Ben Muse

The Hurricane Economics Posts Are Starting

We're still about three and a half months from the (Atlantic) hurricane season. This runs from June 1 through November 30. But the hurricane economics posts have started already.

This one, from Steve Verdon at Outside the Beltway is on a topic I hadn't seen before: "Hurricanes and Distributed Generation" .

Hurricanes and Presidential Politics

Matthew Hisrich discusses the role of disasters and disaster relief in presidential elections:"Did the Florida Hurricanes Cost Kerry the Election?"

I learned about this from Joshua Hall in a post on "The Political Economy of Disaster Relief" at the blog Division of Labour. Hall also links to an abstract of the Economic Inquiry article "The Political Economy of FEMA Disaster Payments" by Thomas Garrett and Russell Sobel.

"We find that presidential and congressional influences affect the rate of disaster declaration and the allocation of FEMA disaster expenditures across states. States politically important to the president have a higher rate of disaster declaration by the president, and disaster expenditures are higher in states having congressional representation on FEMA oversight committees. Election year impacts are also found. Our models predict that nearly half of all disaster relief is motivated politically rather than by need. The findings reject a purely altruistic model of FEMA assistance and question the relative effectiveness of government versus private disaster relief."

Garrett is an economist with the St. Louis Fed. His bio there (the link above) lists his publications, and includes a link to "Political Allocation of Agriculture Disaster Payments in the 1990s." The abstract to this reads:

"Legislation passed during the 1990s attempted to move U.S. agriculture disaster relief to a more market oriented process. The failure of this legislation has been attributed to the political system behind agricultural disaster relief. This paper explores the impact of political influence on the allocation of U.S. direct agriculture disaster payments. The results reveal that disaster payments are not based solely on need, but are higher in those states represented by public officials key to the allocation of relief. The effectiveness of legislation aimed at promoting more efficient disaster payments systems, such as crop insurance, over direct cash payments is also examined."

Sobel is a professor at West Virginia University. Sobel is quoted in this story on the relationship between the hurricane and the election in The Mercury News.

"...Should Ivan's remnants make their way to the Mid-Atlantic, as they may, another battleground state, Pennsylvania, might be similarly situated. In short, experts say, in terms of disaster assistance, it's best to be in a big state where people are having trouble making up their minds.

All politics may well be local, but almost half of all disaster assistance is political, concluded two economists in a paper published last year.

"Florida is a politically important state," noted Russell Sobel of West Virginia University, coauthor of the paper. He said he was not surprised to see it getting this kind of attention..."

Natural disasters aren't good for the economy

We're predators. Our eyes filter out things that aren't moving and focus on things that are. We're alert for injured, vulnerable things, that are moving in unnatural ways.

When we look at Florida after a hurricane we see all the frenetic emergency relief activity and the reconstruction. We don't see the unemployment and lost income. And for some reason we refuse to identify the lost wealth in the destruction we see (maybe because it's the result of past, and no longer obvious, activity).

This past hurricane season in Florida stimulated news stories on how a natural disaster can actually benefit the economy. The reporters focus on what is obvious to them. They may also be intrigued by the apparant paradox of the idea that a disaster can have net economic benefits. There is probably also a very human and understandable desire to see the cloud's silver lining.

On August 18, E. Frank Stephenson of Division of Labour caught Greg Fields of the Miami Herald arguing that Hurricane Charley would make Southwest Florida better off: "Charley-nomics".

On September 26, USA Today published a story on the economic consequences of the recent hurricanes: "Economic growth from hurricanes could outweigh costs".

"Although natural disasters spread destruction and economic pain to a wide variety of businesses, for some, it can mean a burst in activity and revenue.

For that reason, economists tallying the numbers expect the hurricanes will be neutral in their effect on the U.S. economy, or may even give it a slight boost, particularly because of an expected reconstruction boom in the already red-hot construction industry..."

This led to a number of blog posts. Tyler Cowen led off the next day:"Bombing Iraq to Prosperity".

"I would not have dared this [the story in USA Today - Ben] as satire. Nor is it presented as a sophisticated critique of national income accounting, which in fact does treat such expenditures as productive. Will it next be suggested that excess productivity is our main economic problem?

Other posts referenced Cowen's post in the next few days. These may be found listed at the end of his post.

References to Fr�d�ric Bastiat's "broken window fallacy" were common. According to the Wikipedia:

"The parable describes a shopkeeper whose window is broken by a little boy. Everyone sympathizes with the man whose window was broken, but pretty soon they start to suggest that the broken window makes work for the glazier, who will then buy bread, benefitting the baker, who will then buy shoes, benefitting the cobbler, etc. Finally, the onlookers conclude that the little boy was not guilty of vandalism; instead he was a public benefactor, creating economic benefits for everyone in town.

The fallacy of the onlookers' argument is that they considered the positive benefits of purchasing a new window, but they ignored the hidden costs to the shopkeeper and others. He was forced to spend his money on a new window, and therefore could not have spent it on something else. Perhaps he was going to buy bread, benefitting the baker, who would then have bought shoes, etc., but instead he was forced to buy a window. Instead of a window and bread, he had only a window. Or perhaps he would have bought a new shirt, benefitting the tailor; in that case the glazier's gain was the tailor's loss, and again the shopkeeper has only a window instead of a window and a shirt. The child did not bring any net benefit to the town. Instead, he made the town poorer by the value of one window."

Bastiat presented this parable in his essay, "What Is Seen and What Is Not Seen". The broken window, and the efforts to repair it, are what is seen. The hidden costs are what is not seen.

Two of the best posts were those by Lynne Kiesling ( "Bastiat's Broken Window Fallacy"), and Mike Giberson ( "Hurricane of Fortune? Unemployment Claims Up") both at Knowledge Problem. Kiesling linked to interesting essays on Bastiat. Giberson provided citations and abstracts of two recent two journal articles on the economic impacts of disasters. Paulo Guimaraes et al. examined the impact of Hurrican Hugo on South Carolina and,

"...found that the income gains were neutral overall, despite a major surge in some sectors. Even in these sectors, the economic gain remained below the unreimbursed wealth loss. Thus, the catastrophe had a net negative economic effect."

Mark Skidmore and Hideki Toya took a long-run perspective, and found that:

"The cross-country empirical analysis demonstrates that higher frequencies of climatic disasters are correlated with higher rates of human capital accumulation, increases in total factor productivity, and economic growth."

This conclusion stood out from much of the rest of the material in the blog postings.

An additional post, not mentioned in Cowen's: "Who Says Keynesianism is Dead?" by Don Boudreaux at Cafe Hayek.

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This is a second post on economic themes in this season's hurricane commentary. On August 17 I posted on hurricane related discussions of price gouging: "Price Gouging".

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Revised 11-8-04

Disaster relief

Glenn Garvin was in Florida when Hurricane Andrew swept through the state in 1992. He wrote about the public and private responses to the disaster in this January 1993 Reason magazine: "Reaping the Whirlwind".  Lots of interesting observations.  Like this one:

"...local governments have joined with the construction industry to prevent timely and affordable rebuilding. Much of Dade County is in ruins. About 135,000 dwellings were damaged by the hurricane, perhaps 28,000 completely destroyed. About 82,000 businesses were damaged or destroyed. It would take local contractors a decade or more to do all the work. Even the simplest tasks, such as getting a window pane replaced, require going on waiting lists of at least two months.

With so much work waiting to be done, and plenty of money from insurance companies and the federal government available to finance it, hundreds of out-of-town companies have come to Miami to help. It's a classic case of market forces at work�or it would be, if local governments and contractors hadn't entered into a cabal to thwart them. As Charles Lennon, executive director of the South Florida Builder's Association, observed: "We don't need 6,000 unemployed carpenters from Massachusetts clogging up Interstate 95 looking for a job." To see that they won't be, Dade County officials within days of the hurricane ruled that out-of-county contractors can't do any work until they pass a temporary licensing test. And that test will be given...sometime. In early October, county officials still hadn't gotten around to scheduling the first exam..."

I wonder how this came out. When was the test administered? What was its content? How were out of town contractors integrated into the reconstruction effort.  I can see some utility in informational licensing of contractors, but I can also see how this might be used to restrict effort as well - which is the purpose Garvin is suggesting.

This is an interesting article, but it is basically a collection of anecdotes from the Andrew recovery, organized to illustrate the government's incompetence and the vitality and utility of the spontaneous private sector response.

I learned about this from Virginia Postrel

Revised 8-23-04 (title change)

Disaster insurance in Florida

In 1992 Hurricane Andrew killed 23 people, caused $15.5 billion in damage to insured property in Florida alone, and bankrupted almost a large number of insurance companies.

Frederick Mello describes how Florida adapted afterwards, for the Cape Cod Times: "Florida may be insurance bellwether" (Cape Codders, of course, may have their own hurricane disaster sometime, and have an interest in this).

"...Following Andrew, Florida allowed home insurance companies to raise rates annually, sometimes steeply, to create a financial "surplus" as a buffer against future storm losses...

...Average annual premiums already exceed $2,000 in Palm Beach County, $2,200 in Broward County and $2,700 in Dade County...

Florida insurers also began imposing wind-storm deductibles equivalent to at least 2 percent of a property's insured value, as opposed to a standard deductible of $500 or so. A homeowner with a $100,000 policy, for instance, would pay $2,000 out-of-pocket for storm damage. In exchange, homeowners receive a slight break on their annual premiums, and are guaranteed renewal the following year.

After Andrew, the state also created a catastrophe fund, to "re-insure," or reimburse insurers following a major storm causing $4.5 billion in damages or more...

That doesn't mean Florida is entirely out of the woods. The "CAT fund" is designed to withstand two major hurricanes per decade, paying insurers up to $15 billion for a single storm...

After Andrew, companies also adjusted computer-based hurricane models to account for greater storm damage than previously anticipated..."

Price gouging

Hurricane season brings a spate of blog posts on price gouging. This year Michael Munger at EconoLog has weighed in: "The Political Economy of Wishful Thinking". Over at Division of Labor we have E. Frank Stephenson: "Charley and "Price Gouging" ", Chuck Skipton: ""Unconscionable acts" in the sunny state of Florida:", and G. Dirk Mateer: "From CNN on gouging"

There were a number of posts last year. I did one ("The pros and cons of price gouging") that has links to others. This past March Kevin Brancato at Truck and Barter posted on anti-price gouging legislation in Virginia: "Anti-Price Gouging Law in VA".

The anti-price gouging legislation raises three general questions: (1) What impacts do these laws have on efficiency; (2) What is the source of the moral intuition that makes people think of price increases during or after a hurricane are unfair and wrong (as opposed to simply unpleasant); (3) What is the political economy of these things - what determines adoption and program characteristics?

The theoretical answer to question (1) is covered pretty well in the posts. The answer to the resource allocation question seems to be that non-price rationing will be substituted for price rationing. Non-price rationing is likely to involve higher transactions costs than price rationing. Available resources will be used in sub-optimal ways to a greater extent than otherwise. It will take longer for needed supplies to enter the affected region. The cost of government's response to the disaster will be greater than otherwise, because it will incur costs to enforce the price control, and may be expected to intervene to help deal with price control related supply shortages.

(Last year, Tyler Cowen introduced a different dimension to the discussion when he wondered why there wasn't more price gouging during Hurricane Isabel, despite the absence of legislation: "I survived hurricane Isabel, but couldn't buy a flashlight or the right size batteries, the night before the storm was to come. Merchants let supply run out rather than raise the prices...")

The existence of these laws may affect homeowner and business behavior before a disaster. (Skipton notes that, "The state of Florida also, conveniently, defines what is meant for the price of a commodity to be 'unconscionable' as a price that possesses 'a 'gross disparity' from the average price of that commodity during the 30 days immediately prior to the emergency. ' " Does this have implications for pricing decisions just prior to hurricane season?)

The posts (mine included) address the theoretical efficiency implications, but don't generally deal with the empirical literature (if there is any) on gouging laws. For example, do these laws actually significantly slow private sector supply responses? The Tyler Cowen post cited above implies that certain types of merchants will resist raising certain types of prices. This should affect the efficiency implications of a price gouging law.

The blogs don't generally deal with the last two questions either. Why do we think the price increases are unfair? Why will many of them think the fairness issue trumps the resource allocation issue? Who gains and who loses, and how do transactions costs affect the ability of the different groups to organize to pursue their interests politically?

Wednesday's New York Times has an anthology of Florida price gouging anecdotes, prepared by Joseph Treaster: "With Storm Gone, Floridians Are Hit With Price Gouging"

"...Under Florida law, each proven case of price gouging carries a penalty of $1,000; each case of deceptive business practices carries a penalty of $10,000 except when the victim is over 60, in which case the penalty rises to $15,000. The complaints began to trickle in as the storm was approaching and a few came in immediately afterward. But now the pace is picking up, said Sara Kinsey, who has been working late into the night answering the attorney general's complaint hot line.

She said she had heard from a man who said he was told that the new price for a small household generator was now $2,000, up from about $250.

Many of the complaints have been for two necessities: bottled water and ice. But prices have also jumped for construction work and construction materials, and the authorities expect more of that as the recovery stretches on.

Janet Snyder, a pharmacy technician in Cape Coral, said several men in two pickup trucks spotted her roof damage and offered to lay down a temporary covering of plastic sheeting. They wanted $600, about four times what she figured was the right price, based on 15 rolls of plastic that usually sell for $10 each..."

Skip Sauer points to a gouging blog post (by Brenden Koerner) that I missed in " 'The man out to end us had a hurricane business' ".

Bad law in Virginia

Kevin Brancato (Truck and Barter) posts on Virginia's anti-"price gouging" law.  Apparently the law reads (in part),

"During any time of disaster, it shall be unlawful for any supplier to sell, lease, or license, or to offer to sell, lease, or license, any necessary goods and services at an unconscionable price within the area for which the state of emergency is declared. Actual sales at the increased price shall not be required for the increase to be considered unconscionable."

Apparently inspired by the aftermath of Hurricane Isabel, this would limit price increases following a natural disaster to those justified on the basis of cost increases.  Brancato also links to a column on the same topic by Walter Williams.  Williams points to the possibility that price controls imposed under this law will impede recovery efforts in a stricken community.

I posted on post-Isabel price-gouging last September (linking to some other useful resources): "The pros and cons of price gouging".

The pros and cons of price gouging

Tyler Cohen, at "Marginal Revolution", posts on state "price gouging" laws, here "Why don't we see more price gouging?".

"I survived hurricane Isabel, but couldn't buy a flashlight or the right size batteries, the night before the storm was to come. Merchants let supply run out rather than raise the prices. C.C. Kraemer at TechCentralStation.com tells us that half of all states have anti-gouging laws. More significantly, merchants fear that customers will resent price increases during times of trouble. The testable prediction is that wandering "umbrella merchants," as I have encountered in Manhattan, will raise their prices when it is raining. They have little reason to fear long-run negative effects on their reputation. I have found this to be true but can cite only two data points in its favor, twice I bought umbrellas for $10 rather than for the usual price of $5, and I paid more when it was raining...."

This Washington Post story by Kenneth Bredemeier, instances some of the price increases following Hurricane Isabel: "Those With Power Set the Price In Hurricane Isabel's Wake, Many Complain of Gouging "

"Yesterday in Takoma Park, parts of which were still without power, Darryl Williams poked his head into the 4th Street Market and announced he had a $600 generator for rent.

" "It's $100 an hour for a friend," said the 24-year-old D.C. man. "If I don't know you, it's $200 an hour."

"The store's owner, Quacy February, counted himself as a friend. But he still balked at the price. "That's a rip-off," he said.

"Across the street, Tim Jones, a 48-year-old Takoma Park resident, priced an hour with his generator -- which he bought for $400 -- at $200 an hour.

"So far, he said, there are three takers.

"I hate to say it," he said, "but it's not a fair price." "

As an economist I'd argue that the price increases serve a useful function by rationing available resources in short supply to their most valuable uses and by, by creating high short run profits, encouraging the production and delivery of additional supplies of necessary goods to the hard hit areas. 

It's interesting that even people who receive the high price don't interpret the the prices are "fair."  This implies that they feel the value from the availability of the resource (for instance, the generator above) should be made available to the person who wants to rent it, rather than to the person who owns it. 

Perhaps this falls out of the "coding" of a loss as more valuable than an equal benefit - the result of the cognitive psychologist's asymmetric value function.  The person whose power has gone out has suffered a loss - equal maybe to $200/hour.  The ability to rent the generator at the old price ($25/hour?) lets the person minimize that loss, reducing it by $175 an hour.  If the owner of the generator could rent it for $200 an hour, the owner would receive that $175 in value.  However, people might instinctively view avoiding a loss of $175 an hour as more important than a gain of $175 an hour.  This may be why they see the price increase as unfair.

The article points to the political reponse - the governor and the attorney general are calling for an "anti-gouging" law.  This would essentially be a system of price controls imposed to prevent prices from rising in the new supply and demand conditions.  This would exacerbate the conditions of excess demand, at least temporarily - lots of lines and waiting lists for access to goods and services.  This would encourage efforts to obtain the needed items outside the region in which the price controls were in effect - but efforts by consumers rather than by the normal suppliers.  If price competition were not used for allocating goods and service, people would compete for them in other ways.  Alternative rationing systems might include discrimination by merchants on the basis of personal preferences for different people, trade at controlled prices with exchanges of favors or barter on the side, and under the table bribes and payments.  Opportunities would be created to purchase at the controlled prices for resale at illicit, but uncontrolled prices, as below:

The article ends by pointing to the experience of a firm that continued to sell ice at pre-Hurricane prices, even after the demand shifted:

"Stuart Levin, general manager of Talbert's Ice & Beverage Service in Bethesda, said, "I can't get wet ice or dry ice fast enough. People started buying dry ice when the forecasts first showed a hurricane was coming."

"But he said the price his firm is charging is still the same as before the storm...

"Walk-in customers have streamed into the firm's Bethesda store, Levin said, but he soon became suspicious of one customer's need for dry ice.

" "He bought 400 pounds of dry ice [for $640] and he waited till my last truck pulled out and started selling it in my parking lot," Levin said..."

More price gouging posts available this morning.  Tyler Cowen updates his discussion here: "More on price gouging".  "Truck and Barter", here: "Costs and Benefits of Stable Prices "  "Agoraphilia," here: "In Defense of Gouging"  (you may have to scroll down to find this one (9-23-03) - Ican't seem to link directly to the specific posting).  C.C. Kraemer at "Tech Central Station," here: "In Defense of Price Gouging".  Arnold Kling, here: "The Case for Price Gouging".  All of these links courtesy of the Tyler Cowen post leading off this paragraph.

Revisions at 7 AM, 9-23-03