Will the Catastrophe in Japan Create Economic Growth?

In case you have been in a cave over the last couple of weeks, Japan was recently rocked with an 8.9-magnitude earthquake and was subsequently devastated by a 30-foot tsunami. These events are hard to fathom and my prayers go to those families who are now struggling. The costs of these natural disasters are mind-boggling when the loss of human life, physical capital, and rebuilding efforts are taken into account.

The combination of natural disasters that shocked northeastern Japan has led to approximately 22,800 either dead or missing. In addition, the Bank of Japan has supported their financial markets by providing liquidity of more than $500 billion. Moreover, the cost of rebuilding the demolished area of the country has been estimated by the Japanese government to be in the ballpark of $300 billion, which was noted by a recent article to be 6% of Japan’s gross domestic product (GDP). If these dollar estimates for the costs prove to be correct, the catastrophe in Japan will surpass the cost of $125 billion from rebuilding around New Orleans after Hurricane Katrina to become the world’s most expensive natural disaster in dollar terms on record!

After reading these previous reports, it has been perplexing to read articles that somehow rationalize that the events in Japan and other disasters, such as 9/11 and those shown in this video, are beneficial. Proponents of this view argue that economic growth occurs in the long-run from these disasters due to what is called the “jacuzzi effect,” where upgrades and improvements are made that may have never happened had the disaster not occurred. If this flawed argument was supported across the globe, there would be incentives to burn buildings, throw rocks through windows, and hope for an increased occurrence of natural disasters to stimulate the economy.

Another argument that richer countries are less affected from natural disasters relative to poorer countries is certainly viable. Although this may be the case, disasters that are unexpected are certainly costly and provide few benefits. Contrary to the “jacuzzi effect” is the “broken window fallacy,” which demonstrates how there are unseen costs that must be taken into account when assessing any sort of disaster. In economics these unseen costs are called opportunity costs. Specifically, an opportunity cost is the next best alternative that is foregone when making any decision.

There are a number of costs which can be measured explicitly, but during the rebuilding phase there are other costs that go unnoticed, such as time, effort, and what the funds could have been spent on instead of going toward rebuilding the country (unless the funds are raised specifically for rebuilding, such as the funds raised by international humanitarian aid organizations such as Amnesty International). Many of these funds, both private and public, could have been used to improve the area that was demolished, raise education standards, and develop new innovations.

While domestic and foreign aid has been rushed to the area in need, the assistance appears to be sluggish in getting to those that need it due to the bureaucratic nightmare that goes along with these types of situations. Therefore, the resources used for disaster aid are highly inefficient relative to many other alternatives.   

While Japan may see a boost in GDP for a couple of quarters during the reconstruction that may appeal to those who follow the “jacuzzi effect” theory, there will be a drop in their standard of living that will not show up in the data that will support the “broken window fallacy.”

Although the horrific events in Japan could have been devastating to the country, the world can learn quite a bit from the resilience in Japan. The terrible events in Japan allow for more discussions about our world, which reminds me of the quote by Socrates, “the unexamined life is not worth living.”

A similar statement could be made about how an unexamined world is not worth its existence. As we question how natural disasters impact an economy, let us keep in mind the unseen costs and not jump to conclusions that these events will lead to economic growth and societal benefits.

Photo Credit: Wikimedia Commons