Irene's Broken Windows

By Larry Kudlow

Get ready for a bunch of demand-side economists to tell you that the post-Hurricane Irene rebuilding phase is actually a good thing for future economic growth. But don't believe it.

Who has it right?

Joshua Shapiro, chief U.S. economist at MFR Inc., delivered my favorite quote on the subject to The New York Times: "If you're in the middle of recession, you just wander around blowing up buildings, and that would be your path to prosperity. And clearly, that's not the case. It's not the case with a natural disaster, either."

Echoing this thought, Ian Shepherdson, the chief U.S. economist at High Frequency Economics, bluntly noted on CNBC's website that "no one is made better off by the destruction of their home or workplace." He acknowledged the benefits of reconstruction work, but he dismissed the idea that somehow this is a net win for the economy.

It sounds to me as if both of these gentlemen are recalling the parable of the broken window, introduced by French free market philosopher Frederic Bastiat, in an 1850 essay called "That Which is Seen, and That Which is Not Seen." Though Bastiat agrees that repairing broken windows is a good thing, encouraging the glazier's trade and income, he argues that it is quite different from the idea that breaking windows is a good thing, in that it would cause money to circulate and encourage industry in general.

Why? Because a shopkeeper who spends money to fix broken windows cannot spend or invest that money on new ventures.

"It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library," Bastiat wrote. "In short, he would have employed his six francs in some way, which this accident has prevented."

In other words, the businesspeople who are spending to fix the damage of Hurricane Irene are not spending or investing that money on brand-new ventures or startups or on ordinary goods and services. Those are the real economics of Hurricane Irene.

There was a lot of damage incurred along 1,100 miles of U.S. coastline. Tragically, 28 deaths have been reported so far. There were toppled trees, power disruptions and flooding on damaged roads. Homes, commercial buildings and factories all stopped for at least a couple of days. In some sense, the human distress has been even greater than the economic distress.

On the other hand, lost sales, forgone consumer spending and temporary stoppages of production and employment all will be recouped in a relatively short period of time. Mark Zandi of Moody's Analytics suggests that the economic toll will be in the billions, but not the tens of billions. (Remember that the total U.S. gross domestic product is roughly $15 trillion.) So there's no black-swan event here that will throw our fragile economy into a double-dip recession.

Yes, the economic blow from Irene is noticeable, but it's temporary. In fact, what makes this economic setback even less worrisome is that it occurred over a weekend. You really didn't even lose two days of economic activity.

Restaurants, retailers, baseball games and Broadway shows all shut down, but only for a short bit. And actually, there was a lot of consumer buying in the days leading up to Irene. People went to Home Depot and Lowe's to find stuff with which to board up their windows. They went to Costco for food. And they went to Walmart and Dollar General for all sorts of things.

When the final tally is in, Irene may or may not qualify as a top 10 hurricane. But the history of such disasters is that the national economy rebuilds and snaps back shortly thereafter. Nonetheless, the economic rebuilding essentially gets you back to where you were before the storm. Unfortunately, there is virtually no net new investment from all of this.

That said, if President Barack Obama tries to use Hurricane Irene as an excuse to pour tens of billions of new infrastructure dollars into the economy, he's barking up the wrong tree.

For just as Bastiat's seen-and-unseen analysis holds for the shopkeeper repairing his window, it also holds for the impact of massive government spending on the whole economy. It's a huge mistake -- and a consequence of our fiscal profligacy -- when private money is not spent on new investment because funds are absorbed by big-government borrowing.

If we are to restore strong economic growth and job creation, we require measures such as pro-growth tax reform or regulatory rollback and repeal. In this sense, the new House Republican plan just released by Majority Leader Eric Cantor to repeal job-destroying regulations -- especially on labor and the environment -- makes a lot more sense than throwing money at the Federal Emergency Management Agency for new infrastructure banks.

Breaking fiscal windows is just as ineffective as breaking the shopkeeper's pane of glass.
Lawrence Kudlow is host of CNBC's The Kudlow Report and co-host of The Call. He is also a former Reagan economic advisor and a syndicated columnist. Visit his blog, Kudlow's Money Politics.