Amendment to the "Broken Window Fallacy"?

[Carl Close]

The item below appeared in today's (11/6/02) edition of NCPA's Daily Policy Digest. It may interest Armchair-ists who, like me, are highly sensitized any cases that resemble the Broken Window Fallacy.

The item summarizes a paper, by economists Mark Skidmore and Hideki Toya, concluding that natural disasters lead to a substitution away from investment in physical capital and toward human capital, resulting in productivity gains. This need not be an instance of the Broken Window Fallacy if the pre-disaster ratio of human to physical capital was suboptimal because it neglected the effects of future disasters.

However, Skidmore and Toya also claim in their abstract that "Disasters also provide the impetus to update the capital stock and adopt new technologies, leading to improvements in total factor productivity." <http://ei.oupjournals.org/cgi/content/abstract/40/4/664>

Is this an example of the Broken Window Fallacy? Or does it avoid committing the fallacy because in this special case the productivity gains from investing in improvements outweigh the value of the old uses of the resources that contribute to the improvements? (Or does it avoid committing the fallacy for some other reason?)

Carl Close

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NATURAL DISASTERS HELP GROWTH

While natural disasters are great calamities that cause huge
amounts of destruction, they can provide the opportunity to
reinvest and build a stronger community. Recent research
suggests natural disasters can have benefits for an economy.

Researchers measured climatic and geological disasters over the
past 190 years, from 1800 through 1990. They conclude that the
disasters reduce the value of capital, because it has a shortened
life span -- building and machines are destroyed before they are
used up. However, they also find that these disasters cause
firms to invest more in human capital -- schooling and training.
Consequently, firms invest in human beings what they would
otherwise have invested in buildings and machines. The added
productivity of these people increases the total productivity of
the community.

Moreover, researchers find that the destruction of physical
capital has benefits as well. The replacement buildings and
machinery are almost always more efficient and cheaper. By
offering a chance to replace older machinery, disaster-prone
areas can rebuild with the best money can buy.

The authors find that climatic disasters have benefits:

o An increase of one standard deviation in climatic
disasters over the average results in a 22.4 percent
increase in the average annual rate of economic growth.

o This results in a real increase of 0.47 in the
average rate of annual growth.

In contrast, they find that geological disasters like earthquakes
are not a benefit to long-run economic growth, but are a
detriment.

Source: Mark Skidmore and Hideki Toya, "Do Natural Disasters
Promote Long-Run Growth," Economic Inquiry, Vol. 40, No. 4,
October 2002.

For text http://ei.oupjournals.org/cgi/content/abstract/40/4/664