Regional Disasters: AS/AD vs. PSST
By Arnold Kling
Suppose that a natural disaster occurs in one region. How does this affect the rest of the world? In the aggregate supply and demand paradigm, it would seem that the rest of the world benefits from stronger net exports. In the paradigm of Patterns of Sustainable Specialization and Trade, it would seem that the rest of the world is hurt by the destruction of normal trade patterns.
Thus, PSST offers a different “prediction” than the AS/AD paradigm. However, the only way to test this prediction would be to run a controlled experiment, with the same world economy first given a “control” path and then re-started with the same initial conditions and given a path that includes a regional disaster. So, I offer this analysis not so much for empirical testing but as a way of highlighting the differences between the paradigms.
A regional natural disaster is presumed here to destroy part of the capital stock, including manufacturing plants, office buildings, and residential structures. We assume that the region soon begins to rebuild, drawing down saving and using aid from outside the region to pay for imported goods from outside the region.
Within the affected region, from the AS-AD perspective, the destruction caused by the disaster is an adverse supply shock. On the demand side, reduced saving is expansionary. The overall effect on output might technically be ambiguous, although it would seem reasonable to suppose that the supply shock is more important, so that output declines.
Outside the affected region, the rest of the world experiences no supply shock. Assuming that the affected region exports less and imports more, this raises aggregate demand in the rest of the world. Output goes up in the rest of the world.
The PSST paradigm would look at the situation differently. The disaster would disrupt patterns of trade, both inside the region and outside. The disruption would be larger inside the region. However, the effects would be adverse both inside the affected region and outside of it. In the rest of the world, relative to a no-disaster scenario, output would be lower rather than higher.
From the PSST perspective, the productive capacity of one region is important to the rest of the world as well. The rest of the world has established patterns of trade that rely on the specialized output and consumption patterns of the affected region. Losing those trade patterns will require an adjustment. The process of adjustment is costly and requires a significant period of time.