AS IT STRUGGLES to absorb the human tragedy of Hurricane Katrina, the nation is turning its attention to the financial consequences. Congress has already passed an initial $10.5 billion emergency allocation for the relief operation, and there is talk that the Federal Reserve may delay the next increase in interest rates. The risk is that essential federal assistance to help families that have lost everything will expand into a spending splurge predicated on the notion that the economy is at risk. The truth is that natural disasters disrupt economies surprisingly little.
Natural disasters affect economies in two ways. They destroy capital stock (homes, roads, factories, pipelines), and they disrupt the ordinary flow of production and consumption. In a huge economy, the destruction of even an entire city's worth of capital stock represents only a modest financial blow, however great the loss of communities and memories. Insurers estimate that their share of the cost of rebuilding after Katrina could be $25 billion, and even if you assume that uninsured losses could push the total as high as $100 billion, this isn't a catastrophe. The shares traded on the New York Stock Exchange were worth $17.8 trillion as of September 2004, so a market decline of just 0.6 percent can wipe out as much wealth as Katrina did. Moody's Investors Service has said that it doesn't expect to downgrade insurers' credit quality in the wake of Katrina, meaning that a $25 billion loss can be absorbed easily.
If the blow to capital stock can be absorbed, what of the disruption to the flow of economic activity? In general, disasters depress economic output temporarily -- companies and infrastructure that sustain damage stop producing until they are repaired -- but then comes a reconstruction phase that delivers a compensating boost to the economy. In the wake of Katrina, economists at Goldman Sachs forecast that U.S. growth will be slightly lower than it would otherwise have been for the rest of this year, and that this effect will reverse itself next year. Twelve months from now, the economy may be bigger than it otherwise would have been.
It's possible that this disaster will prove more economically potent than others, because it has picked on a preexisting vulnerability. Even before Katrina, Americans were contending with expensive oil, the result of fast global economic growth along with instability in the Middle East and past underinvestment in new oil wells. Moreover, there are barely enough refineries to turn oil into gasoline, the result of a permitting process that has deterred new construction. Katrina disrupted oil production and knocked out more than one-tenth of the nation's refining capacity, causing an abrupt jump in prices at the pump and outright shortages in some parts of the country. If people react by driving less, other sorts of economic activity could drop off. The worst case is that Americans lose confidence in the economy and sharply rein in their spending, triggering a recession.
For the moment, this doesn't appear likely. The disruption of oil production is being countered by opening the government's strategic reserve; gasoline shortages will be alleviated at least partially by tapping into reserves held by Canada and Europe. Moreover, unemployment stands at a low 4.9 percent, and the generally strong economy should make it easier to absorb the shock of higher gas prices. A better picture of the gasoline market will emerge as the extent of the damage to refineries becomes clearer. But for now the nation should focus on getting help to the people who've borne the brunt of Katrina, not on wider economic worries.