Thursday, November 29, 2012

Economists Offer Varying Post-Hurricane-Sandy Economic Predictions

During the last week of October 2012, Hurricane Sandy swept through the east coast of the United States. This “superstorm” damaged homes, businesses, and infrastructure, such as roads and power grids. Hurricane Sandy also shut down business activity for two days in twelve states (from Virginia to Maine). The estimated damage and lost economic activity is between $30 and $50 billion, which amounts to between 0.2% and 0.3% of gross domestic product (GDP). After the storm passed, economists offered their early predictions of Hurricane Sandy’s short-term and long-term national economic effects. However, there is little consensus among these predictions.

Some economists believe that Hurricane Sandy will create greater economic growth in 2013, which will outweigh the superstorm’s negative effect on fourth-quarter GDP in 2012. For instance, Mark Vitner of Wells Fargo predicted that a 0.2% increase in both first and second-quarter GDP in 2013 will outweigh the 0.1% to 0.3% decrease in fourth-quarter GDP in 2012. These economists base their predictions on a theory called the “broken window effect,” which posits that economic activity will increase after an event of severe destruction (if a window is broken, money must be spent to fix it, which boosts GDP). Applying this theory to Hurricane Sandy’s destruction, activity in the construction industry will increase to fix damaged homes, businesses, and infrastructure. This increased activity will lead to job growth and, in the long-term, economic growth.

Other economists rebut this theory—calling it the “broken window fallacy.” Economists, like Gregory Daco and Nigel Gault of IHS Global Insight, argue that Hurricane Sandy will have a negligible effect on GDP because the increased activity in the construction industry will act as a substitute for activity in other industries, such as entertainment. For example, rather than spend money on a vacation, consumers will spend money to fix their damaged homes. History seems to side with this group of economists, as a study by Eric Strobl (from the Ecole Polytechnique in Paris) found that hurricanes between 1970 and 2005 generally had a negligible effect on the national economy.

Despite these differences in predictions, most, if not all, economists would agree that the damaged homes, businesses, and infrastructure should not only be rebuilt, but should be rebuilt to be even better than before—for example, sturdier and more energy efficient buildings. This would increase the nation’s capital stock (a term that includes plant (such as factories and other structures), equipment, and machinery) as it would be more productive and efficient, and would provide the nation with a better chance for economic growth in the future.

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