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March 25, 2011

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"Following disasters like this, there is a lot of reconstruction to do. Even though you have a big net loss of wealth, the reconstruction adds new economic activity in the form of jobs and orders for all sorts of goods..."

Be careful (not you, but everyone) that you don't interpret his words to mean Japan will have a favorable NET economic benefit from this disaster. In other words, remember Bastiat's broken window fallacy.

Hi D, I hope you could expand on that a little bit. I'm on the Mississippi Gulf Coast, and in New Orleans, and I'd certainly admit that the reconstruction, while bringing things up, hasn't been a panacea. But much of that is related to how the reconstruction was funded, what was reconstructed and a host of other considerations. I'm still trying to sort out what will happen, so I'd be interested to see a discussion of where reconstruction has created good or bad effects.

I'd guess that D's point is that after the earthquake, lots of things will be rebuilt, huge amounts of money will be spent, and if you're only looking at GDP, things will look great because all the reconstruction activity is counted but the loss of human and physical capital doesn't factor in at all. But of course the earthquake still represented a huge loss, in both human lives and wealth; it is just that some common economic measures give a deceptive impression.

Wikipedia explains the broken window argument a bit here (note that this is totally different from the broken windows theory in criminology). Wilkinson expands on this argument here.

What Turb said.

If natural disasters were a plus for the economy, you could introduce a few man-made ones for even more stimulus.

With the manmade kind, too, you could evacuate first & avoid loss of life.

The money being spent fixing things up makes some economic metrics look good, but the problem is that you're spending all of that money to, in effect, get back what you had prior to the disaster.

That you'd have a bunch of new buildings is a bonus, but that a bunch of perfectly serviceable structures were destroyed in some unplanned and premature fashion in the process of getting them...isn't that obviously a wasteful, unproductive use for that money?

Sorry, I thought you guys were familiar with the Broken Window Fallacy. Bastiat writes about making sure that everyone considers both "what is seen" AND what is not seen." So, in this example...

We have a boy who breaks a window at a factory. Then an economist (a bad one) comments on the situation by saying "hey look this isn't so bad. Because now the factory owner will have to spend money on a window, which gives work to the window-maker, which helps the window-maker afford to hire a new worker, which helps that worker pay for food for his family, etc. etc. etc." The economist then says "look at all this economic activity that was stimulated by this broken window. See! Breaking a window isn't all that bad. look on the bright side!"

Now, Bastiat says "No, you're dumb. Because what we DINDT SEE is what would have happened if the boy hadn't broken that window. If the window remained unbroken, then the factory owner could have spent his money on some other good. And, support some other enterprise, which could then hire some other worker etc. etc. etc.

Moral of the story: disaster reconstruction does NOT help the net gain of an economy. All it does is redirect money that would have gone to something else. Thus, the Japanese construction industry will now be getting funds that would otherwise have been reserved for other projects, that would in all likelihood, better contributed to Japan's overall economic prosperity.

This is the broken window fallacy. And it is very, very important to remember. Bastiat in fact extends this fallacy to point out the waste of high government spending on projects that are not 100% useful/relevant to the public (as opposed to lining the pockets of bureaucrats), as well as to point out the problem of tariffs on certain goods. I suggest reading him.

(I was citing this from memory, so the exact details of the story might be slightly off, but the point remains the same).

Of course, now there are like 4 other blog posts on top of this one, so this is buried. I don't remembering this happening so often in the past on this site. I'm not sure I like the new format.

Hmmm, the fallacy is, according to the wikipedia page, that breaking windows is a good thing. This seems a little different to looking at a natural disaster and trying to determine how (and if) Japan is going to rebound. I hope I'm not arguing that this is some blessing in disguise, but given the nature of the global economy, I think it is worth reflecting on what might happen.

There are two japan internal factors, one of which was mentioned in the interview. That one was that while the LDP has, even though basically agreeing with medium term goals of the current party in power, the DPJ, has refused to sign off in hopes of being re-elected. This crisis might allow that to happen. Of course, I think of the consensus that arose after 9/11 and how wonderful that has been.

The second is that a massive amount of wealth in Japan is tied up in low interest bank accounts. Japan used to have the highest household savings rate of any country, though that has declined drastically, but it apparently still has rather large corporate savings. (here is a link, but again, I'm hoping folks with more econ nous will be able to give more links and data)

On the other hand, this (also pre tsunami) points to the fact that the Japan is now reaching a point where it will have to borrow money, which could be a gigantic monkey wrench in the world economy, if I understand this correctly.

Also, I was pretty shocked to see the Japanese yen strengthen after this, though I understand why in an abstract sense. Warren Buffett said this was a unique opportunity to buy Japanese stocks (this article argues against that, but it will give an entry point) and this Japan Times blog post (along with a second interesting one about Japanese hoarding) gives a reasonable explanation.

The BWF doesn't predict the future. It's not made to answer "how" or "if" Japan will rebound. It's saying that reconstruction does NOT equate to "rebound." It's saying be careful, don't look at reconstruction efforts and think "look how much better Japan is now. Look at this bump in % GDP growth this quarter."

Perhaps, the best way to think about it is, don't start drawing graphs of Japan's "rebound" until after the north eastern part of Japan is restored. Because anything restoration-related is just money going in to fill a hole. Not to build up the mountain. The real test is after reconstruction efforts, does Japan's economy continue its previous pre-March 2011 doldrums, or do things improve.


As far as the other two theoretical consequences you mention, I don't think those are related to what I'm discussing at all. The first one isn't even economic related.

Sorry, I thought you guys were familiar with the Broken Window Fallacy

I'm sorry; what did I say that might lead you to believe otherwise?

D,
I'm trying to find where the link I cited said 'rebound'. I'm also interested in other examples of reconstruction after disasters and the economic impact. If you think Grimes or anyone else is falling for the broken window fallacy, please explain or link to. Thanks.

If you think Grimes or anyone else is falling for the broken window fallacy, please explain or link to. Thanks.

Well, there is the bit where you wrote:

Reconstruction spending will have a favorably [sic] impact on the economy

While the disaster will likely boost some narrow measures of economic performance, it will probably be a huge net loss to the economy as a whole.

WIll the reconstruction not have a favorable impact on the economy?

More than no recovery, I'd expect. But lots less than no disaster.

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