As the human and economic tolls from Hurricane Katrina continue to rise, it is becoming clear that this will be one of the worst national disasters in U.S. history. The human losses are the greatest cost of the storm, but the total of physical and economic damage also will be huge.
In the face of such destruction, it is important to remember that such natural disasters destroy wealth but usually spur production of goods and services. Except to the extent that damage to transportation and petrochemical facilities hobbles the U.S. economy as a whole, the economic effect of Katrina will be to make hundreds of thousands of people poorer than they were a week ago. Many families will be much poorer, but the enormous loss of property will create a powerful stimulant to many businesses.
The full scope of the damage is still far from known, but Katrina’s damage clearly is historic. One might have to go back to the Mississippi River floods of 1927 to find a disaster of similar scope. As in 1927, the damage may continue to mount for some time. Much time may pass before even a reliable tally of deaths is complete.
A more famous comparison might be the San Francisco earthquake and fire of April 18, 1906, which killed more than a thousand people and destroyed more than 25,000 houses.
In economic terms, when we go beyond lives lost, the damage in such natural disasters takes the form of the destruction of tens of billions of dollars worth of housing, commercial property or facilities and even personal property such as clothing and appliances.
These represent huge losses in wealth for the property owners, whether individuals, companies or government. For many poor families, in which a residence and its contents constitute the only significant assets, the reduction in net worth may be total.
This is more common in floods than tornadoes or earthquakes. Most home insurance does not cover flood damage but does compensate for wind and earthquake damage. Federal flood insurance protects some property, but such coverage is haphazard and limited at best. Households whose financial well-being is most tied up in a house often are the least likely to be covered.
It took decades to construct the buildings destroyed by the storm surge in coastal Alabama and Mississippi and those submerged in New Orleans. They absorbed a significant part of their owners’ income for many years. A large fraction of the affected region’s wealth was wiped out in a few minutes or days. Even with insurance payouts and government disaster assistance, years will pass before many affected families and businesses recover the financial position they had a week ago.
The disaster will, however, spur demand for many goods and services. Households need to repair or replace damaged residences. They also must replace everything from clothing and housewares to furniture and appliances. Businesses must replace destroyed plants, equipment and inventories. State and local governments will need to repair damaged roads, bridges, pumping stations, buildings, parks and other facilities.
All this spending is largely involuntary. Available cash constraints may force households to spread their spending over time. But it will spur local economic activity for an extended period.
The degree to which Americans outside damaged areas will be affected economically remains undetermined. Tax dollars will go for emergency assistance and reconstruction. Either this money must come from other budget areas, or taxes will have to be increased.
Property insurance rates also will increase, if insurers are to remain solvent after the large losses they must handle. As insurers recalculate their risks, increases in rates may be highest in regions exposed to hurricanes, but some increases will spill over to policyholders in regions distant from the Gulf Coast.
Most natural disasters, including other destructive storms such as Hurricanes Andrew and Camille, do little to lower production of goods and services nationwide. Katrina may be an exception for at least two reasons.
A significant chunk of the nation’s petroleum and chemicals flow from or through the affected area. If storm damage reduces such flows to the point where businesses cannot get the supplies they need to operate, national output may drop.
New Orleans also is an important transportation hub. It handles a significant portion of the nation’s international trade and is the interchange point for large volumes of commodities transported on inland waterways. Again, if storm damage is great enough to disrupt flows of goods to the point where factories must curtail production, gross domestic product may drop for some time.
The U.S. transportation system is remarkably robust and many transportation facilities are resistant to storm damage. We may face a case, however, where physical access of workers to work sites and delays in restoring electrical power and other utilities may close some facilities for extended periods.
The region will recover and the recovery will provide jobs. The experience of Germany and Japan from 1945 to 1965 demonstrates how even nations that suffered vast, nationwide destruction can have high employment and strong output growth.
© 2005 Edward Lotterman
Chanarambie Consulting, Inc.