How Riots Influence An Economy

By Stephen D. Simpson, CFA | December 12, 2010 AAA

Sometimes economic and political tensions go beyond the boiling point and lead to full-scale riots. Riots with clear economic proximate causes have fortunately become very rare in the United States, though they were much more common in the early days of industrialization and unionization and the protests that accompanied the WTO conference in Seattle in 1999 were an uncomfortable reminder. (If you've been a victim, your losses may be deductible. Find out how. See Deducting Disaster: Casualty And Theft Losses.)

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Though Canada and North America are fortunate to be in a position where there are multiple nonviolent means of expressing outrage and dissatisfaction, the rest of the world is not so lucky. Economic troubles in Greece led to actual rioting earlier in 2010 and there were worries that Ireland would see similar problems when the government rolled out its austerity measures. Moreover, economic protests in much of Europe often take a violent turn (many of the strikes in France, for instance) and with many countries still straining under large debt and deficits, the risk of future disturbances cannot be ruled out.

It is fair to wonder then what the economic impact of rioting is.

Damage to Property and the Economy
It is not hard to imagine that rioting directly damages property values and economic activity. When people smash windows, steal things, or set buildings and property on fire, that all has direct economic costs. Moreover, if people are rioting they are not working, and even those who are not involved in the disturbances are affected - they cannot get to work, shop or otherwise carry on with business as usual. Some studies have suggested that the LA riots in 1992 ultimately cost the city nearly $4 billion in taxable sales and over $125 million in direct sales tax revenue - that in addition to $1 billion in property damage and the loss of many lives.

Riots also produce a clear disincentive for business owners to locate their operations in riot-prone areas. Who in their right mind builds a factory someplace where they fear there is some reasonable risk that it will be burnt to the ground? Riots are bad for property values, as people do not want to live in those areas and many property owners are hesitant to rebuild or repair in the aftermath (some parts of Washington, D.C. for instance, still carried the scars of riots in 1968 decades later). Riots also appear to be bad for employment - businesses are not going to put valuable capital at risk like that, so they will locate their operations in safer places. (If your business has hit a wall, we've got the answer to break through and increase sales and earnings. To learn more, refer to 10 Breakout Ideas For Small Businesses.)

Nervous Investors, Nervous Tourists
Given the potential impact on business, it is probably not surprising that riots make investors nervous. Rothschild supposedly said that it was wise to "buy on the sound of cannons, sell on the sound of trumpets," but most investors to not share that sentiment. Although the Thai stock market has recovered strongly this year, investors saw a 10% drop while the rioting was going on. Looking at it more broadly, rioting raises investors' uncertainty and leads them to increase the risk premium they assign to securities in that country - all of which spells lower prices in the short term. Moreover, while Thailand no doubt benefited from its reputation as a peaceful and relatively orderly country, countries with chronic troubles risk getting labeled as "basket cases" and virtually eliminated from serious consideration as investment destinations.

Rioting also has a distinct impact on tourism - a vital industry and source of capital for many riot-prone economies. Sane vacationers do not want to arrive in the middle of a riot and will steer clear of areas with a recent memory of these troubles. China reported that disturbances in Xinjiang in 2009 led almost 85,000 travelers to cancel trips to the area, while Thailand has seen a big drop in tourism since its political troubles turned violent this spring.

Perversely, though, there has been a rise in so-called "riot tourism" - activists actually seeking out hotspots and traveling there with a hope of getting involved in disturbances. Suffice it to say, this is certainly not the kind of tourism that countries want to see or encourage.

Perverse Incentives and Moral Hazards
By and large, there is very little evidence that rioting "works" in the sense of leading to any lasting redress of grievances. If anything, many governments tend to respond to riots by enacting more draconian laws and beefing up the budgets of those charged with suppressing trouble. When governments do respond, it usually just with temporary solutions designed to pacify the protesters and get them off the streets; vague promises of redress, government-sponsored reforms, or temporary subsidies (particularly in the case of food or fuel riots) will often mollify the crowds, but seldom lead to any lasting improvement in the quality of life of the people.

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That said, there are some in Europe who believe that the Greek government successfully manipulated other European governments with its riots. Although the Greek government did not apparently encourage these riots, they certainly did help when they brought up the issue of German war reparations, nor were they hesitant in hinting that the riots could threaten the very stability of the government and democracy in Greece. In contrast, Ireland was much calmer and ended up with a much less favorable bail-out package - suggesting, perhaps, that there could be strategic value for the next country to allow matters to get more out of hand before finalizing a deal with the IMF. (You've heard of the World Bank, now find out how it functions and why some groups oppose it. Check out What Is The World Bank?)

The Bottom Line
Riots are almost never the cause or start of a problem, they are almost always the end of the story and an expression of frustration that the government is not meeting the needs of the people (whether those needs are realistic or not). That said, they can have serious long-term consequences. Investors do not want to place their money in harm's way, and businesses steer clear of areas where the safety of their capital, their employees and their customers is at risk. All in all, riots benefit no one but the demagogues who often egg them on, and there can be some serious economic repercussions, as well as the unacceptable cost of human lives.

Find out what happened in financial news this week. Read Water Cooler Finance: Barack Obama Vs. The World.

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