Parable of the Broken Window

Neil Dutta, Head of U.S. Economics, Renaissance Macro Research

In thinking about the devastation caused by Hurricane Sandy, I’m reminded of the Parable of the Broken Window.  In the 19th century, French classical liberal economist Frederic Bastiat tells a story to draw the distinction between what is and what could have been. We can see how the money is spent to repair a broken window, however, we do not see how the money would have been spent otherwise.

The dilemma that is faced in Bastiat’s parable is one to ponder as we assess the economic fallout of Hurricane Sandy.

We do not believe that billions of dollars in property damage is a good thing. Still, damage to roads and bridges does not shave GDP while rebuilding activity helps boost GDP and employment. Dramatic weather events act as a temporary shock, weighing on growth in the immediate term then boosting growth over subsequent quarters. Economic activity is delayed or shifted. Taking a two quarter view, the entire event is essentially a wash.

A few quick points:

  • Recall the fallout from Hurricane Katrina. Growth moderated in Q4 2005 and then rebounded sharply in Q1 2006. Hurricane Sandy hit the most populated area of the United States during the workweek. The flooding the Hurricane has left in its wake suggest a more persistent drag on activity. A 0.5ppt hit to Q4 GDP growth would not surprise us though we would expect the activity to be made up in subsequent quarters. It may well be possible that the recovery is faster, spanning months, limiting the impact to quarterly GDP. Time will tell.
  • Some retailers will see sales decline while others will see sales improve. When a tree is blocking you from leaving your neighborhood, it is relatively safe to say that you will prioritize buying things you need immediately over things you don’t. Auto dealers, apparel retailers, and restaurant sales will likely weaken while spending on grocery stores and home renovation stores pick-up. The broader story is that consumers have already drawn down their savings quite a bit over the last three months, raising the risk to discretionary spending beyond the immediate aftermath of the Hurricane.
  • Residential construction and utilities production will likely moderate in the Northeast. There are a number of reports that refineries in this part of the country have been idled, and that means higher gasoline prices at the pump.

It is all about your time horizon. The near-term effect of the storm will be to make a weak economy that much weaker. Thereafter, we would expect the data to look strong relative to the underlying trend in the economy.