Cost of Catastrophes, Natural and Unnatural

“Hurricane Irene will most likely prove to be one of the 10 costliest catastrophes in the nation’s history,” with damage estimated at US$ 7-10 billion (“Hurricane Irene Seen as Ranking among Top Ten,” NYT, 31 August 2011, 1).

As terrible as this storm was (notably in Vermont where I lived for several years), its cost falls considerably short of another recent catastrophe, the financial storm of 2008, whose effects, like those of Hurricane Irene, linger long after its formal downgrading.

The ideologues and devotees of ‘free markets’ frequently refer to market processes as ‘natural’, coining such terms as the ‘natural rate of unemployment’.  Adapting this usage, I can confidently assert that no hurricane or earthquake has ever or will ever approach the potential of markets to generate human disasters.  To match the devastation, suffering and dead-weight loss of the Great Depression of the 1930s and the recent Financial Crisis, we move into the league of wars, famines and pogroms.

Lest you think that I exaggerate, the statistics speak clearly.  From the beginning of 2000 through the middle of 2008, US total output (‘gross national product’) grew at an annual rate of 2.5 percent.  Three years later, now, total output is still slightly below the peak of mid-2008.  Had the US economy ‘enjoyed’ no growth over those three years, and output stagnated at the level of mid-2008, the income gain would have been almost $5 trillion compared to the actual outcome, or one-third of annual production.

This is a not a relevant comparison, because in no three year period since the end of World War II has the US economy stagnated, even less has it declined.  Over those 65 years, in no year has output been lower that it was three years previously. Only once before, 1974-1975, output declined for two consecutive years.  Five trillion dollars may far exceed the estimated cost of any earthquake or hurricane in the history of humankind, but it is a considerable underestimate of the money cost of the 2008 unnatural catastrophe.

What if US output had continued to grow at 2.5 percent, as it did in the 2000s before the catastrophe?  Despite all the prattle about a ‘New Economy’, this rate was not unusually high, well below the average of 1946-1999 (which was 3.6 percent).  The answer is shown in the chart below.  It measures GDP at the price level of the first six months of this year, eliminating increases due to inflation.  Had the ‘natural’ working of financial markets not reeked havoc, and the economy continued to grow at 2.5 percent, the annual GDP for 2011 would be almost twenty trillion dollars, rather than the stagnant level of less than fifteen.  The accumulated loss for 2008-2011, dead-weight because it cannot be recovered, is $35 trillion (striped region in the chart), far more than double the public debt about which the US Congress is so obsessed.

Actual and Trend US GDP, 2000-2011, trillions of dollars adjusted to prices of 2011

It is complicated to estimate what employment would have been had output not fallen, because we cannot know what productivity growth would have been during 2008-11 had growth not collapsed.  However, it is not necessary to calculate the job loss directly from the output loss, because there is another way to estimate the employment effect.  Dead-weight losses in output mean less  unemployment, a relationship that the Republican politicians dismiss and most Democratics ignore.  A decrease in output results in a decrease in employment, and a rise in unemployment.  If anyone requires evidence of this relationship, he/she should have a look at the diagram below, which is so obvious the statistical association hardly needs calculation (for the numerically-oriented, the simple correlation is .8).

This chart suggests that when the growth rate of GDP increases by one percentage point, the rate of unemployment falls by a bit less than one-half of a percentage point.  For example, from 2003 to 2004 the GDP growth rate rose from about two to three percent, and the rate of unemployment fell from six to 5.5 percent.

The Annual Rate of Growth of GDP (vertical) and Changes in the Rate Of Unemployment (horizontal), 1990-2010

This ratio of changes in unemployment and changes in the growth rate make for a simple estimating method, with the result shown in a third diagram.  The result should not be surprising.  The trend rate of GDP growth from 2000 until the financial catastrophe was 2.5 percent, associated with an unemployment rate of five percent.  It is highly likely that if the trend had continued, the unemployment level would have also continued.  It is simple arithmetic to subtract the trend-implied unemployment from actual unemployment, and obtain the dead-weight employment loss.

During 2008-2011, total unemployment averaged thirteen million per year, and almost fifteen million for 2009-2011, when the rate never fell below nine percent of the labor force.  Almost exactly half of this unemployment, an annual average of 6.7 million men and women during 2008-2011, was above the trend.  That is, half was the direct cost of the financial crisis.

Actual an Trend-implied US Unemployment, 2007 – 2011

Imagine, if you can, a natural disaster that would so devastate the US economy that it threw an average of over six million people out of work for four years, a dead-weight loss of 27 million working years.  It would be the Mother of All Hurricanes, and its name is  ‘Market Forces’.

There are big difference between hurricanes and market catastrophes.  First, the market catastrophes are much more devastating than hurricanes.  Second, we can prepare for hurricanes but we cannot prevent them.  In contrast, market catastrophes can be prevented.  They need never occur except as minor annoyances.  Over six decades, 1950 through 2008, annual unemployment rose above nine percent in only two years, 1982 and 1983.  At the end of 2011, the count will go from two to six.  The ways to prevent market catastrophes are known: tight regulation of financial markets and countercyclical fiscal policy.

Unemployment is the scandal of market economies, all the more so because as in the past it can be reduced dramatically below what it is now and held there for years. The current high unemployment in many developed countries is evidence these countries lack the institutions and democratic mechanisms to ensure all people who wish work can find it.  In his once-famous Four Freedoms speech to the US Congress in January, 1941, Franklin D. Roosevelt said,

“The basic things expected by our people of their political and economic systems are simple.  They are: jobs for those who can work; equality of opportunity for youth and for others; security for those who need it; the ending of special privilege for the few; the preservation of civil liberties for all; the enjoyment of the fruits of scientific progress in a wider and constantly rising standard of living.”

If they wish to serve their constituents, ‘Jobs for those who can work’ would be a minimalist start for the politicians of the 21st century in North America and Europe.

Note:

All statistics from the Bureau of Economic Analysis of the US Department of Commerce, and the Bureau of Labor Statistics of the US Department of Labor.

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