There has been a flurry of articles discussing the economic implications of the Japan earthquake and tsunami. While many worry about the direct impact on output and wealth, and some on the implications for global bond markets, a few have stated that the disaster could result in a net benefit to the Japanese economy, or at least some form of “silver lining”. See for instance here at the Independent, and here at the Huffington Post.
As I wrote in the comments to the Independent article, I appreciate that reconstruction could act as a short-term stimulus to economic activity and mean that people start spending a portion of their (relatively high levels of) savings. However, forcing people to spend their savings is not a measure of success on its own. Putting aside Sean O’Grady’s claim in the Independent that such savings represent “a classic case of deflationary psychology” (perhaps, under the circumstances, excess savings could now be seen as incredibly rational??), it matters how they spend that money. Struggling to replace basic amenities and productive assets destroyed in a disaster would only increase future growth if the resulting assets were more productive than previous versions, and meanwhile the value of the stored wealth is lost to replacement costs rather than being available for investment via the banking system or spending on other goods.
Perhaps part of the confusion is that people are not distinguishing between stocks and flows – the flow of output will rise, yes, but only because the stock of wealth has been significantly reduced. People who see disasters as producing some net benefit must either a) be ignoring the stocks altogether and only focusing on GDP flow as a measure of wealth, therefore being blind to the value of the installed capital that was destroyed (and argue that although GDP growth might take a hit from productive capacity taken off-line, the reconstructive efforts will more than compensate for this), or b) claim that the additional flow of economic activity spurred by the crisis will, in time, result in economic gains that will exceed the lost stock of value destroyed and take the economy to a higher level than was evident pre-crisis.
The first approach seems very short-sighted, while for the second to be true you need two things:
First, to assume a very heartless position in defining value: the GDP value of new flows of reconstructive activity will be qualitatively very different from the human, social and cultural stock of value lost. In accounting terms you may see a “gruesome calculus” that results in a net benefit – but I doubt that that represents any true improvement in the quality of life of the Japanese people.
Second, you need to assume a counterfactual where growth without the disaster is significantly less than growth with the disaster for a meaningful period of time. While Japanese growth has been trending down, continued flat or negative growth was not the only “non-disaster” scenario.
I like Jarrett Skorup’s analysis of this at the Mackinac Center:
The answer is found from French economist Frederic Bastiat in his 1850 essay, “What Is Seen and What Is Not Seen.” “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.”
In other words, what one sees are the workers paid to rebuild these destroyed cities; but what is not seen is where that money would have been spent if not for the disaster. Instead of being used to construct buildings, it would buy food, shelter, clothing and other goods. With the disaster, society has a new building, but without it they have a building and food, shelter, clothing or whatever else this money could be spent on. A country is much richer without the disaster.
Such theory-wrangling aside, economists have actually looked at this problem empirically, as was reported in the Economist yesterday. So you need not get too involved in the “scarcity v abundance” debate as described at Cafe Hayek , and instead can simply quote from the 2010 paper Catastrophic Natural Disasters and Economic Growth” by Eduardo Cavallo, Ilan Noy, Sebastian Galiani, and Juan Pantano:
“Even very large natural disasters, when not followed by disruptive political reforms that alter the economic system, including the system or property rights, do not display significant effects on economic growth. …
Thus, we conclude that unless a natural disaster triggers a radical political revolution; it is unlikely to affect economic growth. Of course, this conclusion does not neglect the direct cost of natural disasters such as the lives lost and the costs of reconstruction that often are quite large.“ (Emphasis added by W.W. at the Economist, original page numbers for the quotes are p27 and p28)
So, in my mind at least, to suggest that temporary increases in GDP flows or the ability to manage better the public budget compensates in some way for the costs of the disaster is both a failure of imagination in terms of the alternative scenarios for non-disaster economic growth, and worse than gruesome when you consider the losses that can’t be measured in accounting terms. Particularly when out best current evidence fails to show any long-lasting economic impact either way.