At this point, you’ve probably heard more about the COVID-19 than you can stand. I feel you. And I don’t want to pile on to the discussion about the disease itself. But, the measures to protect public health will have economic consequences. While doing a full analysis of that economic damage is more work than I can afford to do for free, I can point to some general things to consider.
I don’t know of a better place to start a conversation about a pandemic than with public health. This industry is always difficult for economists to discuss, as it represents a direct trade-off between a healthy population and a healthy economy. As people require more medical attention, it creates jobs in the healthcare industry.
The spread of the virus creates more work in hospitals and clinics. Perhaps more work than the system can handle in the short-run. And, the mountains of paperwork that accompany a pandemic will probably result in increased demand for administrators across the country.
Alaska hasn’t been inundated with patients quite yet. While we can hope it never gets here, it probably will. So, we may see some impact on employment and wages here over the next month or two. Of course, all this social distancing and increased prevention has the side effect of reducing the spread of other diseases. So, some of the increases in demand in the short-term might get offset by reduced visitations for other reasons over the next several months.
There’s also a distributional issue at work here. People most able to take time off or to work from home are middle to upper-income bracket (with health insurance). This implies that the spread of the pathogen is probably going to be greater among the lower-income brackets (which are more likely to be on Medicaid).
Tourism is likely to be the most directly observable casualty of the pandemic. Cruises are already being canceled in April and May. Ships coming in June will probably not be full – especially given that the demographics of passengers tend to skew toward the age groups being told to stay home. Hopefully things will be back to normal before the end of the summer.
Travelers arriving by air will also be lower than average. But, Southeast communities will feel the brunt of it. Of course, this season was scheduled to be busier than last year. So, even if a substantial number of tourists cancel their plans, we should still have a decent season. It will just be a lot less than we planned for.
Leisure and Hospitality
With less tourism, there will be fewer customers in the restaurants and hotels that they frequent. Every conference, concert, and congregation that gets canceled results in a reduced revenue stream for the venue, caterers, hotels, bars, and restaurants that would have accommodated the participants. And, every time we avoid contact with other humans by staying home rather than going out, business owners and waitstaff are separated from their income.
The effects of staying home are going to significantly reduce the ability of many small businesses to stay afloat. And, the reduction in going out in March and April will not be offset by pent up demand coming back strong in the summer. Plus, disrupted supply chains might make it hard to provide product for the next few months. With the razor-thin margins that naturally exist in the industry, at least one of your favorite places to eat will go out of business.
When Russia decided they couldn’t afford to prop up the oil market by matching the reduced demand with a cut in supply, the OPEC cartel’s control over the market collapsed. Reduced travel and transportation set off a cascade of events that crashed through the price floor.
Oil is trading just over $30 a barrel today, half the price from just a few months ago. It’s probably going to fall further before it hits bottom. Of course, the market would immediately rebound if Russia and OPEC hug and make up. But, for now, the strategy appears to be to starve the US shale producers into making the production cuts instead.
As the supply curve shifts to the right, it will strike the demand curve at a lower price and higher volume. In other words, lower oil prices result in lower fuel costs, which in turn leads to increased consumption. Concurrently, lower fuel prices will slow the conversion from internal combustion engines to electric cars. The combination of rising oil consumption, slowing demand destruction, and shale company bankruptcies will push prices back toward long-term equilibrium.
The process will take some time. And the supply glut that is growing from all of the current events will probably take a couple years to fully clear. But, I expect prices to start climbing toward $50 before the end of 2020 and to get back to the $65 level by 2023 (assuming that OPEC+ comes back together before then).
However, the next couple of years of depressed prices will have ramifications. While the 2020 capital plans will probably move forward, the 2021 capital budgets will be smaller (as happens any time company net cash flow is reduced). This probably means that a lot of the activity we’ve been eagerly awaiting will get delayed a couple years.
Consequently, all the employment related to those projects also gets shifted a couple years into the future. Which, of course, means the near-term economy will fall. The most noticeable impact will be in the support services, construction, and professional services sectors. And, this will layer on top of the already anticipated employment reductions from the BP/Hilcorp transaction. All this implies that employment in the oil industry just went from a positive to a negative outlook for 2020-2022.
By one recent estimate, the global demand for jet fuel is down 11% in the wake of the pandemic. As people cancel travel plans and supply chains break, the transportation industry is reeling. That dynamic is likely to continue for another month or two.
But, once things return to normal, supply chains will reconnect, and travel will resume. In fact, with lower fuel prices, travel might even increase. Plus, if avoiding going to the store during the outbreak turns into increased online retail, cargo transport might see a boost. It’s unlikely that the damage inflicted will be fully offset in 2020, but 2021 might be a good year for the transportation sector.
The retail industry has been on quite a losing streak for the last several years. Online retailers have been winning the battle for customers, putting brick and mortar stores out of business.
It’s a tough industry, and it just got tougher. Staying at home means you’re not out shopping for new clothes, toys, books, or whatever else you buy. While we may see an initial spike in activity at box stores, as people prepared for the worst, there will probably be a hangover effect. With stocked pantries, cabinets, and bathrooms, the amount of shopping needed for the next several months is going to be reduced.
We may even see transportation issues result in further inventory shortages, thus reducing the ability to make sales. And, as shelves run empty, people turned to the internet to meet their needs. If that exposure to online shopping turns into accelerated adoption, that’s bad news for retail. So is the loss of employment happening in other sectors. As well as the smaller PFD we are likely to see.
Falling income results in reduced shopping, hitting the retail sector again. This is the secondary effect of reduced tourism, employment, and initial shopping. It’s not clear how all of this plays out with employment numbers just yet, but I’m pessimistic.
Falling wages and reduced spending are bad news for the construction industry. We tend to build when we are optimistic about the near-term prospects of the state economy. With less money in our pockets, federal government projects wrapping up, a non-existent state capital budget, and falling oil prices delaying development, there’s not a lot to look forward to in this industry.
Construction is typically a leading indicator of the direction of the economy. Pay close attention to what happens this summer.
As oil prices crashed, around $500 million evaporated from the FY21 revenue picture. And, as the stock market collapsed, billions of dollars disappeared from the Permanent Fund. Corporate income taxes are likely to take a hit as well, as businesses suffer losses this year. There are probably other smaller impacts we aren’t even thinking about (for example, vehicle rental tax will probably fall).
The most likely path forward is to exhaust the last of the CBR while cutting back on most of the PFD. That gets us through FY21. But, FY22 is going to be a nightmare (unless something drastically changes over the next year). The next legislature is going to walk into smaller revenues, a smaller Permanent Fund balance, no CBR, and an economy in recession. The only options they will have is some combination of taxes and budget cuts – both of which injure the economy.
Seeing as the legislature and the public were unwilling to make the hard choices when the time was right, it’s unlikely they can get it done while the economy is suffering. There’s only one option at that point – a bigger draw on the Permanent Fund. It’s a brutal place to be and it’s going to take some serious compromise and strong leadership. No elected official is going to walk away from the next couple of years without some battle scars.
Municipalities are also going to feel the pain. Any local government that levies a sales tax is going to find out their revenue forecast is overstated. Cities with cruise ship ports are going to find that their large vessel passenger fee collections are not what they planned. And, with the state trying to solve its own financial problems, even more burden will fall to local governments.
There will be significant shortfalls in several municipalities across the state (except maybe the North Slope Borough and Valdez). Local leaders should start preparing now.
Most likely, a global recession is just starting. While the confirming data won’t be available for six months, the consequences of shutting down the economy for a month or two are inevitable. And, just like in every other recession, the impacts are predictable.
Thousands of Alaskans and millions of Americans will lose their jobs this year. Several small business owners will go bankrupt. People will lose their retirement to the market and their homes to foreclosure. Unfortunately, that typically results in a loss of hope and an increase in suicide. The negative implications of preventing the spread of the virus might end up being worse than the virus itself.
There are no easy answers. There is no pain-free solution. But, it’s time to start planning for the fallout of the economic damage this pandemonium has done. Many of our options for getting ready for the future are now gone. The window of opportunity to prepare for this situation has closed. Now it’s time to manage the crisis and minimize the damage.