* The evolution of a new strain of 'avian flu' has raised the possibility of a worldwide pandemic. Outbreaks of the H5N1 strain suggest it is extremely virulent and humans have no natural immunity. Epidemiologists suggest that, while the chance of an outbreak in any given year is relatively low, the question is 'when' rather than 'if' a pandemic will occur.
* While the biggest cost of such a pandemic would be the human toll, a worldwide outbreak would have major economic implications. Past pandemics have been associated with sharp slowdowns and often recession, as consumers shunned retail establishments and cut back dramatically on travel and tourism.
* The impact of a pandemic can be far out of line with the actual number of infections or deaths--the perception of risk and the length of time the pandemic lasts appear to be the most important factors.
What Would a Pandemic Mean for the Economy?
The possibility of a worldwide pandemic of avian flu has received considerable attention in news reports in recent months. Health workers have documented several outbreaks of a new, virulent strain (H5N1) in poultry in the Southeast Asian region, as well as some cases of animal-to-human transmission, including the first confirmed cases in China today. Because this is a new form of the virus, humans have no natural immunity: Of the documented cases (likely only a fraction of the total), roughly half of those infected have died. The virus has only one step to go to qualify as a pandemic--it must develop the ability to pass from one human to another.
It is impossible to predict for certain when an avian flu pandemic might emerge, though many researchers and epidemiologists suggest that the question is indeed when, rather than if. The World Health Organization writes, 'experts agree that another influenza pandemic is inevitable and possibly imminent.'
Clearly, the biggest cost of such a pandemic would be potentially enormous loss of life--a major outbreak of avian flu in 1918 led to 25- to 50-million deaths worldwide. The public health system has improved considerably since then, and future fatalities may be mitigated through aggressive development of new vaccines or other prophylactic drugs, or measures such as quarantines. Below, we concern ourselves with the potential economic impact of an avian flu pandemic.
The United States suffered from major pandemics in 1918, 1957, and 1968. In addition, the threat of SARS in Asia and Canada in 2003 also is instructive. The table following summarizes these events.
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A review of these events leads to several conclusions:
1. Pandemics have a large growth impact. The three major flu pandemics either coincided with or were followed by recession in the United States. While there were other factors underlying these downturns, the correlation between pandemics and poor economic performance is striking. For example, the worst postwar growth quarter was 1958Q1, which was also the quarter when the worst postwar pandemic was at its peak. The biggest impact appears to be on consumer spending, especially those areas that are most likely to bring people into contact with others (retail sales, travel/tourism). For example, retail sales dropped more than 50% from March to April 2003 at the peak of the SARS outbreak in Hong Kong.
2. The growth impact depends on how the population reacts to the threat, not so much on the virulence of the pandemic. Hundreds of thousands of flu-related hospitalizations and an estimated 35,000 flu-related deaths occur every winter in the United States. However, because these are generally elderly people in poor health already, the flu is not perceived as life-threatening by most of the population. Behavior is not altered significantly, and therefore the impact on the economy is minimal. (The exception to this general pattern was 1918, where the sheer number of infections and deaths created its own costs for the economy. Even here though, the reaction of the rest of the population was probably more important.)
Contrast the typical US winter flu season with SARS in Hong Kong, where only 0.02% of the population was infected and 300 deaths occurred (this is roughly equivalent to 75,000 infections and 12,500 deaths in the United States). Fear of contagion crushed retail sales, and the result was GDP growth of -12% annualized in the second quarter of 2003. In Canada, with only a few hundred SARS infections and circa 40 deaths, the impact was still large enough to be felt in the tourism industry, and SARS was cited by the Bank of Canada as one reason for easing in summer 2003.
Noteworthy in this regard is that the H5N1 avian flu strain appears to be extremely lethal. The death rate of recorded cases (from animal transmission) is 55%, although that figure is probably biased upward because mild cases might not have been reported to the authorities. In comparison, the 1918 flu death rate in the United States was around 10% of those infected.
3. The duration of the outbreak is likely important in determining whether there are knock-on effects that push the economy into recession. In the case of SARS in Hong Kong, the economy recovered rapidly despite the huge drop in Q2 2003 output. The outbreak was contained after about two months, and recovery was undoubtedly aided by the openness of the economy and robust external demand. Looking to the United States, the 1968 flu pandemic had half as many deaths as the 1957 outbreak and appears to have been far less severe for the economy, perhaps because of its relatively short duration--about four months versus nine for the 1957 outbreak. Although the economy did turn down in 1970, other factors -- fiscal tightening and a prolonged auto strike -- played a significant role.
4. The impact on financial markets appears roughly proportional to the growth impact. In the examples shown, equities generally lost 5%-15% in value in the early months of the outbreak. The exception was the 1918 outbreak, where the impact of flu appears to have been outweighed by the end of World War I. We would also expect bonds to rally in the resulting slower-growth environment, but the evidence here is mixed.
Andrew Tilton