Yesterday I tried to make sense of the Keynesian idea that breaking and replacing windows could be good for the economy. I found it interesting that soon after writing that broken windows could “increase growth,” Matt Yglesias linked to Nate Silver’s piece about the potential expensive catastrophe of Hurricane Irene. Nate says there could easily be billions of dollars of “incalculable” damage. So does Matt think that if Irene breaks a lot of windows, the money spent to replace them will still “increase growth”? Or are there scenarios where spending money to undo destruction actually leaves the world worse off than before? If the answer to that question is an obvious yes, than I wonder how the Keynesian knows when we have a scenario where spending money to undo destruction actually does “increase growth.”
I’ve been thinking about these Keynesian arguments over the last couple of days. I suppose I need to learn more about the concept of the liquidity trap. I can almost understand a scenario in Paul Krugman’s world where there’s a bunch of businesses that have a lot of money that they’re not spending like they usually would, and some disaster would force them all to spend that money on repairs, increasing demand and getting more money flowing through the economy and so forth. And, indeed, we are living in an interesting world where corporate profits are high but hiring levels are not. So, even without being fully educated on the argument, I think I can conceive of a theoretical scenario where a disaster stimulates the economy.
But when windows get broken in the real world, doesn’t it seem like a pretty big wildcard to expect an unfolding scenario of the stimulating variety? What if the disaster is so big that the repair costs are far greater than the present amount of trapped liquidity, and some companies go right out of business because they can’t afford to repair? Or what if they can, but the damage to the local community and infrastructure is so great that they lose some of their customer base? As far as I’m aware, the economic evidence from Katrina to Japansuggests that disasters lower economic growth.
And that’s common sense. If you have to spend money replacing your broken windows, when it’s all said and done you have the same window you had before but less money to spend on something else – just like Bastiat said a couple centuries ago. Now maybe there exists the possibility of precise scenarios (like an alien invasion in a liquidity trap?) where people who have stopped investing magically end up spending their extra investment money to repair things, and that stimulates the economy, but I think the burden of proof is on the Keynesian to prove that the convenient line of factors required to make that a net gain instead of a net loss ever conveniently line up in the real world.