The Economics of Natural Disasters
Chief Investment Officer
“Rebuilding efforts will stimulate the economy, temporarily."
Before starting this quarter’s discussion, I first want to extend from all of us at Goelzer our heartfelt sympathies to those who have suffered due to the terrible devastation caused by the recent hurricanes and earthquakes. The past two months have been a time of tragedy, frustration, and sadness for many people. We are aware that many of you were affected personally by the storms and we hope that you and your families are safe, healthy, and on a path to recovery.
It may seem insensitive to discuss money and the economy at a time when so many people are suffering. But in our modern world, money and a healthy, developed economy make it possible for people to recover from natural disasters. A healthy economy provides the well-funded banks needed to make loans, solvent insurance companies needed to pay claims, skilled labor force needed to rebuild, a stable government needed to provide aid and security, and the charity of thousands of people who donate money, supplies, and labor. And to that end, the United States is fortunate to have the world’s largest and wealthiest economy.
Because of this, rebuilding will occur. Florida and Texas will recover. And what will be the effect to U.S. economy? The irony is that it will actually experience higher growth, at least temporarily.
Natural Disasters' Effect on the Economy
Natural disasters cause disruptions and distortions to economic activity. A good example of this is displayed in Figure 1 which shows growth rates for the construction and retail industries in Louisiana during the calendar quarter it was struck by Hurricane Katrina and the four quarters that followed. We chose these industries because they are two of the most directly affected by major storms. As expected, activity declined during the quarter that the storm hit. What followed, however, was a surge in activity as workers rebuilt homes and businesses and residents replaced cars, furnishings, and other retail goods. This pattern is typical for major storms.
Katrina’s effect on Louisiana’s economy was dramatic, but its effect on the overall U.S. economy was relatively small. This was simply because the massive size of the U.S. economy dwarfed the storm’s economic costs. Perhaps the storm’s largest effect on the broader U.S. economy was the resulting temporary spike in gasoline and natural gas prices. Early estimates indicate that the damage inflicted by recent hurricanes may be more extensive and costly than the damage caused by Katrina, especially when you add the destruction throughout the eastern Caribbean. This latest round of storms, however, has not caused a significant rise in gasoline or natural gas prices.
More Activity Now, Less in the Future
Whatever the recent storms’ economic effect on the overall U.S. economy, it is important that investors understand that it will be temporary. In addition, investors should be aware that any increased activity over the next year will likely have a negative effect on future activity. For example, workers will immediately begin to replace many roofs that were damaged by these storms. However, a large portion of these same roofs would otherwise be replaced over the next ten years simply due to normal wear. But because workers will replace them in the coming months, they will no longer need to be replaced during the next ten years. In other words, some of the increased activity that we will see over the next year is simply the pulling of future business into the present.
More Activity, but not More Wealth
It is also important to understand that this increased economic activity does not translate into increased wealth for the economy as a whole. Yes, some workers and manufacturers will benefit from their participation in the rebuilding efforts, but their gains are offset by the losses that property owners or their insurance companies incur. Natural disasters are wealth destroyers, not wealth creators.
Hurricanes, earthquakes, and the like are physically, emotionally, and economically devastating. Rebuilding efforts will stimulate the economy in coming quarters, pulling future demand to the present, but at the expense of future growth, all else being equal. Of course, all else is never equal. Many other factors are at play as well, and certain companies and industries will benefit from the rebuilding efforts while everyone affected will bear the burden, financial and emotional.
One final thought. We do know one thing for certain. Americans have always responded generously and heroically in the aftermath of disaster, natural and otherwise. Harvey, Irma, Maria, and the Mexico earthquakes were no exception.