Writing about the French terrorist attacks and the economic risks to the European economy is “always something almost unsavory” and could involve “spurious speculations in unchartered areas of expertise,” particularly when one of those involved in writing the report is a French national. But the report must be written, a Bank of America Merrill Lynch report volunteered, as “the terror attacks in Paris, together with the intensification of the foreign military operations in Syria introduce a new element of risk in Europe’s macroeconomic situation that cannot be ignored.”

(Click on image to enlarge)

Most significant cost of Paris terrorist attack could be higher defense spending, ending the “spoils of peace”

While the economic impact of the terrorist attacks in Paris are likely to have an economic cost, a notion voiced by European Central Bank Chief Economist Peter Praet on Monday of last week, deciphering the exact implications might be more difficult, if nuanced. This is because, after reviewing historical statistics, “no general pattern can be found in the unfortunately rather long list of precedents.”

Instead of considering the risk as a main scenario, the bank’s European Economics team of Gilles Moec and Evelyn Herrmann incorporate it into their baseline and note the “peace dividend” may be off the table.

“The immediate cost of higher homeland security spending and intensified military operations in Syria is fairly easily manageable,” they wrote, speculating the crisis signals “the end of the ‘spoils of peace.’”

After a major drop in defense spending across Europe, which has “helped a lot in improving the fiscal situation in the run-up to monetary union in the late 1990s,” the economic benefits of peace may be over and a new issue may rise – one that asks all EU nations to share the defense burden of the region.The report says that low defense spending “may have reached a floor, with a lot of countries now well below NATO’s target of 2 percent of GDP.” The Paris attacks “will trigger questions on burden-sharing, with Paris, for instance, remarking that if Germany had spent as much as France on defense since the end of the cold war, the two countries would today present the same public debt-to-GDP level.”

(Click on image to enlarge)

Consumer spending might decline, as online e commerce benefits

As the government looks to spend more on defense, spending by consumers in Europe could be going in the opposite direction.

Lowered consumer spending would be most prominently due to the physical impossibility to spend at a normalized rate as restrictions on movement, as can be seen in the metro system in Belgium being partly suspended, to temporary shop closures, as well as general safety concern for going out and shopping, being a primary consideration.

The general deterioration in consumer confidence is likely to bring about “a psychological inclination toward precautionary saving,” the report said. Conversely, in some extreme cases, “with the population fearing a systemic deterioration in supply lines, the opposite reaction — i.e., hoarding goods – could be expected, with, ultimately, a corresponding decline in consumption when the situation normalizes.” The hoarding might provide short term benefits by increasing sales of basic goods, over the long term it could lead to consumers postponing big-ticket or discretionary spending. While consumers may be hesitant to leave their homes for consumer spending, it could push them to rely more on online shopping alternatives in the region, however.

“Any wobble in consumption is all the more relevant to the current cyclical position in France and in the Euro area since consumer spending has recently been the main driver of the recovery.”  Weaker consumption in Europe could result in a “higher-than-usual diffusion effect over the rest of the economy,” which is particularly true “given the subdued contribution from foreign trade” in the region.

Tourism may see drop and insurance costs could rise

There could also be an impact on tourism. “Even if the security situation normalizes quickly, the timing of the attacks may, however, mean that the short-run impact is more pronounced than in previous episodes, if this affects the Christmas period shopping spree, while tourism receipts could fall with foreigners avoiding Paris.”

The report notes that the French Tourism Employers’ Federation has already reported a drop by nearly 50 percent in bookings of Paris hotels this week relative to the same period of last year. However, at the same time November and December are typically among the worst months of the year for tourism in Paris, ranking 8th and 9th for hotel occupation respectively, according to the Paris Chamber of Commerce.

If the terrorist attacks persist, this could lead to an increase in insurance costs. After the 9/11 attacks in the US, for instance, spending on insurance rose by 30 percent. “The comparison is, however, cumbersome, since the Paris attack did not have the same scale in terms of destruction of physical capital,” the report observed. “Even if we retain this increase of 30 percent and apply it to French companies’ insurance expenditure, this would stand at less than 0.1 percent of GDP.”