened U.S. labor market. Job losses not only translated into financial difficulties for workers, but also meant less revenue for the federal and state governments at a time of unexpected spending needs. During the first 8 months of 2001, companies had announced their intention to lay off a record high of more than one million employees. Also noted by Makinen:
Employers reported that between September 15, 2001 and March 30, 2002 they called 462 extended mass layoffs that were directly or indirectly attributable to the attacks. Almost 130,000 employees lost their jobs in these actions, with 9 out of
10 let go within 2 months of the attacks. The air transportation industry laid off 38% of these employees, and the accommodations (hotel and motel) industry, 23%. Although employers in 33 states called terrorist-related layoffs, the majority of events and worker displacement occurred in just five states – California, Nevada, Illinois, New York, and Texas (54).
Figure 2. Monthly Statistics, Number of Unemployed 1997 – 2003 (number in thousands)
(Bureau of Labor Statistics)
As Figure 2 clearly shows, the unusually high demand during the late 1990s was offset by a sharp decrease in employment, beginning in the latter half of 2000.
The Long Term Effects of 9/11: Evaluating its Impact on Recession
On the basis of the observations cited above, it would be easy to attribute the recession in the US economy on 9/11, based on the fall in industrial production, rise in unemployment, decline in consumer confidence, and the contraction in GDP following the second quarter of 2001. However, as noted by Makinen (13), the initial interpretation of key indicators may have been considerably off mark. Based on Makinen’s report:
On July 29, the Commerce Department published the revisions to the GDP accounts for 1999-2001. The results show that GDP had begun to contract in the first quarter of 2001, a contraction that was to continue through the 3rd quarter of the year. Thus, when the terrorist attacks took place, the U.S. economy was in the third quarter of contraction and in a recession.
Table 2. GDP Accounts, 1999-2000
Moreover, the belief that the consumer confidence crisis occurred as a direct result of 9/11, may also have been inaccurate. The argument against this belief focuses on the fact that even after the discouraging effects of 9/11, consumers actually responded extremely favorably to financing incentives given by a variety companies during the latter half of 2001. This showed that consumers were willing to spend, contradicting the claim of consumer confidence crisis as a direct result of 9/11. As Makinen explains:
While it is true, as shown above, that the indexes of consumer confidence fell, did they fall by more than can be explained by the underlying economic variables that confidence depends upon? In this case it is not so, and the drop in consumer confidence can be linked to solid underlying economic causes. This implies that the direct negative effects of 9/11 on the overall economy may have been quite small. (14)
In conclusion, having weighed the breadth and magnitude of the impact of 9/11 across various sectors, it would be fair judgment to classify the effects of 9/11 as being largely short term. In addition, 9/11 did not have a direct impact on the US economy as a whole, and the recession that continued in its aftermath can be traced to a number of domestic as well as international economic factors in play since early 2001.
However, it is also evident that 9/11 did impact certain sectors, which in turn affected the overall economy. To that effect, the repercussions of 9/11 can be said to be largely indirect in nature. The one indirect effect of the attacks that is likely to be permanent, is the increase in the nation’s defense budget, and the marked increase in government expenditure towards public and private security measures.
Dhooge, Lucien J. “A Previously Unimaginable Risk Potential: September 11 and the Insurance Industry.” American Business Law Journal 40.4 (2003): 687+. Questia. 4 May 2006 <http://www.questia.com/PM.qst?a=o&d=5002072889>.
Insurance Information Institute. Facts and Statistics: Terrorism. 4 May 2006
Ito, Harumi, and Darin Lee. “Assessing the Impact of the September 11 Terrorist Attacks on US Airline Demand”. Social Science Research Network 4 May 2006 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=722491.
Looney, Robert. “Economic Costs to the United States Stemming From the 9/11 Attacks”. Strategic Insights Aug. 2002 (Vol. I : 6). 4 May 2006 http://www.ccc.nps.navy.mil/si/aug02/homeland.pdf.
Makinen, Gail. “The Economic Effects of 9/11: A Retrospective Assessment”. Federation of American Scientists 4 May 2006 http://www.fas.org/irp/crs/RL31617.pdf
“Prospects and Policy Challenges.” World Economic Outlook : 1. Questia. 4 May 2006 <http://www.questia.com/PM.qst?a=o&d=5000897916>.
Siddiqi, Moin. “Watch out, the US Is Sneezing!.” African Business Feb. 2001: 14. Questia. 4 May 2006 <http://www.questia.com/PM.qst?a=o&d=5002386131>.
“The World Economy.” National Institute Economic Review : 35. Questia. 4 May 2006 <http://www.questia.com/PM.qst?a=o&d=5000998864>.
Wikipedia. “5.1: The Economic Aftermath”. September 11, 2001 Attacks. 4 May 2006 http://en.wikipedia.org/wiki/9/11.