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Hurricane Katrina and the Economy

Hurricane Katrina and the Economy


Updated September 08, 2005
It's still far too early to predict the size of the impact Hurricane Katrina will have on the U.S. economy. However, there are a number of points you should keep in mind when you listen to pundits discuss the likely economic impact Katrina will have.

Katrina Moving Economic Activity

In the short run, a lot of economic activity that would normally go on in the New Orleans area is going to get diverted to other locations. For instance, I was planning on attending a conference in New Orleans near the end of October. The conference organizers have not announced where the conference will be moved to, though I've heard rumblings tha it will be moved to Washington, DC. This added activity in Washington DC will be beneficial to their economy. This impact will be felt all over America as tens of thousands of conferences, vacations, sporting events, etc. will have to find new venues. None of this will be new economic activity - it merely diverts existing economic activity to new locations, which will be a boon for those locations. Of course, this will be mitigated somewhat in the long run by the added taxes or lower government spending in their city due to government dollars being needed in New Orleans for the reconstruction project.

Oil Prices and Katrina

We've all seen and felt the higher oil prices caused by the damaged caused by Katrina. These will naturally cause the economy to slow, as oil is used in all sorts of manufacturing processes and as a means of getting goods from the producer to the consumer. Many companies will decide that some goods are just not worth the additional cost to produce and ship - causing output to fall. Higher gas prices will also cause people to drive less, which has the beneficial side effect of helping countries such as Canada come closer to meeting their Kyoto obligations.

The Economic Impact of the Reconstruction

There will be a boon for the construction industry and their suppliers as their services will be in great demand when the reconstruction of damaged areas begin. Canada is expecting increased demand for softwood lumber and steel manufacturers are also expecting increased sales.

This does not mean, however, that economic activity as a whole will increased. The money spent on the reconstruction effort is money that will have to be diverted from money spent in other areas. Overall we should expect a net loss to the economy, as explained by The Broken Window Fallacy detailing what happens when a vandal breaks a $250 window, which a storekeeper then has to replace:

    "After all, if windows were never broken, what would happen to the glass business? Then, of course, the thing is endless. The glazier will have $250 more to spend with other merchants, and these in turn will have $250 to spend with still other merchants, and so ad infinitum. The smashed window will go on providing money and employment in ever-widening circles. The logical conclusion from all this would be ... that the little hoodlum who threw the brick, far from being a public menace, was a public benefactor." (p. 23 - Hazlitt)

    The crowd is correct in realizing that the local glass shop will benefit from this act of vandalism. They have not considered, however, what the shopkeeper would have spent the $250 on something else if he did not have to replace the window. He might have been saving that money for a new set of golf clubs, but since he has now spent the money, he cannot and the golf shop has lost a sale. He might have used the money to purchase new equipment for his business, or to take a vacation, or to purchase new clothing. So the glass store's gain is another store's loss, so there hasn't been a net gain in economic activity. In fact, there has been a decline in the economy:

    "Instead of [the shopkeeper] having a window and $250, he now has merely a window. Or, as he was planning to buy the suit that very afternoon, instead of having both a window and a suit he must be content with the window or the suit. If we think of him as a part of the community, the community has lost a new suit that might otherwise have come into being, and is just that much poorer." (p. 24 - Hazlitt)

    The Broken Window Fallacy is enduring because of the difficulty of seeing what the shopkeeper would have done. We can see the gain that goes to the glass shop. We can see the new pane of glass in the front of the store. However, we cannot see what the shopkeeper would have done with the money if he had been allowed to keep it, precisely because he wasn't allowed to keep it. We cannot see the set of golf clubs not purchased or the new suit foregone. Since the winners are easily identifiable and the losers not, it's easy to conclude that there are only winners and the economy as a whole is better off.

Because of this, the economy will suffer due to the hurricane, not benefit as some talking heads have claimed.

Those are my thoughts about the likely economic impact of Hurricane Katrina. I'd like to hear yours!

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