Posted on: Monday, March 3, 2003

Safety may cost economy

By Brendan Murray
Bloomberg News Service

HERSHEY, Pa. — Early in January, Pennsylvania-American Water Co. told its 600,000 customers to expect their bills to go up $10 a year.

The reason: $8.7 million in additional costs per year for security guards to patrol reservoirs and filtration systems of the Hershey-based unit of Germany's RWE AG.

"We consider these security measures as part of our day-to-day operations, and a necessary business expense," said Robert Ross, Pennsylvania-American's chief executive.

"The events of Sept. 11 have changed the face of the water industry and the way we do business."

The costs of protecting against terrorism are becoming embedded in the world's largest economy. Initially dismissed by Federal Reserve Chairman Alan Greenspan and other analysts as one-time charges with limited long-term impact, security spending may trim U.S. productivity and growth, some economists say.

A war with Iraq would heighten security concerns and probably trigger more spending on protection on home: additional money for guards, security devices and procedures that might otherwise be spent on production-boosting technology and workers who generate salable goods and services.

"It's a dead-weight loss as far as the economy is concerned," said Vernon Smith, a George Mason University professor who won the 2002 Nobel Prize in economics.

The U.S. government has budgeted $38 billion for homeland security this year — 0.35 percent of gross domestic product, or a 10th of total defense spending, said economist Bart Hobijn of the Federal Reserve Bank of New York in a study in November. Public and private costs combined may reach $72 billion this year, Hobijn estimated.

Assuming that companies have doubled their security budgets, and that the added workers and protective equipment won't contribute directly to the production of goods and services, Hobijn calculated that the extra costs would reduce productivity by about 1.12 percent.

"There's a long-run loss in output," Hobijn said. "This is a permanent shift in resources as long as there's a big terrorist threat."

While companies such as InVision Technologies Inc., a maker of bomb-detection devices, and security company Kroll Inc. are benefiting from stronger demand, the products and services they sell add little to the economy's capacity to produce, economists said.

The Congressional Budget Office estimated that the costs for security spending would trim U.S. productivity, a measure of output per worker per hour, by 0.3 percentage point. The impact is similar to expenses companies incurred in the late 1970s and early 1980s to comply with environmental regulations, the budget office said last year in its 10-year outlook.

U.S. non-farm productivity rose at an average annual rate of 2.2 percent from 1995 to 2000, up from 1.3 percent during the previous 20 years. In the last four quarters, the rate averaged 5.6 percent as companies eliminated jobs faster than they reduced production.

In the weeks after the Sept. 11 attacks on New York's World Trade Center and the Pentagon near Washington, Greenspan tried to calm concerns about the impact on productivity.

"These adjustments in prices and in the associated allocation of resources, when complete, represent one-time level adjustments without necessary implications for our longer-term growth prospects," Greenspan told the Joint Economic Committee of Congress in October 2001.

Some members of Congress have argued that Greenspan's view failed to account for a permanent threat. "This argument may be less relevant to a situation involving ever-present, ongoing terrorist threat that employs differing and multiple forms of terrorism," the Joint Economic Committee said in a report last year. "In this case, terrorism may have a longer-lasting impact on productivity growth."

Eaton Corp., the second-biggest manufacturer of hydraulic equipment, says its experience with added security costs for such things as emergency evacuation drills and new photo identification badges are in line with Greenspan's view — and not a burden.

"By and large, in the whole economy, the impact on productivity from security costs is negligible," said Arun Raha, senior economist at Eaton.

And there's little dispute that forgoing the benefits of elevated safety — creating confidence among consumers, companies and investors — would carry costs that are hard to measure.