On Sunday, the NY Times summed up the situation facing Europe (at least as far as geothermal matters are concerned) in a simple headline: “Volcanic Ash May Weigh on European Economy“.
Quite. Here’s some analyst commentary on the ash-chaos, which has disrupted air travel into and out of the region, from RBS:
Largest impact to be through dislocation of workforce (Eur1.5bn output loss).
· Sector impacts likely to wash out at the European level
· Risks relate to potential negative confidence shock should health hazards materialise
The volcanic eruption has temporarily reduced the supply capacity of many European economies, in much the same way that a strike does. Millions of people will not have turned up at work this morning as a result of the near complete shutdown of the air transport system. The enforced reduction in the size of the workforce will inevitably lead to a fall in production which can only be partially offset by selling off inventories (which have already been run down through the current crisis).
Two assumptions are critical in getting a handle on the short-run impact of the eruption: the fraction of the European workforce who have been displaced, and the amount of time it will take them to get back home and back to work.
According to the latest estimates (ACI Europe and Association of European Airlines), around 7 million people remain stranded abroad, most of whom are likely to be EU citizens. A reasonable working assumption is that 2 million of them were planning to be back at work, approximately 0.9% of the EU-25 workforce. For the UK economy, that would equate to a little under a quarter million workers missing in action. Our current estimate is that it will take around 3 days for this workforce to be back at work. This would imply a daily output loss for Europe of around half a billion euros or around Eur1.5 billion output loss over the three day period.
At the sectoral level, there are clearly winners and losers. A lot less money will be spent on air travel this month than would ordinarily be the case. The airline industry accounts for about 0.2% of value added across Europe. Assuming activity is down 70%, then the cumulative loss in output over three days amounts to $200 million.
But much of that money will be spent on alternative means of transport as people try to get home: rail, road and sea account for the large majority of passenger journeys in Europe. Not only is the air transport industry small relative to the economy but it is also small when compared to other means of transportation. Indeed, in Europe, 46% of goods are transported via roads. Sea accounts to 37% of goods transportation while rail 11%. Air transport is less than 1%. The same is true for passenger transports in Europe where road accounts by far to the largest share, with 83% of passenger transports being done on roads.
Substitution will occur, albeit at a price. And given the timing of the disruption, with many tourists forced to extend their vacation, hotels and restaurant are likely to enjoy an increase in footfall. Those countries which depend heavily on tourism and have been affected by the disruption in flights – such as Spain – might gain at the expense of those who are net exporters of tourists, but these effects are likely to be relatively small and will wash out at the European level.
A temporary volcanic eruption should have virtually no impact on activity in the long run. Once people are back to work, production can get back to normal. Any adjustment in stocks or household savings will unwind over the coming quarters. There may be some impact on agricultural production over the coming year if crops are damaged by the pollutants in the atmosphere, which could put further upward pressure on consumer prices in the coming months (over and above the short run effects on the cost of transportation). Of course, if there were serious repercussions on human health, that could lead to a fall in spending in the short run through confidence effects and permanently reduce the supply of labour and therefore output in the long run. At this stage, There is no such indication from health organisations.
Overall, we believe that the economic cost of the disruptions would amount to 0.1% of GDP maximum, should airline activity completely recover by the end of the week.
Longer term, should the volcanic eruption lasts, substitution would be the name of the game with economies likely to adjust to alternative means of transportations, assuming that airlines are grounded indefinitely. In this scenario, European potential output (not growth) would be impacted negatively via a decline in productivity incurred by freight taking longer and costing more to deliver (assuming capacity constrains in other sectors to meet new demand). The same reasoning could be applied to people who would take longer to reach business destinations. The quantitative impact on potential will be a function of the speed of capacity adjustment in other sectors but they would likely take years. These channels would likely be dwarfed by the current estimates of the impact of the financial crisis on potential growth.
Related links:
Iata warns on economic impact of travel chaos – FT
BA versus the volcano – FT Alphaville
EU Politicians to Step In as Volcanic Ash Losses Mount – WSJ