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Thursday, September 1, 2011

Natural Disasters and Disastrous Economics

The first need not produce the second.

With both an earthquake and a hurricane in the same week, it’s not just natural disaster season, it’s also economics disaster season. Both natural disasters have led to an awful lot of bad economics from various media commentators and even some supposed economic experts. The most common bit of bad economics is some version of Bastiat’s “broken window fallacy.”

In Bastiat’s story a young boy throws a brick through a store owner’s window. A crowd gathers, lamenting the damage. Eventually someone points out that this might be good for the economy because now the store owner will have to pay the glazier to replace the window. That increase in business will mean the glazier has money to spend on, say, a new coat, which means more business for the clothier and so forth. After a while, the townspeople persuade themselves that the broken window is actually a good thing.

Of course the fallacy here is that this argument neglects the “unseen.” The $100 the store owner spends replacing the window would have been spent elsewhere if not for the young hoodlum, perhaps on new shoes. In that case, the store owner would have both a window and a new pair of shoes. As it stands he only has the window, therefore the boy’s action has not only not created wealth, it has also destroyed it.

Stock of Goods

Implicit in Bastiat’s story is a notion of wealth as a stock of goods (and services). What counts as wealth are the things that we perceive to be valuable, such as a window and a pair of shoes. When we focus on wealth as a stock, it’s clear that breaking the window does not increase wealth but decreases it. Every dollar spent to repair or replace hurricane-damaged property in Vermont, New Jersey, and elsewhere is a dollar that would have been spent on other things. Natural disasters destroy wealth.

Then why do so many people argue that such disasters are good for the economy. The answer, I think, is that they look at the matter in terms of something like Gross Domestic Product (GDP), which is a “flow” not a stock. GDP measures the amount of “economic activity” that takes place in a particular period, such as a year or a quarter. If we imagine a series of pipes that carry water to a large bucket, GDP measures how fast the water is moving through the pipes, while wealth is how much water has accumulated in the bucket at the end. Those arguing that disasters will boost the economy are arguing that the need for repairs and replacement will lead to more spending and thus a higher flow of economic activity.

However, here too the unseen is overlooked. After all, even if we think in terms of a flow, the dollars spent on repair and replacement are simply diverted from the alternative uses to which they would have been put in the absence of the hurricane. So is there any way we can explain why we continue to see these claims?

Narrow Focus

I think there is. The explanation lies in the focus on specific localities. Natural disasters may well lead to higher increased activity in the affected areas, but only because resources are drawn from other parts of the country or from abroad, reducing activity there.

In other words, we can always increase the pressure in one pipe by diverting water from other pipes. Natural disasters can appear to be good for the economy if we  focus only on that one “pipe” and ignore the others.

The more sophisticated critic might argue that if resources were idle, a natural disaster can bring them out of idleness and thus create wealth.  As the great liberal economist W. H. Hutt argued in 1939, being “idle” does not mean that a resource is “unproductive.” Cash in a drawer is performing the service of being available to its owner, which is how the owner prefers it over having to spend it repairing a window.  Idled workers might prefer their current use of their time to the wage that the market is offering.  Even if idled labor is brought into employment, we have no grounds for automatically claiming that its gain is greater than the disaster victims’ losses.

Booming Malinvestment

In our own economy many resources are idle not because markets failed, requiring an external stimulus to activate them, but because of malinvestment during the previous artificial boom. This is true of both capital and labor. They remain idle because bad policies, such as prior fiscal stimulus programs, and uncertainty about the future created by government prevent them from finding genuinely sustainable and productive employment. Disasters can’t fix these problems; only time and freedom can.

The inability to imagine the unseen is the source of a great deal of bad economics. For example, many observers claim the hurricane will create jobs, and they are right. However, creating jobs is not the same as creating wealth if those jobs are just cleaning up the mess from a disaster. And the same goes for creating jobs through government stimulus programs and the like: The path to prosperity comes from reducing the amount of labor needed for what we currently produce so we can free it to produce other goods we’d like to have but can’t yet efficiently produce. This is just another way of seeing why having to devote labor to cleaning up a mess is a loss in wealth, not a gain.

We’ll never put a stop to natural disasters, but if people can start to imagine the unseen, we can maybe put a stop to disastrous economics.

  • Steven Horwitz was the Distinguished Professor of Free Enterprise in the Department of Economics at Ball State University, where he was also Director of the Institute for the Study of Political Economy. He is the author of Austrian Economics: An Introduction.