I apologize for using an opening post to directly link to a new post on my blog, but I genuinely think you guys will find it useful: "Disasternomics."
There's two parts to the post. The first one deals with the general idea of opportunity cost, but it also touches upon the differentiation between wealth and GDP. Some Keynesians respond to Austrians critiques of the "silver lining" approach to natural disasters by suggesting that while wealth takes an economic loss, GDP can still rise because GDP is a flow (temporal additions to the stock of wealth). I argue that ceteris paribus the most likely outcome is that even flow will take an economic loss, because the rate of change (or total size of the flow) will be smaller than it otherwise could have been. In order to believe otherwise we'd have to make extraordinary assumptions, and one example is the "elasticity of expectations" notion that I use in the post.
The second part, I think, is the one that you guys will find the most interest (and the main reason I wanted to share the post with you guys). It borrows from Hayek's 1935 "The Maintenance of Capital," and is a thoroughly subjectivist explanation of the differences between creative destruction and the wanton destruction of natural disasters. The basic idea is that the physical change in the capital stock isn't what matters really, rather it's changes in the value of the capital stock (although, still remembering that capital can't be concretely aggregated; I'm abstracting to make a point).
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It's easy to refute an argument if you first misrepresent it. William Keizer
I only read part II.
While I agree with the conclusion, it seems to me that the blog you linked to is saying the exact same thing.
Zlatko,
The mistake in the blog I link to is here,
Hopefully everybody should accept that we've got both a gross and net benefit here as a result of the destruction of wealth in this case.
The physical destruction of capital isn't necessarily the same thing as the destruction of wealth. If someone scraps capital because that's its best use then that person is maximizing wealth, not destroying it. In fact, not scrapping it would be a loss (destruction) of wealth.
I still think you're saying the same thing but wording it differently.
I fully agree with you that the clearing of the land increases wealth, and so does he from what I can see (he uses the term "net benefit" instead).
Not scrapping it is "destruction of wealth" in the sense that the opportunity cost of not scrapping it is higher than its present value.
But scrapping it is also "destruction of wealth" in the sense that you have to account for the loss of its revenue stream when deciding if the new project is worth it. As such, you're destroying something that is objectively productive, that you can therefore term "wealth". It's just that the thing you're trading it for is even more valuable, so you end up with a "net benefit" (more wealth).
Both lines of reasoning lead to the same conclusion: the world is better off by the clearing of the plot of land. The only difference is that his wording is ambigious and leads to confusion. It would be better to say something along the lines of "the loss of capital leads to a net increase in wealth" rather than "the destruction of wealth leads to a net benefit".
Economic loss is opportunity cost. If the opportunity cost is less than the value obtained through the action taken, then you aren't suffering a loss. Similarly, when I exchange my dollars for a product at the store, nobody thinks about this as a loss.
It would be better to say something along the lines of "the loss of capital leads to a net increase in wealth" rather than "the destruction of wealth leads to a net benefit"
But, this isn't correct. The loss of capital doesn't necessarily mean a "net increase in wealth." And, again, if scrap a portion of our capital, we aren't "losing" it. We're using it towards its most valuable end, which is to be scrapped.
Jonathan M. F. Catalán: But scrapping it is also "destruction of wealth" in the sense that you have to account for the loss of its revenue stream when deciding if the new project is worth it. As such, you're destroying something that is objectively productive, that you can therefore term "wealth". It's just that the thing you're trading it for is even more valuable, so you end up with a "net benefit" (more wealth). Economic loss is opportunity cost. If the opportunity cost is less than the value obtained through the action taken, then you aren't suffering a loss. Similarly, when I exchange my dollars for a product at the store, nobody thinks about this as a loss.
D'oh! You're completely right. I'm just getting confused by the fact that the entrepreneur has to compare the productivity of the old hotel to the new one when estimating his profits. What I'm forgetting is that all capital goods are productive, and all of them are "consumed" in production. An entrepreneur doesn't have to do any estimates of the "productivity of planks" or account for their future income stream when building a house. Their price already reflects their "capitalized value" in a working market. He merely needs to compare their price to the value of the finished house. Same as for the old hotel. It too will have a price. He is not "destroying" the old hotel any more than I would be "destroying" planks by building a house with them. The old hotel is in fact just a capital good that is being advanced further towards consumption ( by the transformation of it in to rubble :P ) whose price enables the entrepreneur to calculate his expected profit, just as the price of any capital good used in any production process enables calculation.
Jonathan M. F. Catalán: It would be better to say something along the lines of "the loss of capital leads to a net increase in wealth" rather than "the destruction of wealth leads to a net benefit" But, this isn't correct. The loss of capital doesn't necessarily mean a "net increase in wealth." And, again, if scrap a portion of our capital, we aren't "losing" it. We're using it towards its most valuable end, which is to be scrapped.
I didn't mean that losing capital creates net wealth in general, I meant it applied in that specific case. But as per the above, I see that even that is wrong, because "losing it" is not a fitting term to describe what we do with capital when we use it in production.