Larry Summers confuses me

In this—what I can only describe as mind-bogglingly strange—statement, Larry Summers (most recently portrayed in The Social Network) is bullish about Japan’s economic prospects after the recent Japanese earthquake:

“If you look, this is clearly going to add complexity to Japan’s challenge of economic recovery,” Summers said. “It may lead to some temporary increments, ironically, to GDP, as a process of rebuilding takes place.”  After the Kobe earthquake in 1995 Japan actually gained some economic strength due to the process of reconstruction, he added.”

That the rebuilding effort in Japan will lead to temporary increases in Japan’s GDP is not ironic, it is simply a matter of fact. GDP is defined such that it contains a government spending component, so spending in the aftermath of the earthquake necessitates an increase in GDP. (Well, things are slightly more complicated since there will be productivity losses in some regions of Japan that partially offset increased government expenditure induced by rebuilding).

That GDP will increase from Japan being forced to rebuild entire cities is far from the country demonstrating “economic strength”. In fact the opposite is true, it is a waste of resources that could otherwise be allocated towards productive uses. A widely cited idea from Keynes is that employment can be achieved by simply digging holes and filling them back in.  While his quote is oft taken out of context, Summers seems to echo it without irony.  Yes, GDP in Japan will increase, but this is not “economic strength”.  This is not prosperity.  If it were then the answer to America’s 8.9% unemployment rate would be to tear down New York and rebuild it.  But we all understand we wouldn’t be better off after the task were complete.

Luckily for us, Frederic Bastiat obligingly wrote this prescient essay back in good ol’ 1850 to help disabuse Larry of his misunderstandings.  (For my money, still the greatest economics essay ever written).

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