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Economic News, Data and Analysis

The World Trade Center and the Economy

Compared to the human loss in New York and Washington D.C., the economic consequences are minor. However, to prevent the tragedy from having further effects, we must get our economic house in order.

Below I look at the possible economic effects of 9.11, the economic outlook, and two of the policies suggested to help prop up the economy: the airlines bailout, and a capital gains tax reduction.

Economic effects

The events of 9.11 are likely to have an impact on the economy. Exactly how large the ultimate impact will be won’t be known for some time. There are sectors that will be hurt: tourism, airlines, insurance (and re-insurance), the financial industry, and the entertainment and sports industries are obvious choices. In addition, the harm to these industries may eventually spread to the broader economy.

It is important to keep in mind that the economy is huge – Gross Domestic Product is over $10 Trillion. So a few 10’s of billions lost by, say, the airline sector is not by itself a major drag on the economy. Real damage can be done though if general fears of a blow to the economy lead to a reduction in consumer spending, housing purchases, and/or a further decline in investment spending by businesses (which appears to have been the cause of the economic slowdown in the first place).

In addition to any kind of general slowdown, the economy will likely see a shift of spending across sectors. Perhaps people will drive more and fly less. Fewer dollars may be spent on travel, but more dollars may be spent on food and clothing (in the form of donations to NYC workers), national defense, Internet security, or other sectors – the Flag-making industry is certainly seeing a boom! See CNNfn for the market reaction to industry sectors.

Also, the rebuilding of lower Manhattan will in part offset some of the negatives for New York. New buildings, new offices, new computer equipment, etc, will help the suppliers of this equipment.

The Stock Market

The stock markets, as expected, reacted badly to the events of 9.11. Major indices were off between 5 and 7% and continued to fall over the next couple of days.

It is important to keep in mind that the stock market is not the same thing as the economy. They are often reported in the press as being the same thing, but they are not. The stock market makes for better news since it changes every day, it seems more dramatic, and you can get good footage of traders running around on the floor of the NYSE.

It is likely, in my opinion, that the stock market has overreacted (no surprise there!) to the events of Tuesday. Historically, knee-jerk declines in the market as a result of these kinds of events have been quickly reversed.

We’ll have to wait a bit to see how the real economy has been affected. My guess is that we’ll see a modest drop in GDP as well as a slight up-tick in unemployment resulting from the trade center collapse.

Looking to the Future

When looking to the future, there are some reasons to think that there may be a quick recovery. Both fiscal and monetary policies are now becoming very expansionary – the tax rebate will soon take hold, spending increases on defense and aid to New York, the airline bailout, as well as interest rate reductions and liquidity provided to the banking system by the Federal Reserve – all point to a strong stimulus to the economy which should begin to affect the economy in the next 6 months.

Bailout of Airlines?

The airline industry was in trouble prior to 9.11; however, the events of the past week were an unexpected occurrence and had nothing to do with the fundamental viability of the industry. A reimbursement for losses that occurred since 9.11 seems to make sense since the air industry is such a vital part of the overall economy. It would stabilize an important piece of our national infrastructure.

Part of the problem is that airlines lost money from nearly a week of idle and diverted planes, and the second part of the problem is that the public is, understandably, reluctant to resume their normal flying behavior. The first problem is easiest to address, but likely the less costly of the two in the long run.

Addressing the first problem is easy – government money could stabilize the financial situation by providing grants and loan guarantees – and congress is likely to pass an aid package of this sort very soon.

Addressing the second is more complicated. Beefing up security, probably by turning it over to a federal law enforcement agency, would go a long way in restoring confidence.

I might also suggest an alternative approach to complement security improvements. The government might subsidize air flight. A temporary subsidy, perhaps at a fixed rate by the passenger-mile, would help bolster airline revenues, reduce ticket prices to encourage more passengers to fly again, and would help airlines finance the higher cost of security in the short-run.

This would not be a good long-term solution, but would perhaps help the flying public and the airlines get over this rough patch.

Capital Gains Tax Cut?

A second policy that has been suggested to help the economy is a cut in the capital gains tax rate. I can’t imagine that this cut would have any significant impact on the economy in the short-run.

The economic argument for a cut in the capital gains rate is that, in the long-run, there will be more savings and hence a greater capital stock and output if the capital gains rate is lower. There are some valid arguments for cutting the capital gains tax rate in general (as well as valid arguments against); however, I don’t think anyone seriously believes that the capital gains tax is a useful tool for macroeconomic stabilization policy.

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