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Katrina: A devastating storm now a source of economic uncertainty

Author: Roger M. Kubarych
September 15, 2005
Market Eye on Nikkei Financial Daily

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The devastation caused by Hurricane Katrina, the most costly hurricane in recent US history, but less powerful than numerous hurricanes (or typhoons, as they are called) in Asia, raises questions about the economic effects of this and other terrible disasters.  Coverage in the press and on TV rightly focuses on the human costs, as well as the damage done to homes, businesses, and infrastructure. But how should economic policymakers view the consequences and what should they be doing about them? 

Many economists believe that it is only logical that the destruction of factories, refineries, offices, and small businesses would depress output just after a disaster like a hurricane, followed by a temporary burst of activity once conditions on the ground get back to normal.  Property losses may be extremely high, and insurance companies may suffer large losses in paying claims.  Uninsured losses may have a “wealth effect” that discourages spending by businesses and households.  But over a reasonable period of time, normally thought to be a little less than a year, the net impact on GDP, the measure of a nation’s current output of goods and services, may turn out to be somewhat positive as the reconstruction effort goes forward. 

That analysis is logical and many accept it as conventional wisdom, but is it always right?  To find out, the place to start is by reviewing the pattern of GDP, employment, and construction activity following past disasters.  What we learn from such an exercise is that broad economic forces, not hurricane damage and reconstruction, usually determine overall GDP growth.  Notwithstanding conventional wisdom, there is no clear pattern of falling GDP growth in the period just after the disaster, followed by a temporary burst of activity later on. 

Looking at the ten most costly hurricanes, the rate of growth of GDP in the United States declined after major storms in about half the cases, but held steady or even rose in the other half.  More striking, in the period thought to benefit from a rebuilding effort, economic growth accelerated in only one of ten cases.  There was no consistent burst of private construction activity, either residential or non-residential.  It is not too hard to find an explanation.  It takes a lot of time to plan major reconstruction projects.  For example, four years after the 9/11 terrorist attacks, work on building a new office tower on the site of the World Trade Center has only just begun.  And private reconstruction often must wait until necessary infrastructure repairs can be made.  That also leads to delays. 

What about employment effects of major disasters?  A review of the data on initial claims for unemployment compensation for the states most affected by the most destructive hurricanes and earthquakes shows that jobless claims do increase locally.  But that rise is rarely big enough to lead to a nationwide increase in unemployment.  And the subsequent reconstruction effort does not seem to pull up total employment levels, except in a few specialty construction occupations. 

Will Katrina follow these patterns?  The hurricane was special.  It has clearly done greater damage over a wider area than past disasters.  It was particularly destructive in the Gulf of Mexico, disrupting shipping, much of the oil & gas industry, and electric power generation.  Four days of destruction was enough to subtract 0.2% from the Federal Reserve’s industrial production index for the month of August, and further adverse output effects will be recorded for September.  But the latest reports from the Gulf suggest that conditions are getting back to normal relatively quickly. 

As for employment, the first comprehensive estimate of the effect on unemployment showed a 71,000 surge in initial claims for unemployment compensation.  Yet, incomes of displaced workers are being supplemented by sizable disaster relief assistance, helping most victims maintain a tolerable level of consumption.  That will be reflected in a big increase in the federal Government’s budget deficit, of course.  On balance, a small but measurable decline in economic growth in the third quarter is likely, and that may carry over into the fourth quarter as well. 

From a medium-term perspective, the biggest question mark concerns the prospects for reconstruction.  Can New Orleans be rebuilt in a way that it can withstand another massive hurricane at a cost that the state and federal government can afford?  No one knows, but there is tremendous political pressure to do the job, regardless of the budgetary consequences.  An economic stimulus of such magnitude may dwarf past rebuilding efforts.  So this time may be different.  This time recovering from the worst hurricane in memory may well have an impact on the overall economy and on inflation that neither policymakers nor the financial markets can easily ignore.

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