Swine Flu: An Investor's Overview

The sudden outbreak of swine flu in Mexico and a handful of other countries, including the U.S., is a scary reminder of unanticipated risks outside the financial system that have the potential to derail any attempt at economic recovery over the next couple of years.

On Apr. 27 the S&P 500-stock index closed 1% lower on news that more than 100 people in Mexico had died of the swine flu and reports of at least 40 cases of the flu in the U.S. The Mexican peso fell 4.4%, and the Bolsa stock index dropped 3.3% that day as a result of the scare.

By the afternoon of Apr. 27, the World Health Organization (WHO) had raised the alert level from phase 3 to phase 4 on a scale of 1 to 6, warning that the virus had made the leap from animal-to-human to human-to-human transmission, which boosts the likelihood that it will cause community-level outbreaks.

Dr. Margaret Chan, WHO's director-general, said she believes it isn't feasible to contain the outbreak and that the focus should be on mitigation measures. But she advised countries not to close their borders or restrict international travel.

How Well Are Nations Prepared?

In view of how quickly the swine flu threat has escalated, it may be prudent for governments around the world to at least consider how well prepared they are for other kinds of events that could emerge as if from out of nowhere to pose a further threat to the already fragile global economy and efforts at recovery. For example, a political or terrorist crisis in Saudi Arabia that could cause the Persian Gulf to be closed, sending the price of oil dramatically higher, or an unexpected major natural disaster such as a big earthquake along the West Coast of the U.S. or another pair of back-to-back hurricanes hitting the Southeast U.S.

"These are real serious things that would do real damage to the economy," says Lawrence J. White, an economics professor at New York University's Stern School of Business.

The Mexican government has ordered a quarantine of infected people and a ban on foreign travel, while the United Kingdom is reportedly already cautioning people not to travel to North America until further notice.

The travel implications aren't confined to tourism—business travelers would be affected as well. An elevated threat level would slow the processing of people through airports and other border locations and drive up costs, says White.

If the flu grows to pandemic proportions—a 1918-19 influenza outbreak killed 50 million people worldwide—the possible economic impacts would be wide-ranging.

Fear of Crowds

Most immediately, travel, tourism, and any retail activity in Mexico aside from essentials like food will suffer, and it's likely that any sort of sports or entertainment event—"anything that involves a crowd"—will, too, according to Andrew Busch, a global foreign exchange strategist at BMO Capital Markets (BMO) in Chicago and author of the book World Event Trading: How to Analyze and Profit from Today's Headlines, a third of which focuses on the effects of infectious diseases.

The Congressional Budget Office published a revised study in July 2006 that estimated the economic impact of an avian flu epidemic. The CBO found that most of the costs would stem from decreased demand for goods and services and higher labor costs due to absenteeism, since lots of people would be staying home, either sick themselves or to care for family members, says Ross Hammond, a fellow in the Brookings Institution's economic studies program and a member of the program's Center on Social & Economic Dynamics.

The CBO estimated that 1% of U.S. gross domestic product could be lost under a mild pandemic and as much as 4.25% if it were as severe as the Spanish flu in 1918, says Hammond. "It's hard to know how to apply those numbers to this case because we don't know how quickly the swine flu will spread or how quickly it will respond [to treatment]," he says. Further complicating the comparison is the fact that the world is already in the middle of an economic crisis, he adds.

Hammond has done some modeling of the economic costs if hospital emergency rooms were hit by a flood of additional patients. "We found there isn't a lot of excess capacity in emergency rooms. It's expensive to maintain that kind of capacity when there isn't a pandemic," he says. "[It] would be hard to keep up with emergency room [traffic] from a viral pandemic where lots and lots of people would show up."

U.S. Farms: So Far, So Good

The potential economic toll on agriculture is equally hard to forecast, especially since there have not yet been reports of infected livestock in the U.S., and the safety of this country's pork industry has not yet been questioned. During the outbreak of a highly pathogenic strain of avian flu in Italy form August 2004 to October 2006, amid the appearance of 350 bird flu articles in European newspapers, fresh poultry sales in Italy, on average, were just under 80% of what they would have been if there had not been any bird flu news, according to a 2008 study by the U.S. Agriculture Dept.'s Economic Research Service.

White at the Stern School says he would expect the food industry to suffer an impact comparable to those seen when the British beef industry was hit by mad cow disease or when there was an e. coli bacterial scare in the U.S. spinach market.

In a sense, the abruptness and potential for contagion of a swine flu outbreak contains all the classic elements of thriller fiction, feeding the popular imagination and making its effects that much more frightening, says David Asch, Robert D. Eilers professor of health care management and economics at the Wharton School. Meanwhile, there's much less speculation or concern about the economic impact of slower-moving medical crises such as the explosion in diabetes and obesity in the U.S., he says.

Hammond at Brookings says there are good grounds for concern about those impacts, as demonstrated by a study that found that 9% of total U.S. medical expenditures in 1998 were for obesity-related medical expenses. That percentage is expected to have grown dramatically in the decade since, he adds.

Obesity has a wide range of economic effects, from the way clothing is manufactured to the size of airplane seats (BusinessWeek, Apr. 20) to the structure and focus of the agriculture and food industries, says Asch at Wharton. Yet diabetes and obesity aren't contagious and don't produce the fear-related effects that a flu epidemic does. "People fear things that are sudden and mysterious, and yet the monster is all around us," says Asch.

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