A Natural Disaster Does Not Increased Measured GDP

by on October 25, 2006 at 5:58 am in Economics | Permalink

It’s common to be told that a problem
with the GDP statistic is that natural disasters increase measured GDP. Sadly, even some textbooks say this but as a
general matter it’s false. The broken
windows fallacy is a fallacy for measured as well as real GDP because the money
spent on new windows would have been spent on other goods and services.

Imagine that you are your friends are going to see a jazz
concert but on your way to the concert you have a little disaster, a fender
bender. Instead of seeing the show, you
and your friends have a miserable time waiting for the tow truck to come to
have your car fixed. Spending on the tow
truck and the auto repair counts as
GDP but it does not add to GDP
because it is counter-balanced by a decrease in spending on jazz, wine and cheesecake. Nothing Tyler says (see above) about
gross substitutability changes this fact.

Consider a bigger disaster, the 9/11 attack. First, the point already mentioned, the
resources used in the cleanup count as GDP but don’t add to GDP to the extent
that they would have been employed on other projects. Now it is true that some of the workers could
work overtime which they otherwise would not – this would tend to increase
measured GDP more than real GDP since leisure is not measured in the national
income and product accounts. Even this
factor, however, must be balanced against the overwhelming fact that the
destruction of the twin towers meant that tens of thousands of the most
productive people in the United States were forced into unemployment or death. Since GDP can also be measured as the sum of wages, rents, interest etc.
the immediate effect of all the unemployed and dead was to reduce GDP. Similarly, Hurricane Katrina has destroyed
more jobs in New Orleans than it
has added (and not all the added jobs represent real additions) hence the
Hurricane reduced measured and real GDP.

Also it is not true, as some sources claim, that destroyed
resources don’t count in the NIPA statistics – firms and the government count at
least some (but not all) destroyed resources as depreciated capital and thus measured Net Domestic Product automatically decreases with a disaster.  (n.b. corrected from earlier where I had said GDP instead of NDP).

Tyler asks “if a new hotel is
built, why should the gdp consequences depend on whether the lot had always
been vacant or a previous hotel on that lot was destroyed by a storm?” Answer: it doesn’t. In neither case can you assume that GDP goes
up. GDP is analogous to an individual’s
expenditures on goods and services. If Tyler buys a new CD does that raise Tyler’s
expenditures? Not if it doesn’t raise
his income. If all you did to measure
GDP was to count new hotels, new shopping malls, new spending then you would
far over-estimate GDP. GDP is a net
concept you have to count all expenditures precisely because some of the new
spending is offset by reduced spending elsewhere in the economy. It’s only after you have totaled that you can
calculate the increase in GDP.  (Note also Tyler’s error, if the new CD doesn’t represent a net increase in expenditures it can’t increase income on net either.)

If you follow through on the false logic you will
find yourself saying crazy things like crime increases GDP because of the money that people spend on locks. Of course, locks count as GDP but if people
weren’t buying locks they would be buying other goods so locks don’t add to GDP. GDP measures production it doesn’t measure
how production contributes to happiness.

There are plenty of problems with the GDP statistic and Tyler and I agree
that it’s conceivable that through a Keynesian effect or intertemporal substitutability
of labor that GDP could rise from a natural disaster but for this to work is
has to outweigh all the effects that I have listed and this is unlikely. Thus what we should teach our undergrads is
that measured and real GDP falls with a natural disaster.

bbartlog October 25, 2006 at 9:03 am

For huge disasters with large loss of life and destruction of employment infrastructure and opportunities, it does seem likely that GDP would go down. However, for small disasters like the fenderbender you described, I don’t see why the money
spent to fix the problem would be automatically balanced 100% by fewer expenditures elsewhere. Also, while business and government may well do capital depreciation when infrastructure is destroyed, I don’t think small individual losses of valuables end up being accounted for the same way.
I think you touch on the real problem when you note that leisure is not measured in the national income. If some person suffers an injury or loss such that they feel compelled to take on a second job / work overtime / leave retirement so as to have enough money to deal with the issue, GDP increases and there is no accounting for the lost enjoyment of free time. For big disasters the systemic effects seem like they will outweigh this factor. But for small things like people buying locks, I would think that the other goods they would enjoy if they did not need to buy locks would include some fraction of simple leisure, so that at least as far as we consider only the lock-purchasing part of the crime equation GDP does increase.
Personally, I’d spend a lot of time focusing on the limitations of the GDP measure if I were teaching undergrads…

Robert October 25, 2006 at 11:55 am

What if, in your example, the jazz tickets had been non-refundably purchased befre the show (drinks and cheesecake included)?

Anonymous pedant October 25, 2006 at 1:11 pm

Doesn’t gdp explicitly exclude depreciation?

vassilis October 25, 2006 at 1:30 pm

Professor, your conclusions says that GDP falls with disaster, but this wasn’t quite obvious to me from your analysis. What was clear, was that it’s not increased — that all the money spent somewhere after the disaster would have been spent elsewhere even before. But could somebody help me understand why instead it should falling? Why not remain the same?

Chairman Mao October 25, 2006 at 6:34 pm

Prof. AT,

GDP = consumption + investment + government spending + (exports − imports)

Countries increase borrowing from abroad as a result of a disaster. A lot of these funds would not be transferred (especially to states with low credit ratings) if it were not for public/international pressure to provide relief.

So if imports (of aid) increase, then is GDP lowered? Are we hurting developing countries by providing aid?

What about domestic private consumption on credit for things such as emergency car repairs. Isn’t the average person more inclined to buy on credit for unforeseen events that hamper essential needs that s/he is to use credit for a jazz concert?

I suppose credit fits into the investment element, but I’m not sure how.

James October 25, 2006 at 8:46 pm

Just to add one more comment to my last post. Alex mentions the loss of productive labor from the twin towers. One key difference here is the fact that much of the population of New Orleans was extremely unproductive before the storm. Since the storm, the population has a much higher average productivity.

Mark October 25, 2006 at 10:02 pm

The destruction of part of the capital stock cannot increase the total amount of good and services produced in the economy. It does not increase the amount of productive resources in the economy – when they are used to replace housing, they cannot be used to produce other things.

Destruction does not create demand – only productive capacity can do that.

layman October 26, 2006 at 6:52 am

you eat popcorn, and have a lot of fun with jazz,so the money is just spent. And in the near two weeks, you will not go to a jazz concert again. So End of the story.

Otherwise, you get your car updated. It will last longer, and consume more oil. So for the next week, you will try to find some kind of new fun to entertain yourself.

Not an econ expert, but it would be expected that you will spend more, and ask for more.

nononono October 26, 2006 at 7:14 am

the car broke down, which is not intense enough to be accounted for the disasterous impacts by a storm like Katrina.

The similar analogy should be upgraded to that the car crashes into some other car, and someone in it get a disasterous hurt so that the event deforms his/her body.

Then he/she will have some psychological scar to have courage, and rebuild his/her life in the near future.

This is what exactly could be called a disaster.

Robert Book October 30, 2006 at 10:18 pm

Suppose that in the post-Katrina reconstruction, construction spending replaces spending that would have gone to imports? Wouldn’t this have tended to increase measured GDP? (Even if it wasn’t enough to offset the decrease from that portion displaced population that remained unemployed, it would at least reduce the reduction, right?)

This is, of course, in addition to any effect from overtime work.

Plus, I’ve heard that wage rates for certain occupations (e.g., construction) are much higher in New Orleans post-Katrina than the rates that normally prevail elsewhere. If a worker switches from building houses at $25/hour in Cleveland to building houses at $50/hour in New Orleans, how will that affect measured GDP? (Assuming he works the same number of hours and has the same productivity in each place — and that the inconvenience of working in New Orleans, priced into the higher wage, occurs in wages not captured in measured GDP.)

aion kina March 20, 2009 at 4:27 am
muhabbet July 25, 2009 at 8:22 am
mardinkusu January 27, 2010 at 6:52 pm

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