ECONOMICS AND SECURITY 003 ESC 05 E Original: English NAT O   Pa rl i a me n t a ry  As s e mb l y ECONOMICS AND SECURITY COMMITTEE EAPC/PFP AND NDC* CONFERENCE ON “FINANCIAL AND ECONOMIC ASPECTS OF THE FIGHT AGAINST TERRORISM”, ROME, ITALY SECRETARIAT REPORT** 14^TH AND 15^TH OCTOBER 2004 * Euro-Atlantic Partnership Council/Partnership for Peace and NATO Defence College International Secretariat 11 January 2005 ** This  Secretariat  Report  is  presented  for  information  only  and  does  not  necessarily represent the official view of the Assembly. Assembly documents are available on its website, http://www.nato-pa.int

003 ESC 05 E 2 1.  On  October  14-15,  thirty-one  parliamentarians  from  the  NATO  PA’s  Economics  and  Security Committee participated in a NATO Defense College - NATO Economics Directorate conference in Rome,   Italy   on   the   Economic   and   Financial   Aspects   of   the   Fight   against   Terrorism.   The conference brought together representatives from NATO, the OSCE, the UN, Interpol and a range of   government   officials,   representatives   of   international   financial   and   lending   institutions, academics, bankers and politicians to discuss this critical dimension of the anti-terrorist struggle. French  Senator  André  Rouvière  led  the  N  ATO  Parliamentary  Assembly  delegation.    The  British MP  Hugh  Bayley  and  Ovidiu  Petrescu  from  Romania  chaired  working  groups  on  the  role  of international organisations and intelligence and inter-agency cooperation respectively. 2.  The  conference  was  conducted  under  Chatham  House  rules  so  this  report  will  not  identify speakers but will delve into the critical themes of the discussions. The conference was part of the NATO  EAPC  Partnership  Action  Program  against  Terrorism.  The  conference  also  engaged Mediterranean and Middle Eastern partners in the deliberations. The fact that such a broad swathe of  institutions  were  represented  was,  in  itself,  indicative  of  how  the  security  agenda  has  shifted over  the  last  decade  and  how  many  different  kinds  of  actors  now  need  to  be  engaged  in  the security dialogue. I. CORE THEMES 3.  The funding needed to finance terrorist acts is very low and can be difficult to track. Moreover, the  effort  demands  a  broad  approach,  and  it  is  critical  to  engage  bankers,  police,  judicial  and security forces in the effort.  This is easier said then done.  It is, for example, often terribly difficult for intelligence and police forces to work together even in strictly national settings to bring those involved  in  terrorist  financing  to  trial.  The  challenge  becomes  all  the  more  daunting  when  such cooperation is needed internationally.   4.  It  is  also  essential  that  legitimate  financial  transactions,  particularly  those  involving  workers’ remittances to their home countries, are not unduly impeded. To over-regulate such transactions risks  pushing  them  underground  and  making  it  even  more  difficult  to  track  suspicious  financial activities. 5.  Western  countries  also  need  to  improve  the  legislative  and  legal  framework  to  facilitate  the tracking of funds that could be diverted for terrorist purposes.  The West should also endeavour to assist  less  developed  countries  to  do  the  same.  Weak  states  pose  a  particular  problem  in  this regard. 6.  Finally improved public-private partnerships are needed. Bankers, for example, are sometimes unaware that their clients are under the scrutiny of intelligence officials, who, for good reason, are reluctant  to  disclose  the  names  of  those  under  investigation.    This  lack  of  communication  can make   it   more   difficult   for   bankers   themselves   to   monitor   suspicious   financial   transactions. Improved information exchange would be very helpful to banks, which have a critical front line role to play in preventing the misuse of the global financial architecture for terrorist purposes. II. DEFINING THE PROBLEM OF TERRORISM AND TERRORIST FINANCE 7.  Defining the problem of terrorism and terrorist finance is an essential first step to dealing with it. Moral and spiritual issues are now central motivating features of the terrorist psychological make up, and this represents an important departure from the political terrorism that Western countries have  confronted  in  recent  decades.  It  also  significantly  broadens  the  target  list.  Because  some perpetrators see violence not as an option but as a duty, the threat has thus become generalised. Indeed the attacks of 9/11 saw the rise of a new terrorist model. Perpetrators suddenly became

003 ESC 05 E 3 martyrs while the media ensured a global audience for the criminals. In this way, terrorist acts can now deliver messages globally while offering models for further terrorism.   8.  Terrorist finance involves moving, storing and using funds for a violent political purpose. These funds can be garnered from legitimate or illegitimate sources.  Charities, for example, have played an  important  role  in  underwriting  terrorist  acts,  even  though  the  great  majority  of  charities  are legitimate. Moreover, the amount of money to carry out specific attacks is usually very small and hard to detect. Terrorists simply do not require a great deal of funding.   9.  Money  laundering  and  terrorism  finance  are  closely  related  crimes;  yet  they  are  also  distinct.   Money  laundering  involves  the  “cleaning”  of  large  amounts  of  ill -gotten  funds  while  terrorist financing  can  also  involve  moving  legitimate  money  to  underwrite  violent  and  illegal  activity.   Freezing assets certainly has an impact on terrorist activities.  But it will not eradicate the threat. A sufficient  amount  of  terrorist  money  has  already  moved  into  operator’s  hands  to  ensure  a  long series  of  attacks.    Beyond  this  rather  daunting  problem  is  the  fact  that  money  today  moves  so quickly  and  seamlessly  across  the  globe  that  it  is  very  difficult  to  track  and  intercept.  It  is  also proving highly difficult to conduct court cases against those who are moving money on behalf of terrorist organisations. III. MICRO-ECONOMIC ANALYSIS OF TERRORISM AND ANTI-TERRORIST INITIATIVES 10.  The international community has steadily sought to upgrade its defences against the problem. The UN International Convention for the Suppression of the Financing of Terrorism, for example, places several obligations on its members to ensure that moving money for terrorist purposes is a criminal  offence.  It  also  requires  banks  to  detect  and  investigate  suspicious  transactions.    But there is a great deal more work to be done. Countries and financial institutions need to engage in greater  information  exchanges  and  the  effort  needs  to  be  reinforced  globally,  regionally  and bilaterally. Countries and banks ought to improve “know y our customer” rules, and there is a great deal  of  room  for  enhanced  judicial  cooperation.  Greater  efforts  are  needed  to  ensure  that  the intelligence, police, and financial communities work together. And finally states must be vigilant to ensure that these efforts respect fundamental human rights and due process. 11.  A  very  interesting  session  was  dedicated  to  a  micro-economic  analysis  of  terrorism,  which looked at terrorist organisations as if they were firms engaging in efforts to increase productivity and  innovation  and  engage  in  “substitution”  efforts  when  conditions  made  this  necessary.  The fundamental  proposition  of  this  analysis  is  that  terrorists  are  rational  actors.  They  choose  the where,  the  when,  and  the  how  of  the  acts  they  commit  and  are  subject  to  classic  economic constraints like production costs. They thus behave like firms except that what they produce is not a good but a “bad”. Those fighting terrorism, on the other hand, are ultimately seeking to disrupt the terrorists’ gruesome trade. 12.  Terrorist  organisations  operate  in  adverse  conditions.  Government  initiatives  can  certainly decrease  their  revenues  or  increase  their  costs.    Prior  to  September  11,  anti-terrorist  initiatives focused   on   raising   the   cost   of   terrorism   by   creating   complications   for   the   terrorists.   The United States, for example introduced metal detectors at airports in 1973.  Embassy fortifications represented another essentially passive defensive measure.   13.  Serious efforts on the revenue side, however, are more recent. Attacks can reduce revenues of  terrorist  organisations,  for  example,  by  compelling  them  to  take  defensive  counter-measures.   Proactive measures are part of the mix and the United States conducted raids on Libya, Sudan, and  more  recently  on  Afghanistan  in  order  to  put  terrorists  on  the  defensive.    But  governments themselves confront two problems: they must consider their own budgetary limits, and their needs

003 ESC 05 E 4 to coordinate the policies of a range of actors including other governments and this can be very difficult. In comparison, unilateral defensive measures might sometimes prove cheaper. 14.  Governments also need to consider substitution effects. For example, although it is relatively cheap to install metal detectors, and while they certainly reduce high jacks, they have also had the effect of deflecting attacks. Once embassies are fortified, an increase of assassinations outside of embassies may occur. Another common substitution effect is to move attacks to countries where governments are very weak, and this too has happened.   15.  Terrorists also have the option to change the timing of their attacks. Indeed their attacks are undertaken in cycles. Operatives tend to lie low after an attack and thereby alter their risk profile.   Terrorists  also  become  more  efficient  over  time.  They  seek  scale,  scope  and  agglomeration economies  and  are  positioned  to  change  their  product  mix  in  order  to  increase  their  lethality. Important terrorist groups today are thus conducting fewer attacks, but they have become much more  deadly.  They  have  shown  a  capacity  to  innovate  and  offer  new  products  like  nerve gas, aeroplanes, beheading, and school seizures.  Future innovations are all but inevitable.  Indeed, the competition between government and terrorists tend to act as a catalyst for further innovation and lead to substitution strategies. This will likely continue. 16.  These   trends   have   implications   for   those   charged   with   struggling   against   terrorist organisations.  One  strategy  might  be  to  take  the  fight  everywhere  all  the  time.  But  to  do  so  is extremely  expensive  and  not  feasible.  Going  only  after  financial  flows,  on  the  other  hand, might simply result in low capital-high labour attacks.  Artificially closing borders is also not feasible. A country  like  the  United  States  cannot  simply  seal  its  borders  not  only  because  it  makes  no economic sense, but also because it’s international assets would remain vulnerable to attack. 17.  There  are  inherent  international  asymmetries  that  affect  the  capacity  of  countries  to  work together  in  the  fight  against  terrorism.    The  lower  the  probability  a  particular  country  will  be attacked, the less likely it will support a coordinated international effort to cope with the problem.   18.  In formulating anti-terrorist strategies it is also essential to recognise that the labour pool for tomorrow’s  terrorism  is  being  created  today  often  as  a  result  of  oppression  and  highly  adverse political circumstances. Coping with these root causes can thus be seen as part of dealing with the problem over the longer term. IV. SOURCES OF TERRORIST FINANCING AND THE ECONOMIC IMPLICATIONS OF TERRORIST ATTACKS 19.  The   sources   of   terrorist   financing   are   multifarious.   Funds   can   come   from   individuals, corporations, charities as well as from diaspora and migrant communities, and it can be secured in a  voluntary  or  coercive  fashion.  Wire  transfers,  traveller’s  checks  and  debit  cards  funded  the attacks  of  September  11.  The  anonymity  of  these  systems  made  it  possible  to  obfuscate  the movement of financial resources.   20.  The  attacks  themselves  cost  $400  thousand,  $300  thousand  of  which  were  transferred through hijackers bank accounts. By contrast, the recent Bali bombings cost only $20 thousand. Much of this information is contained in a recent monograph issued by the US commission looking into  the  September  11  attacks.    Although  detecting  these  currency  movements  is  very  difficult, doing so is also a very helpful way to detect terrorist groups and choke off attacks. 21.  One  of  the  problems  is  that  law  officers  deal  with  money  laundering  while  the  financing  of terrorism is largely an intelligence issue where evidentiary standards are not as high, and human rights are frankly less of a priority.  This condition alone suggests the nature of the challenge in

003 ESC 05 E 5 coordinating  the  work  of  various  government  agencies  and  creating  a  legal  framework  for successful prosecution. 22.  There  are  a  number  of  factors  that  can  make  a  country  vulnerable  to  hosting  terrorist operatives:  corruption,  weak  legislation,  poor  enforcement  of  existing  laws,  opaque  financial institutions,  unfavourable  economic  conditions,  a  lack  of  respect  for  the  rule  of  law  in  society, poorly  guarded  national  borders,  an  absence  of  political  will  to  establish  the  rule  of  law  and geographic  location.    The  UN  has  developed  model  legislation  on  money  laundering  which  also outlines  best  practices  for  dealing  with  these  problems  to  help  vulnerable  states  deal  with  this challenge. 23.  Another  large  challenge  lies  in  the  fact  that  banks  in  many  developing  countries  serve  the needs  of  the  state  and  not  the  consumer.  One  can  even  refer  to  these  as  repressive  financial systems in which banks only cater to the rich. This is exactly why informal Hawala systems, with their low transaction costs, are so important in much of the Arab world. They represent a perfectly rational market response to the current financial order in many countries and have been in place for centuries in parts of the world accustomed to the modalities of a cash-based financial order.   Of  course,  there  are  important  development  implications  in  all  of  this,  not  least  in  terms  of  the grave difficulties these informal systems pose for those charged with gathering economic statistics and conducting macro and micro-economic policies in countries where such transactions are the rule. 24.  The policy response has differed in sending and receiving countries with the latter tending to take  a  more  benign  view.  The  US  Patriot  Act tried to strike a balance between security and the need  for  sustaining  critical  financial  services.    Still  there  are  a  number  of  cases  in  which crackdowns  had  negative  effectives.    The  Barrakat  bank  in  Somalia  turned  out  not  to  be  as egregious  a  case  as  was  suspected,  and  the  result  of  the  crackdown  was  that  more  financial transactions went underground. 25.  There are several ways to deal with the problem but clearly lowering the entry barriers to the formal financial system is critical.  For this to happen, capacity building is needed.  One problem with  trying  to  regulate  Hawala  is  that  once  this  institution  enters  the  formal  system,  they  are  no longer truly Hawala. So one needs to deal with the reasons why Hawala are attractive to so many people.  The  G7,  World  Bank,  the  IMF  and  other  organisations  are  looking  into  the  informal financial systems and considering possible regulatory frameworks.  The big mistake would be to over regulate. That said, there is also a willingness among many Hawala managers to submit to a degree of regulation if for no other reason than to protect their reputations. 26.  The   problem   of   charities   is   particularly   important   and   laden   with   important   cultural ramifications as well.  Most charities are perfectly legitimate and serve very important functions in Muslim  culture.  To  treat  them  with  great  suspicion  and  indiscriminately  prevent  them  from operating  would  be  to  invite  grave  political  tension  and  suspicion  in  societies where the West is seeking  dialogue  and  positive  democratic  change.  The  same  is  true  of  charities.  Recently  the government  of  Saudi Arabia  announced  that  henceforth,  all  charities  would  have  to  keep  their funds in a single bank account—a move that makes good regulatory sense. But it also banned the collection of funds at Mosques, which on the face of it, could be viewed with great hostility among the faithful. 27.  In  the  conference  discussions,  these  themes  were  further  explored.  There  was  a  great concern that policy makers need to make distinctions between terrorism and religion and that the efforts to deal with the latter should not result in religious repression.  At times, there seems to be a  double  standard  in  contemporary  political  discourse  in  the  West.  IRA  terrorism  or  the  Serbian war on the Kosovar Albanians never led to a general discussion about the inherent violence within the  Christian  tradition.    The  same  standard  should  apply  to  the way Western leaders look at so called Islamic terrorism.

003 ESC 05 E 6 28.  Government  compensation  payments  to  the  victims  of  terror  were  also  dealt  with  in  the meeting and particularly the dilemma that governments confront when there is pressure to bail out private  market  operators adversely effected by terrorist attacks. This creates a genuine problem because  it  potentially  places  more  of  the  burden  on  the  state  to  prepare  for  terrorism  when  the market itself needs incentives to insure against such contingencies. This is a classic moral hazard problem. Government intervention can distort markets, reward failing firms and discourage other firms  from  properly  insuring  themselves  against  future  attacks.  This  happened  with  several airliners  in  the  United  States  after  September  11.  Several  of  the  companies,  which  accepted government subsidies, were poorly managed and would have likely failed even without the attacks. 29.  Although  the  September  11  attacks  only  shaved  about  a  quarter  point  off  of  the  American GDP, they did have other important structural effects.  In financial markets, they sparked a flight to quality,  and  as  a  result,  emerging  markets  were  ironically  left  worse  off  than  Wall  Street  itself.   Another  effect  was  soaring  uncertainty.  Yet  the  fact  that  America’s  financial  architecture  was already  robust  and  endowed  with  redundancies  allowed  it  to  weather  the  initial  shock.    Those redundancies were, in part, due to all measures taken to prevent a YK2 disaster.  Within 12 days, the stock market had recovered all its lost value. Tokyo also recovered quickly, while Europe took longer to recoup its losses. It should also be pointed out that the Fed acted very promptly to pump roughly  $100  billion  of  liquidity  into  the  system  to  prevent  the  economy  from  freezing  up  in  the days following the attacks. Government spending thus compensated for the natural hesitations of the  market  in  the  immediate  wake  of  the  attacks.    It  should  also  be pointed out that the Madrid bombings had a far smaller effect, and this is both because it occurred after the grave shock of September 11 and because Madrid is not a global financial centre. 30.  Another  apparent  impact  of  the  September  11  attacks  has  been  the  renewed  pressures  on off-shore  financial  centres  to  improve  their  regulatory  frameworks.  The  Financial  Action  Task Force on Money Laundering (FATF) black list has been particularly effective in putting pressure on those off shore banking centres with lax controls. That said, the most developed of these centres have tended to move most quickly to deal with shortcomings.