Hamish McRae: Shock hits markets around the world

It is a blow to London, a blow to Britain, and also a blow to the entire world economy. The tragic human consequences of the terrorist attack should, in any reasonable sense of values, stand far ahead of the economic ones. But there is some economic damage and that needs to be acknowledged too.

This concern was reflected in the reaction of the financial markets around the world. The London FTSE 100 share index fell by 1.4 per cent to close at 5158.30 while sterling fell against the dollar to $1.74, its lowest for 18 months. But other stock exchanges fell sharply too, particularly on the Continent. The Dow Jones in New York also closed down.

One of the main drivers of the world economy is confidence and any terrorist attack undermines that. Further, the attack comes at a time when growth projections were already being downgraded, not just in the UK but for the whole world. The world economy is still growing despite the surge in the oil price but the pace is slackening.

Sadly, the world has considerable experience of the economic consequences of terrorist attacks. These divide into three main groups: the specific damage to the place where the attack happens; the industries that are most severely affected; and the longer-term damage to international trade and economic relations.

The damage to the fabric and infrastructure of London appears surprisingly small. If there are no further similar attacks - a hope rather than an assumption - the damage is far less than that inflicted on New York, somewhat less than the damage in Madrid and less than the IRA bombings in London. In the context of most natural disasters - hurricanes in the Caribbean for example - the damage is really quite limited. This campaign appears to have precisely the opposite objective from the IRA's mainland campaign, which was to damage property rather than people.

Damage to the industries directly affected, however, is both much greater and much harder to judge. US airlines took more than two years to recover from the 11 September 2001 attacks and still suffer from the additional security costs and passenger inconvenience. British Airways shares fell by nearly 5 per cent on yesterday's news, reflecting a judgement that fewer people will travel to the UK as a result of the attack. To some extent that will prove true. The London economy is obviously vulnerable to any fall-off in visitors, and the attack comes just as the main holiday season is reaching its peak. It is not just hotels that are likely to suffer: London retailers are already having a tough time as a result of the general slowdown and the imposition of the congestion charge. They will inevitably lose some business.

On the other hand, there can be surprisingly positive effects. The volume of sales in US shops actually rose sharply after 11 September, as people spent money on goods rather than travel. So it may well be that the overall impact on demand - and hence growth - in the UK will turn out to be slight, or even neutral. We should be encouraged too by the experience of Spain after the Madrid bombs. The Spanish economy has been one of the strongest on the Continent, while Madrid itself was a serious candidate for the Olympics. Its bid was not in any way undermined by those attacks. All this should be good news for the UK as a whole, if bad news for the industries most directly damaged.

There should, however, be no room for complacency at any level. The greatest uncertainties and arguably the greatest economic threat come from the potential long-term disruption to global trade and investment flows. For example, while the US economy has grown strongly since 11 September, its security response has had the effect of discouraging foreign students from applying to US universities. In the long-run that will damage US competitiveness. Our own economy is a remarkably open one, in some ways more so than the US: open to imports of talent as well as of goods and services. If the UK response were to try to make the economy less open, then we would over the years gradually suffer.

The implications go beyond the UK and beyond Europe. The world economy is now more "global" than at any previous stage in history. World exports are 19 per cent of total output, the highest ever. Foreign assets are almost certainly larger than world output, again the highest ever. This is a hugely interdependent world and hence, potentially, a vulnerable one. The momentum behind this growing interdependence is so strong that it will, mercifully, take more than a terrorist bomb to derail it. But three times in the past century, in 1914, 1929 and 1939, a strong and interdependent world economy has been destroyed by strife. We should remember that if terrorism pushes us towards erecting barriers between different countries and different people.