Do Natural Disasters Stimulate the Economy?

Commentators and analysts have made the argument in recent days that the destruction caused by Hurricane Irene will boost the economy as people are put to work repairing the damage. However, some economists point out that destroying things of value does not usually create wealth.

“Hurricane Irene might have provided some short-term economic stimulus as billions of dollars will likely be spent to repair the damage to the East Coast over the weekend,” Josh Boak wrote for Politico Sunday.

Imagine, for instance, that a business lost the roof to its factory in the hurricane. The loss of the roof, under Boak's reasoning, actually helps the economy because roof repairers would get extra business.

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This argument is not uncommon among reporters during and after natural disasters. Some economists, such as Princeton's Paul Krugman, who also holds a Nobel Prize in economics and is a columnist for The New York Times, made the argument that spending money, no matter what it is for, will help boost the economy during a recession.

After the 9/11 attacks, for instance, Krugman argued that the attacks would benefit the economy.

“The driving force behind the economic slowdown has been a plunge in business investment. Now, all of a sudden, we need some new office buildings. As I've already indicated, the destruction isn't big compared with the economy, but rebuilding will generate at least some increase in business spending,” Krugman wrote on Sept. 14, 2001.

Earlier this month, in another example, Krugman argued on CNN's “Fareed Zakaria GPS” that an alien invasion would help boost the economy because of all the additional spending that would go into countering the invasion.

The logic behind Krugman's argument can be attributed to the writings of John Maynard Keynes, or “Keynesian economics,” which emphasizes the need for aggregate demand to maintain a strong economy. When the economy is in a recession, Keynesian economics argues that the government needs to stimulate more demand for goods and services.

One way to accomplish this is to pay people to do something, and it does not really matter what that “something” is. It could be digging a ditch and then refilling it, fighting an alien invasion (real or imagined), or rebuilding a bridge destroyed by a hurricane. As long as more people have more money in their pockets and go out and spend, the economy will improve, according to Keynesian economics.

Critics of this argument generally find themselves in another camp of economics referred to as the “Austrian School,” or “Hayekians” after Friedrick Von Hayek. They argue that when something of value is destroyed it is bad for the economy because replacing it diverts resources that can better be used elsewhere.

Using the previous example of the business that lost its roof in the hurricane, roof repairers may get more business, but the money spent to fix the roof is money that the business cannot spend to expand its business or hire new workers.

Indeed, under the Keynesian argument, the United States could boost its economy simply by bombing all of its cities and rebuilding them.

As St. Lawrence University Professor of Economics Steven Horwitz explains, however, “cleaning up after a natural disaster (or something like civil unrest) is not a benefit to an economy but a cost. All of the resources used for cleaning up to get us back to where we were before the disaster would have been used to create a level of wealth greater than the pre-disaster level if the disaster never occurred. New Orleans has had a relatively low unemployment rate since 2005, but I don't think you can convince anyone there that another Katrina is the path to prosperity.”

Economist Frédéric Bastiat first explained the “broken windows fallacy” in an 1848 article titled “What is Seen and What is not Seen.”

Bastiat tells the story of a boy who breaks a shop window. The townspeople console the shop owner, saying, “Such accidents keep industry going. Everybody has to make a living. What would become of the glaziers if no one ever broke a window?”

Bastiat responds to that argument by saying, “But if, by way of deduction, you conclude, as happens only too often, that it is good to break windows, that it helps to circulate money, that it results in encouraging industry in general, I am obliged to cry out: That will never do! Your theory stops at what is seen. It does not take account of what is not seen.”

“What is not seen,” argues Bastiat, is the value of the window that is destroyed and the loss of wealth to the shop owner who must spend money to fix it.

Bastiat concludes, therefore, that “society loses the value of objects unnecessarily destroyed,” and, “destruction is not profitable.”

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