by Cory Koch
Insurance companies are now estimating the damages from hurricane Katrina at near twenty-five-billion dollars. The economic effect, though, will be much greater than that due to the loss of revenue while things are being rebuilt. Also, we need to consider the loss of jobs from the companies that won’t be rebuilding. Believe it or not, some companies didn’t have insurance. The Financial Times estimates that the “total economic losses” are close to $100 billion.
Now that is a lot of money! Actually, if you stacked 100 billion one-dollar bills on top of each other, the stack would be about 5000 miles tall. Can you believe that, because I can’t even imagine…
So, will this $100 billion loss affect our economy? Will it stimulate the economy after it all has been replaced? Or will it slow down the economy because of the loss in jobs? These are questions that may be difficult to answer because it will actually do all of the above. The question then becomes what is the remaining effect?
Let’s start first with the individual effects. The first and most obvious effect is the destruction of property. Any time you create anything, like a home or building, you increase the overall wealth of the world. An example of this would be when you build a house. You start out with some raw land worth $1000 per acre. You add $49,000 worth of materials and $50,000 worth of labor, creating a house worth $150,000.
Where did the extra $50,000 come from? You created it by combining labor and materials, making the world $100,000 richer because the labor didn’t exist before you built the house.
So what happens if it is wiped of the map? The world would now be a $150,000 poorer. This house was worth a $150,000 on someone’s balance sheet and now it’s not. This is the effect of wars and natural disasters. This leads us to the next question. The house was insured, wasn’t it? Well, yes it was, but the money to rebuild it still has to come from somewhere, and the insurance companies have to pay for it, so their balance sheets then go down. Before the disaster, the insurance company had $150,000 on their balance sheet and someone owned a $150,000 house. After the hurricane, there will only be one or the other, and in this case the insurance company is the one with the financial loss.
Is wealth then restored when the new house is built? Well, as in the above example, the net gain was $50,000, while the net loss, after the disaster, was $150,000. The reason I say the gain is $50,000 rather than $100,000 is because the labor to rebuild the destroyed house would have been used elsewhere. So in the end, if it hadn’t been destroyed, there would have been two houses rather than just the one property. So we are now still down $100,000, but is better than the initial $150,000. Just imagine now the devastation of $25 billion in properties…
Back to hurricane Katrina and those jobs lost because of the companies that won’t be reopening. It is quite possible that situation will balance itself out with all the new work that has become available with the rebuilding underway. So the employment rate should remain about the same, but the construction trade will benefit while factory workers suffer. The factory workers who can work in the construction trade will do okay, but those who can’t might suffer.
What will result from the destruction of factories? This is a problem. A factory is different from a house because it produces things. A factory is like a machine that creates wealth. Imagine a factory cranking out the houses in our example above. Each product is worth more than the sum of its parts, so it is creating wealth. While time is spent rebuilding the factory, these factories are not producing products. So, the downtime is lost production and less total wealth for the world.
But what if the new factory is more modern and efficient and can produce more products than the old factory? In that case, in the long run the world is better off, although it suffers in the short run. If modernization occurs, New Orleans could be cleaner, safer, more productive and efficient, and in the long run, wealthier. It will, though, suffer in the short run.
In the same way, if the City of New Orleans was smart, it would order that all new high- rise buildings be built with mandatory garages on the first two levels and be able to withstand flooding, so future flooding would be limited to washing the cars away. This could result in a stronger downtown with more usable land area. The whole city has an opportunity to return as a completely modern, rebuilt city.
Finally, what about the disruption in oil distribution and production? The Gulf is responsible for approximately 30% of US oil production and distribution. Shortages cause gas prices to skyrocket, in turn increasing costs both to construction and to the consumers throughout the country. This would be another factor affecting our costs, pushed up through the economy.
Our Federal Reserve System might need to increase our cash flow to ease the transition period, but then will have to clamp down on the money supply to prevent inflation. So we could see an initial lowering of interest rates, followed by an increase several months later.
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