Why Natural Disasters are Good for Capitalism

It’s been amusing today to listen to the pundits discuss the economic implications of Hurricane Sandy.  Of course, we all know it closed the financial markets in NYC for two days.  (That should lead to a sudden spike in productivity, by my reckoning, since millions of people stop looking at pointless charts and do something useful for a change.)  Financial analysts worry about the impact on insurance companies.  Their shares will surely plunge on Wednesday morning when the markets reopen.  One trader interviewed on Toronto radio put it bluntly: “Shoot first, ask questions later.”  In other words, sell them all off, and then buy back any that you later find out may not have been hit so badly by Sandy’s fallout.  [Rarely do you get such an honest glimpse into the base mindset of financial brokers!]

The bigger irony, however, is that natural disasters usually lead to a subsequent improvement in the real economy.  Stuff gets destroyed, and then stuff gets rebuilt.  The act of rebuilding sparks investment, construction, and employment — which in turn generates subsequent downstream spending via a multiplier effect.  Assuming that insurance companies pay out what they’re supposed to, individual households have some resources to fall back on, and U.S. governments step in with some assistance (that one might be iffy, given all the fiscal and political barriers blocking normal government in America these days), Hurricane Sandy will certainly produce a measurable boost in economic activity next year all along the devastated U.S. eastern seaboard.

One well-studied disaster was the ice storm which hit Quebec and Ontario in 1998.  While GDP was lost during the storm itself (due to multiple closures, etc.), the subsequent stimulus provided by the gigantic rebuilding effort generated new activity that more than offset what was lost during the storm itself.  The two provinces led Canada the next year in real GDP growth (over 6%), driven in part by strong public and private investment spending induced by the storm.  Paul Darby of the Conference Board of Canada provided a useful accounting of the storm’s net positive effect, in his short report, “Economic Impact of the 1998 Ice Storm.”

How do we understand the potentially positive economic impact of a very negative, life-destroying event?  The irony is rooted in a fundamental feature of capitalism: what is produced, depends on what somebody is willing to pay for.  With very rare exceptions, in other words, output is limited by demand: not the inherent need for something, but by the ability and willingness to pay for it (Keynes called this “effective demand”).  That’s why at any point in time (including right now), vast productive capacity sits around the economy un-used: because no agent is willing to pay for what those agents can produce.

A natural disaster changes that calculus.  The physical need to rebuild is obvious.  And insurance payouts, government aid, or dis-saving provide the means to do so.  Money that was sitting idle before the hurricane hit, is suddenly put into motion.  “Dead money,” in Mark Carney’s terminology, lives again.  (Tomorrow is Halloween, after all, so a zombie analogy is fitting!)  Formerly idle construction workers are put to work repairing the damage.  They earn wages, which they in turn spend, generating new incomes and spending all the way down the economic food chain.  (Typically the estimated total multiplier effect of major construction spending, which naturally embodies a high domestic content, is close to 2-to-1.)

The same perverse logic applies to wars.  Canada went from depression to genuine full employment almost overnight in 1939.  Why?  Because something happened that induced the country, led by government, to spend enormous sums of money and produce as much as we possibly could.  The normal decision-tree that motivates production under capitalism (namely, something will happen if private cost-benefit decisions mean it is profitable for it to happen) was supplanted.  The motivation for production then became: “do it because we have to do it — and we’ll somehow find a way to pay for it.”

While we can trace the income and expenditure linkages that explain this ironic result, we should never lose sight of the fundamental irrationality on which the outcome rests.  If there were idle construction workers before the hurricane hit, why can’t we put them to work building something new and useful (public transit, affordable housing, reclaiming parkland), instead of waiting for random destruction to rain from the skies?  The short answer is that we can.  Whenever productive resources are idle (and under capitalism that’s most of the time), putting them to work can make us all better off.  But it requires a fundamental change in the decision-making process that guides our economy.  We would start doing things because they are useful and needed, not because someone decided to pay for them.