Post-flood spending is just treading water

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As the waters of the Bow and Elbow rivers slowly recede, the extent of the flood damage in Alberta is gradually becoming a little clearer. Costs will certainly run into the billions of dollars, and it has already been called the second-largest natural disaster in Canada, after the 1998 ice storm.

Aside from the reconstruction costs, economists are busy trying to estimate the cost of lost business activity. How will Alberta's and Canada's gross domestic product (GDP) suffer? It's a tempting question to pose, but in fact, the flood may actually stimulate the economy.

GDP is simply the dollar-value sum of all the goods and services produced in the economy over a period of time. Since a larger GDP often results in wealthier citizens, it's frequently used as a benchmark for societal well-being. A bigger and faster-growing GDP is the politician's dream.

But here's the paradox: Why is it that natural disasters (which are plainly bad) can boost the GDP (which is perceived as good)? The lift in economic activity that sometimes follows a disaster underscores why the gross domestic product is not a good indicator of societal welfare.

Japan offers a recent example. That country's earthquake and tsunami in March, 2011 – a disaster on a massively larger scale than Calgary's flood – resulted in a sudden and pronounced drop in total economic activity. The GDP in the first quarter of 2011 dropped by 2 per cent compared with the previous quarter. The second quarter saw another drop of 0.8 per cent.

But by the third quarter of 2011 – some four months after the event – output in Japan soared by 2.7 per cent, the largest single quarter of growth Japan had seen in years. Annualized, that is growth comparable to China's rates of 7 or 8 per cent. The country was busy rebuilding, which supercharged overall spending. A similar pattern was seen in New Orleans after hurricane Katrina.

Plenty of bad events are actually "good" for the economy, at least in the short run. Think of the GDP that is generated by crime. All those police, court judges, lawyers, correctional facility workers, parole offices, and so on, contribute significantly to GDP. Graffiti removal services and home security companies would be out of business if crime ended tomorrow. But clearly, crime is not a benefit to society.

Natural disasters such as earthquakes, fires and floods also stimulate the economy (even if there's a disruption in the short term). In Alberta, hundreds of millions of dollars will be spent over the next couple of years on clean-up crews, home repairs, contractors, engineers and heavy-equipment operators. Millions more will be spent on replacing carpets, furniture and other household items. Home renovation stores in Calgary will have record sales in 2013.

But none of the economic activity resulting from a natural disaster is productive. Replacing something that was lost or destroyed doesn't get you ahead; it only gets you back to where you were. It's snakes and ladders.

Thousands of Alberta businesses hit by the flood will use whatever financial resources they have (if they have any at all) to rebuild. That money could have been spent on enhanced computer systems, or training programs for employees – things that would actually improve productivity and efficiency. Instead, that money will be spent getting the company back on its feet – no further ahead, and millions of dollars behind.

Families and individuals were looking forward to a fun, relaxing holiday this summer. A camping trip or a golf vacation does wonders to refresh and recharge your mental batteries, making you a well-rested and more productive worker. But thousands of Calgarians' vacations will be cancelled – the saved-up money and time now going toward rebuilding the basement.

All GDP is not created equally. Just because the gears of commerce are spinning, we shouldn't be fooled into thinking we are getting ahead. Natural disasters, like southern Alberta's flood, demonstrate this perfectly. Money spent replacing soggy carpet and mouldy drywall, rather than investments in productivity or mental rejuvenation, is not what economists like to see.

Todd Hirsch is the Calgary-based chief economist of ATB Financial, and author of The Boiling Frog Dilemma: Saving Canada from Economic Decline.