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Disasters are just that, and not a boon to economy

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By James McCusker
Published:
Before, during and after superstorm Sandy we were assured by some analysts that it would result in a boost for the economy, no matter how much damage it did to people's lives and property.
Historian and social critic Thomas Carlyle called economics "the dismal science," a defining nickname that stuck. Predicting a post-disaster economic boost, though, goes beyond dismal. There's something almost ghoulish about it. Under this kind of economic thinking, the Apocalypse would be a bonanza. Unfortunately, predictions like this also fit easily into a view of economists as a bunch of number-noggins who see human misery and loss as an abstraction and calculate how much employment and profit is in it for others.
To the extent that there is any truth in this prediction it reflects the narrow and particular way that we, and the news media, define and measure economic progress by changes in gross domestic product.
There is nothing wrong with GDP. When economist Simon Kuznets developed the system of national accounts in the latter part of the 1930s it was a brilliant piece of work, and it continues to enrich our knowledge of how an economy works as well as the state of its health.
The GDP, though, is focused on national income and Kuznets was very open about its limitations. He emphasized that it was not a good way to measure whether people are better off.
GDP's focus on income also follows the general practice in government budgeting and accounting, which focuses on the income statement and ignores the balance sheet. Although in recent years government analysts have developed a balance sheet, there is no solid linkage between the two as there is in business or even personal finance. And even if there were that kind of linkage, it isn't clear that politicians and the public would pay much attention to it.
The missing balance-sheet linkage is the reason why the number-noggins' predictions about the result of Hurricane Sandy might turn out to look right. The increased activity in recovery, repair and reconstruction might be reflected in the GDP numbers. What does not show up there is the offsetting net loss that people suffered.
A clue as to what's wrong with the economics behind the predictions shows up when we realize that the post-storm economic activity is largely driven by the insurance industry. If insurance did not exist and people were uncompensated for losses, any post-disaster economic activity would have to be funded by the savings and borrowings of the people and businesses who suffered the losses.
Most individuals and small businesses cannot afford to replace all of their assets lost to a storm or other natural disaster. They do not have sufficient savings to cover the loss. Restoration would depend on finding adventurous or bargain-hunting investors willing to invest in the affected area.
Insurance, though, spreads the cost of the loss so that it is shared by a much larger group of people, producing savings large enough to recover and rebuild. In effect, the insurance industry is an intermediary, collecting money from people who agree to share the cost of losses and fund replacement by giving up part of their net worth ahead of time -- usually in the form of annual premiums.
One of the ironclad rules of the casualty insurance industry, though, is that they do not pay for losses not incurred. The maximum payment for rebuilding and restoration, then, is the replacement value of the assets. If it were consistently more than that amount, the insurance company would go out of business.
In the case of a natural disaster, then, what shows up in the gross national product is the amount of any rebuilding activity. The amount of the actual loss from the disaster is estimated and recorded separately in a table of data showing net changes in national assets.
Under the best possible circumstances, the assets lost would be equal to the insurance-sponsored increased activity--and the effect will be no substantial increase or decrease. When the uninsured losses are taken into account, though, there is a negative effect on the economy, which tracks with the cold reality of a natural disaster.
Virtually every college textbook used in an introductory economics course includes a chapter on the national accounting system and there is little doubt that it is the least popular part of the course. Smart instructors, then, keeping in mind their student ratings, usually spend as little time as possible on the subject.
The national accounting system, though, gets our economy's facts straight and keeps us from believing that natural disasters boost our economy. Earthquakes, fires, floods and windstorms often bring out the best in us, but they are still disasters.
James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Herald Business Journal.

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