No, Natural Disasters Do NOT Help Economic Growth

Every time there is a large natural disaster, inevitably someone in politics or the media will say something like, “Well, the upside of this disaster is that the rebuilding efforts will spur economic activity and help the economy.”

This is absurd and patently false.  Anyone with an ounce of common sense can feel it in their gut that property destruction cannot possibly have a positive net economic benefit.  If destruction were ultimately good for the economy, then the best stimulus would be for all of us to burn our houses down.  Let me explain the fallacy at work here.

We’ll start with the Rockwellian image of a group of boys playing baseball in the backyard.  The catcher signals fastball to the pitcher, who complies.  The hitter, anticipating this, connects solidly with the pitch with a resounding CRACK of the bat.  The ball sails over the back fence and crashes through the neighbor’s large plate glass window.

The destruction has now occurred and must be addressed.  Some economists would have us believe that this is a good thing.  The owner of the house must now hire the local glass company to come and replace the window.  Let’s say that this will cost the homeowner $200.  This new economic activity will pay the wages of the person doing the glass replacement.  Then, part of the $200 will go to the glass manufacturing company, part of it will go to the receptionist at the glass company that took the order, and part of it will be used to buy the gas in the truck.  All of the above businesses  and individuals will pay taxes on their respective piece.  All of this wonderful economic activity will happen as the result of that one errant baseball.

Gee, with such positive results, we should just forgo the unpredictable baseball and use the bat directly to bust out all of our windows.  So what is the problem with this story?  The problem is opportunity cost.

The homeowner’s $200 did not appear out of nowhere.  By being forced to spend the $200 on the window, he was not able to buy that lawnmower he was planning to purchase.  That’s $200 that the local hardware store will now NOT be receiving.  They would have used it to pay their employees, suppliers and taxes.  So the broken window did not generate economic activity, but only diverted it from one business to another.

If the baseball game had not occurred, the homeowner would have had both a window and a new lawnmower.  Now he only has a new window but no lawnmower.  His wealth has decreased by $200.

But what if he had insurance?  Insurance pools risk, so if insurance paid the $200, then the homeowner will have both the lawnmower and the window.  But who actually bears the cost?  If there are 100 policy owners, then effectively each of them pays $2 toward the new window.  There is still $200 of wealth lost, but now it is being taken proportionally from 100 people instead of 1 person.

But what if the government pays for the window with their new “Baseball Relief Fund?”  Well, this is effectively the same as the insurance scenario, except the cost is spread among all the taxpayers instead of just the insurance policyholders.

But what if the government funds the Baseball Relief Fund by printing money instead of by raising taxes?  This is ultimately just like the taxpayer scenario, except it is more regressive.  All holders of dollars pay for the new window as inflation decreases the value of their savings.

So now back to the natural disaster.  Yes, we will see lots of new economic activity in a disaster zone.  Some of it will be funded by the homeowners, who will just be diverting spending from other activities, so there is no net benefit to the local community or overall economy. 

Some of it will be funded by insurance companies, who will be taking funds from policyholders outside the affected area.  So this will just be economic activity shifted from unaffected communities to the affected communities.  There will be no net benefit to the economy overall.

Some of it will be funded by the federal government, who will pay for it by raising taxes, printing money or borrowing money.  Regardless of the funding mechanism, it will still result in no net positive benefit to the economy, but rather a shifting of economic activity from unaffected areas to affected areas.

Of course we should help communities that are devastated by natural disasters.  But let’s not be fooled by those who say that this is a positive thing for the overall economy.  If there’s 10 billion dollars in damage, then this is a 10 billion dollar loss in national wealth.  All the communities that are rebuilding will indeed experience a flurry of new economic activity, but this will be offset by loss of economic activity elsewhere. 

We all know instinctively that destruction of property cannot possibly be a good thing economically.  Let’s not be fooled by those trying to tell us it is.

Craig R. Everett, Ph.D.

Associate Director, Pepperdine Center for Private Capital Markets
Graziadio School of Business and Management
Pepperdine University
Malibu, CA
- Author of youth financial literacy thriller Toby Gold and the Secret Fortune