Saturday, March 12, 2011

Will Japan's Earthquake Be an Economic Boon?

Larry Summers thinks so (HT: Jeff Tucker). It is so sad that, almost like clockwork (to use a timeworn cliche in pointing to another timeworn economic cliche), some economist who has drunk too deeply at the fount of Keynesianism, has already asserted that, because of Japan's earthquake, their economy will receive a short term boost.

How in the world will the destruction of massive amounts of capital and durable consumer goods grow an economy, one may be excused for asking. The answer from Larry Summers and Keynesians like him, is that the Japanese will now have to spend more to rebuild, which will result in a boost to GDP. Of course, however, as I point out to my students, spending does not necessarily equal economic well being. I have already explained on this blog that we should be careful not to confuse GDP with the economy. Instead of spending a lot of yen to rebuild a home. It would be better to still have the home and still have the yen that could be directed to purchasing additional goods that could be used to satisfy even more ends. GDP measures spending as a flow of income, it does not measure wealth.

Summers cites as support for his case, the aftermath of the Kobe earthquake that hit Japan in 1995. It turns out that, according to SG Cross Asset Research, the data reveal that Summers' claim is wrong.

There was a significant decrease in industrial production due to the Kobe earthquake. No matter what certain "experts" say, we cannot achieve prosperity, even in the short-term, by breaking things.


  1. Dr. Ritenour- I read the following on a friend's facebook page: "I would comment on building codes, and how government intervention saved millions of lives in Japan this past week, but my libertarian friends might be insulted." I was curious as to how you would respond to this?

  2. Well, first of all I would note that it is a mere presumption that government intervention in the form of building codes saved millions of lives. We have no reason to assume that the buildings that withstood the shock of the earthquake would have been built less sound without government codes.

    Building owners have an incentive to own buildings that will withstand such events. Even without codes it seems that builders have an incentive to be able to provide a product that meets certain quality criteria that building owners demand. One could even right such criteria in a contract, so that if a building does not withstand an agreed-to level of quake, the builder is held liable. The bottom line is that if we have private property, the property owner has an incentive to maintain the value of the property.

    At the same time, it is even possible for building codes to lull people into a false sense of security because a building meets minimal standards, thereby making them actually less safe.

    The bottom line is that building structures that withstood the quake required the right materials, engineering knowledge, and tools. All of this costs money. The Japanese were able to do so because they were wealthy enough to build buildings that could withstand such force. Government building codes did not generate that wealth. Free enterprise does.

  3. Dear Dr. Ritenour, I am studying economics and am very interested in Japan`s economy. For natural desasters, especially earthquakes/tsunami in Japan, is there any accurat economic theory or model to illustrate what should be done in such a situation. As it happened already, are there any models or accurat theories for the Kobe earthquake?
    I would be very glad if you could help me.

  4. Dear Batan,

    I know of no scientifically valid and accurate theories that focus only on disasters of the type experienced by Japan. However, economics does teach us what needs to be done in the aftermath of these tragedies.

    The main economic consequence of these sorts of disasters is the loss of capital. (This is not to minimize the personal tragedy of those who have lost family and friends, but here I am speaking only of the economic consequences. Even here, though, there is a drop in available labor, but that is not as hard to deal with economically as the lost capital).

    The necessary step toward getting Japan back on track toward prosperity, therefore, is rebuilding the capital stock. Rebuilding the capital stock cannot be done by monetary inflation through artificial credit expansion. For such capital investment to be sustainable and productive, it must be funded by voluntary saving.

    This theory draws upon Austrian economists such as Carl Menger, Eugen von Bohm-Bawerk, Ludwig von Mises, and F. A. Hayek. The best contemporary exposition of this theory that I know of is Jesus Heurta de Soto's book, MONEY, BANK CREDIT, AND ECONOMIC CYCLES. You can download the entire book for free as a pdf here:

    Chapter Five in Huerta de Soto's book explains the theory of sustainable economic expansion that is possible when funded by voluntary saving and also explains why any economic progress funded by monetary inflation is not sustainable.

    I hope this helps.