Heat and dust
Apr 22nd 2010
From The Economist print edition
Economies are remarkably resilient to exogenous events
IS YOUR journey really necessary? The second-world-war slogan springs to mind in the wake of the volcanic cloud that has disrupted air travel this week. Although business people tend to think of their foreign trips as vital, the eruption is expected to have very little impact on the global economy. In this, it follows a long line of travel scares that have included SARS, swine flu and terrorist attacks.
Even the attacks of September 11th, which had an understandable impact on confidence, caused American output to dip by only 0.3% in the third quarter of 2001. Other “exogenous events” of this kind are hard to spot in the macroeconomic data. Of course, such events can cause immense hardship to individuals and businesses. Airlines and Kenyan flower producers are two obvious current examples. But there are often gainers as well as losers.
Given all the talk about a connected world, it may seem odd that air travel does not seem to matter that much. In fact, globalisation is far more about ships than about planes. An event which closed the docks in Rotterdam or Long Beach would have a far greater economic impact than the grounding of aircraft. According to the Royal Bank of Scotland, 46% of goods in Europe are transported by road, 37% by sea and 11% by rail; less than 1% goes by air. Economists anticipate a maximum volcanic effect of one or two tenths of a percentage point on Europe’s second-quarter GDP, well within the margin of statistical error.
In addition, economies are adaptable. Substitution effects predominate. If all air travel were stopped for a year, northern Europeans would no longer make their pilgrimages to Spain and Greece. But they would still take their holidays at home, just as they did before the era of cheap flights: domestic hotels and restaurants would benefit.
As for business travel, most meetings could be held via telephone and videoconference. Executives might even increase their productivity if they spent fewer hours on board planes (or kicking their heels at airports). The internet helps. Workers stranded far from the office can work on their laptops and vital documents can be sent via e-mail instead of courier.
True, this episode has already caused disruption for the car industry, which sends some lightweight, high-value parts by air. If the flight ban had lasted longer, such goods would have had to be shipped, potentially creating a long-term deadweight cost in the form of higher inventory levels. Even so, with everything else going on in the economy, that would still be hard to spot in the GDP data.
It is this very adaptability that makes economic forecasting so difficult. It is impossible to do a counterfactual analysis—to hold one factor constant and see the effects on the rest of the economy. That applies to official policy as much as to “black swan” events like volcanic eruptions. Charles Goodhart, a British economist, has joked that he would love to be able to conduct quantitative easing in the north of Britain, but not in the south, to judge whether the policy worked. Since that cannot be done, economic historians will probably spend the next 75 years debating whether monetary or fiscal policy dragged the developed world out of recession, just as they still discuss whether the actions of the Roosevelt administration really shortened the Depression.
Indeed, though it may seem obvious that the level of interest rates or the size of the budget deficit can have a big economic impact, the effect of a host of other government initiatives and regulations is far less clear. The popular perception is that Britain has a completely different economy from France, with the former devoted to liberalisation and free labour markets and the latter governed by dirigiste policies and inflexible employment rules. Despite all that, in 2008 the two countries’ GDP-per-head figures were virtually identical (Britain was ahead on a purchasing-power-parity basis). One cannot claim from the data alone that one model is superior to the other.
A government can completely wreck an economy (see Zimbabwe or North Korea). Societies need the rule of law and respect for individual property rights if they are to function properly. But assuming these basics are in place, the factors that most determine long-term growth are demography, technological innovation, and the skills and education of the workforce. Government policy can affect these (particularly the last) only in the long term. As for occasional acts of nature like volcanic eruptions, most of them are, literally and metaphorically, noise.
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