Disasters and Disastrous Economics

Jon Sanders

3/16/2011 12:01:00 AM - Jon Sanders

Are widespread death and capital destruction good for an economy? Absolutely not. That's apparently news to one of Pres. Obama's top stimulus salesmen. Which makes sense because the stimulus was built on essentially the same fallacy.

Larry Summers, former director of the White House National Economic Council, saw some short-term economic good for Japan after the earthquake and tsunami:

Friday's massive earthquake is yet another challenge to Japan's recovery but it may provide a jolt to the economy over the short term, Lawrence Summers, president emeritus of Harvard University and former director of the White House National Economic Council, told CNBC. ...

"If you look, this is clearly going to add complexity to Japan's challenge of economic recovery," Summers said. "It may lead to some temporary increments, ironically, to GDP, as a process of rebuilding takes place."

Even as Japan begins to rebuild, this devastation cannot be said to be good for their economy. Electrical, water, and transportation infrastructure has been destroyed. Businesses have been wiped out. Cars and homes have washed away. Fields have been covered in sea mud. The capital destruction is harrowing.

Most horrific of all, untold tens of thousands of people have been killed. No tongue could tell -- no ear could bear to hear -- of the great, searing heartache felt by millions of friends, family, and loved ones. On the lower plane, in the economic context, people are the ultimate resource, as economic optimist Julian Simon explained. So even in mundane economic terms, their loss is staggering.

No, the earthquake and tsunami were not good for the Japanese economy, short term or long. How could someone get something so basic so wrong?

It starts by confusing good for GDP with good for the economy, but GDP doesn't take into account capital destruction. It does favor spending, however, including spending by government. Digging out from under a disaster requires a great deal of spending, and on that basis it's easy to see good for the economy.

After any natural disaster well-meaning people will inevitably state that the rebuilding process will be good for the economy. It is, after all, a very visible process, and that is one of the reasons for the persistence of the fallacy.

But economics is not only about what is seen. It also includes what is unseen. And this particular fallacy is debunked in Frédéric Bastiat's parable of the broken window, which comes in an 1850 essay of his titled "What Is Seen and What Is Not Seen."

What the soothsayers miss are all the unseen alternative uses of all that money and capital being used in rebuilding -- that is, what that money and capital would be building had disaster not forced rebuilding to replace societal wealth, rather than add to it. In economic terms it is opportunity cost at its starkest.

Seen vs. unseen (the dictated spending vs. the opportunity cost of the unseen alternatives) plagues the stimulus as well, but it's the seen that politicians especially favor. They like ribbon-cutting ceremonies and press releases where they can pretend they're the real job creators. When Summers helped sell the Obama stimulus plan at a Democratic retreat, Sen. Max Baucus, chairman of the Finance Committee, was moved to say "This is all reassuring." No doubt the thought that the economy can grow at the direction of central planners in the White House and Congress was reassuring. They thought they could "spend our way out" of the recession. By now they should have no assurance left.

Summers' concern above dealt with the short term, bearing in mind Keynes' famous retort, "In the long run we're all dead." Nevertheless, we have reached the long run with the stimulus; we have spent ourselves into far worse unemployment than the White House's worst-case-scenario-without-a-stimulus prediction, and now we are flat broke.

Case in point: the deficit for February 2011 was $223 Billion, higher than all of fiscal year 2007, back when Democrats' political messaging included decrying the Bush deficits. Change indeed.

The Democrats' response to this reality is not to rethink their assumptions but to double down on the fallacy. They are operating a fractured-English web site called whenarethejobs.com to track job-creation legislation in the GOP-controlled U.S. House. The bills create the jobs? They have apparently no concept that reducing federal spending, taxes, and regulations are job-creation bills in the sense that interstates are car-creation plans. Interstates don't make the cars, of course, and politicians don't create the jobs -- but what they can do is make the environment more suitable for them.

Republicans will need to stand resolute to ending the spending binge, in spite of a unified front from the president, congressional Democrats, and their media allies. The disasters that struck Japan came without warning. The disaster facing the United States can still be averted.