People on Twitter might be joking, but in all seriousness, we would see a bigger boost in spending and hence economic growth if the earthquake had done more damage.
Vast numbers of right-wing writers immediately attacked the post as evidence of Krugman's heartlessness and lack of understanding of basic economics. The stock response to the faux-claim has been to cite "The Parable of the Broken Window." If you're not familiar with the parable, it goes like this:
A shopkeeper's son breaks a window. The shopkeeper must replace the window, which costs $50. Lamenting his loss of $50 to a friend, the shopkeeper's naive friend tells him that the $50 spent on the window went to the glazier, who now has $50 more to spend in his shop! The money will come back to the shopkeeper and everything will work out in the end. The shopkeeper, though, realizes the fallacy of his friend's logic and says, "What you forget is that I was going to spend that $50 on a new coat! The clothier now will no longer have the $50 to spend in my store! While I may be able to replace the window, I'm still out the coat!"
Thus, the parable of the broken window concludes that destruction is not beneficial to the economy. Even though the impostor who posted the statement attributed to Krugman has since revealed himself, it seems that he has managed to bring forth the parable as an argument against Keynsian economics. It's not an original argument, and I have no doubt it will be trotted out again many times in the future.
There's are multiple problems with using the parable of the broken window, though, when viewing our current economy. Before describing those problems, I have to lay down some basic ground rules.
1) Economics is an amoral scientific analysis of human behavior and wealth. Note that I do not say immoral, just amoral. There are no basic moral assumptions in economics. For example, the drug trade, prostitution, and murder-for- hire are all examples of activities commonly (not universally) viewed as immoral. However, economics does not consider the moral weight of any of these actions. An economist can draw many conclusions about these activities without making any moral judgment on them. Black markets exist, and an economist can study these markets without condoning them.
2) An amoral economic conclusion, even if it is economically beneficial, is not necessarily an endorsement of a specific economic activity. For example, most people attribute a highly expansionary effect on the economy due to World War II. Few people, though, believe that World War II was beneficial to mankind. Moreover, no one of conscience advocates simply going to war as an good economic solution.
With these ground rules in place, I will affirmatively state that I do not condone or advocate property destruction, whether caused by man or nature, as an appropriate economic tool in any circumstances. The conclusions that I draw are merely an amoral economic analysis and predictions of outcomes based on theoretical scenarios.
Now, back to the parable of the broken window. Why doesn't the parable provide us proper insight into the economic effect of natural disasters? Also, why is it an inappropriate comparison to Keynsian economics?
To begin to answer these questions, we have to look at the assumptions of the parable. The "naive" friend assumes that the $50 spent on a new window is $50 injected into the economy. Therefore, he believes that the money will ultimately "come back" to the shopkeeper when the glazier uses the money to make purchases in the shopkeeper's store. In the parable, this assumption is false because the shopkeeper was planning on purchasing the a new coat. Therefore, the total purchases in the economy in dollar amounts has not changed at all, and the shopkeeper no longer can afford his new coat. The important assumption is that the shopkeeper was going to spend the money elsewhere, and this is why the shopkeeper is correct in the parable.
If the parable of the broken window is to have any truth when applied to a natural disaster, we must consider the basic assumption that the money used to replace the window was going to be used for other purposes. Perhaps this seems like common sense to you. It shouldn't be. The shopkeeper always has the option of simply hoarding the $50. What if the shopkeeper intended to bury the $50 in a jar? If this is our new assumption, the "naive" friend begins to seem a little less crazy. Instead of burying the $50, now the shopkeeper must spend it. With this new assumption, total purchases do increase. The economy has effectively grown, though the shopkeeper is still without his $50 in a jar.
What if the shopkeeper didn't have $50 to spend at all? Unless someone is willing to give the shopkeeper $50, nothing happens. The shopkeeper loses his window, the economy doesn't grow, and no one is better off, least of all the shopkeeper. If someone is willing to give the shopkeeper $50, then we have to consider what the generous benefactor was going to do with that money. If they had planned on spending the money, then the shopkeeper's logic holds. Total purchases do not grow. However, if the benefactor was simply hoarding the money, then total purchases do increase, and the "naive" friend's logic is not so flawed.
Given these different assumptions, it becomes clear that the original use of the $50 is paramount to any conclusion we may draw about the effect of the broken window. If the $50 would be hoarded absent the broken window, then the parable's conclusion is incorrect. If the $50 is earmarked for a different purchase, then the shopkeeper's logic is sound.
Back to our natural disaster. Which of the above assumptions most closely resembles our current economy? In truth, a combination of all the assumptions is closest to our economy. Consider the city of New York. New York consists of poor people and rich people as well as many businesses. Because our economy is still emerging from a recession, some people and corporations are hoarding money. This is what happens in a recession. The demand for money increases while the demand for productive assets decreases. For evidence, consider that Apple was sitting on $76.2 billion in cash as recently as July. However, not everyone is sitting on mountains of cash. Poor people, in particular, would have no ability to replace lost assets without private or public assistance. Would a generous benefactor sweep in to replace the lost assets? Don't hold your breath. If the relief efforts after Hurricane Katrina are any indication, some public and private assistance would be given, but not enough to replace the total lost assets of those without wealth. So some of the citizens of New York resemble the shopkeeper with the jar in the backyard, some resemble the shopkeeper who wanted the new coat, and others resemble the shopkeeper without $50 at all.
With this new framework, what happens to New York after a theoretical natural disaster? Let's start with the wealthy who are hoarding cash. In order to replace their lost assets, they dip into their cash reserves. This will grow the current economy. The individuals with money that would be spent on other goods redirect their funds towards replacing their lost assets. This is a wash for the size of the economy, but a loss of assets for the individuals. The poor, however, must rely on assistance to replace lost assets which typically is not enough to cover their losses. They lose assets, and any economic effect complete relies on the intentions of their benefactors.
To our final economic conclusion: what is the effect of a natural disaster on the total economy? Because some people have cash reserves that are redirected into the economy, the size of the current economy grows. However, these individuals still lose assets. Moreover, the economic stimulus of the event is only in proportion to the amount of cash reserves redirected into the economy, not in proportion to the total economic activity needed to replace all lost assets. Finally, the damaged assets of the event may be replaced, but the total value of the assets is completely lost. Thus, natural disasters may increase the current size of the economy at the expense of valuable assets.
Having concluded that amoral analysis, should we wish for natural disasters to save us? The obvious answer is no. Even though the current size of the economy may grow, we lose valuable assets. Furthermore, the lost assets will hinder long-term economic growth. Simply put, cash hoarders will not always want to sit on their money. Eventually they will want to place their money in productive assets or use the money for consumption which will grow the economy more in the future. So the immediate benefits of an expanding economy are offset by the long-term loss of assets. Furthermore, the greatest effects of the disaster will be disproportinately felt by the poor who do not have the means to replace their assets.
If you are wondering why the "Parable of the Broken Window" is used as a counter-argument to Keynesian economics, you have to go back to the shopkeeper's assumption. The shopkeeper realizes the additional spending on the broken window isn't an economic gain because he was going to buy that new coat. Therefore, increasing spending on the window doesn't help the economy. The flawed logic therefore concludes that Keynes' assertions about government spending are wrong. What Keynes realized, and we see through empirical evidence, is that cash is hoarded in a recession. Therefore, mechanisms that inject additional cash into the economy such as
If you are curious about Krugman's personal response to his impostor, you can find it here.
*edit: in my attempt to keep this post from running too long, I originally condensed some of Keynes main points too much. I've made these changes to better reflect a recessionary economy that does not enter into the Keynesian "liquidity trap." However, our current economy might likely best be defined by the liquidity trap in a Keynesian model.
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