12.7.08

YOU CAN INSTALL A BETTER WINDOW. A Mises Economics Blog post (via The American Mind) calls out a Boston Globe article that appears to rehabilitate the broken window fallacy.
"When something is destroyed you don't necessarily rebuild the same thing that you had. You might use updated technology, you might do things more efficiently. It bumps you up," says Mark Skidmore, an economics professor at Michigan State University. "Disasters help people think about things differently."
The Mises Blog rebuttal raises the usual objection.
As J. Henderson has remarked:, "Using this logic, the federal government should spur greater growth and technological development by regularly and frequently bulldozing random homes and businesses across the country."
That's not quite what the Globe article, or the research itself, suggests.
Studies have found that earthquakes in California and Alaska helped stir economic activity there, and that countries with more hurricanes and storms tend to see higher rates of growth. Some of the most recent work has found a link between disasters and subsequent innovation.

The study of the economics of disasters remains a small field, with few major papers. And skeptics charge disaster economists with oversimplifying enormously complex economic systems and seeing illusory effects that stem only from the crudeness of the available economic measuring tools.
Further into the article come the clarifications.
To critics of this line of thinking, the problem is that it is, at best, a partial picture. It ignores, they argue, the fact that the money and labor that go into post-disaster rebuilding are simply being redirected from other productive uses.

"If you're a carpenter, a trash remover, a physician, you may be made better off, but the things that those producers would have otherwise produced are not going to be produced," says Donald Boudreaux, an economics professor at George Mason University. "Over any reasonably relevant period of time, society is not made wealthier by destroying resources," he adds. If it were, "Beirut should be one of the wealthiest places in the world."

The research on longer-run effects, its supporters argue, is less vulnerable to this criticism, because the key factor is not merely new stuff but better stuff. In this model, disasters perform the economic service of clearing out outdated infrastructure to make way for more efficient replacements - Mother Nature's contribution to what the Austrian economist Joseph Schumpeter famously called capitalism's "creative destruction." The economy, as it recovers, actually becomes more productive than it was before, and some economists argue that the effect can be seen decades after the disaster.
Sometimes, the replacement work simply replaces recently-done work. We saw that in Love's Park, where a tavernkeeper who recently bought a new floor has to buy another new floor. The longer-term effects are more difficult to analyze. Absent a disaster, there are two forces always at work: the option value in continuing to use existing technology, and the gain from replacing it with the newest technology. (The option value is one explanation for a business continuing to use a depreciated asset despite the availability of better replacements. It's a manifestation of economic hysteresis, a macroeconomic term of art that has since been applied to microeconomic phenomena.) During the early 1980s, a simple form of that argument offered the simplest explanation for U.S. heavy industry not replacing its factories after World War II. Thus the Japanese and the Germans had state-of-the art heavy industry courtesy of the Marshall Plan. But there had to be easier ways to replace an old factory than to pattern-bomb it.

The Skidmore and Toya article highlighted in the Globe's coverage is behind the JSTOR wall at Economic Inquiry. Here's the abstract.
In this article, we investigate the long-run relationships among disasters, capital accumulation, total factor productivity, and economic growth. The cross-country empirical analysis demonstrates that higher frequencies of climatic disasters are correlated with higher rates of human capital accumulation, increases in total factor productivity, and economic growth. Though disaster risk reduces the expected rate of return to physical capital, risk also serves to increase the relative return to human capital. Thus, physical capital investment may fall, but there is also a substitution toward human capital investment. Disasters also provide the impetus to update the capital stock and adopt new technologies, leading to improvements in total factor productivity. Copyright 2002, Oxford University Press.
No mention of economic hysteresis, and incomplete analysis of regression to the mean. Developing countries are likely to grow more rapidly than developed countries, disasters or not, because they have been spared much of the cost of identifying the proper first-generation technologies.

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