March 15th, 2011 by
Many are extolling the unfortunate-but-welcome silver lining to the recent events in Japan–namely, that damage caused by earthquakes, tsunami’s and nuclear accidents will cause economic growth as people invest in rebuilding.
Lawrence Summers, president emeritus of Harvard University and former director of the White House National Economic Council, told CNBC that the disaster “may lead to some temporary increments, ironically, to GDP, as a process of rebuilding takes place.” And an editorial in the Huffington Post reads, “By taking Japan’s mature economy down a notch, Mother Nature has accomplished what fiscal policy and the central bank could not…. Entire cities and regions need to be reconstructed in toto, from housing and commercial buildings to roads, rail lines, information networks, the energy grid and even the tsunami warning system that must be digitally revamped…. The result of all the new wealth creation will be money in the pockets of Japanese to buy global goods and services.”
Does this make sense to you? Here’s the basic argument: over many years, a country builds up useful resources >> a disaster happens >> economic activity flourishes to fix the destruction >> people are paid for that economic activity >> we’re back to normal >> so, we’re back to normal plus all of that economic activity, hence we’re better off on net. And if you look at GDP, is does actually go up. What’s wrong with that?
This doesn’t pass the common sense test to me. Yes, GDP does go up, but does it really make sense that a country (or an individual in that country) is better off after the destruction of resources (not to mention the loss of life)? Something must be wrong here.
If we look at GDP, it’s calculated by taking the total consumption (C) for a country at a given time plus the total government spending (G) plus the net exports (X) plus the total investment (I). C+G+X+I = GDP. A building is destroyed and individuals have to pay to rebuild it–C goes up. The government expends resources on sending supplies to victims–G goes up. On net, GDP increases and that’s considered a good thing.
However, this does not take into account what those resources could have been used for. The scarce resources used to rebuild buildings and to send supplies normally would have been used for other things. Besides the obvious statement that the individuals affected would have been better off without the disaster on a human level, they would have also been better off economically–now, huge amounts of resources will have to be spent just to get back to normal.
Many others have discussed what can be summed up as the “broken-window fallacy,” including our very own Ann Zerkle. Check it out!