Terrorism & Economic Growth: The Case of Pakistan

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By Muhammad Ashhar

On 16 December 2014, a terrorist attack killed 150 people, out of which at least 134 were students, when Taliban gunmen abruptly attacked the Army Public School in Peshawar, Pakistan. As a response to this incident, as well as other terror episodes that had been widespread in the country, the state and military of Pakistan implemented a mission to combat terrorism, mainly in the North Waziristan region of Khyber Pakhtunkhwa, under the Operation Zarb-e-Azb. Terrorism is an extensive and intensive issue in Pakistan; the Global Terrorism Index of Pakistan in 2019 was 7.889 out of 10, making it the 5th most terrorism-afflicted country last year. Terrorism poses an immense threat and serves as one of the biggest impediments to Pakistan’s stability and growth.

Terrorism has negative impressions on the economy, as it destroys physical and human capital, creates uncertainty in the market causing reluctance among investors/entrepreneurs, and urgently demands the government’s expenses on security expansion and anti-terrorist facilities.

The situation of terrorism and extremism in Pakistan primarily escalated in the late 1970s and early 1980s. The causes are attributed to multiple factors including the sectarian conflicts that ascended to the political level from 1980 onwards and the foreign funding that was being injected into Pakistan incessantly during the period of some significant international events; namely, the Iranian Revolution, Iran-Afghan war, Soviet-Afghan war and the Cold War. These global events influenced Pakistan on account of its geopolitical and ideological position. Presently, various internal factors are identified as reasons for terrorism in Pakistan, including ethnicity, illiteracy, income inequality, inflation, high population growth, high unemployment, political instability, poverty, and injustice.

Terrorism incidents, whatever the reason for their emergence, can cause “ripple effects” that have negative impressions on the country’s economy, directly and indirectly. Directly, terrorist attacks damage the country’s infrastructure and destroy the three major factors of production: land, labor and capital. All these factors play an important role in determining economic growth, but are the direct victims of terrorism. The emotional toll on the community as a whole, although invisible and incalculable, is another kind of direct cost on the country. Indirectly, the terror activities can decrease domestic and foreign investments, increase inflation, damage the stock market, increase unemployment, and bolster government expenditures on security instead of socio-economic development projects.

Terrorism has long-term and far-reaching effects on investors’ decisions, industries’ performance, and the government’s behavior. Firstly, it causes uncertainty in the market. Uncertainty portrays a negative image of the country to the investors, reduces the average return on investments and diverts potential investments to less terror-stricken environments or countries. As a result, business activities and entrepreneurship decline on account of intermittent terror episodes. Secondly, terrorism sways the government towards spending more on defense and anti-terrorism facilities.

Normally, military spending is considered a stimulant, but “broken window fallacy” – a parable used by economists to illustrate the negative economic effects of war and destruction – brings to light the adverse costs of terrorism on the economy. The state’s primary focus is shifted from socio-economic development that not only influences the economy positively in the long run but also helps eradicate the root causes of terrorism such as poverty, illiteracy, income inequality, unemployment, and injustice. Hence, the opportunity cost – the benefits foregone when choosing one alternative over another – of expending on defense rather than development is reasonably high, and, as in the case of firms, must be included in the economic costs of the country.

A study titled, “Effect of terrorism on economic growth in Pakistan: an empirical analysis,” examined three macro-variables, based on the data for the period 1972-2014, that are indirectly affected by terrorism. These variables were Foreign Direct Investment, domestic investment and government spending behaviour. The results concluded that the impact of terrorism on FDI and domestic investment is significantly negative, whereas the impact on government spending is significantly positive. The net effect, however, is negative. We can anticipate that since terrorist attacks demand a swift response from the state, the influence on government spending is positive. But this shift in government’s behavior can be contested in terms of the opportunity cost of expending on defense rather than development, as mentioned earlier.

The impact of terrorism on a country and its people cannot be precisely quantified in economic terms, but enough estimation can be made to deduce that terrorism has extremely deteriorating effects on various sectors of the economy. Pakistan faces the threat of terrorism from the inside and the outside. According to Global Terrorism Database, out of the 3043 terrorism incidents that Pakistan faced from 2001 to 2012, 2737 were domestic while 191 were transnational. Terrorism is particularly menacing to Pakistan’s economy for two reasons. Firstly, unlike developed countries, Pakistan is unable to absorb terrorism without displaying adverse economic consequences. Secondly, the internal conflicts (domestic terrorism) – which are skyrocketing in Pakistan – have a greater impact on the economy than transnational attacks. What should Pakistan do to counter terrorism in order to avoid economic collapse?

The research “Effect of terrorism on economic growth in Pakistan: an empirical analysis” has pointed out, based on the data for the period 2002-2015, that there is an inverse relationship between GDP and terrorist (suicide) attacks in Pakistan, i.e., when terrorism is low, economic growth is high and vice versa. Considering the economic consequences of terrorism, a practical solution would be one that mitigates terrorism/extremism in the long run and contributes to economic growth simultaneously. Human capital development in the areas of education and health at the national level has proven to contribute to economic growth in developing countries and also reduce terrorism by eradicating its root causes. Human capital is defined as “the knowledge, skills, competencies and attributes embodied in individuals that facilitate the creation of personal, social and economic well-being.”

The Human Capital Index of Pakistan is currently 0.39 out of 1, displaying an indication for massive improvement. The government and the business sector of Pakistan should progressively invest in human capital development, especially in the spheres of education, health and entrepreneurship, to actualize socio-economic growth and combat terrorism at the same time.

Muhammad Ashhar is a student of Economics with Data Science in Information Technology University (ITU). He works at SMCSE (Silverline Management Consultants & Software Engineers) as a Writer & Researcher for the team. He is a Freelancer specializing in the areas of Business Writing & Brand Concept Development. He runs his own Blog, Effective Thoughts, for writing articles and sharing thoughts on multiple aspects of life, education, and business.