The recent spate of hurricanes has caused substantial costs to persons and property across several states. The losses are tragic by any reasonable standard and run into the billions of dollars in physical damages alone. Nonetheless, don’t look for them to decrease our standard measure of economic well-being in the US and across the globe, Gross Domestic Product (GDP). They will not show up as a setback to this widely watched benchmark—just the opposite, in fact!!
It is engrained in us to look at the GDP to determine how we are doing in the economy. Its quarterly release is inevitably the lead story of the day and the occasion for political leaders of all persuasions to give their particular spin to the numbers. Two consecutive quarters of decline in this measure is an almost universally accepted definition of a recession. Even a minor revision in a past number is a subject of considerable buzz in the financial markets, and stock prices rise and fall with its every wiggle. So, what does GDP have to say about a hurricane, tornado, flood, earthquake or other natural disaster? The answer may surprise you, but I’m not going to give it just yet.
Initially, let’s explore exactly what the GDP is—and what it is not! The textbook explanation is that it is the final value of all goods and services produced in the economy in a given period of time (usually a quarter or a year). The key words are “final value” and “produced.” You can get to this number in several ways. You can add up the value added (sales minus the costs of purchased items) by every industry. You can add up all of the payments made to generate the output (wages, rents, profits, interest, etc.). Or, you can add up the categories of spending (consumption, investment, governmental outlays, and net exports). Theoretically, any of these approaches will give you the same answer. In practice, they come remarkably close, particularly given the fact that our GDP is now well in excess of $10 trillion (a fourteen-digit number). With the exception of a relatively insignificant fudge factor to account for the inherent messiness in trying to determine all of these things (known formally as a “statistical discrepancy”), the various techniques for computing GDP are indeed consistent.
Now, what happens when a storm hits the coast? If you stop and think about it, the storm itself does not directly affect “production” in the economy to any significant degree. Thus, it doesn’t show up in the GDP amounts at all. On the other hand, the extra plywood, bottled water, gasoline, and other items that are purchased in anticipation of the hurricane’s arrival actually increase GDP. Similarly, the months and years following a major disaster typically bring a spurt of new construction activity which also adds to the economy. Thus, we find ourselves confronted with the notable irony that something that is unambiguously bad for our well-being has the effect of increasing the GDP.
The answer to this enigma is simply the fact that GDP is a measure of production, not welfare. It doesn’t pretend to be anything else, but we often lose sight of that fact. If your home and possessions are destroyed and you rebuild the structure and replace the lost items, you are certainly going to wish the devastation had never occurred in the first place. In terms of production, however, you clearly caused things to occur that wouldn’t have happened otherwise.
There is nothing new in this phenomenon. Folks have been working for decades to devise measures that better capture our overall progress as an economy (a subject for another day). Additionally, the seemingly ceaseless string of major storms this year is but one of many manifestations of the shortcomings of GDP as a “true” measure of how we are doing. It is just the most observed at the moment. The key to seeing through this fog is simply to remember that GDP only purports to tell us what we produced—nothing more, nothing less! It never was and never will be an indication of how we feel.