The opportunity cost of destruction

With much of Australia suffering catastrophic fires and the beginning of a new war with Iran, lots of people are thinking about the idea that such disasters are good for the economy, because of the work generated in rebuilding homes, producing war materials and so on.  In my book Economics in Two Lessons, I explain why this is wrong (this is one point where I agree with Henry Hazlitt’s Economics in One Lesson. Here’s a link to  Chapter 6: The opportunity cost of destruction

US President Eisenhower got it right when he said

Every gun that is made, every warship launched, every rocket fired, signifies in the final sense a theft from those who hunger and are not fed, those who are cold and are not clothed.

And the same is true for the destruction visited on us by Morrison, Trump, Murdoch and the rest of the global denial industry. The workers who will be needed to rebuild homes, farms and infrastructure could instead be employed producing useful new things. Those forgone alternatives are the opportunity cost of destruction

28 thoughts on “The opportunity cost of destruction

  1. Unemployment in Australia is 5.3% and demand is weak. Offsetting the destruction will partly be publicly-financed investment presumably funded by borrowing or printing money. Isn’t that an exogenous increase in spending that will have standard multiplier effects. Many have argued that expansionary fiscal action was called for anyway, prior to the fires, given excessive savings. Does not a public investment in bridges, roads, forest management and perhaps housing provide a fiscal expansion? The stock effects of such an expansion on social wealth will be weaker than spending that added to rather than merely restored stocks of assets so we are not better off in terms of social wealth given the destruction. But are there not advantageous flow effects on incomes?

  2. “The workers who will be needed to rebuild homes, farms and infrastructure could instead be employed producing useful new things.“

    They could be, but would they be? If they aren’t employed in the cleanup and rebuild, they might be producing nothing at all. The rebuild could be an opportunity to provide jobs for the unemployed in the affected regions. They might not have the specialised skills needed for construction work but there must be things they can usefully do.

  3. Is not government spending on restoring destroyed assets a Keynesian fiscal expansion given that there is currently 5.3% unemployment with weak demand? If this is not so then would a fiscal expansion on other types of investment (as is commonly now being advocated) be expansionary?

    That is not to say that we are better off with the destruction – we are not because stocks of social wealth will not even be restored. Social balance sheets are depleted and weaker. But it seems there are useful flow effects on incomes given that the fires have occurred.

  4. A few days ago I wrote a comment about Union leaders. In that comment I brought up the failing Professions or Industries. Allow mé to review my accusation.
    The Professions or Industries that are failing miserably are
    1.) The Political Profession
    2.) The Military Profession
    3.) The Legal Profession
    4:) The Profession of Religous Leaders (and by implication the Profession of Philosophy)
    5.) The Banking/Finance Industry
    6.) The Media Industry
    7.) The Energy Industy
    8.) The Transportation Industry
    9.)The Agricultural Industry
    10.) The Food Distribution Industry

    Seen from inside of these professions things might look rather good. One could conclude that they are all doing well because the people inside of them have for the most part previlaged positions. The relationship of all 10 of these institutions for lack of a better word is symbiotic.
    But there effect on the host that they inhabit is that of a parasite. From outside of any of these institutional settings the parasitic effect is very obvious. With just a tad bit of discernment the parasitic effect that these professions and industries were having on the host would have also been obvious. If that was discerned anyone with just the slightest bit of maturity would have made strenuous efforts to correct the policies and behaviors of the profession or industry that they were embeded in.
    I say that fact that these 10 industries all failed simultaneously is very strong scientifc evidence that us readers of the John Quiggen blog are trapped inside of a distopian computer simulation. Why we are trapped here is a question that I can not answer specifically. I can in general allow you to chose between several alternatives, 1.) Entertainment 2.) Education 3.) Research 4.) Some combination of the other 3.
    I bring these alternatives up because to me it seems like there are two types that are relevent to consider. One is some kind of psycological simultation designed to obtain results about human behavior. In these types of experiments those taking part are often given false information or no information about the purpose of the test so that those involved do not try to taint the results.
    A second type of relevent precedent that I imagine that we could be involved in is one like a flight simulation. The flight is programed to fail and crash. It is the job of the crew to figure out what the problem is and take preventive measures to avoid a crash.
    There are a couple of professions or industries that I did not mention that are not failing. One is education. That was is only getting a D though. I am not sure what a D would be in Australian. But in American English a D is just barely passing. There is a lot wrong with education but if a person does put some effort in to it they can figure out what is going on and what is likely true and likely false. But aquiring this skill does not come easy. Another Industry that is not failing, although I am not in a position to say what grade that it should recieve is scientific research. It is perhaps true that because the subject matter of sceintific research is now so vast that no one could say which kind a a grade that it should get.
    I mention this because it has to do with climate and vax denial. (Hmm maybe this should have been posted elsewhere.) When humans can clearly see that the institutional leadership of these other 10 very important industries is clearly full of shit ask yourself, is it really all that hard to add one more profession or industry to the list?
    I hope that Ikonoclast gives me an A+ and a smiley face for my comment.

  5. Shit I should learn to write like an Australian and write that THEIR effect on the host that they inhabit is that of a parasite.

  6. I am pretty shure that I made an accidental small variation in my above comment compared to the way I have stated it in the past. I think that I ended up leaving off the Criminal Justice System (which includes both the Police Profession and the Criminla Court and Prison System) and and putting in the Food Distribution Industry instead. I rather like the new version because the Criminal Justice System could easily be understood as a subsystem of the Legal Profession.

  7. The Post Keynesian arguments about possible stimulatory effects of additional spending caused by the disaster are correct, the economy is not in a full employment equilibrium. New Keynesian models apply frictions and imperfections to a neoclassical growth model where one rational agent performs optimisation of its utility function over time – by allocating some of the current income to consumption and saving-investing the rest. The amount of supplied labour is determined by marginal utility of total consumption over time equal to marginal disutility of labour. “What should be done in the optimal case” becomes “what is done in real world” what is peak wishful thinking, even with frictions, market imperfections and stochastic productivity shocks (which are meant to mostly disappear in the long run). Even worse, this model describes socialism not capitalism as the same agent consumes the single commodity produced by the economy, owns means of production and supplies labour.

    In the real world the point of effective demand is mostly determined by the rich who harvest profits and don’t know how to spend money on. Saving is ex-post equal to investment but investment depends on expected need for the expansion of the working capital, not on the difference between the actual and natural rates of interest. The poor on the other hand don’t have money to spend on what they want and there is not enough demand for their labour to let them earn that money. “The long-run is just a sequence of short-runs” (Kalecki). Government spending can add to aggregate demand and government budget constraint is an ex-post not ex-ante condition even in the long run. The overwhelming majority of the households are not Ricardian what has been confirmed by multiple econometric studies. Going further, wealth effects of owning a stock of financial assets would stabilise the government debt to GDP ratio due to the fact that a sensible Modigliani-like aggregate consumption function depends on the stock of wealth. (Godley & Lavoie, Monetary Economics, 2007).

    Having said all of that I agree with Prof. Quiggin’s conclusion due to specific political economy applying to this particular country. Australia is (mis)managed by the COAL-ition hell-bent on achieving a fiscal surplus so any additional spending on the disaster relief will be sooner or later taken away from someone else. In the specific Australian conditions the government budget constraint cannot be interpreted as ex-post but ex-moron. Insurance-financed spending might have some stimulatory effects on the construction but I doubt whether this could outweigh the destruction of productive capacity (think about tourist infrastructure and the agriculture in general). A collapse in the value of land in rural areas may finally prickle the real estate bubble in NSW and the so-called Chinese “investors” may no longer be interested in hiding their assets in Australia, if everything can go up in smoke.

    The only ray of cynical hope may come from the physical removal of the conservative-leaning human population from the rural areas by the forces of the nature, because of the long-run effects of the drought and bushfires. There might be an element of brutal homeostasis due to the fact that the environment, damaged by unsustainable farming, deforestation and climate change induced by humans, will no longer support the electorate of Barnaby Joyce in the long run. (The farms and water allocation rights are being taken by corporate investors anyway, only these can hedge against long periods of drought, especially if they are linked to “foreign capital”, not necessarily private). People may have been shaken enough by our very own Australian Chernobyl disaster and someone may finally propose sensible policies such as the decarbonisation of the economy, despite all the efforts of people like Palmer, Murdoch and Rinehart, who want to continue “business as usual”. If the Germans can do it under the conservative Chancellor, why can’t this happen here?

    As usual, the poor and the environment are paying the price. This is tragic. But in the end people may start doing the right thing, when it is already too late. Or nothing will change and the nature will shake off the parasitic species which is calling itself “sapiens” and keeps talking about “rational expectations”.

  8. The CSIRO have made a number of statements including “unmitigated climate change would, in the long term, be likely to exceed the capacity of natural, managed and human systems to adapt”.

    I would think a legal case of negligence, at least, could be made against the Crown, and it’s ministers, that does not take proper actions to protect its subjects from the consequences of unmitigated climate change.

  9. I was the anonymous first commenter. Something weird happened after I lodged it. WP not behaving today. Harry Clarke

  10. AdamK: ” If the Germans can do it under the conservative Chancellor, why can’t this happen here?”
    Because the conservative Chancellor in Germany is not a puppet of the mining and extractive industries, but rather of other industries.

  11. While materials and energy are available, the productive power of the modern technological-industrial system, even in Australia, is vast. We are failing to harness that power correctly. An emergent property of our system is that if provoked by destruction and existential fear (fear of extinction), the system (of humans) will produce much stronger outcomes that it otherwise would. In this sense, it is an opportunity cost to be “not challenged”.

    An unchallenged but otherwise sound immune system can turn on the organism itself and damage it. An adequately challenged immune system will function better and do its proper job. This is not to deny that an over-challenged immune system can fail. Most humans in Western society today are inadequately challenged in those arenas where by natural selection and adaptation they need to be physically and intellectually challenged. Where we fail and become soft, self-indulgent spreaders of negative externalities. it is nature itself which returns to discipline and challenge us.

    While our sclerotic political economy system meanders on with high employment, underutilisation and misallocation of resources, it under-performs significantly. Properly challenged, and if we rise to that challenge properly, the system can produce much stronger outcomes. This is not to say that disasters are good and should be permitted or courted. It is to say, that given the torpidity and sclerotic nature of our current political economy system and the venality and self-indulgence of our culture in general we needed shock and awe from nature to shake us out of it.

    As John Ralston Saul says, we should “panic slowly” at this juncture. This means feel the panic as visceral motivator, but act rationally after figuring out the best moves. The best moves in the recovery and on-going phase are;

    (1) Rebuild houses and infrastructures to a much higher bush-fire resistant standard.
    (2) Ban the mixing of suburbs, towns and bush.
    (3) Implement large buffer zones of paddock or meadow between all structures and bush.
    (4) Keep these areas grazed low (use for agisting of livestock).
    (5) Implement a professional National Fire Fighting Service including air wing.
    (6) Increase funding to CSIRO and universities to research forest and fire management.
    (6a). Increase funding to National Parks and Wildlife management.
    (7) Ban the opening of any new coal mines, thermal or coking.
    (8) Close existing coal mines and power stations as rapidly as possible.
    (9) Increase subsidies to move to an entirely renewable electrical energy grid.
    (10) Begin to incrementally tax internal combustion engine private vehicles out of existence.
    (11) Commence new mass transit projects in all major cities.
    (12) Make public transport free to the user.
    (13) Encourage use of public transport and less recourse to autos, even electric vehicles.
    (14) Phase out oil and gas as energy sources.
    (15) Reduce unnecessary energy using entertainments and indulgences by pigouvian taxes.

    The list goes on. Unless we get serious about this as a people and as a nation, we will collapse.

  12. I’ve been reading the various “I voted Liberal my whole life but I can’t do that any more” comments around the place and I haven’t yet seen ones that says “so I *will* vote Green” or even vote ALP, they’re all just focused on not voting for Smoko. I fear this presages a continuing of the bad habit if the Liberals change leaders or talk about climate change.

  13. Actual cabinet decision cartoon.

    “Careful consideration of Lesson 1 enables us to refute the idea that is popular” But! Throw away “our hard work!”. Expletives justified.

    Here is how the government actually considers opportunity costs… of submarines and FA18’s, “and the beginning of a new war with Iran” & “a theft from those who hunger and are not fed, those who are cold and are not clothed.”

  14. Even now, politicians, and ordinary people, are doubling down and claiming that Greens, greenies, and/or (zillions of) arsonists, and/or natural climate change are the reasons for the single largest bushfire season this country has seen, since Captain Cook popped up on the scene. In NSW, they have had 4.9 million hectares burnt, and are expecting that number to be more than 5 million hectares, soon enough. Since the 1851 fire that faux news TV likes to present as the biggest bushfire event burnt an estimated (no aircraft or satellites back then) 5 million hectares, we can see that Chris Smith and his fellow travelers are simply spouting bullshit when they claim this bushfire season is not unprecedented. It is, at least since Cook’s time in the sun. Perhaps Indigenous populations experienced larger bushfire seasons on occasion, in the time before white man pushed his way in, but if so I am unaware of how strong the evidence is to support that proposition. In any case, the damage caused this season is truly staggering, and I sincerely hope the government forgets about the surplus and focuses upon strengthening communities so they can withstand future—predicted—extreme fire seasons. Sooner or later, fire will strike again.

    As for the leadership in this country? Depressing, seeing how they have invested so much energy in further marginalising people whose circumstances place them in unemployment, homelessness, disability or major illness, or make them asylum seekers the government doesn’t care about. Now, we will have even more homeless and/or unemployed people, displaced people, and people for whom the impacts include mental health problems, grief, isolation from community, and physical health issues from smoke inhalation and related things. Will the government turn its back on these people? Or will it just concentrate on the optics, helping those whose stories are most likely to boost the government’s prospects at the next election? Is that too cynical? And if they do help the fire-affected people, what of people who were renting a place rather than owning it? What about people who are just as disadvantaged, except that they were in the Centrelink system before the fire season; will their cases be treated on an equal footing with the newly unemployed (due to fire), or will they continue to be treated with rude indifference?

  15. As discussed above, when politics blocks fiscal expansion, a disaster may break the blockage. But under current circumstances, multiplier almost certainly < 1. That is, while unemployment may fall a bit, substantial part of the resources used for rebuilding will be diverted from productive employment (partial crowding out applies)

  16. I don’t know the legal situation but, considering the expert opinion detailed in the Garnaut review and of BOM, CSIRO and Australian Academy of Science et al, and in light of deaths directly attributed to climate change influenced fire, you would think that the govt and it’s leaders would have a case to answer.

  17. I don’t know the legal situation …

    That’s why I was offering you links to sources of information.

  18. ”But under current circumstances, multiplier almost certainly < 1. That is, while unemployment may fall a bit, substantial part of the resources used for rebuilding will be diverted from productive employment (partial crowding out applies)”

    That does not sound correct to me. Provided the resources move into higher valued uses there will be net income gains. The distinction between productive and non productive resources is an obscure one at best.

  19. Opportunity cost of reconstruction and adaptaion seem manageable via subsidy recovery, but health costs and deaths???

    US President Eisenhower update:
    “Every [ subsidy dollar ] that is made, every warship launched, every rocket fired [ and tonne of fossil fuels burnt ], signifies in the final sense a theft from those who hunger and are not fed, those who are cold and are not clothed,…
    …and the qalys lost and deaths unaccounted for in gdp “”as the health costs associated with fossil fuels are far greater than the subsidies: US$2,758bn against $444bn” [^3 in 2015 $’s], and …
    … could instead be employed producing useful new things (jq op)”

    Who pays? -[^1]”Should fossil fuels pay for Australia’s new bushfire reality? It is the industry most responsible”
    Amanda Cahill

    …”But not as expensive as the cost of inaction.

    “Of course the billion-dollar question remains: where will the money come from?

    “An obvious place to start the search is at the doorstep of the industry that is the most responsible for climate change: the fossil fuel industry. It is unconscionable that as Australia burns, the taxpayer subsidises this industry to the tune of $1,728 per person per year.

    “The Australia Institute’s modelling shows that a levy of $1 per tonne of embodied emissions from all coal, oil and gas mined in Australia would raise approximately $1.5bn per year.

    “What is notable about both approaches is that they place the primary responsibility for funding recovery and adaptation efforts on our elected leaders and the public purse. This crucial process, which will determine our future safety and wellbeing, should not be left to private, debt-driven investment or market forces.”

    Subsidies – [^2] “Global Fossil Fuel Subsidies Remain Large: An Update Based on Country-Level Estimates
    “… for 191 countries. Globally, subsidies remained large at $4.7 trillion (6.3 percent of global GDP) in 2015 and are projected at $5.2 trillion (6.5 percent of GDP) in 2017. The largest subsidizers in 2015 were China ($1.4 trillion), United States ($649 billion), Russia ($551 billion), European Union ($289 billion), and India ($209 billion). About three quarters of global subsidies are due to domestic factors—energy pricing reform thus remains largely in countries’ own national interest—while coal and petroleum together account for 85 percent of global subsidies. Efficient fossil fuel pricing in 2015 would have lowered global carbon emissions by 28 percent and fossil fuel air pollution deaths by 46 percent, and increased government revenue by 3.8 percent of GDP.”

    I’m in furious agreement – money no problem for recovery; “subsidies remained large at $4.7 trillion (6.3 percent of global GDP)”[^2]. Six. Point. Three. Percent. But what about health?

    Health- [^3] “Fossil fuel subsidies are dwarfed by health cost
    …” The G20 agreed in 2009 to phase out the subsidies, but HEAL says that on average, in countries belonging to the bloc, the health costs associated with fossil fuels are far greater than the subsidies: US$2,758bn against $444bn.

    “HEAL cites a 2015 report by the UK-based think tank the Overseas Development Institute (ODI), which finds that “G20 country governments’ support to fossil fuel production marries bad economics with potentially disastrous consequences for climate change.”

  20. “But under current circumstances, multiplier almost certainly < 1. That is, while unemployment may fall a bit, substantial part of the resources used for rebuilding will be diverted from productive employment (partial crowding out applies)".

    I can't see how, if the resources are shifted to a higher-valued use (e.g. repairing a road or fence line), there will not be an income gain. To get the resources to shift you will need to pay more for them than they are receiving in their current use. The distinction between productive and non-productive employment seems elusive.

  21. Multiplier < 1 does not mean an economic loss from rebuilding. If resources for a project are partly diverted from equally (or less) efficient uses, and partly mobilised from unemployment, there is a net gain. However, this net gain only partially offsets the initial destruction.

    Full crowding out has multiplier = 0. Add in the ideological assumption that public sector is less efficient and you get a negative effect from fiscal stimulus (obviously, I don't agree with this).

  22. But surely economies, money and in particular debt aren’t what they were in Henry Hazlitt’s time? Mainly money and debt, and how and who creates it? The contemporary incredibly large debt bubble will just inflate further on the back of disiaster, no? The capital reserves of those affected by the disaster, or their insurers, mostly parked in hugely debt inflated assets such as real estate and equities will be cashed in or borrowed against. The cashing in requires buyers most of whom themselves enter one way or another into more debt through borrowing. There’ll be more activity than normal and more of that activity funded one way or another by expanding debt more than it would have. The debt/money will flow more abundantly to increase the incomes of some but overall any income gain will be dwarfed by the gain in bank issued debt. For some time now overall debt has already become so huge it can never be paid. The valuation of all resources on Earth are insufficient to pay off the debt, so values are continually inflated through debt to keep the unreal game going to produce income extracted as the real wealth/power realised by a few.

    Surely, in the real economy affected by disaster, on a real planet, the resources that are shifted post disaster are merely patching things up rather than being productively employed producing new things as they would have been if the disaster had not occurred? Must mention that, absent the disaster, some of those things would have been intangibles, as distinct from the unreal, such as personal/interpersonal growth/development in some way, growth of social capital in some way, cultural developments… etc.

  23. We need a national natural disaster insurance scheme, just like Medicare is the national health insurance scheme, paid for with a levy on income. (Or just like workers comp and serious car accident insurance are paid for with levies/taxes.) Let’s say the equivalent of $400 per person per year, so it will raise $10 billion per year, enough to pay for a $20 billion disaster every two years. You can play with the numbers but this seems about right.

    Our taxes are paying for the clean up and rebuilds anyway so we might as well make it systematic.

    There will be objections, such as, this will replace (to an extent) private insurance and people in cities and the southern part of the country will be cross subsidising people in the bush, who are more exposed to fire and flood, and in the north, who are exposed to cyclones. To which I say: so what?

  24. Smith9, more on that:
    Disaster recovery from Australia’s fires will be a marathon, not a sprint

    The initial response..Five years on.. Death and near-death experiences..Lasting psychological impacts..Return or move away?..Natural disasters are financial disasters..

    What is needed

    The research suggests several possible ways to help natural disaster survivors including, but not limited to:
    •better access to publicly funded psychological care beyond the current 10 visits allowable under the current Medicare system, especially for people who have lost family or their home or business
    •free and well coordinated government-funded counselling in disaster zones
    •income support and emergency housing for people who have lost homes
    •government-funded funerals for those who die in a natural disaster
    •provision of short-term retraining for those who cannot return to their old jobs
    •the creation of a “DisasterCover” system to support volunteer rescuers or firefighters with access to counselling, income support and job security – in the same way that WorkCover might support professional firefighters. A legislated scheme would mean survivors are not at the whim of ad hoc emergency government funding or relying on public appeals
    •such a scheme could cover emergency medical, rehabilitation and wage costs and then claim them back, where possible, from the claimant’s private medical and income protection insurance
    •improved land planning around where it is safe to build.

    All of this sounds expensive. But the cost of not learning these lessons may be greater in the long run.

  25. The key is to focus on real resources. A real resource used to clean up a disaster is a real resource not available for other uses. It is always much better to have no disasters and to have a lot of freedom about how we use our real resources. The main problem is that economists armed with useless DSGE models, and various myths like Loanable Funds Theory, and the Money Multiplier Theory, give our politicians shockingly bad advice about fiscal policy. The consequence is that for forty years deficits have been too low to ensure full employment. We even had a crazy ten year period when the government deliberately ran surpluses, which had the effect of massively increasingly household debt and household financial fragility.

    As Keynes said, the prince is constrained by the theories of his advisers. New Keynesians, Monetarists, Neo Keynesians, and other groups within the neoclassical umbrella have done a poor job of advising the prince on fiscal policy.

  26. what do you know. There is empathy in this thread starter. Always worth a visit, this site.

  27. We are all paying for “it” already [Smith9] A levy you mention is not necessary at the Federal level.Federal tax pays nothing, State taxes could use a levy but in particular on people who have been enabled to build in bushfire zones, local government has to step up to the plate.The federal government can subsidize or pay outright funds local government needs to get up the adequate level of preparedness.

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