The High Price of Zero Risk

The compelling need for homeland security must inevitably compete with other demands on scarce economic resources. It is useful to know, then, what costs the war on terrorism may exact and how we should balance our priorities.

If one tallies the myriad damages of the Sept. 11 attacks--including property loss, lost output, loss of life, increased airport security and the drain on our physical and psychological health--cost estimates quickly reach the hundreds of billions of dollars.

But even beyond this obvious toll, is there another huge, hidden price tag?

The answer will depend on whether the war on terrorism destabilizes Middle East oil markets. It will depend on whether a Fortress America stifles productivity by diverting far too much of its “productive capital” into “protective capital.” Most important, it will hinge on crucial fiscal and monetary policy choices Congress and the president make.

In this regard, the single greatest economic threat facing the United States is not a deep recession but, rather, a return to a nasty 1970s-style stagflation--inflation without economic growth.

Our most immediate danger is that President Bush and Congress will run headlong down an over-expansionary path of massive government spending and tax cuts. This “demand side” stimulus may give us a very quick recovery. But roaring too quickly out of the recessionary abyss may also trigger an ugly roller-coaster ride back to the stagflationary 1970s.

Before Sept. 11, economically sophisticated Americans looked back at the misguided policies of the 1970s in much the same way an earlier generation ridiculed the bungling of the Hooverites who ushered in the Great Depression. Yet it is no longer implausible to imagine a return to a much slower 1970s-style of stop-go growth punctuated by double-digit rates of inflation and unemployment.

Consider a scenario in which the war on terrorism leads to energy supply disruptions, which leads to a deep recession, which, compounded by overly aggressive expansionary fiscal and monetary policies, rekindles inflation--even as the twin burdens of increased military expenditures and soaring security costs drag down productivity.

The cost in lost economic growth could be staggering. Indeed, a drop in the nation’s average growth rate from the roughly 3.5% of the go-go 1990s to the meager 2% we suffered in the 1970s would reduce the gross domestic product by $2 trillion annually by 2011. This would be a staggering “terrorist tax”--equal to roughly 20% of today’s GDP.

The debate over the appropriate fiscal and monetary fix is well underway. Yet the subject of how best to cope with the increased risks of terrorism to businesses and individuals has hardly begun.

In this debate, we must recognize that as we attempt to drive the risks of terrorism to zero, the costs for both business and government will rise to infinity.

If we are to avoid economic calamity, we must find a balance.

We must also recognize that the real terrorist target was not the World Trade Center or the Pentagon but our economic system and the prosperity and freedoms it brings. To succumb to the productivity-stifling economics of a Fortress America would be to grant the terrorists their fondest wish.