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A Tsunami of Bad Economics

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A Tsunami of Bad Economics

The broken Krugman fallacy.

Japan was hit by a tsunami last year on March 11. That’s not news, but the reaction of some economists sure is. Just imagine looking up at a hundred-foot tall column of water rushing towards you at highway speed. This was the last thing some people ever saw. According to official estimates, that wave killed more than 15,000 people and injured nearly 27,000 more. What’s the upside to this natural disaster? I’ll be blunt. There isn’t one. But some economists think there is.

To come to such an inhumane conclusion is to forget the economic discipline’s most fundamental lessons. Now that a year has passed and rebuilding is well underway, economic data is starting to come in that quantifies the tsunami’s impact. As it turns out, Japan’s GDP is growing twice as fast as America’s. Paul Krugman, in a recent post in his New York Times blog, argues that the tsunami played a starring role. He writes:

So Japan, which is spending heavily for post-tsunami reconstruction, is growing quite fast, while Italy, which is imposing austerity measures, is shrinking almost equally fast. There seems to be some kind of lesson here about macroeconomics, but I can’t quite put my finger on it...

Imagine for a minute that the tsunami never happened. Japan’s GDP growth would probably be slower; Krugman is almost certainly correct on that. And yet, a tsunami-less Japan would be better off. For one, the survivors wouldn’t have 15,000 holes in their hearts where their families, friends, and neighbors used to be.

As far as the economy goes, all that reconstruction spending would instead go to creating brand new wealth, as opposed to merely replacing what people already had to begin with. It is better to build than to rebuild.

Krugman, just as he did after 9/11, has fallen for the broken window fallacy. If a kid breaks a window, that creates a job for the repairman and boosts the economy. The lesson: break every window in the world, and we’ll all be rich. That tsunami broke a lot of windows, and according to Krugman, Japan is reaping the benefits. Maybe we should hope for another one.

If there is indeed a macroeconomic lesson here, it is to not rely so heavily as Krugman does on GDP to measure how well an economy is doing. GDP certainly has its uses. But over-reliance on that single statistic can lead to ghastly conclusions such as the one Krugman hints at: pray for more tsunamis. Or, failing that, alien invasions (I’m serious).

The trouble with such thinking, besides its basic inhumanity, is that Japan’s GDP surge isn’t evidence that its people are richer because they endured a tsunami.

To understand why, you need to know the difference between a stock and a flow. Things such as buildings and roads are stocks of wealth. GDP doesn’t measure that. It only measures the flow of wealth. Buildings and roads only add to GDP in the year in which they are built. But they remain tangible stocks of wealth for as long as they exist.

Despite Fannie Mae’s best efforts, your home is worth more than zero -- even if it’s more than a year old. GDP doesn’t capture that. And when that tsunami practically washed away entire towns, Japan’s GDP didn’t go down by a single yen. Clearly this is not a good yardstick for measuring the tsunami’s economic impact.

GDP measures how fast wealth is being created, and the faster the better. But the speed of that flow doesn’t measure how much wealth actually exists at a given time. Nor does it distinguish between replacing something that was there before, versus creating something new. The tsunami destroyed a good chunk of Japan’s stock of wealth. The rush to restore it has quickened the flow of GDP, which is the cause for Krugman’s ghoulish celebration. But Japan is still poorer than it would be if the tsunami never happened.

Natural disasters are called disasters for two reasons. One is that they kill people. The other is that they destroy wealth, even if post-disaster GDP makes it look they create it.