Thursday, October 01, 2009

Tragic acounting - the moral vacuum at the heart of modern economics

This is what I wrote after the 2004 Boxing Day tsunami

It didn't take long after perhaps the greatest natural disaster of modern times for an economist to say what would otherwise be unthinkable.

Fred Bergsten runs the Institute for International Economics in Washington. He is a former assistant secretary of the US Treasury. Three days after the tsunami hit, with at that time tens of thousands confirmed dead, he told US National Public Radio (NPR) that the tragedy might be a good thing for the economies concerned.

He said: "Like any disaster, you get negative effects through destroying existing properties and people's health, but you do get a burst of new economic activity to replace them, and, on balance, that generally turns out to be quite positive."

What on earth could he have meant? How could the loss of so many lives so suddenly, with so many more to come, be "on balance, positive"?

It is one of the mysteries that first got me interested in economics and economists. I remember hearing at school that it would have been a good thing for Britain, economically, if it had lost World War II and had its buildings and factories destroyed.

Bergsten agrees. He told NPR that after Japan and Germany were flattened in 1945 they experienced economic booms that lasted for the next 20 to 30 years. He said that happened partly as the result of reconstruction spending but mainly because their old factories were replaced with state-of-the-art ones.

Applying that lesson to the devastation wrought on the Thai island of Phuket he says: "When they put up new resort hotels, they'll be more modern, they'll be more attractive. They'll probably bring in more people in the future."...

Bergsten isn't alone in his distasteful optimism. Britain's Standard Chartered Bank has told its clients it expects the impact of the tragedy to be "V-shaped". It says that was the pattern with the SARS epidemic, the Bali bombing and Japan's Kobe earthquake: a large dip in economic activity followed by increased aid and government spending, then an economic recovery a year or so later.

It says it expects the same sort of pattern in most of the countries affected by the tsunami, although it acknowledges that the present disaster is far greater and more widespread than the earlier ones.

(The bank says the exceptions to its optimistic outlook are Sri Lanka and the Maldives. Each faces severe difficulties, being in bad financial shape before the tsunami and relying on tourism for most of its foreign income. The Maldives collects more than 90 per cent of its tax revenue from tourism-related taxes and import duties.)

Such analyses only make sense if you don't pay attention to the lives that are being lost. They would sound ludicrous to someone whose family had been swept away.

The models of Bergsten, Standard Chartered and their ilk value the production that has been lost with those lives (tourism services, factory output and so on) and look forward to its return. But they don't value the lives themselves. Most of us value human lives above what they can produce.

When one of our parents or children is at risk of dying we find ourselves prepared to pay almost anything to stop that from happening, regardless of their productive capacity.

I say "almost anything" because a relatively new branch of economics believes it has found an upper limit to what we are prepared to pay to save a human life. The most widely quoted American limit is $US6.1 million ($7.83 million), known as "Viscusi's number" after the Harvard University economist Kip Viscusi.

In more than 60 studies Viscusi and his colleagues have tried to determine the monetary value we place on human life by examining our behaviour. If, for example, I demand an extra $610 a year to move from a job which I know is completely safe to a job in which I know there is a one in 10,000 annual risk of dying, they conclude that I value my life at $US6.1 million. They apply the same sort of calculations to decisions about my purchases, such as how much extra I am prepared to pay to buy a car with extra safety features.

The range of values resulting from the studies is wide, from as low as $US900,000 a life to more than $US27 million per life. But the average, $US6.1 million, has acquired an almost mystical status in the US. It has come to be regarded as the statistical value of human life. In 2000 the US Environmental Protection Agency used it to set the permissible level of arsenic in drinking water. Had the Viscusi number been higher than $US6.1 million, the agency would have imposed a less lenient standard.

There are many reasons for believing the number should be higher. One is that most of the workplace studies conducted by Viscusi and his associates exclude women. Recent studies suggest that women typically value safety about five times as highly as do men.

Another is that most of studies conducted in the US examine the value of life only to the person whose life is at risk. But other people value that life as well. In my own case they include my daughters, my son, my father, my wife. If I died tomorrow my own loss would only be the beginning.

The loss resulting from the tsunami is far more than the missing production and infrastructure. And it is far more than one Viscusi number for each of the 150,000 or so people believed to be dead. The entire planet appears to be grieving. We all seem to have lost something.

The economics profession is struggling to find the language to talk sensibly about what has happened.

That it can't yet do it says as much about that profession as it does about the scale of the tragedy.