The BP Effect: Will Public Pessimism Harm the Economy?

Now that CEO Tony Hayward is stepping off the kitchen stove and resigning from his responsibilities for BP’s (NYSE: BP) oil spill response, it’s time to look past the grandstanding and analyze how this may affect the US economy.

What are the economic effects of an environment disaster such as the one we are seeing in the Gulf right now? Economists are scrambling to estimate the damages to BP and we can expect the actual claims to be challenged for years to come.

Some of these effects are discrete and measurable, such as lost wages, lost profits, lost jobs, lost businesses, but some are not. How do we measure the loss of wildlife, for example, or future economic effects of declining sea populations? Furthermore, what are the larger, more subtle, effects of a major crisis such as Gulf leak on economic behavior in general?

Can one event, for example, sink a recovering economy? In other words, if consumers control 70 percent of the economy, can a change in attitude to the downside, however slight, doom a recovery? For lack of a better term, let’s denote growing public pessimism following a crisis and its effects on the larger economy “the BP effect.”

Now, let’s sample and compare economic data before the BP spill, which began on April 21, to data following the disaster. (Note: Weekly data is sourced from the second week in each month.)

The chart shows weakening in June in all categories but consumer sentiment. The Phil Fed index for general business conditions shows a sharp drop in June, along with drops in retail sales. In other words, pessimism toward the overall business climate increased and consumption decreased.

Consumer sentiment is clearly headed in a different direction, perhaps reflecting cautious optimism about employment. But the overall change is to the downside in terms of economic attitudes and activity.

Many factors are at play here, not just the BP spill, and it’s impossible to isolate one event, but it is reasonable to speculate “the BP effect” may dampen economic activity, and in particular, consumer spending until the crisis is significantly improved or resolved.

In fact, watching all that oil gush out of that hole may be a bit like watching the housing value and buying power gush out of your retirement fund – an unhappy reminder of what happens when we trust public and private institutions to govern themselves.