Economics of Disasters

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Economics of Disasters
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Are Disasters Good for the Economy?

• Directions
• Distribute the clues so that each person is
  holding at least one clue.
• Clues 1-4 Black Death, 5-8 Spanish Flu,
  9-10 Hurricane
  Katrina
• Share the clues in a round-robin fashion, putting
  each clue into one of the following piles
• Relevant to solving the problem
• Not helpful in solving the problem
• Not sure
• Answer the question ARE disasters good for the
  economy?
• Determine the least of clues necessary to
  answer the question.
• Be prepared to defend your answer clue
  selection.

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Are Disasters Good for the Economy?
NO !

labor-intensive products
labor-intensive products
labor-intensive products



NO! NO! NO! NO! NO! NO! NO!
4
Scarcity IS

• Resources are limited
• Resources are necessary for production
• (output ƒ resources)
• Disasters increase resource scarcity
• (disasters destroy land, labor /or capital)
• Output must be lower than it would have been had
  the disaster not occurred

GDP
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Activity Clue 9 J.P. Morgan senior economist
Anthony Chan "Preliminary estimates indicate
60 percent damage to downtown New Orleans. Plenty
of cleanup work and rebuilding will follow in all
the areas. That means over the next 12 months,
there will be lots of job creation, which is good
for the economy."
HUH?
6

• Terminology Measurement
• What do we mean by the economy? 2 options
• output real GDP
• well-being or standard of living real
  GDP/capita
• or
• economic growth
• increase in real GDP /or real GDP/capita
• ???? Confusion ???? Did he mean level or
  rate?

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Level vs. Rate
Real GDP/capital
Real GDP/capital
time
time
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Economic Growth pre post DisasterRate?Level?
trend
QD
Output

D
B
Time
bottom
disaster
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Economic GrowthRate?Level?
trend
QD
Output

D R
Time
disaster recovery
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Economic GrowthRate?Level?When ?
trend
Output

Q
Time
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Economic GrowthRate?Level?When ?
trend
Q
Output

Time
12
Economic Growth StimulusNO Evidence for this
Scenario
new trend
old trend
Output

Q
Time
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Activity Clue 9 J.P. Morgan senior economist
Anthony Chan "Preliminary estimates indicate
60 percent damage to downtown New Orleans. Plenty
of cleanup work and rebuilding will follow in all
the areas. That means over the next 12 months,
there will be lots of job creation, which is good
for the economy."
How do we get here ?
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Models Tools of Economic Reasoning

• Production Possibilities Frontier (PPF)

x

• Assumptions of the Model
• All resources are used to produce the 2
  categories of products on the X and Y axes
• At all points on the curve, all resources are
  fully employed, given the available technology.
  
• (we choose from the possibilities)

services
goods
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Models Tools of Economic Reasoning

• Production Possibilities Frontier (PPF)

• Assumptions of the Model
• Technological improvements or the discovery of
  new resources makes more production possible.
  The curve moves out, to the right.
• Destruction of resources or technology makes less
  production possible the curve moves in and
  down, to the left.

services
goods
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Productivity output per unit of input
ƒ human capital, physical capital

• skills talents
• education
• training

• buildings
• machines tools
• technology

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Labor Productivity output per person-hour
ƒ availability of capital
pop. growth
pandemic
Effect of population change in economy with
little capital
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Capital to Labor Ratio
ratio falls
ratio rises
capital-intensive products
capital-intensive products
labor-intensive products
labor-intensive products
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ratio falls
ratio rises
capital-intensive products
capital-intensive products
labor-intensive products
labor-intensive products
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ratio falls
ratio rises
capital-intensive products
capital-intensive products
labor-intensive products
labor-intensive products
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ratio falls
ratio rises
capital-intensive products
capital-intensive products
labor-intensive products
labor-intensive products
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ratio falls
ratio rises
capital-intensive products
capital-intensive products
labor-intensive products
labor-intensive products
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ratio falls
ratio rises
capital-intensive products
capital-intensive products
labor-intensive products
labor-intensive products
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ratio falls
ratio rises
capital-intensive products
capital-intensive products
labor-intensive products
labor-intensive products
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Are Disasters Good for the Economy?

• NO! NO! NO! NO! NO!
• Resources are destroyed
• Total output ( real GDP) falls

The PPF always shrinks



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Why Might Disasters SEEM To BeGood for the
Economy?
economic well-being - standard of living
(real GDP/capita)



When capital to labor ratios rise, real
GDP/capita may rise even as total real GDP falls
capital-intensive products



labor-intensive products
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• Activity Clue 9
• J.P. Morgan senior economist Anthony Chan
  "Preliminary estimates indicate 60 percent damage
  to downtown New Orleans. Plenty of cleanup work
  and rebuilding will follow in all the areas. That
  means over the next 12 months, there will be lots
  of job creation, which is good for the economy."
• Questions to Ask
• Is this a credible source?
• If so, are the standards for comparison
  specified?
• (What are you measuring?)

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Frédéric Bastiat
There is only one difference between a bad
economist and a good one the bad economist
confines himself to the visible effect the good
economist takes into account both the effect that
can be seen and those effects that must be
foreseen.
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What Is Seen and What Is Not SeenEconomic
Sophisms, 1845
The Broken Window Fallacy
Suppose James Goodfellows son breaks a window?
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The Broken Window Fallacy
"It's an ill wind that blows nobody some good.
Such accidents keep industry going. Everybody has
to make a living. What would become of the
glaziers if no one ever broke a window?"
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. . . Suppose that it will cost six francs to
repair the damage. . . . The glazier will come,
do his job, receive six francs, congratulate
himself, and bless in his heart the careless
child. That is what is seen. 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.
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It is not seen that if he had not had a
windowpane to replace, he would have replaced,
for example, his worn-out shoes or added another
book to his library. Let us next consider
industry in general. The window having been
broken, the glass industry gets six francs' worth
of encouragement that is what is seen. If the
window had not been broken, the shoe industry (or
some other) would have received six francs' worth
of encouragement that is what is not seen.
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Frédéric Bastiat
. . . Destruction is not profitable.
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He Should Know Better
"Ghastly as it may seem to say this, the terror
attack . . . could do some economic good." . .
. destruction will stimulate the economy through
business investment in rebuilding .
Paul Krugman, Princeton University
New York Times, Sept.
14, 2001
Bastiat Hasnt Been Forgotten
We know this has to be fishy just by asking
Would there have been even greater "economic
good" had the terrorists succeeded in destroying
buildings in Los Angeles, San Francisco, Chicago,
Philadelphia, Boston and all other major cities?
Of course, you and I know that is utter nonsense.
Property destruction always lowers the wealth of
a nation. I hope one of Krugman's students asks
him, "If property destruction is good for the
economy, why aren't Beirut and Belfast boom
towns? Walter Williams, George Mason
University http//www.jewishwo
rldreview.com/cols/williams100401.asp
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"If property destruction is good for the economy,
why aren't Beirut and Belfast boom towns?
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Are Disasters Good for the Economy?
1. How do we measure non-tangible human loss?




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Are Disasters Good for the Economy?
2. How do we measure what might-have-been?
Disaster casualties immediate AND future losses




Unrealized potential
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Over ???? population
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Julian Simon
Paul Ehrlich
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The Ultimate Resource Is Human Intelligence in
a Free Society
Julian Simon
The . . . more people there are, the more
minds that are working to discover new sources
and increase productivity. . . .
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Knowledge Productivity

• The source of . . . improvements in productivity
  is the human mind, and a human mind is seldom
  found apart from a human body. And because
  improvements their invention and their adoption
  come from people, the amount of improvement
  plainly depends on the number of people available
  to use their minds.
• (Simon, The Ultimate Resource 2, 372)

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Productivity Population

• The data show clearly that the bigger the
  population of a country, the greater the number
  of scientists and the larger the amount of
  scientific knowledge produced more specifically
  . . . scientific output is proportional to
  population size, in countries at the same level
  of income.
• (Simon, The Ultimate Resource 2, 380, 385)

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Not Just Rocket Science . . .
. . . The main contribution that additional
persons make to society is the new knowledge of
all kinds scientific, organizational, and
everyday knowledge . . . that they create and
leave behind them. And to repeat an earlier
statement, these gains are the result not only of
geniuses but of a real number of work-a-day
ingenious people. (Simon, Ultimate Resource 2,
380 385)
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Not Everyone Is Hurt By Disasters
Fallacy of Composition To erroneously assume
that what is true of the whole is true of an
individual
Economic change creates winners and losers.

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And the Winners Are . . .