Tuesday, 26 September 2006
Economics of Disasters
My heart and prayers go out to all of those victims of the flooding this past weekend. I would also like to express my sympathy for all those whose homes were flooded. I know my parents were one of those who suffered from flooding and they live on a hill! The rain came down so fast it flooded the backyard and filled the window well. The pressure from the water broke the window spilling a inch or two of water into the basement. Heck, it even caused the cancellation of the great St. X / Trinity rivalry.
Unfortunately, this tragic event provides an opportunity to better understand basic economics. It is unfortunate that tragedies make great object lessons, but we must take every chance to learn a valuable lesson.
Some people will talk about all of the commerce that will be generated from the damage that was wrought by the flooding. Just think of all of the new furniture that will need to be bought. The carpet that will need replacing. The ruined appliances that will be replaced. It will be a regular bonanza to the the furniture, carpet, and appliance industry.
And they will be correct. A great deal of commerce will be necessary to replace goods damaged by the flood. They will see this as a good thing for the local economy. This time they will be wrong. In fact the flood will cause a net loss to the economy and the community.
How is that possible? There will be a lot of money spent! Well, let's back up a second, and take a look at an individual family and extrapolate to the entire community.
Let's say a family lost carpet, some furniture, and a washer and dryer. Since they didn't have flood insurance, they are going to have to replace everything at a cost of $6000. But before the storm, they were already planning on spending that $6000 to buy new winter jackets for their kids and put a down payment on a new car.
Since they have to pay to replace already functional goods they longer have the capital necessary to purchase the new jackets or the new car. The family decides to wait until the following year or the year after than to buy the jackets and car. So while the furniture, carpet, and appliance stores will have gains, the clothing store and car dealership will lose exactly what the others gained. And in addition, the economy as a whole no longer gains these new winter jackets or the new car. Therefore the economy's lost production of the jackets and car create a net loss to the economy.
If we expand this out to all of the families who lost because of the storm, the net loss to the economy would be quite large. And so, I will add the loss to our local economy to the other more tragic losses that occurred over the weekend.
