Disasters and Prosperity

Some bad ideas never die. Such is the case with the recent “bright side” arguments coming from pundits on hurricanes and earthquakes. The idea is that Irene and the recent Eastern Seaboard earthquake are positives, at least in the sense that cleaning up the mess and rebuilding damaged stuff will create jobs.

It is true that on the surface, many people will benefit. Carpenters, electricians, engineers, and many other kinds of workers will have more to do. But does that mean the economy grows as a whole?

*The answer is no, and the reason is as simple as a brick. First, let’s take an example of a private business. The money that would have been used to hire a new employee will now have to be used to rebuild the store. Yes, the contractor who rebuilds benefits. Him/her we can see. What we don’t see are the potential uses of that money elsewhere that have to be foregone.

What if the business is covered by insurance? Same thing. That insurance money could have been used for other things. Given enough of a disaster-related layout, the insurance company may also have to raise its rates.

What if government chips in to help? Same thing again. Tax money has to be shifted from other uses or taxes have to be raised.

In other words, disasters do not lead to prosperity, a point that I am embarrassed to explain. My readers already know this, as does the least sophisticated non-economist in America. Policymakers, however, do not seem to get it. Let’s see if we can uncover their reasoning.

The idea is that resources are underutilized in our economy currently. In other words, there is unemployment not because businesses do not have the resources, but because they are not spending money that they do have–a liquidity trap. Disasters (when an alien invasion is not forthcoming) give businesses a reason to spend. The contractor buys more tools and drywall from the hardware store owner, who has to hire more employees, who then spend more, and so on.

If we were to accept this reasoning, it would imply some strange things. First, it would suggest that we can get something for nothing. Destroy a store, grow an economy. If this does not sound right to you, pat yourself on the back and write Paul Krugman a nasty note. It would take all those expenditures just to get things back to where things were before the disaster unless somehow, magically, the net effect were positive. If that were the case, all we would need to do to cure unemployment is destroy some stores ourselves.**

Second, it implies that increasing demand starts a virtuous cycle of prosperity, even if the demand is created artificially. Let’s see, can we think of an entity that can do that? Hmmmmm…that’d be government, wouldn’t it. More on that another time…

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*Based largely on Bastiat’s Broken Window Fallacy.

**To be completely fair, even Keynesians admit that this only works if there is less than full utilization of resources. At full employment, this does not work. At less than full employment, their argument assumes that the disaster spurs businesses to do more than replace the broken stores. That is, they go on to invest in projects that do more than replace what has been destroyed. I, for one, am not convinced.

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About Terry Noel

I am an Associate Professor of Management and Quantitative Methods at Illinois State University. My specialty is entrepreneurship.
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