On Destruction and Prosperity

by Don Boudreaux on November 1, 2012

in Seen and Unseen

Commenting on this post, Jamie Newman endorses that part of Peter Morici’s argument that insists that natural disasters can make their victims wealthier by obliging these victims to replace destroyed assets (houses, cars, etc.) with newer assets.  Newer assets – having less wear-and-tear on them than did the older assets (since destroyed by the likes of hurricane Sandy), and often being more technologically advanced than those older, now-destroyed assets – are better than the older assets.  Therefore, it is alleged, the victims who are obliged by the natural disaster to rebuild with newer assets find themselves better off as a result of the natural disaster.

To summarize, as Peter Morici put matters in the aftermath of hurricane Irene in August 2011, “the capital stock that emerges will prove more economically useful and productive.”

(Indeed, after Irene Morici was even more explicit than he is today about this alleged benefit of destruction.  His argument then prompted me to write what I immodestly regard to be one of my favorite letters.)

But this argument is an especially mistaken one.  Some microscopic sense can be found in the vulgar Keynesian notion that a natural disaster can kickstart people’s commercial activities out of the doldrums.  That is, it’s possible that, if all that ails an economy is a deficiency of spending, then the spending induced by a natural disaster can rev the economy back up to full-speed.  Possible, but hardly plausible and highly improbable.

Yet the alleged benefit highlighted by Jamie Newman is even more far-fetched than the vulgar Keynesian notion that natural disasters are likely to rev sluggish economies into states of higher employment and improved standards of living.

As Yevdokiya Zagumenova responds in the comments section:

If all those people so value those fantastic improvements so much, why weren’t they knocking down their homes voluntarily, burning up all the stuff inside them and erecting these new modern palaces? Why wait for a hurricane to come along every 125 years to install these wonders of technology?

(Greg Webb has a similar comment.)

This question is indeed key.  Asking this question should by itself be sufficient to expose the fallacy at the heart of the argument that Jamie Newman and Peter Morici find appealing.  Yet Mr. Newman has two come-backs.  Neither, alas, succeeds.

First, Mr. Newman points out (quite correctly) that people do often voluntarily tear down or otherwise refurbish their homes and businesses without being prompted to do so by a natural disaster.  Of course they do, but the fact that they do such tearing down and refurbishing on their own timing makes all the difference.  There is nothing at all irrational (or contrary to anything that Bastiat or any other good economist taught) about someone deciding that the benefit of ‘destroying’ (or abandoning, as is usually the case today with computers) older assets and replacing these with newer assets is worth the cost of doing so.  As Mr. Newman understands, it happens all the time.

But what also happens all the time is that people choose each day not to destroy or abandon older assets in order to replace them with newer and technologically better ones.  My house is almost 20 years old.  I wish that it were newer and had less wear and tear.  But I choose today (as I’ve chosen for each day of the nearly 12 years that I’ve lived in it) not to destroy it today in order to replace it with a newer and better version.  While I understand that I would get some, perhaps much, benefit from having a newer and more modern home, the cost to me of purchasing that benefit is greater than the value to me of that benefit.  And so I’m darn pleased that my home was spared by hurricane Sandy.

Mr. Newman’s second response is this answer to the question “Why didn’t people in Breezy Point burn down their own homes?”

Why didn’t the residents of Breezy Point burn down their own homes? Because their insurance companies would not pay to rebuild them if they did.

There are two related flaws in this response.  First, while the residents whose homes are destroyed by Sandy and then rebuilt with proceeds from their insurance policies might well be better off after the rebuilding – that is, actually pleased that Sandy did what it did to their properties – the owners of insurance companies are worse off by a greater amount.  The economy as a whole is poorer.

To see why the losses suffered by shareholders of insurance companies are larger (as a result of Sandy) than are any resulting benefits enjoyed by policy holders whose homes are rebuilt with those insurance proceeds, one need only ask – and then answer – the question: If the benefits to the homeowners of destroying their homes and then rebuilding newer ones is greater than the losses suffered by insurance companies for paying for such voluntary destruction and rebuilding, why would homeowners’ awareness that insurance companies will not pay to replace voluntarily destroyed homes stop the homeowner from destroying their homes and rebuilding newer ones?

By assumption here, the net benefits to homeowners exceed the costs of destruction and rebuilding.  So even without insurance companies’ picking up all or part of the tab, if in fact the net benefit to homeowners of destroying and rebuilding is worth the full cost of doing so, homeowners will take this course regardless.  The fact that an insurance policy contractually transfers, under some circumstances, the costs of rebuilding from a principal (the insured) to an agent (the insurance company) does nothing to alter the measure of the full benefits and costs of rebuilding.

As Mr. Newman points out elsewhere, such voluntary destruction and replacement does take place on many occasions, typically without insurance companies footing the bill – a fact that should clue him in to the fallacy in his insurance-company point.

(There are likely much-better ways to articulate this last point of mine, but the press now of other duties today robs me of the time necessary for me to improve my exposition.  Others are encouraged to try.)

UPDATE: Jason Brennan makes a related point, succinctly and correctly.

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