Counterterrorism and stockmarkets

A calculation of conflict

Jul 20th 2006
From The Economist print edition
When is counterterrorism counterproductive? Ask the stockmarket

THE decline in the Israeli stockmarket as Israel's conflicts with Hizbullah and Hamas have intensified—9.4% between July 10th and July 13th, though it has revived since—may reflect more than the expected financial response to unrest and uncertainty. If a recent study of the Tel Aviv Stock Exchange is any guide, Israel's targeting of Palestinian political leaders in response to the capture of its soldiers has been counterproductive. Although Israel's army says it has been careful to minimise casualties during its latest incursions into Gaza and Lebanon, a study* by Asaf and Noam Zussman, brothers and economists at Cornell University and the Bank of Israel respectively, shows that the stockmarket's reaction to counterterrorism favours attacks on important militants rather than on political leaders or low-ranking militants.

An analysis of more than 100 assassination attempts carried out by Israel between 2000 and 2004 shows that the Tel Aviv 25 index dropped by an average of 1.1% in response to an attempted assassination of a Palestinian political leader. The killing of a Palestinian leader from the military wing led to a 0.6% increase in the stockmarket. The market reaction to a large terrorist attack against Israel brought an average drop of 1.2%—a response only marginally greater than if Israel killed a Palestinian politician.

The stockmarket is an appealing indicator of the effectiveness of counterterrorism measures because terrorism damages the Israeli economy and the market gauges public perception of the news. The goal of Israel's strategy of assassinating leaders is to weaken the capabilities of their organisations without inspiring further attacks. The study concludes that eliminating leaders in the military wing of an organisation is most productive, as these people recruit and train terrorists and plan attacks. Their deaths are a drain on the organisation's resources. Those on the political wing tend to be spiritual, social or political leaders, and attacks against them motivate future violence because they are seen by Palestinians as actions that break the rules of engagement.

Some industries, such as security, benefit from an increase in terrorist attacks. But counterterrorist actions have had a wider impact on the Israeli economy. The effects on the market are not just ephemeral, emotional responses that disappear in a day. The study finds that they can linger for weeks. The violence in Lebanon remains so volatile and fluid, says Asaf Zussman, that it is difficult to divine what the market's initial response means.

Perhaps surprisingly, the assassination study shows that both sides of this coin look alike. The Palestinian stock exchange's Al-Quds index reacted similarly to the Tel Aviv 25, probably because the Palestinian economy is so closely tied to Israel's. Perhaps behind those common numbers is common ground: investors on both sides see that a capable Palestinian political leadership remains in the best interest of both.