Katrina and the economy

by John Quiggin on August 31, 2005

People are already wondering what effect Hurricane Katrina will have on the US economy. So far, most of the discussion I’ve seen has focused on very simplified Keynesian or GDP-based views of the economy, in which the resources that go into rebuilding New Orleans and the surrounding regions count as a net addition to economic activity.

As far as the national accounts go, this may be right. As the name says, GDP is a gross measure, which means it takes no account of depreciation, including the massive destruction caused by events like hurricanes. Depending on how things like insurance payouts are counted, there could easily be an increase in measured GDP. The main lesson from this is that, if you’re interested in economic welfare, don’t look at GDP.

But I don’t think the old-style Keynesian story, in which a reconstruction effort brings unused resources into use and thereby stimulates more economic activity, is likely to be applicable. I assume any injection of funds will come primarily from the national government, which is already running massive deficits, to the point where its capacity for fiscal stimulus is pretty much exhausted. The impact of any further expenditure will almost certainly offset, in part by cuts to other areas, but even more by tighter monetary policy and upward market pressure on interest rates. Insurance company money might have more of a net stimulatory effect, but I haven’t thought this through yet.

The immediate reaction of oil prices shows how tightly stretched the entire market has become, but I don’t think the effect on supplies will be great enough to have much effect in the medium term (say in six months time). However, that’s just a guess.

The real problem I haven’t seen discussed much so far is what will happen if, as is now predicted, it takes three to six months to pump all the water out of the city of New Orleans. In the absence of well-designed and large-scale intervention, that would imply bankruptcy for the vast majority of private businesses based in the city. This in turn would imply unemployment for many people who might otherwise return, and a whole lot of second-round effects working through supply chains. It’s unclear what kind of economic activity will survive, beyond a tourist market centred on the French Quarter (apparently relatively undamaged).

Even in the best of all possible worlds it would be hard to design a policy response to a disaster of this magnitude and duration. In practice, based on recent past experience, I think we’re likely to see some impressive rhetoric, a lot of gigantic boondoggles as favoured interests cash in on the reconstruction program, but not much effective alleviation of hardship or coherent thinking about sustainable economic recovery.

{ 30 comments }

1

No Matter 08.31.05 at 3:56 pm

Market psychology, as anyone with a window and a view can see, has already been fundamentally altered. I see a large worldwide negative macroeconomic spillover that is immediate and long lasting.

It will be a very slow weekend for sales of everything excepting gas and fuel efficient cars.

2

Jim Harrison 08.31.05 at 5:47 pm

Under the first Bush, FEMA had the reputation of a dumping ground for political appointees. I gather that it has reverted to that status under BUSH II. Maybe the outfit will surprise me, but I expect that it will be even more incompetent than the Iraq occuptation since the people in charge will not only be political operators but second-string political operators.

3

Ian Whitchurch 08.31.05 at 5:51 pm

Much of the US’s oil and gas production, refining and importing facilities is located in and near Katrina’s path.

http://www.theoildrum.blogspot.com/ is probably the best place to track estimates for the oil industry.

So far, we’re looking at

(1) direct production fall in the GOMEX of roughly probably 500 000 bopd, or about 3% of US consumption

(2) port facilities that handle about 15% of US requirements are underwater

(3)current shutdowns in refining of about 10% of US production

2 and 3 put together are the scary ones, as if the refineries are down, you need to put more refined crude thru the port systems – much of which are down as well.

The SPR doesnt help that much, as it needs to be refined, and see point 3 (btw, refineries were running at close to capacity before this).

The resulting supply shock is going to have waves through the general economy, as it’s going to result in repricing of gasoline etc …

Ian Whitchurch

4

jet 08.31.05 at 5:58 pm

Will this cause the housing bubble to “burst”? And does anyone predict a downturn in the economy?

5

Ian Whitchurch 08.31.05 at 5:59 pm

Jet,

I’m sure you can get some good deals on waterfront property in New Orleans.

Why, they are running gondola’s down the Canal St Canal already …

Ian Whitchurch

PS “Why do you laugh ? Because it hurts too much to cry”

6

Ian Whitchurch 08.31.05 at 6:02 pm

Jet,

I hear you can get a good deal on New Orleans waterfront property, and they are running gondolas down the Canal Street Canal already …

Ian Whitchurch

7

Tracy W 08.31.05 at 7:28 pm

I would expect GDP to go up some too just because a lot of people are and will be working overtime.

If it takes 3 to 6 months to pump all the water out from New Orleans, I don’t know what sort of “well-designed and large-scale intervention” would stop people starting lives elsewhere anyway. Is there a history of “well-designed and large interventions” outside the US in response to disasters of this magnitude? If so, what are they?

8

Anodyne 08.31.05 at 7:44 pm

9

'As you know' Bob 08.31.05 at 7:57 pm

Let’s get a pool going on how long it takes before Homeland Security/FEMA/DoD decides that the first priority for rebuilding New Orleans involves a no-bid contract awarded to Halliburton.

I say it happens withing a week.

10

'As you know' Bob 08.31.05 at 8:01 pm

Let’s start a little betting pool on how long it takes before the Dept. of Homeland Security/FEMA/DoD decides that the very top priority for rebuilding New Orleans involves some project that includes awarding a no-bid contract to Halliburton or a subsidiary.

I give it a week, tops.

11

jet 08.31.05 at 9:06 pm

This appears optimistic.

John why do you assume that the primary source of rebuilding funds will come from the government? Is that normal in hurricane relief? Don’t insurance companies usually pick up a hefty part of the tab?

12

Ben P 08.31.05 at 9:37 pm

I’d also like to point out that the Port of Southern Louisiana is the largest port in America and the 5th largest in the world. See Stratfor’s analysis for the potential implications of this. Needless to say, even if the port can be “opened” its going to be rather hard pressed to be of any use if the surrounding infrastructure is destroyed and the southern Louisiana eco-system is essentially destroyed. And this isn’t helped by the fact that Biloxi and Gulfport, which perhaps could have been counted to pick up the slack, face similarly dire conditions.

I also think the infrastructure in the Gulf oil and gas fields is also more severely damaged than some of the more optimistic reports were suggesting as late as yesterday.

This is a grave crisis.

13

Ben P 08.31.05 at 9:39 pm

Jet, thats a rather weak source. Even considering that the source is the notoriously incompetent white house economic team, even then I think this can be interpreted in a negative light. “Provided that the energy infrastructure can recover.” Thats a pretty big if right now.

14

steve kyle 08.31.05 at 9:50 pm

Also dont forget that New Orleans is a major port for exports of farm and other products from the entire Mississippi Basin. It is a particularly bad time for it to be shut down.

15

Species 8 08.31.05 at 10:21 pm

With the pictures of the contaminated water flowing through NO, one wonders what the cost will be for new enivironmental/pollution controls that will be put into place, to prevent it from happening again. With these new controls, how many businesses will decide the cost is not worth and move.

16

y81 08.31.05 at 11:05 pm

The larger businesses, and the owners of any buildings with commercial mortgages, will have business interruption insurance. Smaller businesses will at least have insurance on their inventory, and their leases will provide for rent abatement while their premises cannot be occupied. So I don’t think the level of bankruptcies will be as high as the author suggests.

17

rollo 09.01.05 at 12:41 am

no matter-
” excepting gas and fuel efficient cars”
Oh right. Nobody’s going to use the fear of environmental disaster to justify the purchase of a ten-cylinder suburban assault vehicle. Right.
What do you think the marketing noise was for those things to begin with? Safety, dude.
Personal safety at any cost.

18

Bob B 09.01.05 at 1:17 am

I was first astonished and then appalled to read these news reports found from a google search on what had happened to recent funding of flood and hurricane protection projects in and around New Orleans:

“The U.S. Army Corps of Engineers has identified millions of dollars in flood and hurricane protection projects in the New Orleans district. Chances are, though, most projects will not be funded in the president’s 2006 fiscal year budget to be released today. In general, funding for construction has been on a downward trend for the past several years, said Marcia Demma, chief of the New Orleans Corps’ programs management branch. In 2001, the New Orleans district spent $147 million on construction projects. When fiscal year 2005 wraps up Sept. 30, the Corps expects to have spent $82 million, a 44.2 percent reduction from 2001 expenditures.”
http://www.findarticles.com/p/articles/mi_qn4200/is_20050207/ai_n10176537

“New Orleans had long known it was highly vulnerable to flooding and a direct hit from a hurricane. In fact, the federal government has been working with state and local officials in the region since the late 1960s on major hurricane and flood relief efforts. When flooding from a massive rainstorm in May 1995 killed six people, Congress authorized the Southeast Louisiana Urban Flood Control Project, or SELA.

“Over the next 10 years, the Army Corps of Engineers, tasked with carrying out SELA, spent $430 million on shoring up levees and building pumping stations, with $50 million in local aid. But at least $250 million in crucial projects remained, even as hurricane activity in the Atlantic Basin increased dramatically and the levees surrounding New Orleans continued to subside.

“Yet after 2003, the flow of federal dollars toward SELA dropped to a trickle. The Corps never tried to hide the fact that the spending pressures of the war in Iraq, as well as homeland security — coming at the same time as federal tax cuts — was the reason for the strain. At least nine articles in the Times-Picayune from 2004 and 2005 specifically cite the cost of Iraq as a reason for the lack of hurricane- and flood-control dollars.”
http://www.mediainfo.com/eandp/news/article_display.jsp?vnu_content_id=1001051313

19

bad Jim 09.01.05 at 2:58 am

If gas hits $4 a gallon in the next few weeks, as some expect, a surge in sales of SUV’s to people who commute daily to their jobs is unlikely.

There’s worse news, though:

New Orleans warehouses hold about a quarter of the nation’s raw coffee, 211 million pounds.

We should probably not expect lines at our coffee shops soon, though.

20

Bob B 09.01.05 at 3:03 am

However, it does look as though the cuts in the funding of the flood and hurricane protection projects to finance the Iraq war will turn out to have other very costly consequences:

“People who thought of New Orleans only as a mecca of jazz and jambalaya are about to get a lesson in the unheralded commercial prominence of the Big Easy. . .

“In coming weeks, the economic fallout will ripple across the country. Is it enough to tip the United States into recession? Probably not. But consumers will curse Katrina every time they gas up, and some major exporters already are puzzling over how they’ll reach customers if Louisiana ports remain idle for a significant period.

“With global oil supplies already stretched, energy is the immediate worry. The gulf’s treasure-trove is its roughly 4,000 offshore oil-and-gas operations, connected to land by 33,000 miles of pipelines. Together, they account for more than one-quarter of total U.S. oil production. Louisiana’s Offshore Oil Platform, known as the LOOP, also is a major entry point for foreign oil.

“Katrina wreaked havoc with that delicate network, prompting the evacuation of thousands of energy workers from more than half of the gulf’s nearly 1,000 manned platforms and rigs, the Minerals Management Service said. . . ”
http://www.usatoday.com/money/economy/2005-09-01-katrina-econ-fallout-usat_x.htm

21

Darren 09.01.05 at 3:12 am

22

Jonathon Martin 09.01.05 at 3:24 am

I wonder several things. One of them is whether it is sensible to rebuild New Orleans. Whether or not climate change is man-made it does seem that it is a reality and that it will lead to more and larger hurricanes in the Gulf. Since New Orleans was devastated and was spared a direct hit, would it not be sensible to relocate the majority of the population?

Economically I have a couple of questions. Firstly, will it not be the case that rebuilding/renovating buildings will become insanely expensive due to the incredible demand driven by the insurance payouts? Secondly, will that affect the insurance payouts themselves. Our policy (not in the US) states that we are entitled to the replacement cost of the house, which is obviously going to be much higher if the cost of labour quadruples.

23

Procrastinator 09.01.05 at 3:53 am

These images and the associated captions made me laugh (well, I am an insensitive git).

http://us.news3.yimg.com/us.i2.yimg.com/p/ap/20050830/capt.ladm10208301530.hurricane_katrina_ladm102.jpg

… a young man walks through chest deep flood water after looting a grocery store in New Orleans on Tuesday, Aug. 30, 2005. Flood waters continue to rise in New Orleans after Hurricane Katrina did extensive damage when it made landfall on Monday. (AP Photo/Dave Martin).

Compared to:

http://us.news3.yimg.com/us.i2.yimg.com/p/afp/20050830/capt.sge.cyn78.300805074130.photo01.photo.default-268×384.jpg

… two residents wade through chest-deep water after finding bread and soda from a local grocery store after Hurricane Katrina came through the area in New Orleans, Louisiana.(AFP/Getty Images/Chris Graythen).

24

Tim Worstall 09.01.05 at 4:54 am

No bid contract to Halliburton? Quite likely. They are the people that own the pumps needed, after all.
Insurance is a little more difficult….I think (note, think, not know) that flood insurance for low lying areas is actually Federal? Not insurance companies? The tab for the flooding of NO might thus fall on the Feds.

25

Barry 09.01.05 at 5:10 am

“The larger businesses, and the owners of any buildings with commercial mortgages, will have business interruption insurance. Smaller businesses will at least have insurance on their inventory, and their leases will provide for rent abatement while their premises cannot be occupied. So I don’t think the level of bankruptcies will be as high as the author suggests.”
Posted by y81

One hopes that their leases have such clauses. In addition to inventory, there’s equipment on the premises, which is also hopefully covered. However, since it looks like life in New Orleans will be substantially disrupted for several months, any business would need to be able to survive that period. In addition, since housing and ‘life support’ is minimal in New Orleans, businesses will have a problem with their people.

26

Penta 09.01.05 at 8:39 am

Flood insurance is ONLY offered by the Federal Government, that is correct.

27

Procrastinator 09.01.05 at 9:10 am

> Will Katrina give Bush the kiss of death?

Yes, I like the thought of this’ being the nemesis to his hubris, but hang fire for the moment. It seemed perfectly reasonable, ten months ago, that his complete failure to capture bin Laden or stop religious loonies from popping up in Iraq or Afghanistan would count against him with the American public.

28

dsquared 09.01.05 at 11:38 am

I doubt that business interruption insurance will pay out. If a company isn’t prepared to write flood insurance, then it’s going to make darn sure that it isn’t writing flood insurance in the form of BII.

29

Tracy W 09.01.05 at 9:07 pm

Anodyne – the dams and levees are very impressive and interesting, but that is an engineering programme.

From John’s post he appeared to be talking about some sort of economic programme to address bankruptcy and unemployment problems in New Orleans if, as is apparently likely, it takes 3 to 6 months to pump the water out. I don’t know of any programme for economically re-establishing a city after 3-6 months of abandonment .

BTW, thanks for the link – the Dutch have done some amazing work.

30

Anodyne 09.01.05 at 11:38 pm

tracy,

Sorry, I was a bit too cryptic. If you click on the “Flood” icon in the link you will see a blurb on the 1953 Stavenisse flood (there was also trouble in the UK as a result of the related storm). The city was nearly abandoned for a while after the flood. I don’t know what percentage of the original residents returned, but government assistance was involved in sustaining them and rebuilding the city. The Deltawerken program was underway at the time of the flood, but was it was altered and expanded in the aftermath. An interesting story here.

I guess we’ll see whether Fallujah works out as another example.

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