Some nuance on destruction

by Russ Roberts on March 15, 2011

in Stimulus

This is Summers Part III. Here are Part I and Part II.

In the aftermath of the quake and tsunami in Japan, Larry Summers talked about the human tragedy and then gave his thoughts on the economic impact:

“If you look, this is clearly going to add complexity to Japan’s challenge of economic recovery,” Summers said. “It may lead to some temporary increments, ironically, to GDP, as a process of rebuilding takes place. In the wake of the earlier Kobe earthquake, Japan actually gained some economic strength.”

In Parts I and Part II I discussed why I thought this conclusion was bizarre. It unmistakenly suggests without qualification, that there can be a positive financial impact from destruction.

As some commenters pointed out, GDP is a flow and wealth is a stock. That is, GDP compares the change in output over time while wealth is a snapshot. So it is possible to lose wealth (destroy buildings) while GDP goes up. It’s possible. I don’t think it’s very likely but it’s possible. In this sense, an increase in GDP is a misleading measure of well-being. Is that what Summers meant? It’s not consistent with his remarks about gaining “economic strength.”  He doesn’t say anything about this distinction. And as I pointed out in Part II, Paul Krugman offered no qualifications of this kind when he said that the destruction of the Twin Towers could lead to economic growth.

Some commenters (Tim Worstall, for example) pointed to savings or the liquidity trap as a way to make sense of Summers’s remarks. Yes, during a recession, some people hold their wealth in the form of cash and do not spend all of it. So if I have nothing to spend my money on or if savings are not being invested, then spending will be lower than it otherwise would be. In the Keynesian story, this is why spending of any kind is essentially a free lunch–there’s no foregone consumption or investment. I confess I have trouble understanding this argument. Oh I understand how it works in the model. But in reality, is this plausible? Yes, there are always resources that are unused at any point in the economy. Always. Even when unemployment is “only” 4%. But there is also a very imperfect match between any particular spending increase and connecting it to those unused resources. But even if you believe that some spending creates some output that wouldn’t have been there otherwise, surely that isn’t true of all spending at all levels. So you’d still want to qualify your remarks on spending creating economic strength.

As John Dewey pointed out in a comment, the destruction doesn’t simply destroy bricks and mortar. Much of what has been destroyed is part of the productive capacity of Japan. So suggesting that somehow rebuilding buildings is adding to GDP holding everything else constant is a silly statement. You can’t hold everything else constant. Look at this horrifying video and tell me if you think recovering from this tragedy is going to increase GDP in Japan or lead to increased economic strength.

Cleaning up the mess and rebuilding are going to mean many sacrifices that wouldn’t be necessary in the absence of the destruction. Japan is going to be poorer for a while. Not richer. And the loss of capital means the losses will extend over time.

Destruction is bad for the economy and yes, even bad most of the time, maybe all of the time, for measured GDP. The remarks by Larry Summers (and by Krugman in the aftermath of 9/11) imply otherwise. If they have something more subtle in mind, they should say so.

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rjh March 15, 2011 at 11:45 am

Another aspect is Summers’ reference to the post-Kobe experience. It illustrated the improvement potential for semi-random destruction (as compared with creative destruction). For various reasons the earthquake destruction in Kobe primarily destroyed old structures. It also resolved various disputes about demolition and improvements by arbitrarily destroying things. This enabled replacement of obsolete systems with new more effective systems. So there was both the transient GDP effect of reconstruction efforts and the permanent GDP effect of replacing inefficient facilities with efficient facilities.

Earthquakes are not a desirable form of resolving conflicts and removing old systems, but they do have that effect at times.

Seth March 15, 2011 at 11:50 am

Wealth is a stock. Destruction of wealth is a flow. It’s flow that doesn’t get counted in GDP, as far as I know. However, it’s real. Companies have to recognize the value of destroyed assets in their flow statement (income statement) against earnings. Countries do not, apparently.

Ryan Vann March 15, 2011 at 1:26 pm

Exactly right GDP accounting is like GAAP, but without the recording of losses.

Daniel Kuehn March 15, 2011 at 12:03 pm

“the destruction doesn’t simply destroy bricks and mortar. Much of what has been destroyed is part of the productive capacity of Japan”

This is an essential point. When Samuel Cohen, the inventor of the neutron bomb, died I wrote about the “unbroken window”, and how you can think about neutron bombs as one extreme in a spectrum of potential reactions to a broken window. In this situation you have complete destruction of productive capacity (human labor), and no destruction of anything that might need to be potentially replaced at all (buildings).

On the other end we can think of a hurricane hitting a community like the Outer Banks or some other vacation/resort area. You’ll have no substantial productive capacity destroyed, but a lot of consumer durables destroyed. That’s a recipe for a GDP boost.

Disasters run the gamut between these two, of course. What comes out of it is largely contingent on what kind of destruction you’re dealing with. Regardless, nobody who points out these effects deserves to be accused of thinking that destruction is a good thing for the economy.

cmprostreet March 15, 2011 at 1:00 pm

Re: Outer Banks

GDP boost perhaps (vacation rentals and tourism would come out of GDP, rebuilding would go in). Boost in economic strength? Absolutely not, unless you are using some bizarre notion of ‘strength.’

Thus, while different types of destruction may be different, Summers deserves to be called out for his comment both for referencing economic strength and for the fact that this particular disaster seems to have destroyed productive capacity (both in terms of labor and material capital).

It’s possible that this was just a poor choice of wording, and that both he and Krugman have far more nuanced positions than they are capable or willing to communicate. However, if that is the case, they probably deserve to be called out for that as well, as their actual statements are perpetuating economic fallacies absent those nuances. Whether this is intentional or due to negligence or incompetence is immaterial to whether they should be called out for it and asked to explain their reasoning.

Why insulate someone from criticism when you believe they are either wrong or saying something other than what they mean? I see no reasonable interpretation of Summers’ comment that should vindicate him of criticism for it. Furthermore, doesn’t the extent of the disagreement here and elsewhere regarding what his comment meant indicate that it was at best less than obvious what he meant? Or is it just ideological grandstanding on one side and honest, thoughtful communication on the other?

Daniel Kuehn March 15, 2011 at 1:09 pm

As I said in the other comment, I found that point absurdly vague on Summers’ part. What does “economic strength” even mean? Since he doesn’t have a track record of reveling in the misfortune of others; since I think it’s safe to say there is no assessment of natural disasters that doesn’t conclude they destroy existing wealth; since he was just talking about GDP, I think it’s safe to assume he was refering to GDP. If you or anyone else wants to twist yourself into pretzels trying to make him say something else, be my guest – but my view of Summers is based on that interpretation of what he said.

re: “However, if that is the case, they probably deserve to be called out for that as well, as their actual statements are perpetuating economic fallacies absent those nuances”

The only people perpetuating economic fallacies are the ones who are telling people that Krugman and Summers said that destruction is good for the economy.

Don Boudreaux March 15, 2011 at 1:14 pm

Destruction of consumer goods might well increase GDP – but all the worse, then, for the way we measure GDP. Destruction of valuable consumer goods – goods that people would enjoy consuming were these goods not destroyed – makes people poorer.

Daniel Kuehn March 15, 2011 at 1:18 pm

All the worse for GDP because it is in fact a production measure rather than a measure of poverty?

That seems odd.

I don’t think less of inches and feet because of their inability to tell me what time it is or how cold it is outside. Why should I dismiss or be concerned about GDP because it doesn’t provide me with a measure of wealth or happiness?

Don Boudreaux March 15, 2011 at 1:41 pm

Daniel: Fair point. So I re-word: “Destruction of consumer goods might well increase GDP – but all the worse, then, for the way most reporters, pundits, and non-economists uninformedly talk and think about GDP as if it is an unambiguous measure of economic well-being; all the worse given that when the general public hears the likes of Larry Summers or some business reporter proclaim that destruction will boost GDP the general public hears these people saying that destruction will strengthen the economy and implying that it will make people wealthier over the long-run.

It remains the case that destruction of valuable consumer goods – goods that people would enjoy consuming were these goods not destroyed – makes people poorer. It remains the case that when people such as Summers trumpet the positive economic effects of destruction they give the mistaken impression that such destruction is good for the economy (even if all that Summers and his ilk on this matter MEAN is that the statistical measure that we call “GDP” will rise).

Daniel Kuehn March 15, 2011 at 1:58 pm

You really think people will be confused by what he meant? I don’t think the idea of rebuilding after a disaster is that confusing.

Daniel Kuehn March 15, 2011 at 2:02 pm

Anyway – even if this is a concern for you, I would have thought the reaction would be to expand on and clarify Summers’ answers to a live TV interview. I wouldn’t have thought someone interesting in clarifying things for the general public would proceed to say that Summers’ logic suggests that we should “just blow up empty buildings randomly”, as Russ did. If you really think Summers’ was talking about GDP not wealth and if you really are interested in educating the public, why promote the idea that he was talking about wealth or total economic wellbeing rather than GDP?

Daniel Kuehn March 15, 2011 at 2:03 pm

Why not start with “I know that thing Summers said sounded a little odd at first, so before anyone jumps to conclusions let me walk through this carefully – he wasn’t refering to economic wellbeing – he was refering to the amount of goods an economy produces in a given period”.

Methinks1776 March 15, 2011 at 2:16 pm

I know that thing Summers said sounded a little odd at first, so before anyone jumps to conclusions let me walk through this carefully – he wasn’t refering to economic wellbeing – he was refering to the amount of goods an economy produces in a given period”.

Wow. Suddenly, the guy who is so reticent to put words in people’s mouths and guess what was in their mind when it doesn’t suite his purpose is putting words in Larry’s mouth and reading his mind.

Do you understand that it is not for you or Don or Russ or anyone else to clarify Larry’s statement? Larry Summers is a grown man and an economist in his own right. He can speak for himself and doesn’t need Danny Keuhn to do it for him. I had no idea you had a side career in public relations.

Daniel Kuehn March 15, 2011 at 2:28 pm

All I can do is read the plain language and make reasonable inferences, Methinks.

We clarify and expand on each other all the time… that’s part of being human, Methinks. What’s the big deal with that?

Methinks1776 March 15, 2011 at 2:41 pm

You’re right, Danny.

Why rely on the words that actually tumbled from the speaker’s mouth when you can infer something much more palatable?

Of course, if the inference is not to your liking (as with Krugman’s distribution of income), then you can insist that those were not the actually the words that tumbled from his mouth and the inference is thus invalid because it would require reading his mind to infer.

I think we all have your number now.

Methinks1776 March 15, 2011 at 2:48 pm

I miss the edit button most of all.

John V March 15, 2011 at 5:45 pm

For someone who digs to the furthest depths to see the silver lining in the words of people you want to agree with, you have an amazing ability to be just as shallow in the readings of words of people you don’t want to agree with. IOW, you are a pedantic contrarian.

Neither Russ nor Don have claimed that Summers said destruction is good for the economy. They took issue with the idea that the economic activity resulting from the rebuilding of destruction is good for the economy…when compared to no destruction at all.

It’s so simple, so obvious and so right-in-front-of-you. But since you are a contrarian, you choose to not acknowledge it and instead use many times more energy to dig deep to use defenses for Summers that avoid a much easier exercise: Seeing the point of our hosts.

But you don’t want to see the point because you want to be a contrarian.

Daniel Kuehn March 15, 2011 at 11:28 pm

I made sure I quoted Russ verbatim on that, actually. It didn’t seem like something I should just make up. Word for word. Check it before you spend your time writing three paragraphs.

If they did say what you are claiming (“when compared to no destruction at all”), they’d be wrong there too. The sentence after the sentence that Russ decided was worth quoting – in other words, the sentence that Russ failed to quote – was when Summers said “this is a tragedy that Japan surely did not need”. That doesn’t sound like “they’re better off with the destruction compared to no destruction at all” to me, John V.

John V March 16, 2011 at 9:37 am

“It unmistakenly suggests without qualification, that there can be a positive financial impact from destruction.”

Implied: The economic activity resulting from rebuilding destruction.

It’s pretty easy, DK. If Russ or Don were Keynesians, you’d rush to see their point and see it easily. But since you are here as a contrarian, you choose not to. You parse or take at face value depending on who is talking or what they are saying. You are a contrarian.

Daniel Kuehn March 16, 2011 at 10:56 am

The point changes – here it’s about GDP and I haven’t contested anything in this current post. In the last post it was about (and again, I quote): “it implies that destruction is a good thing for the economy”. Of course there’s a lot ot critique about that claim, regardless of their theoretical background. Russ was just as non-Keynesian when he said that and I disagreed with it as he is here where I’m agreeing with him. Whereas I vary my response to Don and Russ depending on what they’re saying, you seem to always have the same assessment of me. You don’t even make the effort of cracking a thesaurus – aren’t you getting tired of calling me a “contrarian”.

John V March 16, 2011 at 11:11 am

DK,

If you can’t admit what the long form of that statement is, then it’s hopeless.

And Contrarian works quite well. No need to change it. What you do is so transparent.

Eric Hosemann March 15, 2011 at 6:04 pm

“What comes out of it is largely contingent on what kind of destruction you’re dealing with.”

Destruction is destruction is destruction. There are no “types” of destruction. There are only degrees of destruction. Your Outer Banks example is a case in point. Destroying a resort area destroys productive capacity for leisure. The capital consumed in replacing that productive capacity is also destroyed. This is also known as depreciation.

John Dewey March 15, 2011 at 6:48 pm

“You’ll have no substantial productive capacity destroyed, but a lot of consumer durables destroyed. That’s a recipe for a GDP boost.”

It’s not a question of whether the destroyed productive capacity is substantial relative to the U.S. economy or even the North Carolina economy. The GDP boost you assert will only happen if the increases due to rebuilding and refurnishing exceed the income losses in the Outer Banks.

According to the Outer Banks Chamber of Commerce, 40 percent of the jobs there are in retailing, accomodation, and food services. The income provided by those services – and related services such as food wholesalers and goods distributors – are probably not insignificant relative to the GDP increase you expect.

When sections of the Gulf Coast have been hit by hurricanes, the loss of tourism income has been severe. While some of those tourism expeditures may have been transferred to other parts of the nation, significant amounts were likely spent in Mexico and the Carribean.

It is not clear to me why the destruction of vacation/resort area is “a recipe for a GDP boost”.

Daniel Kuehn March 15, 2011 at 11:32 pm

Couldn’t have said it better myself – after all, it’s dependent on circumstances as I said. Clearly if the sorts of establishments you describe are destroyed, that would be the destruction of productive capital. I have no idea how that would all shake out and I’m guessing you don’t either. But it’s towards the other end of, say, a neutron bomb that only destroys productive capacity – the reproduction of which does not enter into GDP statistics.

Methinks1776 March 15, 2011 at 12:15 pm

Regardless, nobody who points out these effects deserves to be accused of thinking that destruction is a good thing for the economy.

You are an unbelievable twit. That does deserve to be pointed out.

W.E. Heasley March 15, 2011 at 12:38 pm

Ran into Frédéric Bastiat yesterday. He was downtown peering through a showcase window with TVs on display. Apparetly watching the newscast of destruction in Japan.

“Hey Fred! What’s up with Summers and Krugman?”.

Fred: “Thought the bridge keeper in the Holy Grail tossed them into the Gorge of Eternal Peril?!? Yeah, the breaking point of Europen or African made glass was question three”.

DavidinOC March 15, 2011 at 12:58 pm

Coincidentally, the Los Angeles Times book review section on Sunday 13 March had a review of a book (by Toby Wilkinson, if memory serves) on the brutality of the ancient Egyptian leadership. Pyramid building may be no less brutal and destructive than earthquakes and wars.

Phil Nicolai March 15, 2011 at 2:05 pm

Before everyone writes off Japanese economic ability to rebuild, did you notice in the videos of the destruction shot by foreign corresspondents that the roads they drove on were already clear, that the gasoline shortages are in part due to the “convoys” of emergency related vehicles. I predict cleanup within 6 months and rebuild within 2 years.

JCE March 15, 2011 at 2:11 pm

In your previous post on this subject you said: “My eleven year-old understands that spending on rebuilding means less spending on something else.”
Perhaps you should understand youself, and then explain to your daughter, this: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=226650

as einstein said: “make everything as simple as possible, but not simpler”

TOO much simplicity, as in ‘spending on something means spending less on something else’ leads to confusion and mistakes

Mao_Dung March 15, 2011 at 2:51 pm

Must I remind you that there is something call “creative destruction.”

http://en.wikipedia.org/wiki/Creative_destruction

jjoxman March 15, 2011 at 3:18 pm

You don’t have to remind us of it. You might actually want to get acquainted with its meaning, however.

Ken March 15, 2011 at 6:29 pm

Dung,

As I explained to another idiot (Gil) that creative destruction is not about going places and destroying people’s stuff so they have to get new stuff. It’s about making industries obsolete through innovation thereby destroying that industry. Like making the horse and buggy obsolete due to the more efficient product the car.

It helps to know about which you talk before talking. You can avoid sounding like such a dumbass in the future.

Regards,
Ken

Methinks1776 March 15, 2011 at 9:25 pm

I can imagine that if you sarcastically suggest to Gil or Muirdiot or Chinese Shit they grab a bat to help the cause when they’re committing the broken window fallacy they’ll accidentally beat themselves bloody with it.

Don Boudreaux March 15, 2011 at 3:06 pm

Daniel Kuehn below writes (in response to an earlier comment of mine [also below]): “You really think people will be confused by what he [Summers] meant? I don’t think the idea of rebuilding after a disaster is that confusing.”

Summers said – or carelessly suggested – more than that people rebuild after a disaster. Summers used words that suggest that the disaster, because of the rebuilding effort, will have net positive economic effects for Japan. Whether Summers meant it as I believe most people interpret it – or whether he meant merely to point out the esoteric fact, uninteresting to all but national-income-accountants, that this conventional accounting measure called “GDP” will rise in nominal value as a result of the rebuilding effort is not for me to say.

Ian March 15, 2011 at 3:19 pm

Isn’t it entirely possible that insurance will cause Japan economic growth at the cost of the rest of the world?

I would assume given that Japan is such an industrialized nation most of the damage will be insured and reinsured against lose. Isn’t it possible that the new infrastructure paid for by insurance will be superior (i.e. greater wealth) then the old?

On a personal basis “the Ian nation” this seems to hold true. While my house might get flooded while I’m on vacation by a broken pipe, insurance pays for the whole house to be renovated due to the destruction thus raising the wealth and GDP of the “the Ian nation”.

Greg Ransom March 15, 2011 at 3:58 pm

People will be forced to trade high quality leisure for low quality hard work.

And GDP will see this as a “gain”.

Greg Ransom March 15, 2011 at 3:59 pm

More work, less leisure. Winning!!

Scott March 15, 2011 at 4:12 pm

I immediately thought of something as I watched the video and heard the warning sirens in the background. If you replace the water rushing down the streets with bombs raining from above, the results are still the same: death, destruction, and a great opportunity for GDP growth.

I think I just solved the international aid problem. All that we have to do is move people out of the way, and then bomb the living daylights out of any country that we want to “help”. It would be more efficient and effective than anything that’s been tried in the past. Someone get Jeff Sachs on the phone.

danny March 15, 2011 at 8:38 pm

There is a sort of unrelated, but I think an important and oft overlooked (despite being obvious) aspect of this kind of destruction that helps the people that employ the broken window fallacy. The idea is that projects to replace lost capital are going to have much greater returns on average than those to create new capital mostly because the risk will be lower.

If you start a new restaurant it has a high probability of failure. If a very successful restaurant burns down, rebuilding it will have a much lower probability of failure. As a result, an economy can make a seemingly amazing recovery from something like this because effectively every decision they make is “right” since they just have to rebuild (and maybe they can even fix some of the mistakes from before).

I’m not at all saying they are better off than if there hadn’t been the disaster, but I think blurring the distinction between returns on “innovative?” new capital and “replacement?” capital (for lack of a better word) is one of the many ways people allow themselves to hold on to the misconception of the broken window fallacy.

danny March 15, 2011 at 8:40 pm

first sentence was bad, it should read…

“broken window fallacy IS the”

Methinks1776 March 15, 2011 at 9:30 pm

Nice job talking about this on Judge Napolitano’s show tonight, Russ!

Roberts, Boudreaux and Benjamin Powell all in the space of a week. The judge’s show is becoming a can’t miss.

Sam Grove March 15, 2011 at 10:18 pm

Look at this horrifying video and tell me if you think recovering from this tragedy is going to increase GDP in Japan or lead to increased economic strength.

Only if you compare to now instead of before the quake.

John Papola March 15, 2011 at 11:14 pm

@Daniel (and all Keynesian apologists)

Forget about Summers. Here’s Lord Keynes:

“Pyramid-building, earthquakes, even wars may serve to increase wealth…”

INCREASE WEALTH. That’s Keynes. Not increase aggregate demand. No increase the flow of spending. Keynes said increase wealth. Summers says “economic strength”. Krugman (regarding 9/11) said “economic good”. Both men have words they could have used instead. They didn’t. The implication is absolutely clear, and clearly Keynesian orthodoxy. Destruction can increase total wealth. That’s the claim being made.

And lets honestly think about the context here. If Summers or Krugman were acutely aware of the difference between GDP and wealth, than surely they would be taking pains to point out that the potential increase in GDP that comes from destruction SHOULD BE IGNORED because it’s a statistical anomaly. They would surely be pointing out that, indeed, our economic metrics commonly referenced as a gauge of national economic wellbeing are, in fact, totally unable to account for the devastation and can even lie to us in times of crisis.

They haven’t done that. Summers was off the cuff. But he’s in line with Krugman, whose articles aren’t off the cuff at all. They’ve very deliberate. 9/11 could do some “economic good” is not saying that GDP may go up as a statistical artifact. It’s saying that the economy will be improved. Our material wealth will be improved. It’s dangerous damn crackpottery.

brotio March 16, 2011 at 11:31 pm

I’m sure DK will be along in the morning to tell us that Keynes didn’t mean, increase wealth.

You obviously don’t have the nuance to be a Keynesian.

Booklet Printing March 16, 2011 at 2:17 am

Nature has done a big injustice with the Japan. We need to come to aid of Japan in its time of need.

Emerson White March 16, 2011 at 2:50 am

I can think of one way in which a disaster could solve economic woes… but it’s a really terrible thought, so be forewarned. In the event that a natural disaster occurs it is possible that the population with lower productivity associated with disabilities and aging will be selectively thinned. In that event consumption will fall with out affecting productivity, and the economy after repair can be in a more advantageous position.

rodney smith March 16, 2011 at 2:54 am

The incident of japan has taught that we are the doll in the hand of God. We are here in the world by the will of nature and we have to depart by the will of the almighty.
http://www.muziic.com/profile.php?id=106266

Joe Cushing March 16, 2011 at 8:45 am

The destruction of wealth could lead to a growth in gdp that, when summed up, equals more than the wealth lost. This is because what is destroyed is often a pool of depreciated assets. What gets built are new assets that are worth more than was lost. What is lost without posibility of recovery is the free time of those who did the rebuilding.

Also, there are lots of wealth tranfers in a recovery. Wealth is transfered from those who pay for the rebuilding to those who do the work. Wealth is also transfered from outsiders in the form of insurance, donations, free labor etc. This tranfer from outsiders distorts the picture of recovery. While a town could recover wealthier than was before destrction, other towns have lost wealth.

It’s not such a clear picture whether or not a mass destrction is on net bad or good as either side would argue. It’s quite cloudy.

Greg Ransom March 16, 2011 at 12:06 pm

This is refuted by Hayek in his _The Pure Theory of Capital_.

scott March 16, 2011 at 9:30 am

I am surprised nobody has mentioned Tyler Cowen’s “Great Stagnation”. He picked apart the myth that GDP is an unbiased measure of economic growth. Cowen clearly shows that government spending can increase GDP simply by arithmetic: if govt spending goes up X, then GDP goes up X divided by GDP of prior period. Ditto for education and health care spending, that go into GDP as costs and do not reflect market value of services or productivity. If a person overpays for a health procedure, or better is charged for unnecessary one (same as a digging a hole and filling it in) then GDP goes up, eventhough wealth has not been increased.
So for this discussion, the increase in government spending after a disaster does increase GDP numerically but the economic consequences of this mis-measurement for a natural disaster are small compared the flows in education and health care.

John Dewey March 16, 2011 at 6:20 pm

“If a person overpays for a health procedure,”

What does that mean? If a physician offers his service for $X and the person receiving the service agrees to pay $X, how can that person “overpay”? If the person’s insurance company agrees to pay the $X, how can that insurance company “overpay”?

FW Garvin March 16, 2011 at 11:45 am

I do understand the objections to the idea that destruction leads to greater wealth – and I generally agree with them.

However, it all depends on your point of reference.

The destructive event actually destroys wealth. You have X today, and X-D tomorrow. The event destroys actual wealth, removes productive capacity, leaves people homeless, etc.

Failing to replace D, you have X-D permanently, and your level of wealth and capacity to generate more is permanently reduced.

If your point of reference is pre-event, then, no, you have not gained anything. If your point of reference is post-event, then yes you have.

Post-event, you are at X-D – there is no way around that. Any increase in wealth from X-D, say through reconstruction, is X-D+R, which is by definition greater than X-D.

In a state of X-D, X-D+R generates economic activity that would not have existed otherwise – which may rise to the level of the original X.

There are also some potential benefits in that infrastructure that was destroyed is hardened and modernized, potentially creating greater capacity for wealth generation.

If someone breaks the window, and the shopkeep replaces it with unbreakable polycarbonate instead of glass, he has reduced his risk of future loss, and no longer needs to reserve for such a contingency, allowing him to divert more of his capital to productive uses.

The question is do you want to be at X, or at X-D? Intentionally destroying in order to create wealth is a ridiculous notion because you have to impoverish yourself in order to achieve some questionable incremental, external benefit.

Would the shopkeeper break his own window so that he can replace it with polycarbonate to remove the risk of someone breaking his window? Definitively, no.

However, if an uncontrollable event occurs, you are improverished regardless, there is no choice in the matter.

So, the notion that what Summers said leads down the logical path that we could or should willfully destroy wealth in order to create more, is not valid.

It ignores the fact that Japan has no choice in the matter, and that the end result will be X-D+R regardless, unless Japan just decides to throw in the towel.

The only question is: will R be sufficient to offset D (short-term), and will the external benefits incurred by undertaking R create greater wealth generation capacity than the original X (long-term)?

Greg Ransom March 16, 2011 at 12:06 pm

“The destruction of wealth could lead to a growth in gdp that, when summed up, equals more than the wealth lost. This is because what is destroyed is often a pool of depreciated assets. What gets built are new assets that are worth more than was lost. ”

This old chestnut is refuted in Hayek’s _The Pure Theory of Capital_.

Guarded March 17, 2011 at 4:06 pm

Greg,

Any chance you could provide a couple of paragraphs that summarises Hayek’s refutation?

Greg Ransom March 16, 2011 at 12:08 pm

In all sorts of important ways it would reflect most of us being BETTER OFF if GDP went down.

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