Academic journal article Federal Reserve Bank of New York Economic Policy Review

What Will Homeland Security Cost?

Academic journal article Federal Reserve Bank of New York Economic Policy Review

What Will Homeland Security Cost?

Article excerpt

* As the government and the private sector increase their spending on security measures, concerns have arisen over the magnitude and economic effects of these expenditures.

* A review of the evidence, however, suggests that public- and private-sector outlays for increased security will be relatively small-- roughly $72 billion per year, or 0.66 percent of the nation's GDP in 2003.

* Fears that private-sector productivity will decline significantly as firms shift resources to protection appear ill-founded. Firms' security initiatives will lower labor productivity levels by no more than an estimated 1.12 percent.

* Indirect costs of homeland security-notably, the delays related to heightened airport security and the diversion of research and development funds from productivityenhancing technologies-are also likely to prove modest.

Increased spending on security measures-high on the agenda of the government and much of the private sectorwill undoubtedly have an effect on the economy. If firms devote sizable amounts of time and money to the protection of their businesses, they will reduce their overall productivity. Furthermore, if the government's spending on homeland security is significant, it could lead to a rise in the cost of capital and wages and reduce investment and employment in the private sector. Finally, the homeland security efforts could have many indirect economic effects, such as the costs of increased airport waiting times and long-run productivity effects resulting from a reallocation of research and development (R&D) spending.

In this article, we attempt to quantify the economic effects of the homeland security efforts of the public and private sectors, focusing specifically on the costs of these efforts. In practice, it is difficult to classify which expenditures are related to homeland security. For this reason, we use the broadest possible definition: all expenditures possibly aimed at either preventing damage due to terrorist attacks or at preparedness for the response to potential attacks. This broad definition suggests that the figures presented here should be interpreted only as estimates of the maximum effect of homeland security on the economy.

From this perspective, our study can be interpreted as the cost side of a cost-benefit analysis. To estimate the costs of homeland security, we focus on three main questions. The first involves the likely magnitude of government expenditures on homeland security. To answer this question, we review the historical as well as the proposed expenditures on homeland security by the federal, state, and local governments and compare them with historical spending on other programs and items.

The second question concerns whether firms will spend significant amounts of time and money on security and protection. To offer insight into this issue, we estimate the share of inputs that firms devoted to protective services before 2001 and consider what effect doubling this share would have on firm productivity levels. This technique is similar to the one used by the Council of Economic Advisers (CEA, 2002) to assess the productivity effect of homeland security.

The final question involves the size of the many indirect effects of homeland security. Of the many possible effects, we examine two in particular: the costs associated with increased waiting times at airports and the possible effect on long-run productivity growth attributable to a shift in R&D expenditures. The answer to this question turns out to be the most speculative of the three.

Despite our broad definition of homeland security expenditures, our results suggest that the amounts of publicand private-sector spending are likely to be relatively small: the total annual direct costs of the homeland security efforts are estimated to be $72 billion, or 0.66 percent of GDP in 2003. Moreover, the homeland security efforts in the private sector are estimated to lower labor productivity levels by at most 1. …

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