The swine flu epidemic has become front page news this week. Mexico is the epicenter of the outbreak and thousands of cases have been reported in that country. However, scores of cases have been confirmed in the United States, and countries as far afield as Israel and New Zealand have hospitalized people with symptoms that resemble swine flu. Not only have the Mexican stock market and currency been hammered over the past few days, but financial markets in most other countries have been adversely affected as well.
The financial and economic costs of the epidemic will ultimately depend on its severity. The outbreak of Severe Acute Respiratory Syndrome (SARS) that swept through Asia in the spring of 2003 is instructive. The SARS epidemic was deadly—nearly 800 people in 7 countries died—but it was not catastrophic. The economic effects of that epidemic were significant but temporary. However, if the current outbreak were to morph into something like the influenza pandemic of 1918, which killed 50 million people worldwide, the economic and financial fallout would obviously be much more devastating.
In this brief note, we attempt to outline how the economies of Mexico and other countries could be affected by the current outbreak of swine flu. In that regard, we draw on the experience of the 2003 SARS epidemic to inform our economic prognosis and we reference some analytical work that has modeled the economic effects of severe pandemics. We acknowledge, however, that it is ultimately impossible to forecast precisely the economic and financial effects of the current outbreak due to the unpredictable nature of the epidemic.
Significant, But Temporary, Economic Effects Likely in Mexico
Because Mexico is the epicenter of the swine flu outbreak let’s begin our discussion with the Mexican economy, which could be adversely affected in a number of ways. First, Mexico’s trade with the rest of the world could be disrupted. Indeed, many nations have already announced import restrictions on Mexican pork products. We do not have data on Mexican pork exports, but they surely represent a small proportion of the $7.9 billion worth of agricultural goods that Mexico exported last year. Moreover, the direct effects of an import embargo by foreign countries on Mexican pork products would be rather miniscule in terms of the $1 trillion Mexican economy.
A larger impact on the economy may be felt in the hospitality sector if foreign tourists decide to eschew travel to Mexico. Tourism revenues totaled $13 billion in 2007, a bit more than 1 percent of Mexican GDP. Although not all tourists will cancel their trips, a significant hit to the tourism industry would come at an inopportune time with the Mexican economy already in a deep recession.
Mexican trade and tourism are likely to suffer, but the biggest effects on the economy likely will occur via domestic demand. For example, the Mexican government has announced that schools will be closed until May 6, and other businesses may shut down temporarily as a precaution. At a minimum, businesses will be affected as some people will choose to stay confined to minimize their chance of infection. Most of the confirmed cases of swine flu in Mexico have occurred in Mexico City. Although we do not know what proportion of Mexican GDP is produced in Mexico City, about one-quarter of the country’s population resides in the metro area. If enough people in Mexico City decide to curtail their daily activities, the short-term effect on the Mexican economy could be significant.
The economic effects of the SARS epidemic, which swept through Asia in the spring of 2003, are instructive. The outbreak started in China where the year-over-year growth rate of real GDP dipped from 10.3 percent in the first quarter to 7.9 percent in the second quarter. Hong Kong was also adversely affected. Tourist arrivals in Hong Kong plunged almost 70 percent during the spring of 2003, and the value of restaurant sales in the city fell 20 percent during that period. Real GDP in Hong Kong contracted about 9 percent (annualized rate) in the second quarter of 2003 relative to the previous quarter.
In short, SARS had a significant effect on economies in Asia during the spring of 2003. However, the effects proved to be temporary. The year-over-year growth rate of real GDP in China rebounded to 9.6 percent in the third quarter of 2003, and GDP in Hong Kong jumped about 25 percent during that quarter as the epidemic passed and daily life resumed its routine. Outside of Asia, however, the SARS epidemic appears to have had very little economic effect.
If the current swine flu epidemic progresses in a similar fashion, then the effects on the Mexican economy could be significant in the near term, but they are likely to be temporary. Until investors have a better sense of the severity of the outbreak, however, the Mexican stock market and currency likely will remain under downward pressure. However, the Mexican peso is not likely to “crash.” The Bank of Mexico (the country’s central bank) has been selling dollars and buying pesos to retard the rate of decline of the currency. Moreover, the Bank of Mexico has an ample war chest of international reserves (about $80 billion) to successfully fend off a speculative attack on its currency.
Will the U.S. Economy Become Infected As Well?
There have been scores of confirmed cases of swine flu in the United States, the most reported by a single country outside of Mexico. We are not aware of a foreign country that has placed an outright ban on travel to the United States, but some governments have cautioned their citizens about traveling here at this time. Certain tourist destinations could feel the pinch if enough foreign travelers decide to stay home. Foreign travels spent about $120 billion in the United States in 2007, but the amount represented less than 1 percent of GDP. That said, any significant pullback in foreign travel expenditures at this time would impart an unwelcome shock at a time when the U.S. economy is already experiencing its worst recession in decades.
It seems that very few Americans are choosing to stay confined at this point. Therefore, it is hard to envision a large demand side effect on the U.S. economy other than the potential disruption of foreign tourism. However, potential supply side disruptions spring readily to mind. That is, some Mexican-based companies are important in the U.S. supply chain. As of this writing the Mexican government has not mandated the closure of Mexican businesses. However, if enough Mexican workers choose to remain confined, then output in Mexican factories could grind to a halt, which could then adversely affect U.S. businesses that use Mexico as a supply source.
How Bad Could It Get for the Global Economy?
How bad could it get? We are not virologists, so we will not speculate on the possibility of a 1918 redux. However, in a recent paper three economists estimated the effects on global GDP from three different scenarios.1 The “mild” case was modeled on the 1968-69 Hong Kong flu that killed about one million people. A scenario resembling the 1957 Asian flu, which is blamed for two million deaths worldwide, was their “moderate” case. The “severe” scenario was a repeat of the 1918 pandemic that is blamed for millions of deaths worldwide.
Under the “mild” scenario global GDP would be reduced by 0.7 percent (about $400 billion). The “moderate scenario would result in a loss of 2 percent of world GDP (roughly $1.2 trillion). The “severe” scenario leads to a reduction in global GDP of nearly 5 percent (about $3 trillion). By their reckoning, about 60 percent of the losses occur via demand side effects (e.g., disruption of travel, curtailment of non-essential retail shopping, etc.). Nearly 30 percent come from temporary supply side effects like illness and absenteeism. The remainder comes from mortality.
Therefore, if the current swine flu epidemic ends up infecting millions of people, then global GDP could be adversely affected at a time when the global economy is already in its worst recession in decades. If, however, the current epidemic ends up being about as virulent as the SARS outbreak of 2003, then Mexico will likely suffer a short-term economic setback but the overall effect on global GDP is likely to be rather small.