The economics of the Christchurch earthquake

Written By: - Date published: 1:00 pm, September 7th, 2010 - 27 comments
Categories: Economy - Tags:

There’s been some frankly bizarre talk about the earthquake being an economic boon for the country. I guess the Right is just desperate for anything to improve the economy under National. So, I thought it would be worthwhile going through the economic ramifications of the earthquake from the immediate effects to long term:

Initial effects: The economic heart of Christchurch is shut down. About $2 billion worth of damage has been done, much of this damage will impede economic activity. Infrastructure is damaged as are buildings and factories. People are dislocated, injured, or busy trying to get their personal lives together. People needing elective surgery are unable to get it. In economic terms, the large parts of both the capital and labour needed for production are out of action.

Westpac, using a model derived from the Los Angeles and Napier earthquakes, estimates that $300 million of economic activity will be lost (0.2% of GDP). ASB chief economist Nick Tuffley puts the hit at 0.6% of GDP. NZIER was already forecasting that growth in this December quarter would be -0.2%. That’s likely to be much worse now.

The damage will include businesses that are already on the brink thanks to the recession going to the wall and hundreds if not thousands of job losses. Those workers who lose their jobs will flood an already bad jobs market. The government will lose tens of millions of dollars in tax revenue and face big increases in costs from emergency benefits, ACC claims, and its share of the cost of rebuilding local infrastructure before we even get to the EQC payouts. The added borrowing needed to fill the gap will probably mean the government has to pay more interest on its debt.

The Earthquake Commission, logically, has most of its assets offshore, and so do the insurance companies. To make the payouts, they’re going to have to buy a lot of New Zealand dollars – higher demand equals higher exchange rate. Offsetting this, possibly, is that it just became much less likely the Reserve Bank will increase interest rates again, which should dampen demand for the dollar. Overall, the effect is that we haven’t seen a sharp fall in the currency, which would have been a boon for exporters, that you might expect from a disaster like this.

Medium term: EQC and insurance companies will begin making payouts within weeks but it will be months before the big rebuilding starts. The rebuilding will increase GDP by about 1% of a year’s output when it is spent because GDP simply reflects economic activity in a given time period not accumulated wealth. But that will only be returning the country’s physical wealth to where it was before, it will not be real economic gain.

If I break my cellphone and have to dip into my savings to replace it, I am not better off, I am worse off – even if the new phone is better because obviously I had preferred to have my old phone and my savings rather than the new phone. The same is true of the need to spend our savings on rebuilding. People who say it’s good for the economy are forgetting that the rebuilding is funded by giving up our savings and the option to spend them elsewhere. That’s the broken windows fallacy – it mistake of seeing what is gained but not what is lost, or mistaking temporary economic activity for economic wealth.

It is good timing, however, in one sense. The slow-down in commercial construction was about to put 20,000 jobs at risk. At least they’ll have something to do for a while now, and the construction industry has the spare plant and equipment for the rebuilding task. Of course, that’s just jobs that would otherwise be lost saved, not new jobs created.

Longer term: once the rebuilding is over, there will be little to show for it. The boost of the rebuilding itself will not be permanent and will contribute little to long-term production capacity. Once the rebuilding is over, the GDP boost will disappear. That’s true of a stimulus package too, of course. But the idea is that a stimulus package gets the economy revved up again and builds up its production capacity. The rebuilding of Christchurch will not be like that it’s not going to create sustainable economic momentum or add greatly to the productive capacity of Christchurch.

As Westpac noted “This will boost national GDP by far more than the initial income loss, with a corresponding letdown once the reconstruction boom ends.” Just as with the Rugby World Cup, the one-off up-tick in GDP will be matched by a corresponding downwards movement when the spending stops. This is not a permanent increase in economic output.

This boom and bust might further damage business confidence and, with it, longer-term growth.

Ultimately, about $2 billion of capital from the government and private insurers will be converted into expenditure to rebuild the capital that was lost. In the end, we replace the physical assets by running down our financial assets via a temporary increase in economic activity but our national wealth is decreased – that can’t be forgotten.

Of course, I and others have been arguing for some time that the government should decrease its net assets to more economic activity. Of course, we meant by borrowing, rather than selling assets like the EQC will but essentially it’s the same thing from the perspective of the government books. The difference is that, without the earthquake, we could have spent that money on re-igniting the economy and making a wealthier country for the future. Now it needs to be spent just on what was lost.

We’re going to be left with higher net debt, which we will either pay interest on or pay down – either option means less consumption/lower economic standard of living in the long term

27 comments on “The economics of the Christchurch earthquake”

  1. Richard 1

    I agree with all that.

    However, there will be a boom for individual businesses, particularly those in construction. It is for the economy as a whole that there is a net loss.

    As you note, there will be in some cases some marginal benefit, in that when something is rebuilt it could be “better” than what existed previously. For example, when considering energy efficiency, it is often uneconomic to retro-fit energy efficiency measures to a built structure, whereas it is quite economically viable to incorporate energy efficiency into a new build. Likewise, replacement buildings are likely to have better earthquake strengthening incorporated (or you’d like to think so).

    • ZB 1.1

      I disagree. A sustainable economy requires a working ChCh. The argument basically seems to
      be that its a cost, but actually its more like a reinvestment. Companies, Households, Nations,
      all have crisis that hit them, if they are governed well they have stores of money to cover the
      re-investment. Government runs a EQC for this, has insurace for this, has a low govt debt for
      this reason. We’ve already saved to pay for disasters. We’ve already had some of the pain.

      The economy needs a kick in the teeth, if the ChCh Quake makes manufacturing exporters
      jobs harder, if it puts money into tradespeople in ChCh, if we build new quake resistent
      buildings, and stop new subsections on sand (like on that beach subsection in the Coromandal,
      because its now a huge insurance risk to build so close to the sea, on sand.

      Sorry, we live in interesting times and we should beware because simple analysis doesn’t work.
      We are rebuilding! Rebuilding with savings! We saved for the purpose! At the bottom of the
      market, not the top! Not when every developer shister is selling crap – like that subsection in
      ChCh built on SAND! Nobody knows if this is a good thing, I think sometimes you get lucky
      with a early morning quake removing a lot of previously buildings needing expensive
      quake resistent upgrades without any loss of life.

      And the Quake just keeps giving, dispelling the impression of the loose financal era,
      that we can trust big business, that markets will save us not good regulation.

      It could have be so much worse. Imagine the quake with Key in charge in 2006-7,
      and the whole developer speculator class lining up for handouts to rebuild ChCh,
      the debt Key would have run up with tax cuts to the few would have made NZ
      a Greece, Ireland, Spain.

  2. Zaphod Beeblebrox 2

    I was under the impression that for economic stimulus to be effective it had to be spent quickly so that the money recycled through the economy immediately for short periods of economic downturn. Given how long it takes it get building permits, import building materials (which adds to the current account deficit) and get a builder, I would have thought the stimulus effect would be extremely diluted by the anticipitated time this money will be spent over.

    • Blighty 2.1

      to make a measurable difference, you would have to spend it quickly but it would just be quicker up, quicker down.

      • Zaphod Beeblebrox 2.1.1

        But whats the point of stringing it out? In 12 months time the recession may be a distant memory and all you will end up doing is stoking inflation, higher interest rates and government debt. Economic cycles move a lot quicker than decision makers apparently which renders a lot of these decisions irrelevant.

    • Loota 2.2

      The stimulus effect is a lost cause – yes firms and contractors are going to get big injections of Govt and insurance money – but they are probably going to direct it to paying off debt (household and company) and saving reserves for (the next) rainy/shaky day.

      They are not going to spend up large.

      Trickle down is dead.

      • nzfp 2.2.1

        “They are not going to spend up large” maybe, maybe not – but it doesn’t matter because the Government could spend up large and should – we need soo much infrastructure built and repaired in our nation and that doesn’t include the lack of investment in human infrastructure such as health and education. You’ve seen my other posts so you know where the money can come from tax free – without interest or debt.

  3. nzfp 3

    But why stop at Christchurch Marty, and why stop at rebuilding what exists. Economic activity can be stimulated by something as simple as a bridge in the right place which reduces the cost of transport for products from A to B.

    Why not use this stimulus to build a high speed rail network with Christchurch as the nexus throughout the entire South Island, couple this with building Fiber to the home and improved telecommunications. Both of these suggetions would reduce the cost of transport of goods and improve the Online economy – both would boost sustainable economic productivity.

    The only problem we have is creating the necessary funds and putting the money to use fueling the labour necessary to produce the necessary infrastructure. Make the infrastructure green while you’re at it and you reduce the environmental impact.

    The Earth Quake represents the single best opportunity for real economic progress for our country. Yes what I’m saying is Pie in the Sky but as you well know this was the policy of Sir Michael Joseph Savage so it’s happened before.

    • Zaphod Beeblebrox 3.1

      What a sad reflection upon our government.

    • Rex Widerstrom 3.2

      I find myself nodding in agreement with what seems like the common sense of much that you say above nzfp (with the exception of handing out a knighthood to Savage, whom I’m pretty sure never got, nor probably wanted, one – a recolelction his official biography seems to confirm).

      However, how would you respond to the coventional wisdom that what you’re proposing would be inflationary and thus damaging?

      • nzfp 3.2.1

        Hey Rex,
        “how would you respond to the coventional wisdom that what you’re proposing would be inflationary and thus damaging”

        Great question as it is the question that is always raised when public credit is proposed in opposition to private bank credit.

        In short public credit is no more inflationary then credit created as a result of foreign borrowing (debt). In fact it is less inflationary as it doesn’t include the requirement to service interest on debts denominated in foreign currency.

        When the Government borrows 200 Million dollars as a result of the sale of NZ Bonds, the Governments receives 200 Million dollars in foreign currency. The 200Million in Foreign Currency was created out of nothing at all by foreign banks – an exercise the Government could do itself.

        However, the foreign currency cannot be spent into the NZ economy so the Government converts the 200 Million into NZ Dollars. To do this they park the foreign currency in a foreign currency account and create an equivalent 200 Million NZD out of nothing.

        Already you can see the injustice and fraud of this system:

        NZ Govt sells 200 Million in NZ bonds -> Foreign Bank creates 200 Million from nothing to Buy Bonds -> NZ Govt creates an equivalent 200 Million against the 200 Million in Foreign currency created by foreign banks out of nothing -> NZ Govt spends or lends the new money into the economy -> NZ Govt taxes NZr’s to service the interest on the foreign debt (GST increases).

        To counter this the Government has two options:

        1. Keynesian – the Government issues 200 Million in NZ Bonds -> The RBNZ creates 200 Million out of nothing to Buy the NZ Bonds -> The Govt spends or lends the money into the economy -> NZ Govt taxes NZr’s to service the interest on the debt to ourselves. This is also part of the State Theory of Money. The Tax ensures the velocity of money – that it circulates. However the level of tax could be set a lot lower then the neo-liberal monetarist model and in many cases most taxes could be eradicated.

        2. Public credit – the Govt issues 200 Million in money and spends or lends it directly into the economy. Essentially it is the same as pure Keynesian theory with the exeption that we don’t borrow from our own bank but have the Treasury create the money directly – otherwise the rules apply.

        In both cases there is no need to service foreign interest debts and no need to pay money back to foreign banks in a currency we have no control over. If interest rates increase our interest and repayment burdens increase – it only takes a little war in Iran to cause interest rates to sky rocket.

        Remember that either of these methods are required to pay for infrastructure that cannot be paid for out of current taxes – and shouldn’t be.

        Remember that inflation of the money supply is only inflationary if there isn’t an equivalent increase in products and services including human services such as health and education. Infrastructure improvements by definition are an increase in products and services and have the benefit of improving commerce which stimulates productivity increasing products and services.

        It is better explained by Professor Michael Hudson in an earlier post of mine here and on his website here.

        Radio NZ reported this morning that the Govt was selling 200 Million in NZ Bods today (this afternoon). Rather then sell 200 Million – since they obviously need the money – they could create 20 Million via the RBNZ or Treasury. The net effect would be a reduction in inflation due to the fact that we don’t need to service foreign interest debts. Any foreign capital that comes into our nation for investment of purchases of NZ products could be used to service current debts – while the Govt creates credit to fuel infrastructure instead of borrowing.

        The overall effect would be hugely beneficial to our economy and would result in a net lowering of all taxes.

      • nzfp 3.2.2

        Thanks for the correction and the Savage BIO Rex. I never knew Savage was a Georgist although in hindsight it seems obvious. George was one of the “Renegade Economists” – a term coined by SMH and TheAge columist and economist “Ross Gittins”.

        By the way:
        “200 Million in NZ Bods” should be “200 Million in NZ Bonds
        And
        “they could create 20 Million” should be “they could create 200 Million”

  4. Armchair Critic 4

    The difference is that, without the earthquake, we could have spent that money on re-igniting the economy and making a wealthier country for the future. Now it needs to be spent just on what was lost.
    I thought the EQC funds were set aside specifically for post-disaster rebuilding. On this basis, how could the money have been spent re-igniting the economy etc.? It’s set aside for a specific purpose, not for politicians to spend on whatever whim takes their fancy, even if their fancy happens to be a good idea.

    • Lanthanide 4.1

      Essentially the EQC money has been saved previously. So instead of spending $50 back in 1990, the government spent $40 and banked $10. Now we’re getting access to that $10 again, but it isn’t new money magicked out of nowhere, but deferred spending from 1990.

      • Armchair Critic 4.1.1

        Yeah, I got that bit. And I agree with most of the post. The bit I don’t get is where Marty G says:
        …we could have spent that money on re-igniting the economy…
        I understood that the money (especially from EQC) to be spent rebuilding is dedicated to rebuilding. As it was deliberately set aside for a specific purpose, it can’t be used for another purpose.
        anti-spam: following. Not at the moment; I’ve tried following the logic and I’m missing out somewhere.

    • Bright Red 4.2

      yeah but one pot of government money is the same as another in reality. And borrowing is pretty much the same as selling an asset

  5. Grant M. McKenna 5

    I’ve missed the bit where “the Right” said that the earthquake would be good for the economy. Where and when was that averred?

  6. aj 6

    No matter what way you look at this, in human terms it is far less than a zero sum game. A small number may have short term gain through the economic boom as a consequence of repairs. The cost in human terms will be long lasting and greatly outweigh simple $$ calculations. Stress over the long term, that is within families and individuals will result in many problems further down the track for health authorities, social services, etc.

  7. Kleefer 7

    Once again you are labouring under the misapprehension that, while an earthquake destroying buildings is bad for the economy, the government spending money to “stimulate” the economy is good. Both are bad for the economy but due to the visual impact of buildings literally being destroyed it is easier for the layman to identify the economic damage from an earthquake than from government “stimulus”.

    Advocates of government spending fall prey to the same broken window fallacy that afflicts those touting the supposedly stimulatory effects of the earthquake. In both cases they think only of one side of the transaction, those who financially benefit from the broken window/government spending, while forgetting those who are worse off, the person with the broken window/less money because the government has taken it to give to someone else.

    What the broken window fallacy is really about is opportunity cost. While we can see the benefit to the glazier from repairing the window (or in this case the contractors for repairing the buildings) we can’t see what the person with the broken window would have done with the money if he hadn’t had to pay for the repair.

    We can see the results of government stimulus such as school buildings, roads and poorly-fitted insulation but we can’t see what wasn’t made as a result of resources being diverted by the government to these uses. So while the government isn’t necessarily knocking things down (although wars do plenty of that), it is still fallacious to tout the results of stimulus without thinking about the other side of the ledger.

    Henry Hazlitt, the former New York Times economics editor, wrote in his book Economics in One Lesson that when assessing the economic impact of a policy we must look not just at its immediate effect on one group but on its long-term effect on everybody in society. I applaud the writers of The Standard for taking on the idiots saying the earthquake will be good for the economy. Now you just need to apply economic principles consistently.

    • nzfp 7.1

      Henry Hazlitt is credited with bringing Austrian economics to an English-speaking audience, he secured a position at New York University for the economist Ludwig von Mises, and he introduced the novelist Ayn Rand (Alisa Zinolev’yevna Rosenbaum) to Mises. His influences included: Frédéric Bastiat, Philip Wicksteed and Ludwig von Mises. He opposed Karl Marx, Thorstein Veblen, Major Douglas (Major Clifford H. Douglas), John Maynard Keynes and Alvin Hansen. He influenced Milton Friedman.

      Milton Friedman gave us the Washington Consensus and the Chicago School of Economics which in turn gave us Rogernomics and Ruthenasia in the 80’s and 90’s. Friedman also gave Chile Augusto Pinochet and the Chilean deathsquads and disappeared.

      Von Mises gave us Ayn Rand and Libertarianism. However, the Austrian School of Economics defines money as a commodity with intrinsic value, which is contradictory to historical and empirical evidence. Aristotle best defines money in Ethics 1133 where he states “Money exists not by nature but by law”.

      Hazlitt opposed Major Douglas – Major Clifford H. Douglas the founder of the Social Credit school of economic democracy.

      Considering these points it makes it difficult to take seriously the economic theory of somebody who is unable to correctly define money and who’s economic theories influenced the architect of Washington Consus neo-liberal monetarist policy – the fruits of which are evident in the current Global Financial Crises.

  8. Bright Red 8

    Patrick Smellie agrees with you, Marty http://www.stuff.co.nz/business/industries/4107029/Shaky-times-for-the-economy

    good work on forcing this argument. the msm would just have blindly followed the stupid ‘silver lining’ angle otherwise.

  9. Draco T Bastard 9

    So, breaking news is that the estimate for rebuilding Christchurch has increased to $4b. At the same time there’s some question about availability of resources. This is where the government really needs to step in an ban all exports of building and construction materials. We’re going to need those ourselves for the foreseeable future (It’s going to take years to get Christchurch back to the same level that it was).

  10. Too much coffee man 10

    Well said. I remember when that visionary leader George Dubbyerbush decided to dump billions of dollars of bombs on Iraq and Afghanistan the right crowed with delight about the benefits to the US economy that would entail. Dropping a million dollar bomb doesn’t result in a million dollars worth of production, it results in a million dollars with of destruction, and that million dollars has gone for good.

    When a building gets replaced at a cost of a million dollars, that million dollars is also lost forever.

  11. Anthony 11

    Dear Marty

    I must say that this is a very critical analysis.

    But one thing I would like to ask how does an increase in interest rate will dampen the demand for kiwi dollar?

    As you pointed out in the last paragraph, “Offsetting this, possibly, is that it just became much less likely the Reserve Bank will increase interest rates again, which should dampen demand for the dollar.”

    Because an increase in interest rate will lift up the return for every dollar overseas investors invest in New Zealand relative to other countries’ interest rates, therefore the demand for kiwi dollar should have increased rather than decreased.

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