Tsunamis good for the economy? (Broken Window fallacy)

[Drooper]

I have never owned a home, so perhaps home insurance works differently than auto insurance.

A few years ago my car was hit by someone. The insurance company, after some inconvenience, cut me a check for something like $1500. The insurance company did not fix my car. That was my problem. The insurance company did not give me a blank check towards fixing my car. I got a reasonable estimate of the cost of fixing my car.

If you have a valid home insurance claim, do they give you whatever you want? Do they pay for a jacuzzi even if you didn't have one before? Maybe, but it seems odd.

The argument that is being made is something like this:

I'm using a chemistry analogy. There is a thermodynamic driving force for my books to become carbon dioxide and water. Why don't they? There is a kinetic barier. Let us suppose that someone owns a bathtub. They could buy and install a jacuzzi for $5,000. They want to do so. Why don't they? There is a certain amount of trouble and inconvenience that they don't want to put up with. The huricane comes along, and that barier is removed. In effect, the disaster acts as a catalyst for economic transactions that were thermodynamically favored.

Now, does that make the disaster a good thing? Not really. It does mean that there can be hidden benifits. You have to realize that there is a 'kinetic' element to transactions as well as the 'thermodynamic'.

Beware, this way lies madness. This analogy simply goes to show why chemistry isn't the best way to analyse economics, or why economics isn't the best way to analyse chemistry, or physics the best way to analyse chemistry etc.

 

[Drooper]

As in most ceses like these, I can see some truth in bost positions here.

Shanek is essentially correct about the fallacy of natural disasters. In a natural disaster we witness a loss of capital, physical and human, that reduces the level of income. However, following this there is a less than optimal level of capital stock the marginal return on capital is now higher), so investment rises, which produces faster growth in income - but from the lower level.
Since most layman's experience of economics is a type of pigeon Keysnianism, they see only the accelerating growth.


Having said that, I could see how under special circumstances, in some places, there could be some long term net benefits to income (not necessarily welfare). For example, heritage protection of structures exists to protect important buildings from greater financial benefit of replacing them. It allows us to capture what we deem as a society to be non-marketable welfare benefits by protecting our heritage, This is a museum-type argument.

Imagine the City of London, which has a lot of protected structures and an 18th century road network that goes with it. If that were flattened tomorrow there could be some net benefit in the long term as measured by marketed ouput/income (i.e. GDP/GNP) as wider roads are built, more modern and large building are built, the opportunity is take to do large scale underground works etc. However, we still would have lost an irreplacable architecture and heritage.

 

[Cain]

First of all, it was responding to a specific argument, so the existence of another argument does not take away from its validity. Now, it may be that they might manage to get more foreign aid than their actual losses. That's especially true when a relatively minor disaster receives massive coverage. But it's doubtful in general, especially in this case, sinc, given the scale of the disaster, it's difficult for the coverage to be "disproportinate".

The first sentence here makes no sense. The second, even if empirically true, ignores that we are addressing logical fallacy. The example of entropy is rather inspired here: Entropy may be at work in the universe, but some things, if we examine particularities, can buck theoverall trend.

If this assumption is false, that means that an opportunity exists to increase wealth. This leaves two questions:
1. Is it possible for wealth to be created?
2. Will wealth consistently be created?
The answer to the first question is "yes", but this is rather trivial. After all, if I go driving drunk, it's possible that I might hit and kill a psychotic killer, and society will be better off, but that's hardly a defense of drunk driving.
For the second, a "yes" answer would require not just that humans lack knowledge, but that disasters would effectively "know" more than hummans. The idea that the blind forces of nature can plan better than intelligent humans is difficult to swallow.

This does not follow. It's not a matter of blind forces "knowing better"; it's a matter of humans reacting to events and responding in new ways. Suppose a child pulls the firearm alarm as a prank. As a result the school discovers that it was not sufficiently prepared in the event of a real emergency. A conciously pernicious act had an unforseeable but positive effect. What's the famous quote by Adam Smith about the self-love of the butcher and the baker -- how narrow self-interest leads to the collective good.... Or how random mutations, forces of nature, created human beings. In fact, our existence is largely owed to the KT event 65 million years ago, which reset the playing field. Or do you wish to suggest our mammalian ancestors were the most fit and would have won out anyway? My God, have you ever watched sports? A multi-million dollar athlete gets side-lined with an injury. The coach subs in a young rookie who performs brilliantly.

Also, as an elementary point, the opportunity to create more wealth -- the possibility -- exists today, right now. We don't know what it is because it has not been invented or discovered yet.

Finally, we need not always claim reorganizing a firm or economy is unforseeable or unknown prior to disaster. Maybe a person does possess an inventive, positive idea, but others are naturally conservative, risk averse. When a hurricane or a tsunami wipes out everything, nobody really has much of a choice anymore.

Incidentially, this is precisely what is supposed to make capitalism efficient. Competition -- outside forces threatening the existence of a firm -- compels it to reorganize and become more efficient. Although a misuse of his intended purpose, we might appropriate Schumpeter's famous term "creative destruction" (which he in turn took from Nietzsche).

 

[shanek]

I have never owned a home, so perhaps home insurance works differently than auto insurance.

A few years ago my car was hit by someone. The insurance company, after some inconvenience, cut me a check for something like $1500. The insurance company did not fix my car. That was my problem. The insurance company did not give me a blank check towards fixing my car. I got a reasonable estimate of the cost of fixing my car.

If you have a valid home insurance claim, do they give you whatever you want? Do they pay for a jacuzzi even if you didn't have one before? Maybe, but it seems odd.

Not exactly...it's kind of like the car insurance, in that they give you the money to fix up your home, and it's based on things like how much damage there is to your home, how much insurance you paid for, your deductible, etc. But you can't just get that to spend however you want. It has to be used on home repairs or remodelling. So theoretically it could be used to install a Jacuzzi (although I admit I actually don't know about that), but it couldn't be used, say, to buy you a new car or a Caribbean cruise.

Let us suppose that someone owns a bathtub. They could buy and install a jacuzzi for $5,000. They want to do so. Why don't they? There is a certain amount of trouble and inconvenience that they don't want to put up with.

Which is all worked into what they feel the value of the Jacuzzi is worth.

The huricane comes along, and that barier is removed. In effect, the disaster acts as a catalyst for economic transactions that were thermodynamically favored.

But they still don't value the Jacuzzi as being worth that. It's just something they have to do anyway, so we're back to the "might as well" thing.

Yes, the Jacuzzi people get a sale they wouldn't have made otherwise; yes, the couple has a Jacuzzi they wouldn't have ordinarily had. But it's still not a creation of wealth, because if they had had the $5,000 to spend however they like they wouldn't have bought the Jacuzzi. The person who pays for it is not the same person as the one who decides to buy it. That's a huge difference.

 

[shanek]

Shane, this does create wealth under certain circumstances. If the houses replacing the old are better (have more value), and the money comes from outside the region, and goes to builders in the region, we have a case where wealth is not necessarily created but moved into the region.

But moved does not mean created. Yes, builders, plumbers, etc. get jobs and money they ordinarily wouldn't have gotten; but that money is being taken from other places which would have got the money had there been no disaster. That's why disasters do not create wealth. The Broken Window fallacy.

A disaster can be an economic boon for a region that is not a closed system.

Well, since we're bringing thermodynamics into the equation, you know that in order to reduce entropy in one system you have to create a greater amount of it elsewhere. That's pretty much the case here. In order to pay those who rebuild the homes, businesses, and infrastructre, you have to take money away from other places. Wealth isn't being generated on its own.

 

[shanek]

Imagine the City of London, which has a lot of protected structures and an 18th century road network that goes with it. If that were flattened tomorrow there could be some net benefit in the long term as measured by marketed ouput/income (i.e. GDP/GNP) as wider roads are built, more modern and large building are built, the opportunity is take to do large scale underground works etc. However, we still would have lost an irreplacable architecture and heritage.

Well, that really goes to my point: if people really did value the wider roads etc. more than the historical value of the current infrastructure, then they'd do it on their own. In the case of a disaster, the historical value is wiped out anyway, so we're back to "might as well."

 

[Bubbles]

There is one serious problem with your argument. It implicitely assumes that people are omniscient. If you don't like omniscient, try rational.

It assumes that the descision prior to the transaction will be the same as the one after the transaction. By that I mean that we make descisions looking forward at the unknown. We scrutinize those descisions looking back at the known. Consequently, a persons estimated value of the jacuzzi prior to owning one means less than their estimated value of the jacuzzi after they've had it for a month. They may well be saying 'If I had known what a chick magnet this thing is, I'd have gotton one years ago!"

While I don't believe the 'broken window' argument entirely, perhaps it is something like dynamic budgeting. It presents a factor into an analysis that mitigates some of the impact of a simpler analysis.

 

[shanek]

There is one serious problem with your argument. It implicitely assumes that people are omniscient. If you don't like omniscient, try rational.

Neither is the case, and I've already refuted this strawman once this thread.

 

[Tmy]

In a disaister you have many assest destroyed. The lives for example. Businesess, the bad PR for the large tourist industry.

Sure the bottled water guy will make alot of money, but for the most part the countries will be hurt by HAVING to spend money on an area which normally generates income for the country. Less tax revenue and more tax expenditures. Sounds like a bad deal for most of the players.

 

[Walter Wayne]

But moved does not mean created. Yes, builders, plumbers, etc. get jobs and money they ordinarily wouldn't have gotten; but that money is being taken from other places which would have got the money had there been no disaster. That's why disasters do not create wealth. The Broken Window fallacy.

Shane the whole point of my post was that he never suggests wealth is created, he said that "the countries will probably be wealthier". Countries in this context obviously refer to those hit by the tidal wave. If the rest of the world pays the cost of rebuilding, and in rebuilding put in systems slightly better than before the "countries become wealthier". Your argument about wealth creation is irrelevant as he never suggest wealth creation.

Walt

 

[Snide]

Shane the whole point of my post was that he never suggests wealth is created, he said that "the countries will probably be wealthier". Countries in this context obviously refer to those hit by the tidal wave. If the rest of the world pays the cost of rebuilding, and in rebuilding put in systems slightly better than before the "countries become wealthier". Your argument about wealth creation is irrelevant as he never suggest wealth creation.

Walt

Exactly, which I think Cain was trying to point out, too.

 

[shanek]

Shane the whole point of my post was that he never suggests wealth is created, he said that "the countries will probably be wealthier". Countries in this context obviously refer to those hit by the tidal wave. If the rest of the world pays the cost of rebuilding, and in rebuilding put in systems slightly better than before the "countries become wealthier". Your argument about wealth creation is irrelevant as he never suggest wealth creation.

Again, wrong, because you're failing to take into account things like the loss of life and the amount of time it takes to rebuild, things that cannot be recovered.

 

[Tmy]

Again, wrong, because you're failing to take into account things like the loss of life and the amount of time it takes to rebuild, things that cannot be recovered.

But I can see the point that the FUTURe of the country will be brighter coming out of the tradgety.

Liekofyou have an apartment building that catches fire. When your done rebuilding, the new apartments are now up to code and much nicer than the old. You can get higher rents and happier tenents once all is said in done. That wouldntve happened without the fire.

 

[shanek]

But I can see the point that the FUTURe of the country will be brighter coming out of the tradgety.

Again, if you ignore the things that won't. Sure, you could say that 100 years from now they'll have a much better infrastructure than they could, but they'll also have much lower human capital because of the 120,000+ people who won't be contributing their descendants.

Liekofyou have an apartment building that catches fire. When your done rebuilding, the new apartments are now up to code and much nicer than the old. You can get higher rents and happier tenents once all is said in done. That wouldntve happened without the fire.

Again, if that is a real benefit that creates wealth, then the person would have had the incentive to demolish the old apartments and start over. That happens, you know. There are companies whose sole service is demolishing buildings, and they exist because their clients believe that it is of a greater value to get rid of the buildings and put something else in their place.

 

[Cain]

Again, wrong, because you're failing to take into account things like the loss of life and the amount of time it takes to rebuild, things that cannot be recovered.

Are you kidding? One can take into (economic) account both. Human capital counts as infrastructure.

Sure, you could say that 100 years from now they'll have a much better infrastructure than they could, but they'll also have much lower human capital because of the 120,000+ people who won't be contributing their descendants.

I wonder if abortion and birth control has decreased society's overall wealth, you know, by limiting the output of the "ultimate resource".

Again, if that is a real benefit that creates wealth, then the person would have had the incentive to demolish the old apartments and start over. That happens, you know. There are companies whose sole service is demolishing buildings, and they exist because their clients believe that it is of a greater value to get rid of the buildings and put something else in their place.

Indeed, it's perfectly possible for an apartment owner to believe that demolishing his buildings and then financing reconstruction will ultimately bring him greater wealth. However, the relative risks involved may deter her from undertaking that measure. This is not a simple matter of, "Oh, well, if it increases wealth/income, then the owner would have done it already." As I said in my earlier post, this is precisely why competition is hailed as a good thing. It forces owners and managers to innovate as they under the constant threat of extinction.

Maybe smashing an entire city and rebuilding it will bring greater long-term wealth, but how does one implement such a dramatic undertaking? How and from whom does one obtain consent?

 

[shanek]

Are you kidding? One can take into (economic) account both. Human capital counts as infrastructure.

How do you rebuild human capital? How do you put lives back together? How do you reverse not only the death, but also the pain and suffering and loss to others which that death causes?

Indeed, it's perfectly possible for an apartment owner to believe that demolishing his buildings and then financing reconstruction will ultimately bring him greater wealth.

Wealth is, in large part, belief. Wealth is created in this case because the new building means more to the owner than the sum of the old building plus the costs of demolishing and rebuilding.

However, the relative risks involved may deter her from undertaking that measure.

Risk is figured into costs. It's a part of the equation.

Maybe smashing an entire city and rebuilding it will bring greater long-term wealth, but how does one implement such a dramatic undertaking? How and from whom does one obtain consent?

If it does create wealth for the property owners, you won't have to do anything. They'll do it on their own. And again, there are companies whose job is to do exactly that.

 

[The Central Scrutinizer]

Or, as suggested in the "catalyst" examples above, you can use the 200K and some of your own money to have both the cedar shakes and the jacuzzi, figuring that even though it would have been inconvenient to put in the tub before, doing it this way is no more inconvenient than not adding the jacuzzi, since you are already homeless for the time being.

Correct. And it is also easier to add the jacuzzi to new construction than to retrofit it into an existing home.

 

[Cain]

How do you rebuild human capital? How do you put lives back together? How do you reverse not only the death, but also the pain and suffering and loss to others which that death causes?

I very specifically referred to economic accounting, which is what figures into the standard cost-benefit assessments of sexually frustrated free-market academics ("who know the price of everything and the value of nothing"). See www.marginalrevolution.com/ for a couple of libertarianish public chocice theorists who dream of putting prices on everything. I should think you would be open to this mode of analysis.

Wealth is, in large part, belief. Wealth is created in this case because the new building means more to the owner than the sum of the old building plus the costs of demolishing and rebuilding.

Fine, even assuming an owner develops a fetish for the building itself above and beyond the cash returns you're failing to account for the total social benefit. Suppose EVERYONE ELSE in the neighborhood developed a certain nostalgia for the old building (a standard example of a public good). Unfortunatley, in a market it becomes difficult to express that satisfaction. Others cannot pay -- in effect bribe -- the owner because a free-rider problem arises. Also, it's highly doubtful a rationally self-interested uber-business man destroys a profitable apartment complex to build a new because the new one looks prettier. Accordingly one might consider the purchase of a lottery ticket to be "rational" because the thrill of playing offsets the cost. Yeah, because everyone buys lottery tickets for the love of the game, not the final outcome.

Risk is figured into costs. It's a part of the equation.

Fine, but the important point to digest is that risk is bourne out of uncertainty. Moreover, risks are perceived, and very often our perceptions are wrong. In fact, as recent research indicates, humans are rather bad at predicting not only benefits and costs, but the final effects of benefits and costs (for example, people generally think they will be unhappier with a broken leg than a trick knee. People generally think a BMW will make them happier than it really does, and so on).

If it does create wealth for the property owners, you won't have to do anything. They'll do it on their own. And again, there are companies whose job is to do exactly that.

No, here you go again making assumptions with the most presumptuous certainty. It's not a matter of "if it does" but "if they THINK it does". And even what they THINK is subject to varying degrees of personal risk.

 

[crackmonkey]

Is it just me, or is shanek's own definition of 'wealth' extremely elastic?

 

[shanek]

I very specifically referred to economic accounting, which is what figures into the standard cost-benefit assessments of sexually frustrated free-market academics ("who know the price of everything and the value of nothing"). See www.marginalrevolution.com/ for a couple of libertarianish public chocice theorists who dream of putting prices on everything. I should think you would be open to this mode of analysis.

Strawman, ad hominem, poisoning the well...man, how many fallacies can you cram into one paragraph?

Fine, even assuming an owner develops a fetish for the building itself above and beyond the cash returns you're failing to account for the total social benefit.

Wealth is about more than cash returns.

Suppose EVERYONE ELSE in the neighborhood developed a certain nostalgia for the old building (a standard example of a public good). Unfortunatley, in a market it becomes difficult to express that satisfaction.

Balderdash. They can chip in to purchase it if it means that much to them.

Also, it's highly doubtful a rationally self-interested uber-business man destroys a profitable apartment complex to build a new because the new one looks prettier.

Right; because the increase in beauty is not worth the costs of demolishing and reconstructing the complex, not to mention the lost income in the interim when he cannot rent out the apartments. Do you like making my point for me? You do it an awful lot.

Accordingly one might consider the purchase of a lottery ticket to be "rational" because the thrill of playing offsets the cost.

You're the one who keeps throwing around the word "rational," not me. If someone values the joy of playing the lottery more than the amount of the lottery ticket, or thinks that the chances of winning, however meager, are worth more than the money he pays for the ticket, then wealth is created.

Fine, but the important point to digest is that risk is bourne out of uncertainty.

So?

Moreover, risks are perceived, and very often our perceptions are wrong.

Again, so?

No, here you go again making assumptions with the most presumptuous certainty. It's not a matter of "if it does" but "if they THINK it does".

It is you who is being presumptuous, not to mention pigheaded, otherwise you'd realize that they're the same thing. It's all in what the person values. That's the whole point.