April 30 , 2003

When I am asked what the severe acute repiratory syndrome epidemic will do to the world economy, my first response is to ask how it alters productive resources.  People are dying  (about 6 percent of the afflicted).  Work days are lost (more than 4000 cases and tens of thousands of quarantines for 10 days to see if symptoms develop).  Resources must be redirected  to attack the disease. 

The fatalities are frightening and my CDC contacts will need to inform me whether 6 percent mortality is dramatic (I think it is but I do not know).  However, this is not in the class with the influenza that swept the world after World War I (about 18 million fatalities there).  That epidemic did not spawn a world recession (although postwar rebuilding might have offset some of its economic impact). 

What is different about this epidemic is how the world is reacting to it.  The fear is a greater economic concern than the disease, and that fear is a difficult issue to monitor.  In the past month, trans-pacific travel has declined by 40 percent.  Trade shows are experiencing less attendance than conferences in the U.S. the week after 9/11.  As a result, business orders for the next six months of Asian work are off almost 30 percent. 

Hotels in Hong Kong are sometimes less than 10 percent occupied.  Restaurants are vacant.  Movie houses are being closed.  Even shopping malls are emptying, with sales off 50 percent in the past few weeks.  Tourism is 3 percent of the Hong Kong economy, and it is off by more than half (a 1.5 percent drop in GDP is noticeable, even when it is mostly tourists). 

While the impact is most dramatic in Hong Kong, where the fatalities have been the highest, similar conditions are developing in Singapore, Shanghai, and Beijing.  Thailand has not yet lowered its GDP estimates, but the IMF is expecting more than a percentage point drop in growth there.  And the story continues throughout Asia.  The 5.3 percent growth forecast for the region may fall by as much as a percentage point if the crest of the disease is not reached soon.

My second concern is how long activity can be so dramatically different from normal before financial repercussions begin to develop.  Ten percent full hotels cannot pay their mortgage notes.  Restaurants will fail if customers do not arrive soon.  How will this mounting financial impact be handled by the financial community?

Of course, the answer is not known until the magnitude of the fear is measured.  Hotels shuttered for a month will not create serious financial distortions.  Hotels shuttered for a year could seriously impair the lending capacity of the banks that are holding the hotel notes. 

So far, the supply side of the Asian economy has not been significantly impacted.  People will not go to movies and shopping malls (unless they work there).  They are going to their workplaces.  Furthermore, the vast majority of the fatalities are people who had other medical conditions or were aged.  At this point, the capacity to produce in Asia (and Canada and wherever else the disease hits) has not been significantly altered. 

However, the weakness in demand for services could begin to cause job loss.  That could begin to undermine domestic activity in Asia (although much of the stimulus to growth remains export activity, which remains largely unimpaired).  The more substantial concern is the loss of financial capacity that could have serious growth restraints further down the road. 


Now that I have outlined the economic issues from this epidemic, let me try to put some numbers to them.  First, I do not believe a recession will develop, although the reduced demand will lower Asian economic growth by a full percentage point and world growth by almost 0.3 percentage points. 

Second, Asian financial institutions will be strained.  In areas such as China, Korea, Thailand, and Japan, the further weakness of domestic capital markets could impact domestic growth.  However, much of the Chinese growth is financed externally, and most of the manufacturing production will continue to perform. 

So far, the financial markets have not seriously discounted the economic impact of this epidemic, although the Hong Kong stock exchange is beginning to sag significantly.  A little backing away from Asian securities at this point might be justified (although Chinese equities have been among the strongest performers in the world in the first quarter of this year).  This probably would include debt instruments. 

However, the reduction of demand relative to supply usually lowers prices.  The current rush to gold because of Asian concerns is probably the wrong thing to do.  If anything, downward pressures on prices will intensify.  As far as my U.S. forecast is concerned, SARS will probably lower inflation (which already is well under 2% when energy prices are excluded) but will have minimal impact upon economic activity. 

Now if there only was another cure for the fear than actually containing  the disease, we could eliminate SARS from our forecasts altogether. 


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