Natural Disasters and Capital Replacement

by Don Boudreaux on July 6, 2008

in Myths and Fallacies

I was recently interviewed by a newspaper reporter who asked what I think of the idea that natural disasters make economies more productive by forcing the replacement of capital equipment embodying older technologies with capital equipment embodying newer, state-of-the-art technologies.

I don’t think much of this idea.  It’s got flaws aplenty (which now I leave to the astute patrons of the Cafe to identify).  But here’s a closely related flaw that that I will share now.

I got a skeptical response from the reporter when I told him that businesses often — and, likely, efficiently — replace capital embodying older technology with capital embodying newer technology.  They often make such replacements without being forced to do so by natural disasters, wars, or any other non-market phenomena.  Businesses will make such replacements when the net present value of the expected stream of additional profits made possible by the newer capital exceeds the cost of acquiring and implementing the newer capital.

“But do such replacements happen in the real world?” he asked.  “I’ve interviewed some economists who argue that people often miss these opportunities and hang on too long to older capital.”

“I disagree.  I see such replacement going on constantly.” I answered.  “For example, the supermarket nearest to my home was recently refurbished; it’s now much more attractive than it was previously.  But, as far as I can tell, there was nothing about the store in its pre-refurbishment condition that was unfunctional.  Another example is on-line banking: many [most? all?] banks now offer this service despite the fact that real-world bank tellers and ATMs remain functional.”

I could tell that he was still skeptical.

“Look,” I asked, “have you ever replaced a personal computer with a newer and better one even though your older computer was still working?”


“So have I.  And so has everyone else I know who owns a computer. The undeniable frequency of such replacements – along with the equally undeniable fact that almost no one replaces his or her personal computer the moment a newer, more updated version hits the market – is strong evidence that people in the private sphere make reasonably sensible cost-benefit calculations about when, and when not to, replace older but still-functional capital equipment.”

I suspect that my response did very little to dent his skepticism of my claim that there’s no reason to worry that the market generally adopts new technologies too slowly.
Finally, although this reporter and I did not talk about international trade, it occurred to me afterward to wonder how many persons who worry that the likes of hurricanes and earthquakes are helpful in getting private firms to efficiently undertake modernizing investments that these firms would otherwise stubbornly resist also worry that the moment freer trade with a lower-wage country becomes reality that firms in higher-wage countries will rush headlong into moving their production facilities to such countries.  Just wondering.


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