October 2, 2005

More on Katrina & Rita.  A number of you have asked for more analysis of recent natural disasters to hit the Gulf Coast.  Here are some things to consider.

Rita’s impact on the Houston economy:  The Houston economy is estimated to be about $157 billion a year.  When Rita hit Houstonians started to flee the city on Thursday and Friday and returned slowly on Monday.  So we assume the city lost about 3 days of output.  That puts the economic loss (not including the actual damage done by the storm) at about $1.2 billion…give or take a few hundred thousand.  This figure does not take into account the wasted gasoline from the evacuees sitting on I-10 and I-45.  Things could have been significantly worse.

Paying for the clean-up:  President Bush has said of the clean-up and recovery “It’s going to cost whatever it’s going to cost.”   In addition to the “traditional” government role of clearing debris, rebuilding roads and bridges, etc. the Bush Administration is planning on giving $5,000 to each evacuated family, $2 billion in tax incentives to businesses and has pledged the Federal government is going to pay for the “great majority” of the rebuilding. 

As Stephen Slivinski of the Cato Institute points out, this is highly irregular.  Usually, in keeping with the 1988 Stafford Act, state and local governments pay for at least 25% of the clean-up of a natural disaster.  These statements by the administration have sent economists scurrying to figure out what the total costs are going be.  Stephen Moore in the Wall Street Journal estimates the federal government’s bill will be over $200 billion.  That turns out to be more (in adjusted dollars) than we spent on the Marshall plan to rebuild all of Western Europe after World War II.

So how will the Federal Government pay for all of this?  The federal government has three options:  it can either borrow more, raise taxes and/or reduce spending elsewhere.  The first option is NOT  a good one.  The federal government is already running massive budget deficits, so further borrowing should not be considered an option.  That leaves raising taxes and/or cut other spending.  Given the Bush Administration’s approach to fiscal policy, a tax increase seems highly unlikely.   So where might the federal government look to trim spending?  Let’s look at some of the recent spending increases under the Bush Administration:

-  The Farm Bill of 2002 had a price tag of $248 billion.  Economists have argued for years that price supports for the agricultural industry are counter productive.  We had taken steps in the 1980’s and 1990’s to reduce the agricultural industries dependence on federal subsidies, but this trend was reversed with the 2002 Farm Bill.  Maybe it is time to reexamine this issue.

-  The Transportation Bill of 2004 had a price tag of $268 billion.  Much of this spending went to “questionable” projects including things like $2.75million for the National Packard Museum.  For those of you are too young to remember Packard is a failed automobile manufacturer that eventually merged to create American Motors.  American Motors also eventually failed, but you get the idea.  Maybe it is time to re-examine the money spent in this bill.

So just these two bills represent a little over $500 billion.  Then there is the Medicare drug prescription plan (conservatively estimated cost $ 400billion).  Slightly scaling this back could save a few billions.

But then again, there are some in Congress who argue that there should be no reductions is spending.  Does that mean more government borrowing?  If so, what does that mean for the dollar and the “global imbalances” that already exist in financial markets?  So it will be interesting to see how the federal government plans to pay for all of this.

Election results.  Some times election results are encouraging and other times they are discouraging.  So it is with last month’s elections around the global.  The good news:  Japan, where voters gave Prime Minister Junichiro Koizumi a strong vote of support.  Koizumi used this in giving instructions to his cabinet to “reduce the size of the government boldly.”  Specifically watch for Koizumi to restructure the Japanese financial system and labor markets.  The Japanese economy may be poised for sustained economic growth.  The bad news:  Germany.  Angela Merkel's German conservatives won the election by just three seats, falling short of a governing majority.  So what will happen next is anyone’s guess.  Might new elections be called?  Maybe.  One thing is for sure…it will be awhile before any significant economic reforms come to Germany.   This is a pitty.

All the best,