The Latest Keynesian Stimulus: Hurricane Sandy

Hey! Did you hear the good news? Hurricane Sandy will create jobs and provide economic growth that will help drag our economy out of the doldrums. According to University of Maryland economist Professor Peter Morici, there is actually a benefit to mass destruction:

However, rebuilding after Sandy, especially in an economy with high unemployment and underused resources in the construction industry, will unleash at least $15-$20 billion in new direct private spending — likely more as many folks rebuild larger than before, and the capital stock that emerges will prove more economically useful and productive.

You can read the entire news article here.

This kind of thinking blows my mind. Mass destruction apparently is the newest tool in the Keynesian bag of economic stimulus. But it is not atypical of contemporary economic thought. On its face the argument seems plausible: people will be hired to repair the damage, money is spent to rebuild, the money flows through the local economy, and it stimulates growth.

The only problem is that it isn’t true. In fact this is one of the oldest fallacies in economic, yet it gets repeated by even prominent economists every time we have a disaster. French economist Frederic Bastiat explained this in his 1850 essay “That Which is Seen and That Which is Unseen.” In his famous Parable of the Broken Window he discusses the consequences of the lad who throws a stone through a shopkeeper’s window. A crowd gathers around and people say, well, now the glazier will have work, thus it is a good thing. Not so, as Bastiat explains:

Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier’s trade—that it encourages that trade to the amount of six francs—I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.

But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, “Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen.”

It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.

Before the broken window he had a window and six francs. Afterward he had a new window and was out six francs. There is a loss, not a gain. This concept is now referred to in modern economics as “opportunity cost”. Whenever something is so destroyed, there is always a loss, not a gain. If it were good, why don’t we just start destroying older buildings for example. Think of the benefit to the economy with all the new construction. Some people have said that even war has a silver lining. Put in such a context it’s obvious that it is a really stupid idea.

But the lesson hasn’t been learned. Even today we have similar schemes that ignore the unseen costs. The most famous recent example is “Cash for Clunkers”, that inane program enacted by the Washington Wise Men in 2009. The ostensible justification was to get older gas guzzlers off the road for the benefit of civilization. The deal was that the cars traded-in had to be destroyed. What it really was, was a government stimulus program to help Detroit. The government paid out almost $3 billion. Like most such programs it was a massive failure. This from Wikipedia:

On August 26 the DoT reported that the program resulted in 690,114 dealer transactions submitted requesting a total of $2.877 billion in rebates. At the end of the program Toyota accounted for 19.4% of sales, followed by General Motors with 17.6%, Ford with 14.4%, Honda with 13.0%, and Nissan with 8.7%. It led to a gain in market share for Japanese and Korean manufacturers at the expense of American car makers, with only Ford not taking a significant hit. Meanwhile, Japan’s own program excluded U.S. cars. The Department of Transportation also reported that the average fuel efficiency of trade-ins was 15.8 mpg (miles per gallon), compared to 24.9 mpg for the new cars purchased to replace them, translating to a 58% fuel efficiency improvement.

A study published after the program by researchers at the University of Delaware concluded that for each vehicle trade, the program had a net cost of approximately $2,000, with total costs outweighing all benefits by $1.4 billion. Another study by researchers at the University of Michigan found that the program improved the average fuel economy of all vehicles purchased by 0.6 mpg in July 2009 and by 0.7 mpg in August 2009.

The result was that 690,114 older, serviceable vehicles were destroyed with no net gain, and you and I paid $2,000 for the privilege. If you track auto sales, all the program did was to pull future auto sales into the present. Sales shot up to a 14.5 million unit rate during the program and then fell off a statistical cliff. It took until this year for sales to reach the peak achieved during the program.

They didn’t see that coming. They never do.

Hurricane Sandy was a tragic, destructive event. We will have to rebuild, but think of what was lost. Tell the victims what a great opportunity they now have to better themselves.


24 comments to The Latest Keynesian Stimulus: Hurricane Sandy

  • Barry

    Probably a bit more effective than the FED handing money to eight dealers by buying $40 billion a month in agency MBS via Tradeweb.

  • Norman

    Different slant on things here. Now, doesn’t the private sector benefit from the infrastructure that the taxpayers paid for, yet the private sector doesn’t maintain said infrastructure? Consider all those heavy vehicles on the road today, (pot holes anyone), but you don’t see the private sector forking over the bucks to repair them. As I sit here and read the opposing views of economic theory, I’m compelled to say that both fail to fulfill the wants and needs of society today. Perhaps some enlightened individual[s] can come up with a different design that is more in tune with the present, the 21st Century if you may. Of course, it’s easier to point to others failures, than to engage in a better way of doing things.

    • Matt H

      Hayek was in favor of government maintaining roads.

    • 1. Government roads are built and maintained from taxes. Here in California the State takes in huge amount of revenue from gasoline sales, but that money doesn’t all get spent on roads. So we and the truckers pay.

      2. Putting the big picture in context can you suggest anything run by the government done as well as anything in the private sector? The private sector builds all the roads anyway. Where they have private toll roads, the roads are well maintained.

      • Stefan Klippenstein

        I don’t disagree that the private sector is far more sensitive to free market forces than government and therefore should have an important role in determining economic policy. My concern comes when people assume that human values such as justice, fairness, and regard for the common good are properly appraised in today’s free markets. Realistically they are not. As a result it is possible for producers and consumers to externalize many of the real costs of their activities to the detriment of third parties everywhere. The role of government is to realize these externalities in light of societal values and redistribute capital accordingly. Leaving this role to the private sector would result in an obvious conflict of interest and we all know how hopelessly irresponsible consumers are these days. I fear government is the lesser of three evils. Our task, then, is to reform it as best we can.

    • dd

      last i checked the private sector, as individuals and companies, pay taxes that pay for roads among other things. what are you talking about?

      Norman, Jeff and his contributors have worked hard to explain the better “way of doing things” as you put it, and they’ve done so for a long time now. you just choose to ignore them.

    • Mark

      Norman, where do taxpayers get the money for govt to tax and invest in infrastructure in the first place, if not from the productive enterprises created by the private sector that hired them? Even with the argument that corporations themselves cleverly deduct away their taxable income, it is mistaken to think the private sector is getting something for nothing here.

  • Sam

    Norman, normally I refrain from commenting on others comments. Your depth of ignorance is astonishing, you would willingly give up your freedom, make no mistake that is what the “private” sector is, and turn it over to some “enlightened” individuals. An entire continent did that nearly 80 years ago and over 30 million people died. The “Cultural Revolution”, 20 million people died under the guise that central planning to transform society would work because the “enlightened” elites knew better than anyone else.

  • John B.

    The way this professor Peter Morici thinks is absolutely clear. He only sees value in growth and in monetary operations. Therefore mass destruction brings more consumption, boosts GDP and is good for the economy. It is the same like in the case of the destruction of the rain forests in Brasil or Ecuador or ruthless exploitation of natural resources in many parts of the world. But let´s wait. Good for the economy? What does exactly mean? Isn´t economy supposed to be a social construct created to help the ordinary people to manage their needs?

    Author of this article obviously criticizes it. But, he by himself can not really think outside of the box. It is not a problem of money or economy we have here. It is a problem of survival. And our survival depends on our ability to produce NECESSARY products, which have life-value and not money-value.

    Natural disasters show us how weak we really are. It shows us that without a better planning is necessary. We can not depend on the premise of the free market, that order would arise from the chaos. We have to focus on projects like Fresh City Farms, which allow us to achieve ability to survive in the times of crisis. We have to focus on the survival rather than on the profit.

    • I am sorry that you are not surviving. I am and I believe most of my readers are surviving well enough. But you seem to favor having government determine what is a necessary product, not the consumer. I suggest you study the role of prices and profit in allocating resources; it is the most efficient method and is driven totally by consumers. You suggest that we consumers don’t know the difference in values, yet my guess is that you would be willing to substitute your values on others, by force appparently, which is what government does. Actually what these disasters show is how strong we are rather than how weak we are. NYC is mostly up and running a fews days post Sandy. I say we should focus on free markets and international trade to make us all wealthier and happier.

  • GaryP

    Actually, the big trucks do pay a “road use tax” that should cover the cost of the damage done to roads. Maybe the road use tax is not set at the correct amount but it does exist.
    Actually, everything the govt does is paid for by the private sector. The govt creates no wealth it simply takes wealth from someone who has it and gives it to someone else (taking a significant cut for itself, of course–someone has to pay for Obama’s essential $1million dinners, don’t they?)
    If you are the person being “given to” you like it, if you are the person being “taken from” not so much.
    As long as the govt takes only a little of your wealth you won’t fuss much. But if it takes a lot of it, you will either: 1) Leave, like the wealthy are leaving France now, 2)Hide your wealth, like the wealthy do all over the world, or 3) Quit working so hard to make wealth since you don’t get to keep it, like many of the not so wealthy are doing in the US and Europe.

  • Rob

    Clearly there will be a boost to GDP. Most people are taking their “six francs” and spending them on repairs AND on their new pair of shoes. This is because insurance comes in with the cash that would otherwise not have been in the system and provides a net boost. So the question is not what people would have otherwise been doing with the money, but how insurance companies are impacted. Becuase the hit will be to earnings, the shareholders of the insurance companies will get hit. However, I would argue that those shareholders will still buy their pair of shoes (hopefully they have a diversified portfolio). The loss is spread (this is what makes insurance an efficient way of managing risk). Another example would be rebuilding Europe after WWII. You had absolutely astounding growth for decades funded by other people’s capital. That growth was not “fake” growth. Now maybe someone else suffered – I understand the concept of opportunity cost – but the growth was still real. There will be a net positive mid-term boost to GDP because of the storm (following an obvious retrenchment due to the shut down of NY/NJ).

    • Individuals will always be poorer from such losses. If they have insurance they will still be less well off, but the insurance companies will be less well off. That means that they will take a profit hit, stocks decline, dividends may be cut, and their employees and shareholders will be less well off. Insurance money doesn’t ever sit on the sidelines;it is always invested in the economy: that’s how they make money.

      You confuse spending with economic growth and wealth. GDP just measures spending, not necessarily wealth creation. When the Fed prints money, spending increases but there is no net creation of new wealth. Yes, WWII created growth but that was because they had to start over. Growth came from capital, someone’s savings, rather than destruction. You fail to account for what was lost and what could have been had Europe not been destroyed (opportunity cost). Storm benefits always fail to account for what could have been. Someone always loses.

      • dd

        Jeff, this response section is really depressing. no wonder we are where we are. i’d suggest those above buckle-up. i’m not trying to be mean-spirited, but i just don’t know how the point could have been made any more clear.

        the paths described above will likely be implemented, and if so, it will get worse. we’ll compare notes in 5 years.

      • Rob

        Jeff, in the free market, people create wealth by accumulating the wealth of others. Those who do so more successfully by creating greater demand become wealthier, but only because there was a unit of wealth measurement transferred to them from someone else. When people rebuild, an entire segment of the economy benefits and becomes wealthier. This is a transfer of wealth that would not have occurred other than as a result of the destruction of wealth – i.e. the storm (as opposed to a market induced transfer), but wealth is indeed created for some people. You are ignoring the carpenters, factory workers on the appliance lines, asphault mixers, etc. They become wealthier in real terms as a result of the storm. And further, I would hope you agree, the economy is not a zero sum game. As individuals we can choose to create or not create and in the end it is our creation that makes wealth. The market is merely a place to make creation more efficient. So in rebuilding there may be creation that otherwise would not have occurred. Also, I think your response was a little too condescending. I was talking in terms of GDP creation not net wealth. In the end, I think it is difficult to speak in terms of absolute wealth, which parameters are more difficult to track.

        • I give up. Try looking at the unseen.

          • Rob

            Let’s start with a house worth $400k that was destroyed in the storm. We have wealth destruction of $400k. Insurance pays the homeowner $400k. So the homeowner is made whole. He uses the $400k to rebuild, transferring the wealth to those who build. As an aside, the rebuild may be more efficient and thereby generate wealth in its own terms. Now those who were hired to build and who made the materials have wealth (disposable income) that they otherwise would not have had. They use it to go on a vacation they otherwise would not have taken, buy a pair of shoes they otherwise would not have bought. In the end you just transferred $400k from one hand to a few others. And on the way you may gain a few efficiencites. Also, the velocity of money has increased, thereby increased GDP. Or am I missing something? I appreciate your posts. Maybe you can explain the unseen in a few sentences.

          • dd

            Rob, you are missing where the money came from, ask yourself whether the insurer is better or worse off. if it didn’t need to deplete its savings, what might it have done that money?

        • Mark

          Hi Rob,

          The net loss here comes from the scarce physical & human resources (namely building materials & time) that are being consumed in the repair process.

          Without any destruction, those physical (non-monetary) resources would be available for IMPROVING upon current living standards. With destruction, those resources are being consumed (and becoming more scarce) to merely RESTORE the current living standard from its damaged condition.

          All the people involved in the various industries supplying the recovery effort could have otherwise been free to seek employment supplying the needs of other productive, as opposed to restorative, efforts.

          The abundance of physical & human resources has decreased while living standards remain unchanged…thus, a net loss.

          • Rob

            Yes, but under current economic situations I would argue that those people employed in rebuilding would not otherwise have been busy. I am not arguing that the destruction is not real. I am arguing that the rebuilding increases the velocity of money over what otherwise would have transpired absent the storm in this particular muddling growth, high unemployment environment, which will increase GDP to a level above what it would have been at absent the storm. Whether that increase can equal or exceed the cost of the storm in the long run is perhaps not as clear as Jeff believes it to be. Depending on the source and cost of that money, the nature of the rebuild and the value of the assets destroyed, the rebuilding can actually have a net positive effect. Here the cost is paid by the insurers, and I am not convinced that the use of their reserves would have the same impact – at least in the short term – on the economy.

  • Vitaeus

    “Clearly there will be a boost to GDP. Most people are taking their “six francs” and spending them on repairs AND on their new pair of shoes. ”

    The money spent on insurance by the individual and the increase in rates as a result of pursuing a claim will end up making it a net negative, again. In economics you can get any answer you wish by where you start and stop your analysis. Of course the over time for the claims adjusters would make it a net positive again from the boost to their earnings and the wheel continues to turn, ad nauseum.

  • shelbyz

    Rob, look at it this way. I work for automotive dealership as a technician. When a customer decides to purchase a vehicle from us, money (wealth) is exchanged for goods or services. That is the capitalist, free enterprise sytem at work. When they bring it to me for normal service, same thing. These are outlays of money that are planned ahead and budgeted for (hopefully).
    If the same customer has an accident or inflicts damage on said vehicle, funds that were allocated elsewhere have to be spent to return their purchase back to a usable condition. Obviously, those funds most likely would have had a greater ROI elsewhere, but a reality appeared that had to be dealt with. That’s a transfer of wealth.
    Jeff, if can you add any insight, please feel free to do so.

  • shelbyz

    BTW, Jeff you were dead on about the cash for clunkers fiasco. One customer asked me what we were going to do to her old vehicle. She literally burst out into tears when I told her I was required by law to permantly destroy a perfectly good running engine.
    A gentleman said to me, ” That’s asinine. Why would anybody in their right mind destroy a perfectly good vehicle!” He got back into his old vehicle and drove away.
    Asinine, indeed. Well, we are talking about the government here………..