Tuesday, August 30, 2011

Hurricane Economics

Today, I read two interesting perspectives on the clean up after a hurricane. First, Russ Roberts:
The hurricane increases the demand for glaziers and that is good for glaziers. But that is good for all glaziers, employed and unemployed. It pushes up the price of glass repair. That discourages some folks from having glass work done who otherwise would have done it. So there is some offset of the hurricane’s impact on glazier employment.
The important point is that the resources for clean up have to come from somewhere, and those diverted resources represent a cost to society.

Second, once disaster strikes, how do we pay for it: spending cuts of tax hikes (update: or debt)? Here's Paul Krugman:

What the government should do, in this case, is set all the marginals equal: the marginal benefit of an additional dollar spent on bombs, dental work, national parks, soup kitchens, etc, should all be equal, and this common marginal benefit should equal the marginal cost of raising an additional dollar of revenue.

Now suppose a disaster strikes. What this does is raise the marginal benefit of spending on disaster relief. The appropriate response is to move all the marginals to get them in line: spend less on everything else, and also raise more in taxes. So even there it shouldn’t be all offsetting spending cuts.

Both perspectives portray an important part of the picture when it comes to the economics of natural disasters. Roberts: Disasters are costly, even if it looks like "stimulus." Krugman: When faced with a disaster, we want to choose the least costly ways to clean up after them. This involves setting marginal benefit equal to marginal cost. There is something to be said for both of these perspectives.

Update: (HT: Mankiw) Steve Landsburg attacks the Krugman post. Here is the key excerpt, which I think is mostly right:
To get a little wonkier, there are actually two separate points here. First there’s the point that comes from public finance: Unless you believe that everything is perfect to begin with, the Ricardian argument fails, leaving you with no reason to believe that the cost of new spending should be spread widely. Instead, you should start by cutting back on your least wise activities. Cantor and Krugman probably have some legitimate disagreement about what those least wise activities are, but neither of them has any reason that I know of to believe that all activities are currently equally wise at the margin. I’m guessing that if Cantor had proposed paying for disaster relief entirely through an tax increase on the very rich, that Krugman would not have been so quick to dissent with an appeal to Ricardian public finance.
Basically, if we have a wasteful enough starting point, we could finance the disaster relief strictly by spending cuts to the most wasteful programs. But, this point begs the question. Why wait for disaster to cut this excess spending? If that spending is so bad, we want to cut it whether or not there was a disaster.

My interpretation of Krugman's initial post is that we should look for the lowest cost ways to finance emergency spending (indeed by equating MB and MC). Krugman argues that issuing more debt combined with moderate spending cuts to the most wasteful programs is lowest cost, but Landsburg makes a good point. If you believe that enough of our government spending is wasteful, you could finance disaster relief by merely cutting the waste. And, that might be the best plan of action going forward.

Update 2: Krugman responds and Landsburg responds back.

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