Tuesday, September 27, 2005

Economics Lost Lesson

Hurricanes Katrina and Rita have been first and foremost, human tragedies. But, there are important economic consequences as well. Several analysts, who should know better, are misunderstanding these consequences. A recent Wall Street Journal article (Tuesday September 27, 2005) exemplifies this mistake. The article reports on a recent National Association of Business Economics economic forecast survey (www.nabe.com). According to the forecasters, U.S. economic growth will slow in 2005; however and here is the kicker, higher government spending will offset declines elsewhere sustaining economic growth. Other analysts are even claiming that growth in the fourth quarter will be even better than previous estimates due to the increased government spending.

Bad ideas just never seem to go away. As Henry Hazlitt famously noted in his 1962 book “Economics in One Lesson”, you cannot create economic growth by breaking windows. Yes, the government will be “pumping” in billions of dollars into the Gulf Coast economy. This money is not free. The money will be taken from people who would have spent it on something they valued and will be funneled to re-create something that was destroyed – not a growth enhancing proposition. And, this assumes that the money sent to the Gulf Coast will be spent wisely – a dubious assumption given the infamous politics surrounding New Orleans and Louisiana politics.

There is more. The current administration and Congress are spend-a-holics. Disregarding the calls to the contrary, Congress and the President will most likely finance the higher expenditures with higher U.S. budget deficits. These deficits will have real consequences. These will include more U.S. dis-saving, higher U.S. interest rates, as well as pressure to rescind (as opposed to extend) the capital gains and dividend tax relief implemented in 2003. All of this will reduce U.S. economic growth and consumption – one of the two current engines for global economic growth.

To end on a positive note, these impacts will not be large enough to derail the current economic expansion. They do represent the “costs” of the hurricane reconstruction – and this is the bottom line. Natural disasters are just that – disasters. They hurt economically, and require sacrifice to overcome. These sacrifices will be made whether the government is willing to admit it or not. It is as simple as economics first lesson: destroying capital does not create economic growth.

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