Can a destructive storm increase measured gdp?

by on October 25, 2006 at 6:00 am in Economics | Permalink

Say Katrina comes along and knocks down some hotels, which are then rebuilt.

We all know the "broken window fallacy" — this sequence of events is not good for the economy.  But under what conditions will it increase measured gdp?

Under one view, the money spent rebuilding the hotels would otherwise have been spent buying shoes or something else.  Measured gdp should not go up.  See Alex’s comments below for more along these lines.  (But note that Alex’s fifth paragraph makes a mistake.  I am not just "buying a new CD," but rather a new CD is being produced, generating income, in the analogous example he sets out, just as a new hotel is being produced to replace the old one destroyed by the storm.  He doesn’t come squarely to terms with how new output ever increases measured gdp.  A second factual but not theoretical point is that most Katrina refugees are now earning more elsewhere.)

An alternative approach invokes the assumption of "gross substitutability," or more prosaically that new production attracts a greater expenditure than the relevant alternative.  (Addendum: We also can speak of the velocity of money rising.)  New production in general raises measured gdp.  If a new hotel is built, why should the "gdp consequences" of that production depend on whether the lot had always been vacant, or a previous hotel on that lot was destroyed by a storm?

A further complication is that the hurricane destroys wealth.  The loss of hotels induces negative income effects, which probably will lower measured gdp in other sectors of the economy.  Natural disasters are not a good way to build up gdp in the longer run.

Many factors are at play.  Will we consider Keynesian effects through a possible employment increase for rebuilding, or intertemporal substitution effects through a temporary boost in labor supply in repair industries?  If the repairs dig into future productive capacities, short-run gdp is more likely to rise than long-run gdp.

Will natural disasters increase measured gdp in the short run, once we consider expenditure switching effects?

Your thoughts?

theCoach October 25, 2006 at 8:13 am

My working assumptions is that GDP is a very gross measure, and that, yes, because it is a crude measure only of a substiture for what we are really interested in, that measured GDP will go up in the short term after natural disasters. With that said, I know very little about the actual details of the metric. Related, how do we discount things like prison construction or divorce lawyers in calculating this. I, for one, would be interested in knowing more about the areas where the measure falls apart.

Thijs October 25, 2006 at 8:40 am

I would say there are two main effects of the storm: (1) productivity of NOLA residents drops = bad for GDP (2) increased demand for construction drives up prices in that sector (and possibly elicits extra supply) => increases measured (nominal) GDP. Net effect is probably negative.

John D. October 25, 2006 at 9:06 am

What if a natural disaster destroys infrastructure in disrepair, forcing the government to rebuild it new? Because the gains of the road/port are not realized by the government (who is responsible for building it), they will underinvest until the condition of the road is REALLY bad.

Paul McMahon October 25, 2006 at 9:24 am

1) Assets most likely to be damaged are those that have already been depreciated to some significant degree (assuming that more recent construction meets stronger building codes, and therefore were less likely to be severely damaged). Hence, these assets that are being replaced were, in some sense, less valuable. The new construction/equipment, then will appear as a boost to the GDP, if I understand the National Accounts right (and I’m not sure that I do).

2) In a like vein, consider the Y2K replacement of personal computers and major accounting programs. True, most of these systems already had fixes in place for the year becoming 2000, but the restructuring also had other significant benefits.

Ironman October 25, 2006 at 9:42 am

There’s also the aspect of managing risk to take into account. Could people and businesses shift their activities specifically to avoid increased risks of additional damage following a major natural disaster?

In the case of hurricanes, which have a regular, predictable season, we would see economic activity shift outside of the period of greatest risk. We would see the lowest periods of GDP coinciding with the highest disaster risk period, and the highest outside the period.

Post-disaster, you would see GDP levels oscillating much like a dampened spring – prompted by an initial dip for the disaster itself, boosted by the immediate recovery effort and insurance payouts, then with the gradually weakening oscillations as people transist from the specific risk avoidance strategy described above to more generalized risk avoidance (more “normal”) strategy as time passes and the fear of a one-two punch is less a concern.

Tyler Cowen October 25, 2006 at 10:00 am

It need not be assumed that savings are otherwise idle. The need for repair work causes the velocity of money to increase. Imagine that I woke up one morning to find that my car’s gas tank was virtually drained. I would fill up with gas that morning instead of driving directly to work. Measured gdp would rise in the short run. Both my funds and my time are allocated more heavily toward the present. Of course this need not augur well for future measured gdp. But that is a simple proof of the proposition that a loss can cause measured gdp to rise in the short run.

Will Wilkinson October 25, 2006 at 10:52 am

I think Tyler’s right, in principle. But the short run for one is always also the long run for another. If Tyler dips into his savings in one period to fill up his car to replace the disastrously disappeared gas, that’s also a period in which somebody else tightens his belt because of savings spent in an earlier period managing the aftermath of an earlier “disaster” of a size equivalent to Tyler’s. If there was a disaster of uniform size every month somewhere within the national borders, no disaster would register. I imagine this is the way it is with car crashes or house fires. Of course, that’s not how it is with big natural disasters like hurricanes, so Tyler’s probably still right that you could get a short-run uptick. But that doesn’t effect Bastiat/Alex’s general point in any interesting way.

spencer October 25, 2006 at 11:17 am

I think Tyler’s gasoline example is making a common mistake
of confusing consumption with production.

GDP does not directly measure production. Rather it measures
consumption and adjust that for trade and inventories to
indirectly measure production.

The gasoline that Tyler purchases now has already been
produced and the fact that Tyler shifted it from a tank
in the ground at the gas station to a tank in his car
has no impact on gdp. He is not changing the ammount
of gasoline he is consuming. If because his gas tank was
low he had elected to walk to work — a nonmarket event
that is not included in gdp — his gasoline consumption
would have fallen and with a lag gasoline production and gdp would also be lower.

Scott Wood October 25, 2006 at 12:54 pm

What is “the economy” here? While I am perfectly happy using an externality adjusted measure of GDP, or something like that, I get the impression that most people are really just interested in unemployment. Couldn’t we imagine a not terribly unreasonable definition of “the economy” in which “the economy” is better off but the value of the capital stock is lower?

Zoran Lazarevic October 25, 2006 at 3:13 pm
james October 25, 2006 at 3:37 pm

Perhaps its best to teach undergraduates that this is a good reason that glancing over at net gdp can be useful, if available. the net calculation should take into account the abnormally high level of depreciation caused by the natural disaster and give a better account of the effect of the disaster on income.

Nick October 25, 2006 at 4:05 pm

I feel that a big storm can help the economy because it will produce jobs. There are always people that need work and when something bad happens it can pull the people together and make the economy boom. Like with the CD example, when things are destroyed then there has to be more produced with means income for the poeple in that area. So in my opinion I think that a big storm would help the GDP.

Chris R October 25, 2006 at 4:29 pm

OK, time to put on my neoclassical macro hat. What we have here is a sudden decrease in the capital stock. The return to the existing capital rises, which causes an investment boom. Think of people putting in long hours rebuilding their homes and businesses and cleaning out huge amounts of muck from everywhere but the statehouse and city hall.

So we have two things at work. A decrease in productivity (Spencer’s point) because of the fall in capital will cause GDP to fall. It’s just harder to get stuff done when roads and buildings and communications cease to exist. But, the demand to replace these things and the resulting investment boom, and the longer hours that go with it, will cause GDP to rise. Theoretically, it’s ambiguous–something of this magnitude all depends on how willing people are to put in extra hours (a “labor supply elasticity” for you econ geeks).

This is one case where GDP is a poor measure of income–this kind of touches on Jim Outen’s point from a half hour ago. Literally, it is just a measure of value added in the economy due to economic activity in a given period. Net domestic product (a somewhat better measure of income) is GDP minus the fall in the capital stock from wear, tear, depreciation, and disasters. Under normal circumstances, these things track each other pretty well. But, NDP almost certainly falls as a result of Katrina, unless things are even more out of whack than they normally are in NOLA.

Matt L October 25, 2006 at 7:11 pm

I’m not an economist, just an engineer, but reading these post I’m wondering if the effects of time and space are properly being accounted for. I’m sure there were positive economic effects post-Katrina in NOLA but I would suggest that there were negative effects in the rest of the country. In the rush to rebuild the demand for construction products went up in a very short time period. This certainly had an effect on construction projects in the rest of the US (and possibly elsewhere). There were certainly construction projects that did not proceed because of the increased costs. Whatever the benefits of rebuilding NOLA it’s unlikely that they would have occurred in such a short time period without Katrina. If perhaps NOLA was rebuilt over a longer time period, with or without Katrina, the increase in costs of construction products would be spread out and may not have influenced construction projects elsewhere.

dWj October 25, 2006 at 11:12 pm

Not everything that is destroyed needs to be rebuilt; if reconstruction is concentrated on higher-value stuff — stuff that is higher-value than what construction opportunities existed otherwise — then resources are directed toward higher-productivity uses than would have existed in the absence of the destruction. I would think this would push up measured GDP.

Anonymous October 14, 2008 at 2:13 am

Comments on this entry are closed.

Previous post:

Next post: