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Factoring Terrorism into the Economic Equation

When will the US economy recover from September 11? The psychological impact of the terrorist attacks makes forecasting more difficult than ever.

Forecasting has always been a difficult occupation, whether the subject is the weather or America's economy. The terrorist attacks on September 11 didn't change weather forecasting; meteorologists still can track cold fronts and measure temperatures and other weather-related factors to predict the weather for tomorrow and for several days to come. Economists didn't get off so easy.

Yes, they will continue to track Gross Domestic Product (GDP), unemployment, housing starts, and other indicators. But, forecasting the depth and length of the current economic downturn and the arrival of the upturn is especially difficult due to the psychological impact of the terrorist attacks, says Robert Fry, DuPont's senior associate economist. Following is a review of where we are today (with figures to November 15, 2001) and his forecast for economic recovery.

“The immediate impact of the terrorist attacks was severe,” Fry says. “Business ground to a halt on September 11. Air traffic was stopped. Malls were closed. Workers were sent home. Those who stayed suffered an almost total loss of productivity. All of which was a great loss for the economy. The loss of one day's production reduces output for a calendar quarter by 1.1 percent. At an annualized rate, this represents a 4.5 percent decline.”

Fry continues, “In the days that followed, travel and tourism plummeted, and consumer confidence fell. People remained glued to their TV sets rather than go shopping, go out to dinner, or attend ball games. This so-called ‘CNN effect’ caused retail sales to fall 2.4 percent in September, the largest monthly drop since 1987. New claims for unemployment insurance soared to 535,000 in the week ending September 29, the result of widespread layoffs in such sectors as airlines and other travel-related business.”

Travel and tourism were still suffering through the month of October. United Airlines and Delta Air Lines reported large losses in the third quarter. United's loss, says Fry, amounted to $1.16 billion compared to the previous year's loss of $116 million. Delta lost$259 million in the third quarter compared with last year's profit of $133 million.

“Unemployment rose from 4.9 percent immediately before the attacks to 5.4 percent in October, and could go as high as 6.5 percent in the second quarter of 2002,” Fry continues. “The only reason it isn't already much higher is that the labor force has stopped growing. Unemployment figures count only those people who are looking for work. But, there are strong indications that many people are discouraged and have stopped looking for jobs and, therefore, are not counted in the unemployment figures.

“Industrial production fell 1 percent in September, partly due to bottlenecks caused by security measures imposed after the attacks, and another 1.1 percent in October. GDP declined 0.4 percent at an annual rate in the third quarter, with further decline expected for the fourth quarter.”

The Fall of the Computer
Computers, which contributed positively to GDP in 1999 and 2000, contributed negatively in 2001.

Shipments of computers and computer storage devices peaked in 2000 at an annual rate of $120 million. Last fall, before the terrorist attacks, they were down to about $85 million.

“The trouble with computers,” Fry points out, “is that they are the first things to go when companies cut capital expenditures. They stopped buying new computers, because they could still use last year's for another year or so.”

The impact of the terrorist attacks also was felt outside the USA, says Fry. “Much of Asia — Japan, Singapore, Malaysia, Taiwan — was already in recession before September 11, because our economy was in a downward slide. The European economy was not as weak as Asia's, [but] much of the world's economy is supported by the US economy. It is the locomotive that keeps the world economy growing. When America slows, other countries lose their locomotive, and they slow down, too. Likewise, when the US economy picks up steam, so will theirs.”

“Before September 11,” Fry explains, “we were looking for recovery to begin in the US manufacturing sector that month. That recovery has obviously been delayed by a month or two, and it is still too early to forecast the economic impact of the war against terrorism.”

One of the positive conditions Fry identifies is a further reduction in interest rates. “The Fed has reduced them four-and-a-half points since the beginning of 2001. Another positive is the fiscal stimulus of $40 billion in tax cuts — with more on the way, another $40 billion in recovery spending, and a $15 billion airline bailout.”

The full effect of all this stimulation won't be felt tomorrow, Fry points out. “It takes 6 to 9 months before any impact registers and 12 to 15 months before we can enjoy the full impact.”

Tighter inventory control is another positive, according to Fry. “Manufacturers have been very good at getting inventories down. Inventory-to-sales ratios don't look too good, because sales have dropped so much. If you look only at inventory levels or inventory growth rates, you see that manufacturers have done a very good job of getting them down. The auto industry, in particular, has done a great job of keeping its inventories down, and its inventory-to-sales ratio looks good. Zero interest rate financing stimulated automobile sales. Sales of GM's vehicles rose 31% in October to 551,461 vehicles. Ford saw a 35% rise to 417,738 units, while Chrysler reported a sales increase of 4.3%, presumably because the 0% financing program was limited to fewer models.

“Zero percent financing didn't cost the automotive industry as much as it might appear on the surface. With interest rates as low as they are, zero percent financing doesn't cost them as much as the rebates and other incentives they were using. Given low inventories and the decline in sales after zero percent financing ended, new demand for cars and trucks will have to be met by new production.”

Mixed Evidence
Other data also show tentative evidence of a rebound. For example, says Fry, “new claims for unemployment insurance fell to 450,000 the week ending November 3, still well above pre-attack levels but down considerably from their peak of 535,000 in late September. And retail sales soared in November, up 7.1% on the strength of record motor vehicle sales.

“Don't forget energy prices,” he says. “Indications are prices will stay soft because demand has stayed down. An increase in jet fuel demand — if it comes — is not, by itself, enough to cause a price increase. The economies of the world are in recession, and demand will continue to stay low. So will crude oil prices.”

Other volatile economic factors, says Fry, “are the uncertainties surrounding stock prices and consumer confidence. Leading indicators based on measures of real activity, such as housing permits, orders, and inventories, suggest economic activity is about to turn up. Indicators based on financial variables, which include interest rates and money supply, also suggest a strong near-term rebound. But psychological factors, measured by stock prices and consumer and business confidence, may temporarily circumvent the stimulus coming from fiscal and monetary policies and postpone the recovery the other indicators are predicting.”

Although consumer confidence gets more attention in the press, it is business confidence that well may hold the key to the timing of the recovery, in Fry's view. “So far, the downturn in the US economy has been dominated by business investment as businesses have cut capital expenditures in response to disappointing earnings, falling capacity utilization, and lower stock prices. Housing starts, home sales, motor vehicle sales, and total consumer spending have not indicated a recession. The biggest risk to a quick and robust recovery from the current recession is that layoffs will cause consumers, and especially home-buyers, to pull in their horns.

“Even if the US economy turns up soon, the upturn may not be apparent to most businesses for many months. Economists tend to look at seasonally adjusted monthly data. We see an upturn a month or two after it happens. Businesses look at quarterly data versus the same quarter a year ago, so they are looking at a year-over-year percent change in quarterly data. And that will not turn positive until about six months after the monthly data turn positive. So, economists will say the economy has turned around, but business will say they're not seeing it. It's possible, then, that economists could see an upturn before the end of this year [2001], but businesses will not recognize the recovery until the second half of 2002.

“Furthermore, business leadership is much more negative about the economy than consumers are. Unfortunately, they are in a position to make their pessimism a self-fulfilling prophecy. Optimistic consumers aren't in a position to hire anybody. Pessimistic managers can lay people off, and that is what is happening now. So, you can get into a spiral where the layoffs cause a big decline in consumer confidence, which causes consumer spending to decline, which causes corporate earnings and sales to decline even more, which starts the cycle going again.”

All of which brings up Niels Bohr, a physicist who won a Nobel Prize in 1922. It was he who said, “Forecasting is very difficult, especially about the future.” To which Robert Fry says, “Amen!”

Two Days of Infamy
December 7, 1941
People remembered where they were and what they were doing that Sunday. It was the day the Japanese bombed Pearl Harbor — a day, said President Roosevelt, that would “live in infamy.”

September 11, 2001
People remember where they were and what they were doing that Tuesday. It was the day the terrorists attacked the World Trade Center and the Pentagon, causing thousands of deaths.

These two days are similar in some ways: Americans were attacked in their homeland, and both attacks came as a total surprise. Economically speaking, however, they are quite different.

In 1941 the US was beginning to emerge from the Depression that followed the stock market crash of 1929. Unemployment, as a percentage of the civilian labor force, stood at about 18%. In 2001 the unemployment rate after the terrorist attacks was 4.9%.

Economically, the US was a smaller nation in 1941. Gross Domestic Product that year was valued at about $89 billion. GDP for 2001 was valued at around $9,000 billion. According to the Bureau of Labor Statistics, employment in December 1941 stood at slightly more than 38 million persons. Employment in September 2001 was in excess of 132 million. The Federal Reserve Board index of total industrial production in December 1941 was 18.543. In September 2001 the index stood at 140.3.

In 1941 the titans of America's economy included steel, chemicals, and automobiles. Today's high technology didn't exist then. In 2001 the “old economy” takes a back seat to products not even thought of 60 years ago: laptop computers, cell phones, satellites, and a spaceship encircling Mars, to mention only a few.

December 7, 1941, turned out to be the first day of a war with unprecedented costs. No one knows what September 11, 2001, will bring about. But as Robert Fry says, “From an economic standpoint, the costs of the terrorist attacks are enormous. From a human standpoint, they are much greater. And, while the economic impact will be temporary and largely reversible, the human impact will not be. The tragic loss of life on September 11 should force us to keep things like GDP, corporate earnings, and stock prices in perspective; the true cost of September 11 cannot be measured in dollars.

Robert C. Fry Jr. joined DuPont's Economist's Office in 1987 after a three-year stint in Conoco's Coordinating and Planning dept. As senior associate economist, he analyzes and forecasts global macroeconomics and its impact on DuPont. He assists DuPont businesses by interpreting economic data and using it to forecast DuPont-performance. He writes the monthly newsletter “Current Business Developments.

Robert received his B.S. in economics from Ohio Univ. and an M.A. and Ph.D. in economics from Harvard. He is immediate past-president of the Board of Visitors of the Honors Tutorial College of Ohio Univ. and a member of the Economic Roundtable of the Ohio Valley and the National Assn. for Business Economics.

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