Sandy: More Broken Windows

And now we see the Broken Windows Fallacy taken to an extreme — on CNBC of all websites.

Damage From Sandy? What About Potential Economic Boost? - Asia Business News - CNBC

The positive multiplier effect of reconstruction after Sandy could be as much as five times, according to Frank Holmes, CEO and CIO of money manager U.S. Global Investors. If the cost of the damages comes up to $20 billion, the economic boost in terms of spending and activity could be $100 billion, he said.

Hurricane Sandy might appear to create economic activity, but such activity is not going to have the multiplier effect some theorize. At least, not based on the experiences of previous disasters. By this twisted logic, the horrible events of Sept. 11, 2001, should have been an economic boost: buildings and transit lines had to be rebuilt. Instead, the economic effects linger for many families and businesses.

Sandy is just one more thing New York and New Jersey didn't need.

There are many, many problems with viewing a natural disaster as an economic boost. These issues are both ethical and economic, and we should consider these equally in the instance of a disaster.

1. People were lost, and that's not a positive psychologically.

Psychology matters in economics. Suffering families might not spend as much, for a number of reasons. Plus, these families lost wage earners. We might have lost productive workers, creative artists, and entrepreneurs. You never know the value of lost people and shouldn't rely solely on numbers. One of the problems I have with analyses of World War II is that economics views the loss of working-age men as an "opportunity" for others. While true, shouldn't we also ask what was potentially lost?

People are an economic engine. That's why countries with immigrants are more likely to thrive, while nations with declining populations are in economic decline. Look to some European nations for an example of the population:growth correlation. As I ask later, what if the survivors leave the damaged area? That did happen to New Orleans.

2. Resources were wasted.

This is both an economic and ethical issue. The cars, computers, furniture, and other materials lost were manufactured in processes that consumed natural resources. That's a lot of wasted energy (hydrocarbons) that will be expended again to recreate the lost items. It is also a lot of wasted materials, only some of which can be recycled. That's not an economic benefit.

3. Replacement "pulls forward" demand, not always creating new demand.

Yes, the taxis and subway cars will need to be replaced. But, these "durable goods" wear out anyway. In some states and cities, taxis and transit vehicles are retired after a set number of years. The idea is that such scheduled retirements improve safety and energy efficiency. Replacing durable goods early merely shifts the schedule — so instead of replacing a taxi or train car in three years, it will be replaced in 2013.

The "Cash for Clunkers" program shifted demand. The pulling forward not only shifted demand cycles, but also created a spike in used car prices. I'm expecting a similar spike because many of the vehicles lost would have entered the regional used car market. Other replacement cycles will be interrupted and distorted, too.

4. Residents and businesses with means relocate.

Some people cannot imagine leaving New York or New Jersey, but there is a good chance that some people will relocate — taking their economic activities with them. If you can afford a beachside property, you likely won't have a problem buying another house somewhere else.

Most businesses cannot wait to rebuild, so they will relocate if possible. With the current glut of retail and industrial properties, it isn't unthinkable that companies will be able to relocate quickly and return to business. That's a good thing for the nation, yet a bad thing for the region that loses a business.

5. Holiday tourism and shopping will decline.

New York and much of the Mid-Atlantic enjoy brisk tourism and retailing during the winter months. From the holiday parades and displays to the peak of the Broadway season, New York is going to be dealing with a decline in visitors. Fewer visitors translates into lower fourth-quarter transactions and lower tax revenues.

It isn't merely tourists that will be cutting back in the Mid-Atlantic. Residents having lost property, including entire households, are not going to be spending on toys and luxuries for the holidays. These residents are going to be rebuilding whatever they can rebuild. That's going to affect discretionary spending.

6. Rebuilding costs opportunities.

The businesses and people not relocating will need to rebuild. Some of the funds will come from insurance, but other funds will come from savings and current income. Those expenses take money from new ideas, new products, and basic daily needs. Opportunity costs are the basic reason the Broken Windows Fallacy is a fallacy: spending to rebuild means you aren't investing in the future.

There will be growth… sort of.

There will be rebuilding, which should include improvements to infrastructure and some businesses. These are investments that should have been made anyway, but were often delayed by political choices. Hopefully, there will be investments that have long-term economic benefits. Still, I expect only a minor, short-term bump to GDP and regional economies.

Sometimes, after a serious disaster a place doesn't recover. I don't fear that New York and New Jersey won't recover, but the recovery will be slow and painful. It will be unlikely to help our economy "bounce" from its current doldrums.