Monday, March 14, 2011

A Sticky Situation

There have been 2 stories in the last month that have really dominated headlines around the world: the revolt in Libya and now the earthquake in Japan. The latter is already a travesty, and, if the rebels fail, the former is likely to turn into one, too. In economics, there is a term "sunk costs." The old adage, "No point in crying over spilled milk," captures the idea of sunken costs fairly well. It's over, it happened, and past, "sunken" costs should not affect your future decision making. Sunk costs abound in political, economic, and natural disasters.

In Libya, we might say that starting a revolt in the first place is a sunk cost. You can't take it back, and even if the backlash from Gaddafi looks like it's going to be brutal, the only option now is to keep moving forward. Perhaps obviously, the rebels cannot abruptly stop their revolt and expect life to go back to pre-fighting levels. As the U.S., unambiguously supporting the rebels is the correct move. You don't scold your friend for getting in a car crash while he's still in the hospital. Gaddafi has shown (if he hadn't already) that he's completely insane. The rebels are that hospitalized friend. Maybe they should have waited for Gaddafi's power to weaken before revolting. Maybe they should have planned their uprising more diligently. U.S. support could make for these mistakes. Economically speaking, ending this war is only going to be good for Americans. The main concern is the effect the war will have on oil prices. This fear is fairly overstated. Libya only accounts for 2.1% of global oil output. Experts pointing to the fall in the consumer confidence index are missing the point. Despite the drop from 77.5 to 68.3, this is an overreaction. Consumers' fears about the rise in oil prices should soon be calmed when they realize the effects will be smaller than expected.

Sunk costs in Japan? Well, perhaps for the first time in a while, I disagree with some of the Epicurean Dealmaker's points. While risk analysis is important, and the failure to be properly prepared for a (somewhat) likely disaster is close to inexcusable, now is not the time to discuss these points. In economic terms, a catastrophe like the recent earthquake holds the keys to two very distinct paths for Japan. The country which just recently lost its position as the second largest economy in the world has been on a slow, painful decline for years now. Not to sound insincere, but this earthquake has given the country something as close to a tabula rasa as possible. The opportunity to rebuild should create jobs, update infrastructure, and hopefully allow the country to rediscover a competitive advantage. The gains are also measurable, post-disaster. While the specter of deflation is vague, the sight of ruined towns is tangible and progress can be observed and applauded. On the other hand, Japan could easily falter. The recovery could drag on painfully, refugee camps could become entrenched, and the already shaky government could end up taking the brunt of this damage. If the Japanese allow natural disaster to evolve, or perhaps devolve into political disaster, economic catastrophe is sure to follow.

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