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Is There Any Good Economic News in the Japan Disaster?

Daniel Gross
Fin - Daily Ticker - US

Larry Summers, former Treasury Secretary and president of Harvard University, suggested last week on CNBC that the earthquake, tsunami, and ensuing nuclear debacle could have some positive, temporary short-term effects for Japan's long-suffering economy.

Spending on aid, clean-up and reconstruction could fill in for some of the economic activity that has been destroyed. But, as Aaron Task and I discuss in the accompanying video, there's plenty of reason to think that the quake won't prove stimulative.

Here's George Melloan in the Wall Street Journal:

"As the great 19th-century economist Frederic Bastiat taught in the "fallacy of the broken window," the GDP growth that comes from reconstruction brings no net gain in society's wealth. It just replaces, over time, what was lost. "Destruction is not profitable," he wrote."

Developed economies generally have a greater ability to bounce back from natural disasters than undeveloped economies do. But in richer nations like the U.S. and Japan, it's difficult to replace what was destroyed.

Michael Mandel, the former economics editor at Business Week, warns that the earthquake could exacerbate existing trends and accelerate Japan's decline. After all, Japan is an aging society that, with each passing year, has fewer workers and consumers.

Will the government conclude that it is worth it to rebuild small villages populated almost entirely by the elderly?

The rational reaction may be not to rebuild certain areas. New Orleans has received plenty of investment and attention since Hurricane Katrina. But it only has filled up part of the economic hole created by Katrina. As one study notes, "By April 2010, the metro [area] had regained 85 percent of its pre—Katrina jobs," but the metro area's population was back to where it was in 1970.

But what if it forces you to do something new, to rebuild afresh? One of the things about our world is that state of the art technology improves and doesn't necessarily get more expensive.

If a storm destroyed the wire that brought slow, dial-up access to your house and it was replaced by a fiber-optic cable, you could see how that would be economically useful. If a two-lane road that fell into the sea was replaced with a four-lane one, or if a ruined dock was replaced with one that could handle larger ships, that would be also prove useful over time.

The challenge is to replace the damaged stuff not only with something better, but with something that has the potential to be a platform for other growth. That's what happened in Japan after World War II, when the nation's entire economy was rebuilt after wholesale destruction.

And that's what is happening, on a much, much smaller scale, in Greensburg, Kansas, 95 percent of which was destroyed in a tornado in May 2007. The tornado could have been a fatal blow for a community whose population had been shrinking since 1960. But Greensburg's decision to rebuild as a showcase sustainable community has attracted attention and capital. A new wind farm went into operation on March 5 and several new buildings, constructed to high environmental standards, have risen.

This new infrastructure has the potential to make larger contributions to the region's economy. But Greensburg remains a shadow of its former self. Greensburg's population in 2010 was about half what it was before the tornado.

In this area, China, as in so many areas, provides a counterexample.

With a centrally planned government hell-bent on bludgeoning the landscape and its people into the future, destruction can lead to growth. In late 2009, I went on a six-hour boat ride down the Yangtze River from the interior to the massive Three Gorges Dam. The construction of the dam flooded vast areas and required the relocation of millions of people.

The boat passed under a dozen-odd new bridges that had been built above the new water line, and passed by dozens of new cities built alongside the river. Clearly, the construction of the dam brought a lot of new capital to the region, and living standards in the new river towns are likely higher than they were in the old ones. It clearly created lots of new infrastructure — a dam, electricity generation capacity, transportation networks — that are likely to add to productivity growth in the future.

But this dynamic works only if you're starting from a relatively primitive baseline, and only if an authoritarian country is willing to impose huge costs on the environment and on its citizens. It comes at a price that few countries and political systems are willing to inflict, and to accept.

Destruction is rarely profitable.