So it turns out that the mandarins in
Japan's Ministry of International Trade and
Industry have hatched yet another crazy plan to
boost their flailing electronics manufacturers -
Sony, Panasonic are suffering while Sharp looks
set to bite the dust.
The cunning plan, as
Baldrick from Black Adder would describe
it, goes thus: first find some seriously stupid
people to come on television with a particular
focus on financial media. Okay, that's not so
difficult. Then get the news anchors to ask them
some incredibly stupid questions. Alright, that's
not difficult either. Wait for the inevitable
stupid answer.
That's about it actually.
You see, when people like me watch such stuff on
television, physical laws pertaining to the
accelerating momentum of
irregular objects inevitably colliding with the
plane of stationary surfaces comes into play. Or
to put it into simpler words, I throw stuff at the
television; sometimes I throw potato chips but at
other times the bowl the chips came in. Ergo, new
television needs to be purchased; and therefore
the Japanese export problem is resolved.
The proximate provocation was an analyst
from a "big" investment bank who came on financial
television to breathlessly advise the unsuspecting
public that Hurricane Sandy was actually good for
the US economy because all the reconstruction work
by homeowners, increased federal and state
spending to fix infrastructure, and all those
insurance company payments would boost
construction, consumption and even (bless his
noble heart) propel employment. I don't know what
he said after that because the television was
broken at that point. Alright, I broke it.
It does strike me though that the
confusion between production and wealth lies at
the core of the conflict between the discussions
propelled on the one hand by Keynesians and on the
other by Austrians. But I am getting ahead of
myself so let's return to the case about Sandy.
So imagine that before Sandy, the
economies of New York and New Jersey were
producing some US$1,000 (feel free to add as many
zeros as you want in this example if $1,000
doesn't excite your imagination). Thanks to Sandy,
there's reconstruction of houses of $20, and
government spends on roads and flood defenses for
another $25. Against that, a bunch of folks can't
get to work or are dead so we lose $30 in
production and consumption. In the above example,
the economy is ahead by $15, or 1.5%; which counts
as gross domestic product (GDP) growth. So the
idiot on television was right after all; why on
earth would I object to this wonderful bit of
logic?
The reason is of course that
Keynesians fail to understand that old problem in
economics, framed as Bastiat's broken window: the
added production presumes that there are no wealth
effects. In the example of Sandy, the homeowners
who have to rebuild their houses (or pay more than
what the insurance contracts cover) would have
dipped into the savings for a holiday or the
purchase of an artwork. The "lost" purchase of a
holiday or artwork isn't factored into the economy
because it hadn't taken place (or may not have
occurred in the year in question).
But
that's not all of it. Homeowners living in an area
that has been affected by the floods would have to
countenance higher running costs for their house
through more insurance payments (eventually),
flood preparations such as electricity generators
and survival kits; as well as face the wealth
effects of lower home prices, which could mean
greater savings for other investments designed to
improve retirement preparations.
So when
you add all of that up - or more precisely,
subtract all that - the effect on the homeowner's
annual spend is negative due to the higher
wasteful and investment expenditure that he is now
committed to due to the flood. Therefore, it would
take the thinking of someone from a parallel
universe to consider any of that as positive for
the homeowner and by extension the economy.
Alright, you say; the homeowner has no
benefit but what about the government investment
in new road and flood defenses: surely that bit is
positive for the economy? Yes, in the strict sense
of production, but once again it ignores the
universal effects on the action.
In a
country like the United States, which is now
running a massive fiscal deficit, emergency
spending is actually worse than a zero sum game:
new roads in New Jersey mean less funding for
planes manufactured in Seattle that the government
may have ordered otherwise; but also more
preparatory (or contingent funds) that reduce from
the total budget.
And what about
situations where the government is running a
fiscal surplus (I could only think of some Asian
countries when trying to come up with some
examples) - is emergency infrastructure spending
negative there as well? Well, yes: in those
countries, the government will not hand out tax
cuts that may otherwise have been pushed through.
So whichever way you think about it, there
is nothing "good" about the spending that follows
a storm; any boost to economic production is
strictly an arithmetic exercise that is considered
without the benefit of evaluating wealth effects.
If this stuff were so obvious, why do some
folks fail to get it?
The glib explanation
is that these folks are Keynesians and it is
beyond their genetic disposition to look at the
world beyond headline statistics into more
complicated stuff like cause and effect. These are
the same folk who tell governments to boost their
spending in order to counter the effects of wealth
destruction in the private sector (colloquially
referred to as a recession). So governments start
borrowing from the future, piling on risks for the
folks who have to repay the debts finally.
They (ie taxpayers) deal with this
situation by postponing consumption to accommodate
higher taxes in future. Folks who don't get that
natural reaction (like that of the homeowner
affected by floods who sets aside emergency funds
for future contingencies) - let's call them
Krugman acolytes - would at this point demand the
government does even more, in an effort to
steamroll the taxpayers into submission. That
might work for a year or so; but pretty soon
everyone tries to get out of the debt trap by
saving more and the elusive growth that the
Keynesians were rather counting on.
That
right there is the source of the whiplash effects
on the economy, producing inexplicable volatility
in asset prices and returns. I might add at this
stage that this type of volatility - uncertainty
rather than risk in the Frank Knight sense of the
terms - doesn't augur well for wealth planners who
usually respond by cutting spending even further
to boost investments and savings.
So the
most useful thing about Hurricane Sandy is that it
might help Keynesians think twice about their
recommended course of action; and the sheer
futility of trying to offset wealth effects with
immediate spending boosts. In that sense, this
storm may end up being "good" for the economy.
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