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Hurricane Sandy Could Boost the Economy, But It’s Not the Kind of Stimulus We Want

When all is said and done, Sandy could end up costing $50 billion, according to estimates by IHS Global Insight.

by ALEC LIU
Nov 1 2012, 12:00am

PHOTO: Michael Bocchieri/Getty Images/AFP

Days after the worst of Hurricane Sandy is over, we’re only beginning to assess the economic havoc wreaked by the largest-ever storm to ravage the region. It’s a region home to 60 million people, who contribute a quarter of the U.S.’s $13.6 trillion economy. Millions remain in the dark. Public transit could be weeks away from full operation. The lower half of Manhattan feels like a warzone. “The initial impact on the economy could be quite large,” wrote Paul Ashworth of Capital Economics.

Last year, Hurricane Irene destroyed about $8 billion worth of property. Sandy is expected to be much worse. When all is said and done, Sandy could end up costing $50 billion, according to estimates by IHS Global Insight. Economists already predict that Sandy will negatively impact on GDP for the fourth quarter, say Chris Burritt and Brian K. Sullivan at Bloomberg:

Sandy ultimately may subtract 0.1 to 0.2 percentage points from U.S. gross domestic product in the fourth quarter as spending drops on services such as restaurant meals, according to Mark Vitner, a senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina. The economy, with annualized GDP of $13.6 trillion, expanded at a 2 percent pace in the third quarter.

“There’s a loss of activity that’s going to be hard to make up,” Vitner said yesterday. “If you’re a restaurant and you’re closed today, people are not going to eat two lunches tomorrow.”

Storm economics, however are never quite so straightforward. Even with all the local disruptions and property damage — flooded subway tunnels, downed power lines, and damaged homes — Hurricane Sandy could ultimately have a stimulative effect.

For starters, it gets us to buy stuff: stocking up on supplies like water, batteries, and candles. But this is minor. Most of the gains will be seen on the backend during the rebuilding efforts. Take 2005’s Hurricane Katrina, which caused about $46.6 billion in damages. Despite the loss of human lives and destroyed communities, Katrina may have boosted the regions’ economy in the long-term, says Keith Humbre, chief economist at Nuveen Asset Management. “You can look back on impact of Katrina, in immediate aftermath, there was an economic downturn in a number of data points,” Hembre told CNN. “Ultimately the rebuilding activity ended up being stimulative.”

New Orleans and the rest of the region ended up spending $120 billion in the wake of Katrina, “investment that would never have been made at this magnitude if the disaster had not occurred,” says banking analyst Dick Bove. Bove sees similarities with Sandy. “The steps noted in Katrina’s wake will now take place in the mid-Atlantic to Northeastern states,” he said. “Of particular interest is New York City. This metropolis is critical to the nation’s finance system. Unfortunately, it is being discovered that the financial system now rests on the physical infrastructure of a 19th-century city. This is a multi-year process that will entail spending tens of billions of dollars,” he said. “This will inspire growth.”

In fact, we could even see net-positive growth by the end of it. In other words, thanks to Sandy, we might even see an economic boost. Call it the Sandy stimulus. Does this mean that dangerous storms are actually good for the economy? Not quite.

The long term economic effects could be minimal, says Mark Zandi, chief economist at Moody’s Analytics. “The rebuilding will kick into high gear pretty quickly. It’s already begun,” Zandi told the Huffington Post. “A few weeks down the road, I don’t think we’ll see big economic consequences.”

In economics, this is known as the parable of the broken window (different from the theory on urban crime). To summarize: a shopkeeper’s son breaks one of his store windows. Now he has to get it fixed so he calls the glazier, who makes six bucks repairing the glass, after which, everyone is happy and you could say that the broken window helped spur the economy, right? Not so fast, explains Frédéric Bastiat in his 1850 essay Ce qu’on voit et ce qu’on ne voit pas (That Which Is Seen and That Which Is Unseen), in which the parable appears:

“Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen.” It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.

As Daniel Alpert, managing partner at Westwood Capital, explains it, the destruction of property will not be captured in future economic data. “You can knock down a bridge, but that doesn’t show up as a negative to GDP,” he said.

In other words, this only looks good because of our limited means of measuring economic output in the first place. Take China for instance, where real value often gets muddled in the race for pure GDP. Since 2007, 15 bridges have collapsed, often due to shoddy construction and lack of government oversight.

“Sometimes the GDP number looks good, but it didn’t really create wealth for society. It was, instead, a waste of society’s wealth," said Wang Yang, Party secretary of Guangdong Province, in 2009. “For example, building a bridge creates GDP. When the bridge collapses and is taken down, it creates another addition to the GDP. When the bridge is rebuilt, more GDP is created. As such, one bridge resulted in three additions to the GDP. But it was a tremendous waste of resources.”

Of course, that doesn’t mean the effects of Sandy are economically meaningless and some Wall Street traders are already expecting a reaction from the Federal Reserve to ease the economic impact of the storm aptly dubbed “QE Sandy,” a play on the Fed’s recent strategy of quantitative easing. But thanks to the stimulating effects of the hurricane, Federal assistance may be unnecessary, as explained by the economic paper, “Natural Disasters and Monetary Policy is a DSGE Model” by University of Oklahoma’s Benjamin Keen and University of Arkansas at Little Rock’s Michael R. Pakko. Keen and Pakko’s paper dives into the effects on monetary policy following Katrina.

Since catastrophic storms destroy capital and disrupt production, the end result is higher inflation — the ultimate target of the Fed’s policy of printing money in the first place. As the paper explains:

In the period after the disaster, the return of productivity to its pre-disaster level permits firms to increase output, which lifts households’ income and enables them to increase their investment in physical capital. That process continues for a number of periods as the capital stock is slowly reconstructed. In the longer term, the protracted rebuilding of the capital stock is associated with below-trend output and persistent, above-trend paths for employment, investment, and inflation.

So Hurricane Sandy could end up being a compelling if not painful band-aid for the sputtering economy, which is nice for Ben Bernanke since it allows him to save a couple policy bullets for a rainy day. For the millions still without power however, it’s a silver lining that’s tough to swallow.

Follow Alec on Twitter: @sfnuop

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