fedgazette

Do disasters have a silver lining?

Economic Myth Busters

Toby Madden - Regional Economist
Rachel West - Intern

Published September 1, 2008  |  September 2008 issue

Natural and other disasters are a gut-punch to communities. But it's argued that economic uplift often rises from the wreckage of such events. Reconstruction dollars pour in from the outside to rebuild. These dollars flow to workers, and to machines and materials, much of which is purchased locally. Economic activity is visible and financially tangible.

A recent example is the devastation caused by the August 2007 collapse of the Interstate 35W bridge in Minneapolis. Immediately following the collapse of the bridge, the federal government provided $179 million in emergency aid to Minnesota; four months later, another $195 million was allotted for rebuilding purposes, in addition to existing state expenditures. With funds of this magnitude pouring into the region, isn't this disaster effectively a boon to the regional economy? Or is this a myth?

Nineteenth century economist Frederick Bastiat demonstrated that this is a myth through his parable of the broken window and related the economic concept of unintended consequences. The story goes like this: A boy smashes a store window. When the window is replaced, it benefits the window maker. In turn, the window maker uses his increased income to buy bread from the baker, and so on. So the boy's vandalism triggers a cascade of economic transactions.

But Bastiat reveals the economic fallacy of this event because it considers only the benefits for one group of people at one point in time. To understand the full consequences, one must look at the effect on all groups of people at all times and consider the conjectured alternative—what would have happened had the window not been broken? Perhaps the store owner wanted to buy a suit with the money he paid to have the window fixed. Then the tailor loses a sale, and so does the manufacturer of the fabric used to make the suit, and so on. One must also consider the value of spending derived by the shopkeeper. Clearly, he would have preferred to spend the money on a suit rather than to repair a window that someone else ruined. Taking into account all the costs and benefits, one finds that the destruction of wealth is a net cost to society.

The same logic can be applied to the I-35W bridge catastrophe. Without even factoring for the economic loss of the 13 people who died in the accident, about 140,000 daily commuters who previously used the bridge have to find more time-consuming travel routes. The state of Minnesota estimates that the cost of not having the bridge is $400,000 per day. In addition, the millions of dollars of federal and state funds used to rebuild the bridge cannot be used for other purposes. Most important, the families of the people who died or were injured have to deal with emotional and economic pain and suffering.

Minnesota does benefit from federal relief money. But this is not costless; taxpayers in all states are worse off because they funded the relief. Neither does Minnesota capture all of the economic spillover; a portion of the money spent on the new bridge leaves Minnesota when materials, equipment and labor are purchased from out-of-state sources.

Had the I-35W bridge not collapsed, the region would still have a bridge, fewer families would be disrupted and public spending for a replacement bridge could have been invested in other necessary public goods. Given the hidden as well as visible costs, the economic benefits from the I-35W bridge collapse are far outweighed by the costs.

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