In the aftermath of the quake and tsunami in Japan, Larry Summers talked about the human tragedy and then gave his thoughts on the economic impact:
“If you look, this is clearly going to add complexity to Japan’s challenge of economic recovery,” Summers said. “It may lead to some temporary increments, ironically, to GDP, as a process of rebuilding takes place. In the wake of the earlier Kobe earthquake, Japan actually gained some economic strength.”
In Parts I and Part II I discussed why I thought this conclusion was bizarre. It unmistakenly suggests without qualification, that there can be a positive financial impact from destruction.
As some commenters pointed out, GDP is a flow and wealth is a stock. That is, GDP compares the change in output over time while wealth is a snapshot. So it is possible to lose wealth (destroy buildings) while GDP goes up. It’s possible. I don’t think it’s very likely but it’s possible. In this sense, an increase in GDP is a misleading measure of well-being. Is that what Summers meant? It’s not consistent with his remarks about gaining “economic strength.” He doesn’t say anything about this distinction. And as I pointed out in Part II, Paul Krugman offered no qualifications of this kind when he said that the destruction of the Twin Towers could lead to economic growth.
Some commenters (Tim Worstall, for example) pointed to savings or the liquidity trap as a way to make sense of Summers’s remarks. Yes, during a recession, some people hold their wealth in the form of cash and do not spend all of it. So if I have nothing to spend my money on or if savings are not being invested, then spending will be lower than it otherwise would be. In the Keynesian story, this is why spending of any kind is essentially a free lunch–there’s no foregone consumption or investment. I confess I have trouble understanding this argument. Oh I understand how it works in the model. But in reality, is this plausible? Yes, there are always resources that are unused at any point in the economy. Always. Even when unemployment is “only” 4%. But there is also a very imperfect match between any particular spending increase and connecting it to those unused resources. But even if you believe that some spending creates some output that wouldn’t have been there otherwise, surely that isn’t true of all spending at all levels. So you’d still want to qualify your remarks on spending creating economic strength.
As John Dewey pointed out in a comment, the destruction doesn’t simply destroy bricks and mortar. Much of what has been destroyed is part of the productive capacity of Japan. So suggesting that somehow rebuilding buildings is adding to GDP holding everything else constant is a silly statement. You can’t hold everything else constant. Look at this horrifying video and tell me if you think recovering from this tragedy is going to increase GDP in Japan or lead to increased economic strength.
Cleaning up the mess and rebuilding are going to mean many sacrifices that wouldn’t be necessary in the absence of the destruction. Japan is going to be poorer for a while. Not richer. And the loss of capital means the losses will extend over time.
Destruction is bad for the economy and yes, even bad most of the time, maybe all of the time, for measured GDP. The remarks by Larry Summers (and by Krugman in the aftermath of 9/11) imply otherwise. If they have something more subtle in mind, they should say so.