by Judith Curry
I recently received a query from a journalist:
Do natural disasters help local economies?
I know that the answer is ‘no’ in highly vulnerable and impoverished societies, where disasters are relentlessly impoverishing. But what about more developed economies? I decided to look into this.
How disasters help
An article in the Boston Globe argues ‘ Natural disasters can give a boost to the countries where they occur – and sometimes the more the better.‘ Excerpts:
Rebuilding efforts serve as a short-term boost by attracting resources to a country, and the disasters themselves, by destroying old factories and old roads, airports, and bridges, allow new and more efficient public and private infrastructure to be built, forcing the transition to a sleeker, more productive economy in the long term.
The study of the economics of disasters remains a small field, with few major papers. And skeptics charge disaster economists with oversimplifying enormously complex economic systems and seeing illusory effects that stem only from the crudeness of the available economic measuring tools.
While not even the most fervent believer in the economy-catalyzing qualities of disasters would wish for one, the study of the costs and possible benefits of such events may help us better understand how to target recovery efforts – and, perhaps, how to replicate the salutary effects of disasters without the disasters themselves.
“The data are pretty clear about it,” says Gus Faucher, director of macroeconomics at Moody’s Economy.com, an economic consulting firm. Faucher has looked at disasters in regional US economies and found in some cases a dramatic impact. The year after Hurricane Andrew struck southeast Florida in 1992, causing what would today be more than $40 billion in damages, the state saw sharp increases in employment thanks to new construction jobs. And Faucher credits the rebuilding jobs and aid and investment that followed the 1994 Northridge earthquake for helping pull the Los Angeles area out of its early-1990s economic slump. Hurricane Katrina, Faucher says, has proved an exception: Because so many residents left the area and because government aid was so slow to arrive and insurance payouts so low, the area didn’t see an economic bounce.
To critics of this line of thinking, the problem is that it is, at best, a partial picture. It ignores, they argue, the fact that the money and labor that go into post-disaster rebuilding are simply being redirected from other productive uses.
“If you’re a carpenter, a trash remover, a physician, you may be made better off, but the things that those producers would have otherwise produced are not going to be produced,” says Donald Boudreaux, an economics professor at George Mason University. “Over any reasonably relevant period of time, society is not made wealthier by destroying resources,” he adds. If it were, “Beirut should be one of the wealthiest places in the world.”
The research on longer-run effects, its supporters argue, is less vulnerable to this criticism, because the key factor is not merely new stuff but better stuff. In this model, disasters perform the economic service of clearing out outdated infrastructure to make way for more efficient replacements. The economy, as it recovers, actually becomes more productive than it was before, and some economists argue that the effect can be seen decades after the disaster.
Skidmore and Toya found that, in the case of climatic disasters – hurricanes and cyclones, as opposed to earthquakes and volcanic eruptions – the more the better: nations with more climatic disasters grew faster over the long run than the less disaster-prone. Why only climatic disasters? The authors suggest that, as we’ve gotten better at forecasting violent weather, its human costs, at least, can be mitigated much more easily than with geological disasters, which still take us by surprise.
Jesus Crespo Cuaresma, a professor of economics at the University of Innsbruck, has found some support for Skidmore and Toya’s argument. In a paper published earlier this year, Crespo Cuaresma examined post-disaster rebuilding efforts in developing countries and found that, at least in wealthier developing countries like Brazil and South Africa, there is indeed a tendency to use the rebuilding process as an opportunity to upgrade infrastructure that might otherwise have been allowed to grow obsolete.
Of course, even analysts of the “creative destruction” school don’t see disasters as good things – disasters kill people, often in great numbers, and uproot many more. Skidmore is careful to point out that, even from a coldly economic standpoint, the most productive disasters are those that don’t take lives.
Nonetheless, a recovery planned only to maximize growth might well conflict with more basic humanitarian concerns. Those most in need of help and resources in the wake of a disaster – the poor and the uninsured near-poor – are going to contribute the least to growing the economy as it recovers.
It may be, then, that disaster economics works best as a guide in those times when we don’t have disasters to contend with. Investing in human capital, replacing outdated plants and infrastructure – the things that Kunreuther and Skidmore argue disasters drive us to do – are also, it turns out, good ideas even in the absence of a crippling catastrophe. If the disaster economists are right, calamities are simply pushing societies to make the sort of sound economic decisions that inertia or fear or bureaucratic sclerosis prevents them from otherwise making. Governments and businesses might do well to adopt some of the urgency and innovation of a post-disaster mind-set even in more clement times.
Disasters are not good for the economy
The Foundation for Teaching Economics has a post on this topic. From the conclusions:
We should take from this lesson the firm conviction that despite our desire to look on the bright side and despite the occasional appearance to the contrary, disasters are not good for the economy. While contemporary news coverage offers tangible evidence that disasters can produce economic opportunities and benefits for some, and while economic historians continue to argue about the standard-of-living impacts on the survivors of disasters like the Black Plague and the Spanish Influenza, we are still left with the hard economic reality that disasters impose losses on economies. The destruction of resources reduces GDP by reducing productive capacity: fewer inputs mean fewer outputs.
Economic historians have long noted, and our contemporary experience confirms, that economies tend to be remarkably resilient. The speed of rebuilding after localized disasters is often nothing short of amazing, but we certainly have no evidence that allows us to argue convincingly that a disaster-induced spurt of economic activity can boost an economy beyond where it would have been had the disaster not occurred. Post-disaster improvements, and even higher standards of living among survivors, should not blind us to the reality of the economic loss. To posit that disaster should be welcomed as an economic stimulus would lead us to the logical but ridiculous policy of trying to boost the economy of a declining city by deliberately burning it down around its residents! In simplest terms, disasters increase scarcity and thereby reduce our ability to provide for people’s wants and needs. And that is clearly not good for the economy!
Resilience building versus humanitarian response
The UK govt has a document Economics of Early Response: Lessons from Ethiopia and Kenya. Excerpts from the conclusions:
“The separation of relief and development is both artificial and unhelpful. Not only are the recipients the same, but also the underlying causes that create the need are the same—the vulnerability of dryland communities. But what often takes place, are emergency interventions that undermine development (for example some food aid and water trucking interventions), and long term programming and investments that do not pay sufficient attention to the inevitability of drought.”
Early response is far more cost effective than late humanitarian response. The assumptions used in this analysis were conservative, and the findings nonetheless indicate that early response can decrease costs and losses substantially, with very high benefit to cost ratios indicating tremendous potential to improve value for money. Modelling of household level data for Wajir grasslands in Kenya suggests that early response could save between $107m and $167m for a population of 367k in a single event alone. In southern Ethiopia, with a beneficiary population of 2.8m, household level data suggest that early response could save between $662m and $1.3billion in a single event. A perceived risk in responding early is that humanitarian funds will be released incorrectly to situations that turn out not to be a disaster. However, these figures suggest that donors could mistakenly release funds two times in Kenya, and seven times in Ethiopia, before the cost is even equivalent to the cost of humanitarian aid in one event.
There is a great deal of uncertainty around the cost of building resilience. Nonetheless, the estimates presented here suggest that, while the cost of resilience is comparatively high, the wider benefits of building resilience can significantly outweigh the costs, leading to the conclusion that investment in resilience is the best value for money. The model accounts for the time lag in resilience benefits reducing humanitarian cost, and therefore is a reasonable estimate of how the shift in balance from humanitarian aid to resilience might look over time. The cost of resilience would have to approach $200 per capita per year for 10 years (almost 50% higher than the figure assumed in this paper) before the modelled costs of resilience begin to approach the cost of humanitarian response.
Resilience meets disaster economics
Stanford Social Innovation Review has a post with subtitle Investing to stop disasters before they start can save lives and money.
Global needs for crisis response are increasing. Last year, US, British, and European government funders of foreign aid announced programs that would place greater emphasis on building resilience to shocks like hurricanes, earthquakes and droughts.
What do resilience strategies look like in practice? Efforts to get smart about resilience are what initially brought Mercy Corps together with the microfinance institution Fonkoze and the global reinsurance leaderSwiss Re in Haiti. The 2010 earthquake highlighted the country’s many long-simmering problems, including lack of economic opportunity.
Fonkoze, Mercy Corps, and Swiss Re mapped out a microinsurance product for Haiti and beyond. To support this new endeavor, we created a for-profit company calledMiCRO that combines parametric insurance—featuring a payout that is quickly triggered by measurable, weather-related thresholds such as wind speed or rainfall—with a possible second payout if the original payout is insufficient to cover actual losses.
In 2012, MiCRO enabled Fonkoze to pay out more than $6.8 million to more than 28,000 clients for damages, primarily from Tropical Storm Isaac and Hurricane Sandy. Assessments show that Fonkoze borrowers are willing to pay a small premium to have better control over their financial destinies, and Swiss Re estimates that the global microinsurance market could yield annual premiums of $40 billion. All of this adds up to communities that are better off, more resilient to shocks, and less dependent on foreign aid.
While MiCRO seeks to help individuals mitigate their financial risks at the local level, this kind of thinking is taking place even at a cross-continental level in Africa. The African Risk Capacity (ARC) Project is a unique partnership led by the African Union Commission, with support from the World Food Program, among others. The index-based weather risk insurance pool would provide African governments with contingency funding in the case of severe drought. The engine behind this endeavor is a sophisticated modeling tool called Africa RiskView, which calculates drought response costs across the continent. Implementation of ARC is still underway, but it looks to be an ambitious and promising undertaking.
Initiatives like MiCRO and ARC certainly won’t stop shocks from happening, but they can improve people’s abilities to cope with them. At a time of global belt tightening and increasingly volatile weather, leaders would be wise to look ahead and make cost-effective investments that help people not only survive, but thrive.
In response to Hurricane Sandy, the New Yorker has an article on Disaster Economics. Excerpts:
Politically speaking, it’s always easier to shell out money for a disaster that has already happened, with clearly identifiable victims, than to invest money in protecting against something that may or may not happen in the future. Healy and Malhotra found that voters reward politicians for spending money on post-disaster cleanup, but not for investing in disaster prevention, and it’s only natural that politicians respond to this incentive. The federal system complicates matters, too: local governments want decision-making authority, but major disaster-prevention projects are bound to require federal money. And much crucial infrastructure in the U.S. is owned by the private sector, not the government, which makes it harder to do something like bury power lines.
The U.S., as a rule, tends to underinvest in public infrastructure. We’ve been skimping on maintenance of roads and bridges for decades. In 2009, the American Society of Civil Engineers gave our infrastructure a D grade, and estimated that we’d need $2.2 trillion to bring it up to snuff. Our power grid is, by the standards of the developed world, shockingly unreliable. A study by three Carnegie Mellon professors in 2006 found that average annual power outages in the U.S. last four times as long as those in France and seven times as long as those in the Netherlands. This isn’t because of a lack of resources—the U.S. is the world’s biggest economy. But, though we may have the coolest twenty-first-century technology in our homes, we’re stuck with mid-twentieth-century roads and wires.
Meaningful disaster-prevention measures will certainly be expensive: estimates for a New York seawall range from ten to twenty billion dollars. That may seem unreasonable at a time when Washington is obsessed with cutting the federal deficit. Yet inaction can be even more expensive—after Katrina, the government had to spend more than a hundred billion dollars on relief and reconstruction—and there are good reasons to believe that disaster-control measures could save money in the long run. The A.S.C.E. estimates that federal spending on levees pays for itself six times over, and studies of other flood-control measures in the developed world find benefit-to-cost ratios of three or four to one. The value for money is even higher in poor countries, where floods obliterate weak infrastructures. And a 2005 independent study of disaster-mitigation grants made by fema found that every dollar in grants ended up saving taxpayers $3.65 in avoided costs.
The size of our current deficit does not change this calculus. In fact, there’s never been a better time for a Delta Plan in the U.S. With interest rates so low, it’s cheap to borrow money, and there are plenty of unemployed workers and unused resources that can be put to work. In a time of austerity, there’s bound to be opposition to expensive infrastructure projects. But if the government—and, by extension, taxpayers—is already on the hook for all the damage caused when disasters strike, we owe it to ourselves to do something about how much those disasters cost.
JC comments: Regarding disaster economics, some categorization seems to have emerged regarding disaster typology, including the relatively predictable ones such as hurricanes and drought versus the unpredictable ones such as earthquakes. There seems to be a further relevant distinction regarding specific disasters that are rare in a particular region versus those that can be expected to occur on a decadal basis, such as hurricanes striking the southeast U.S. and droughts in Africa.
A discriminating factor in disaster economics seems to be the wealth and overall resilience of the locale. It seems that in some developing countries, there can be a significant disaster bounce. In the poorest countries (e.g. Africa) disasters are relentlessly impoverishing. I like the suggestion of coupling development funds and humanitarian response, to increase resilience especially for disasters that repeatedly strike in one region. The micro finance strategy is also interesting. In the U.S., there is an obvious huge difference between the disaster economics of New Orleans and New York City. I also like the suggestion in the Boston Globe piece that Governments and businesses might do well to adopt some of the urgency and innovation of a post-disaster mind-set even in more clement times.