How might coronavirus impact Minnesota’s economy?

Coronavirus has knocked almost everything else off the nightly news and front pages. It is a big public health issue which could become a very big public health issue. To find out about these public health aspects – particularly what you can do to help stop or slow the spread of the disease – get off social media and look at the website of the Centers for Disease Control and Prevention.

What might its economic impacts be?

Short term boost from spending, but medium term decline

I was in Target last weekend and toilet paper, hand towels, soap and hand sanitizer, cough medicines were all sold out. People are rushing to buy to stock up. In terms of consumer spending and its impact on GDP figures, this will have a similar impact to Christmas, though perhaps not in scale, which also boosts retail sales.

Against that is reduced spending elsewhere. Restaurants, cinemas, sporting events and the like will all, more than likely, see a fall in demand. Indeed, the NBA has cut off supply by suspending its season.

Which of these effects will dominate? In the short term they might cancel each other out. But the point about stockpiling is that once you’ve done it you’ve done it. You don’t do it week after week. The decline in spending, however, can be an ongoing thing, particularly if this drags on. While these effects could balance each other out in the short term, in the not-much-longer term the drag from lower spending will come to dominate. And, the longer this drags on, the more dominant this effect will be.

Positive income effects, negative wealth effects

One of the effects of the coronavirus – in part – has been a fall of crude oil prices which has fed through to the gas station. A month ago the average price per gallon in the Twin Cities was $2.31. It is now around $1.90 or even $1.80. This will have two positive effects.

First, by reducing the cost of a major input, it will help producers. Second, by reducing the cost of a major item of spending, it will benefit consumers. It will be a positive real income shock, like the oil shocks of the 1970s in reverse.

It will have a negative impact on the oil industry in the United States. One major difference with the 1970s is that the US is now a net oil exporter, not an importer. As a result, there is now a sizable US oil sector which will be hit by this. Overall, though, the benefits to the economy generally of lower oil prices should help.

Against this overall positive income effect of lower gas prices is the negative wealth effect of a tumbling stock market. For many, their portfolios of stocks are a good chunk of their overall wealth. As the prices of these stocks fall so they become less wealthy. This is very likely to cause them to spend less, as happened when house prices fell during the sub-prime bust.

Minnesota’s economy

If you had polled economists a few months ago about what the major downside risks were to the economy, I doubt that many would have said ‘Pandemic’. This event is, in many ways, the classic ‘Black Swan‘ – an event with a low probability but high (or incalculable) impact.

This turmoil highlights the importance of a strong economy. That provides us with the resources to tackle threats like this and provides a cushion to our well-being so that we do not feel the economic impacts too severely.

In one respect, Minnesota’s economy is well placed to handle this. We have a very diverse economy, with our sectoral profile matching that of the US generally very closely for a relatively small state. As with a diversified portfolio, this should help us in the face of economic turmoil.

That said, there will be sectors affected. The Chinese economy has taken a big hit and companies which do business with China will find this far more difficult. Also, sectors such as aviation will feel a pinch as the numbers of travelers falls.

And there are deeper seated problems, as we explain in our new report The State of Minnesota’s Economy: 2019. Owing to excessive taxes, our state lags national averages on labor productivity, capital investment, venture capital, entrepreneurship, and research and development. Because of this, our economic growth lags the national rate. If Minnesota’s economic growth rate had matched that of the US generally since 2000, GDP per capita in our state would have been nearly $12,000 – or 18% – higher in 2018 than it actually was.

Coronavirus is a human tragedy. It illustrates, once again, the need for a strong economy to provide the resources to cope.

John Phelan is an economist at the Center of the American Experiment.