Paying for the New National Security State

The ultimate security cost will, of course, depend upon events which are still unfolding: Will the United States win a decisive victory over the terrorists in Afghanistan? Will the terrorist cells which have already infiltrated the United States engage in further major acts of violence, such as detonating bombs in office towers or on airplanes?

The list goes on: Will the biological war move from anthrax to more contagious diseases such as small pox? Will the terrorists attempt to use nuclear weapons material which they obtained from the former Soviet Union during the 1990s?

Even though these questions are still unanswered, it is possible to begin to calculate the new costs the United States faces. These costs include the direct cost of the current war, the cost of the increased intelligence effort which is vital to fighting terrorism, the costs of additional internal security — and the additional costs individuals and businesses will have to pay for insurance in today’s riskier world.

First, the costs of the war. The Gulf War of 1990-1991 cost the United States $65 billion. The current war will be a bit cheaper, but expect the bill to run at least $30-$40 billion. At that cost, the war itself may amount to just a fraction of the expected $236 billion the country is set to spend on addtional security. Additional outlays for intelligence and federal internal security will cost relatively little, but still add significantly to the overall bill. The main burden for additional internal public safety costs will fall on state and local governments — and the private sector — starting with police and fire departments.

To assess the true costs associated with the war on terrorism, one needs to be aware that the U.S. private sector employs three times as many policemen as the public sector does. In California, for example, the ratio is four to one.

Of course, the mayors of U.S. cities are not rushing out to hire thousands of new police just to search for terrorists. But as soon as the likelihood of numerous additional acts of violence against property increases during the next 12 months, many companies could feel compelled to expand their use of private police considerably.

If we adjust the available 1996 data for inflation, the United States is probably now spending about $70 billion on police in the public sector — and $110-120 billion on police in the private sector. The cost of fire departments and the prison system currently totals $21 billion and $47 billion, respectively.

The cost of maintaining business insurance is also likely to increase dramatically. Property casualty insurance premiums in the U.S. economy were about $300 billion last year. About half were paid by business — and half were paid by households.

As a result of the terrorist attacks, U.S. households will see premiums rise by 5-10%. Business insurance costs, however, could increase by 100-150%. The U.S. insurance industry will have to raise premiums significantly because the attack on the World Trade Center appears likely to consume nearly half of the capital assigned to commercial insurance operations.

Has the United States economy ever faced such a “tax” on its operations? Believe it or not, the best analogy for this new burden is business spending on pollution control. Spending on pollution control has been a constantly increasing business cost since the 1970s. Since 1972, business spending on pollution control has risen $105.5 billion — from $16.5 billion in 1972 to $122 billion in 1994.

According to the Survey of Current Business, pollution control cost $122 billion in 1994, or a sum equal to about 1.8% of GDP. The government does not have current data on pollution costs, but if it remained at 1.8% of GDP spending last year, it would have been about $180 billion.

The sharp growth in pollution spending during the 1970s and 1980s was a drag on economic growth because it added business costs without boosting productivity or profits.

That is the way in which these costs are similar to the likely impact on business of the anti-terrorist activities. They, too, will cost a substantial amount of money without contributing to profits or productivity growth.

In addition to these direct costs, business faces a substantial indirect impact on productivity from increased security measures.

There are already longer lines at airports and more barriers to entry at major office buildings. The flow of goods between companies could be slowed on a more long-term basis because of new restrictions on the transportation system, especially for international trade.

The latter factor represents a significant development. After all, during the past 20 years, there has been a sharp decline in the ratio of inventories to final sales in the U.S. economy. The development of smaller inventories was possible because of the introduction of computers and just-in-time-delivery systems.

During September 2001, these tightly managed inventory systems left many firms short of raw materials and parts. Few businesses were prepared for a harsh new reality when the U.S. government unexpectedly decided to impose restrictions on air freight and trucking activity over the Mexican and Canadian borders.

With U.S. imports now equal to 36% of the goods-producing share of GDP, border delays could be a major threat to these inventory management systems. Dell Computer, for example, has responded to these shocks by announcing that it will move from a policy of maintaining three days’ inventory to seven days’ inventory. Other U.S. firms are also likely to bolster their inventories as a precaution against future transportation delays.

As a surprising result, inventory build-ups could emerge as a source of GDP growth in 2002. This shift would be particularly pronounced considering the sharp fall during the fourth quarter in response to recent transportation problems.

In conclusion, the direct cost for the United States in terms of increased military expenditures, greater domestic security and increased property causality insurance premiums for business will probably approach 2.5% of GDP. But these estimates are highly conditional upon developments still unfolding.

These developments, outlined at the outset, have the potential both to restrain costs — or to cause security expenditures to increase sharply. South Africa, for example, spends four times as much as the United States as a share of GDP on police because of a high crime rate in urban areas.