After a case of swine flu was confirmed in the Midlands, Nariman Behravesh, chief economist at financial analyst IHS Global Insight, assesses the potential impact on commerce.

The sharp rise in the number of reported cases of swine flu – in a matter of days - has, once again, triggered fears of an epidemic that could have dire consequences for a global economy already suffering its worst downturn in six decades.

The bad news regarding this outbreak is that it could not have happened at a worse time, in terms of its impact on growth. The good news is that having learned from the SARS epidemic in 2003, and subsequent fears over the possible outbreak of an avian flu epidemic, the healthcare systems of many countries – especially in the developed world – are better prepared now than even a few years ago.

Many countries now have stockpiles of anti-viral drugs that could cover between 25 per cent and 50 per cent of the population. Unfortunately, many emerging markets have neither the drug stockpiles nor the healthcare systems to cope with such an epidemic. This means the economic impact of a potential swine flu epidemic will probably be much larger for emerging markets than developed ones.

Supply-side impacts

There are two ways in which a swine flu epidemic would have an impact on economic activity and growth. The first is the direct effects on the supply side of the economy. This includes the physical and psychological effects and includes:

n Deaths – measured by a reduction in the labour force.

n Worker absenteeism – measured by a reduction in overall hours worked.

n Overwhelmed healthcare systems – measured by a reduction in both work hours and productivity.

n Closed schools and public transit systems – measured by a reduction in hours worked and productivity.

n Restrictions on in-bound travel, tourism and trade.

For a mild epidemic, the supply-side impacts would be small – no more than a few tenths of a percentage point of GDP – and probably last less than a year. In a more serious epidemic, the supply-side impacts could be five to ten times larger and last at least two years.

Demand-side effects

The demand-side effects include the change in the behaviour of consumers and businesses in reaction to the pandemic. These effects are often two to five times greater than the supply-side impact. The economic consequences of Asia’s SARS outbreak in 2003 provide an instructive example. That outbreak caused only 800 deaths – in other words, its supply-side effects were rather insignificant, given the region’s huge populations.

Yet, psychological effects of the outbreak were considerable and led to a significant demand-side effect. Asia’s GDP growth was reduced by two percentage points in the third quarter of 2003 and by a 0.5 percentage point in all of 2003.

The demand-side effects encompass most spending categories, including:

n Travel and mass transit services.

n Hospitality services, such as hotels, restaurants and tourism.

n Retail and wholesale shopping.

n Other entertainment activities, including movies, theatres, concerts, sports, and gaming industries.

Export-oriented economies – including Mexico, where the recent epidemic started – would be especially vulnerable to demand-side shocks, because of the negative effects on both domestic and foreign demand. Moreover, the reaction, or over-reaction, of financial markets to an epidemic could exacerbate the demand-side impact by reducing household wealth and hurting the balance sheets of companies.

In this regard, the response of national and local governments in dealing quickly with the health issues and in reducing public panic could be crucial in limiting the negative effects of a pandemic on consumer and business confidence.

The bottom line

In a mild epidemic the growth impacts would be limited, but in a more severe epidemic the consequences could be quite dire.

In an epidemic – with roughly 75million infected in the United States and 100,000 fatalities – the supply and demand effects cut less than 0.5 per cent off the growth rate of real GDP and last less than a year. The impact in emerging markets would likely be two to three times as big. In a more serious epidemic or pandemic, with fatalities four to five times higher, the impact on real GDP growth in developed economies would be more like -two per cent to -three per cent.

In the case of the United States, this could mean a growth rate of -four per cent to -five per cent in 2009 and an even bigger rise in the unemployment rate.

For poorer countries, which are less able to cope with such an outbreak, the impact would be devastating and produce downturns of depression-like proportions.