the effects of natural disasters on long run growthbusiness.uni.edu/economics/themes/popp.pdf ·...

61

The Effects of Natural Disasters on

Long Run Growth

Aaron Popp

ABSTRACT. This paper seeks to determine the relationship between natural disasters andlong run growth. Natural disasters affect several important macroeconomic variables, mostnotably technology, that can increase or decrease economic growth. Recovery followingdisasters is important, and the institutions of a country help determine how the recoveryprogresses. Institutions also help determine the outcomes of some events, such asinflation, that could affect long run growth. Countries can help maximize the positiveeffects of natural disasters on growth by improving their response to disasters andpreparing for the next disaster.

I. Introduction

There were earthquakes and floods of extraordinaryviolence, and in a single dreadful day and night all yourfighting men were swallowed up by the earth, and theisland of Atlantis was similarly swallowed up by the seaand vanished. [Plato, 1977, 38]

Tales told through the generations of the destruction of Atlantisand Pompeii by natural disasters show that natural disasters fascinatedand affected listeners throughout history. Natural disasters still play avital role in modern life, costing countries billions of dollars in damageand killing thousands annually. Most previous research on naturaldisasters focused on their short run effects on economies. Only one studyhas focused exclusively on the long run effects of natural disasters ongrowth, so the nature of the relationship between natural disasters andlong run growth is still an open question. This paper seeks to determinethe relationship between natural disasters and long run growth. Therelationship is complicated. Natural disasters affect key macroeconomicvariables, notably technology, that affect long run growth. The effects ofnatural disasters on the macroeconomic variables can be positive ornegative depending on the country’s institutions and how the countryrecovers following disasters. The type of disaster that affects a countrymatters as well; droughts and geologic disasters tend to have a morenegative effect on growth than climatic disasters. Countries cannot

Major Themes in Economics, Spring 200662

directly control most of the macroeconomic variables and effectsfollowing a disaster, but any effort to improve their institutions, recoveryfollowing disasters, and preparation for disasters pays off in the long run.Depending on the circumstances, natural disasters can foster long rungrowth.

A. CATEGORIES OF NATURAL DISASTERS

There are two broad categories of natural disasters. Climatic disastersresult from atmospheric phenomena. Floods, hurricanes, and droughts arethe major climatic disasters that affect countries on a large scale. Floodsoccur when torrential rainfall or snowmelt causes rivers to overflow theirbanks and inundate surrounding areas [Abbott, 2004, 362-363].Hurricanes are large storms that form in the tropical and subtropicalregions of the world where the water is warm. They need a constantsupply of warm water in order to stay intense; any interaction with landor colder water weakens hurricanes. The effects of hurricanes are thestrongest near coastlines, on islands, and in mountainous regions, but theeffects on each of those regions are different. Near coastlines and onislands, the winds and associated storm surge, which is the sea level riseassociated with the passage of hurricanes, cause the most damage. Inmountainous regions, the increase in elevation helps to produce areas ofenhanced rainfall that can cause significant flooding [Abbott, 2004, 304-306]. Droughts are periods of below-average rainfall that affectagriculture and the water supply to the regions affected by the drought[Abbott, 2004, 265-266]. Climatic disasters affect people and capitalthrough forces of wind and water.

Geologic disasters include earthquakes, volcanoes, and thedisasters that occur as a result of geologic changes. Earthquakes are themost significant geologic disaster. The direct effects of an earthquake,however, depend on the economy of the region. Earthquakes that strikerural areas tend to cause less physical damage, because agriculturalinterests are not as affected as much as industrial interests. They do notkill large numbers of crops and livestock, but collapsed buildings arecommon in areas struck by earthquakes. Volcanoes erupt and send lava,mudflows, ash, and debris into the surrounding area. Geologic disasterscause other, secondary disasters. Earthquakes can trigger landslides,tsunamis, and damaging aftershocks, and volcanoes can cause tsunamisas well [Abbott, 2004, 112 and 161]. The effects of geologic disasters are

Popp: The Effects of Natural Disasters on Long Run Growth 63

less predictable than the effects of climatic disasters because of thevariety of secondary disasters that they cause.

B. THE EVIDENCE OF A LINK BETWEEN NATURAL DISASTERS AND LONG RUN GROWTH THUS FAR

Economists have not come to a consensus regarding the effect of naturaldisasters on long run growth. Only one study concluded that naturaldisasters can spur long run growth. Skidmore and Toya [2002, 682]concluded that climatic disasters, excluding droughts, lead to increasedgrowth rates, but they found some evidence that geologic disasters causea decrease in economic growth. They attributed the increase in growthrates after climatic disasters to an increase in human capital accumulationand an increase in technology, and they attributed the decrease in growthrates after geologic disasters to a decrease in physical capital and the lossof human capital from the initial loss of life [Skidmore and Toya, 2002,671-672]. While Skidmore and Toya are the only authors who supportthe idea that natural disasters can spur long run growth, their studyprovides substantial evidence for the claim.

Other studies conclude that natural disasters either hurt or do notharm long run growth. Rasmussen [2004, 11-12] concluded that the long-term effects of natural disasters on growth are ambiguous. He noted thatnatural disasters could decrease long run growth by irrevocablydestroying agricultural, fishing, or other natural resources. Rasmussenalso noted that reconstruction efforts could crowd out productiveinvestments, increase the rate of interest and reduce investment, and leadto inflation or financial crises, all of which would decrease economicgrowth. A regression on natural disaster occurrence controlling for landarea and the population affected found a positive relationship with GDPgrowth. Rasmussen explained that the relationships were marginallysignificant and “could be driven by other factors.” [Rasmussen, 2004, 11].Auffret [2003, 17] found that the effect of natural disasters on long rungrowth was difficult to predict, because the growth prospects of thecountry depended on how reconstruction efforts progressed. Replacementof physical capital was vital. If the economy did not replace the physicalcapital, then a negative effect on growth would result. He did not provideany empirical evidence to support his claims. Benson and Clay [2003, 14-19] emphasized that the economic impacts of natural disasters depend ona myriad of factors but saw few reasons why natural disasters wouldcause long run growth. They emphasized that each natural disaster has


unique effects. While the majority of the studies support the idea thatnatural disasters hurt or do not harm long run growth, the studies do notsupport the claim with substantial evidence.

II. The Effect of Natural Disasters on Key Macroeconomic

Variables

Natural disasters affect certain macroeconomic variables that, in turn,help determine long run growth. Natural resources, physical capitalaccumulation, human capital accumulation, and technology are the fourkey macroeconomic variables studied. All four macroeconomic variablesusually have a positive effect on long run growth. If the net effect ofnatural disasters on the macroeconomic variables is positive, then naturaldisasters aid long run growth. If the net effects on the macroeconomicvariables are negative, then natural disasters hurt long run growth. Inmost cases, the net effect is ambiguous, but some characteristics ofcountries and empirical research by Skidmore and Toya help clarify someof the effects of natural disasters on macroeconomic variables and thuslong run growth.

A. AN INTRODUCTORY NOTE ABOUT INSTITUTIONS

Institutions are the norms, rules, and mechanisms that help societyoperate. Countries with sound institutions do not have significant social,legal, or governmental barriers to growth. There are neither significantbarriers nor steep costs to open businesses, and, in general, thegovernment allows markets to operate freely. A country with soundinstitutions is not a corrupt country; leaders do not require bribes orkickbacks to enforce laws and to allow entrepreneurship. Studies haveshown that countries with lower measures of corruption, a sign ofinstitutions more conducive to growth, tend to grow at a relatively fasterpace [Aron, 2000, 116-120]. Since institutions and the economy areclosely intertwined, the relationship between the two is symbiotic. Betterinstitutions allow for growth, and growth allows for better institutions.

B. THE IMPACT OF NATURAL DISASTERS ON NATURAL RESOURCES

Natural disasters affect a country’s natural resource stock. Hurricanes


and other storms can topple vast stretches of forest. Hurricane Isabel in2003 caused over $550 million in damage to timber in North Carolina[Trickel, 2003, 3]. Hurricanes and droughts could wash or blow awaytopsoil and decrease soil fertility, which would hurt agricultural yields.Additional fertilizer could compensate for the depleted soil. Thedestruction of crops and death of livestock in a disaster would alsodecrease agricultural yields in the short run. Tourism dependent onnatural wonders could suffer. The extratropical remnants of TropicalStorm Delta toppled Tenerife’s most important tourist attraction, a rockstructure known as “El Dedo de Dios” [The Tenerife News, 2005, para. 6].Excluding the effects of disasters on natural wonders, natural disastershave short run negative effects on the natural resource stock.The impact of natural disasters on natural resources is not exclusivelynegative. Floods, for example, provide sediments to the surroundingflood plain that increase agricultural yields [Abbott, 2004, 351]. Volcaniceruptions deposit ash, which enriches the soil [Abbott, 2004, 170].Farmers would not benefit from the disasters immediately, and farmerswould not reap the benefits in a lump sum either. Tourism can see a boostfrom some disasters as well. Relatively docile volcanoes in Hawaii attracttourists, and other tourist attractions exist because of ancient disasters.Crater Lake in Oregon exists inside the caldera of Mount Mazama, avolcano [Abbott, 2004, 172-173]. A disaster that does not significantlydamage natural resources but provides a lasting benefit may boost thenatural resource stock of a country. The positive effects of naturaldisasters on natural resources tend to affect countries in the long run.People can see the immediate damage from natural disasters onagriculture, but they cannot immediately see the benefits from naturaldisasters. The net effects of natural disasters on the natural resource stockdepend on the country and the situation, but the effect is not exclusivelynegative.

C. THE IMPACT OF NATURAL DISASTERS ON PHYSICAL CAPITAL ACCUMULATION

Physical capital accumulation plays a vital role in achieving economicgrowth. Physical capital allows workers to produce more than what theycould without tools. Since economic growth is directly related to theoutput of each worker, a greater amount of physical capital in an economyshould yield a higher level of per capita income. The influence of


physical capital accumulation on economic growth depends on if there areenough qualified workers to use the physical capital. Simply buildingmore physical capital without a sufficient labor force to work the capitalwill not result in economic growth. While the exact empirical avenuesthrough which physical capital accumulation increases economic growthare the subjects of controversy, the general consensus among economistsis that countries with more physical capital tend to be more prosperous[Temple, 1999, 137-138].

Natural disasters destroy physical capital. The change in thephysical capital stock depends on the amount of investment that occursafter the disaster. Countries, if they can, seek to repair and rebuild thephysical capital. In countries where institutions are not healthy, thereconstruction can be more complicated. Bureaucratic barriers,corruption, and low rates of insurance can delay or even preventreconstruction of physical capital. Corrupt leaders could horde foreignaid or divert the aid to fund pet projects rather than the projects thatwould aid the country the most. As long as countries replace the physicalcapital, disasters should not affect physical capital accumulation, but poorinstitutions could cause a decrease in physical capital accumulation.

Empirical evidence indicates that natural disasters will have anegative effect on physical capital accumulation if any relationship exists.Skidmore and Toya [2002, 676 and 678] show that any relationshipbetween natural disasters and physical capital accumulation is negative,but the relationship is not consistently statistically significant acrossmultiple tests. The weak relationship exists because of human capitalaccumulation. Human capital accumulation may increase following anatural disaster, which could increase the return to physical capital. Theincreased return to physical capital leads to increased physical capitalaccumulation.

D. NATURAL DISASTERS AND HUMAN CAPITAL ACCUMULATION

Human capital accumulation positively affects economic growth in mostcircumstances. If the technology embodied in the physical capital of aneconomy is sophisticated, then investment in human capital will yieldhigher productivity. Investment in human capital yields more educated,competent workers, and workers who can learn and apply new conceptsquickly are more productive than workers who cannot. Investment in


human capital, however, is not a sufficient condition for economicgrowth. A country with insufficient opportunities for workers may nothave the physical capital or types of jobs necessary to justify theinvestment in human capital. Years of collegiate education areunnecessary if people simply toil in the fields afterwards. Examples ofcountries in which investment in human capital has not yielded a boost ineconomic growth exist, but the general consensus among economists isthat human capital accumulation positively influences economic growth[Temple, 1999, 139-140].

Natural disasters affect human capital accumulation in severalways, which makes the analysis difficult. Initially, natural disasterssubstantially reduce human capital only if there is a substantial loss oflife. Between 1970 and 2001 (excluding droughts), only three naturaldisasters resulted in the deaths of over 100,000 people and only nineteennatural disasters resulted in the deaths of over 10,000 people. Of thenatural disasters that resulted in the deaths of over 10,000 people, fiveoccurred in India, three occurred in Bangladesh, and two occurred in Iran.The remaining disasters occurred in Central and South America, Armenia,and Turkey [Abbott, 2004, 5]. While the loss of life was tragic, nocountry during the period suffered a disaster that resulted in the deaths ofa substantial percentage of the population. Only epic natural disastersthat strike without warning, such as the tsunami in the Indian Ocean in2004, result in catastrophic loss of life. Improved warning for naturaldisasters allows people to take precautions to avoid harm. As warningand prediction technologies improve, the number of lives lost in disastersshould fall. For most countries and most natural disasters, the effect ofnatural disasters on the population level is relatively negligible and willdecrease with better warning and prediction technologies.

Another potential impact of natural disasters on human capitalaccumulation results from damage to the educational system. Damage toschools and universities may decrease human capital accumulation,because students forced out of classes lose out on the education that theyotherwise would have received. Hurricane George in 1998 destroyed 4%and damaged 28% of the schools in the Dominican Republic, and thegovernment used 443 of the largest schools as shelters for the homeless.The damage forced an estimated 100,000 students out of class for severalweeks [Auffret, 2003, 23]. If sufficient funding to rebuild the schools anduniversities does not exist, then the damage to human capitalaccumulation would be more severe as time progressed.

Disasters can have negative effects on human capital even ifschools remain open. In poor countries, when a family loses a source of


income because of a disaster, some or all of the children may need toleave school to reduce expenses and increase the family’s income.Natural disasters that cause a severe initial shock to the economy maylower human capital accumulation in later years, because many youngstudents leave school for an extended period. Several studies have foundthat economic crises result in lower primary and secondary schoolattendance rates. Attendance rates for older students, however, mayincrease following economic crises. If the real wage falls immediatelyfollowing a disaster, then the opportunity cost for students to attendschool falls, and more students will attend school. Older students aremore likely to have a job, so the change in the real wage would push themback into school [Skoufias, 2003, 1092].

Substitution away from physical capital accumulation may havea net positive effect on human capital accumulation despite the factorsdiscussed above. Since the risk to physical capital increases because ofnatural disasters, investment in human capital becomes relatively moreattractive. People and governments may increase investment in theeducation system and job training, which would increase human capitalaccumulation.

Countries with better institutions are able to avoid the factors thatimpede human capital accumulation following disasters. Schools willreopen more quickly, because countries will be able to repair the damagemore quickly or transfer the students to other areas not damaged by thedisasters. Countries with better institutions tend not to allow child labor,so pulling students out of class to work is not feasible. Parents are leftwith the choice of keeping their children in school or pulling them out tohelp with the recovery. Schooling provides parents with a sort of childcare service, so parents who let their children go to class are able to focustheir energies on recovery and prosperity.

The empirical evidence shows that natural disasters can increasehuman capital accumulation. Skidmore and Toya [2002, 678] found thathuman capital accumulation increases following climatic disasters, butthey did not find a statistically significant relationship between humancapital accumulation and geologic disasters.

E. THE IMPACT OF NATURAL DISASTERS ON TECHNOLOGY

Vital to the argument that natural disasters induce long run growth is theeffect of natural disasters on the level of technology in a country. Ahigher level of technology embodied in physical capital makes physical


capital more productive so long as the human capital is sufficient tooperate the new technology. Technology also increases the return tohuman capital. Since capital becomes more productive, workerproductivity increases. Economic growth results from the increase inproductivity. Since natural disasters destroy physical capital and theinfrastructure of an economy, countries have an opportunity to rebuildwith new applied technology following the disaster.

Measuring the level of technology in use in an economy,however, is a problematic endeavor. Skidmore and Tova [2002, 678-680]analyzed the relationship between natural disasters and total factorproductivity. Total factor productivity directly measures the productivityof labor and capital and thus indirectly measures the level of technologyembodied in capital. It also indirectly measures human capitalproductivity, institutional stability, natural resources, and the politicalclimate. They found that total factor productivity increases followingclimatic disasters. Following geologic disasters, they found nostatistically significant relationship. Natural disasters increase, or at leastdo not decrease, the level of technology in a country.

There are several possible objections to their supporting evidenceand the argument that the amount of technology embodied in capitalincreases following a disaster. First, as already noted, total factorproductivity does not measure the level of technology embodied incapital; it also implicitly measures human capital productivity,institutional stability, natural resources, and the political climate. Theother possible effects of natural disasters on the indirectly measuredvariables taint the measurement of technology.

Second, reconstruction does not necessarily occur following anatural disaster. If there are institutional factors that prevent or hamperreconstruction, then physical capital accumulation in an economy will fallbecause of the disaster. The positive effect from better technologyembodied in capital depends on the replacement of the capital lostfollowing a disaster. The boost in productivity from better technologycannot occur if the country does not build the capital to use thetechnology.

Third, disasters that destroy relatively modern physical capital donot have a significant impact on long run growth. Unless a breakthroughoccurs or costs of significantly better technology plummet in the interimbetween disasters or the construction of the capital, the marginal benefitof the increase in technology is minimal. If the increase in technology


from a disaster is small, then the cost to replace the capital may outweighany potential gains from the increased productivity from the technology.Fourth, while technology in a country may increase, institutional factorsmay negate any technological improvements in a country. Industries thathave strong ties to the government could influence the government to banor discourage the spread of technology that hurts those industries. AfterWorld War II, the steel industry in the United States suffered. Othercountries, such as Japan and Korea, greatly expanded their share of theinternational steel market. Producers of steel in the United States, withthe support of the United States government, sought anti-dumping casesagainst foreign producers of steel [Howell et al, 1988, 37 and 514-517].While the steel example is not an example of natural disasters and theireffects, it is conceivable that governments would take similar protectiveactions after disasters to prevent new technologies from spreading if thetechnologies harmed favored domestic industries in a similar manner.

Fifth, recovery efforts could divert resources away from researchand development. Technology does not simply appear. Firms orgovernments must invest in research and development to achievetechnological breakthroughs. Disasters strain resources, so investment inresearch and development could decrease and technological growth wouldsuffer.

The objections raised affect countries in different situations indifferent ways. All countries are vulnerable to the problem of disastersdestroying relatively modern capital and, depending on who is in power,the problem of governments protecting domestic industries from newtechnology. Relatively prosperous countries with healthier institutionsshould not see any impacts from political instability or forces that hamperrecovery after a disaster. The countries could divert money away fromresearch and development, because more prosperous countries tend tohave more investment in research and development. Less developedcountries with poorer institutions would need to worry about recoveryefforts, human capital accumulation, and political instability the most.Since less developed countries tend to have lower budgets for researchand development (and initial levels of technology), disasters do notnecessarily have an impact on technological innovation in developingcountries. The objections raised may, in some cases, be sufficient toreverse the anticipated increase in technological application following anatural disaster. The empirical evidence indicates that the effects of thevarious objections do not completely negate the positive boost to


technology. Countries that recover sufficiently and avoid the otherpitfalls should still see a boost in technology following natural disasters.

F. DROUGHTS: A DIFFERENT SORT OF DISASTER

Droughts do not affect the macroeconomic variables as other disastersaffect them. Droughts do not usually destroy physical capital, so theincrease in technology embodied in capital that can result from otherdisasters will not occur because of a drought.

In developed countries with sound institutions, droughts do notendanger lives. They affect mainly agricultural interests and the onlyeffect that the average person may see is a restriction on water usage.Agricultural interests in countries with good institutions will be able tosurvive the initial impacts of droughts. Insurance protects farmers againstthe initial economic losses and allows them to continue farming after thedisaster. Even if animals die from excessive heat and crops wither, seedcan be readily obtained and markets for livestock can readily replace lostanimals. The effects of droughts increase as the quality of the institutionsfalls.

In less developed countries, the effect on agriculture can be morecatastrophic. Seed may be shipped in from other countries, but thepossible effect on livestock is more catastrophic. It is difficult andexpensive in poor countries to ship in replacement livestock. If a droughtkills a large percentage of the livestock in any given region, then it willtake many years to replace the livestock lost. Until the herds of livestockare replenished, the supply of food falls. Skidmore and Toya [2002, 666-667] estimate that it could take 25 years for countries to recover from adrought if a country recovers substantially at all. Growth in countrieswith an economy based on agriculture, especially on livestock, suffersbecause of droughts. Taking into account crop failures, droughts can leadto food shortages.

The catastrophic loss of life from droughts results frominstitutional factors and food shortages. The scarcity of food causesfundamental changes in the economy that reduce growth. Feedingstations constructed during a famine in Ethiopia in the mid 1980’s becamehavens for starving families who did not want to stray far from theirlifeline. A lack of infrastructure and governmental organization resultedin locating feeding station far from areas of need [Keller, 1992, 617].Many families depended on food aid, rather than working their land, to


survive. The displaced people contributed little to the economy, and anybusinesses or trade to which the displaced people contributed suffered.Schooling for the children of the displaced victims may not occur, sohuman capital accumulation suffers as well. The economy suffers, andpeople who suffer and become displaced affect the stability of thecountry.

Droughts can affect the institutional stability and the politicalclimate of the country, especially if the country is inherently unstable orif the disaster is particularly severe. In Ethiopia, a severe drought in the1970’s and the associated famine over the next decade helped toppleHaile Selassie, the leader at the time. Political chaos and civil warfollowed for the next two decades, and droughts exacerbated the conflictto such an extent that the armed forces began to deny their oppositionfood as a key strategy [Keller, 1992, 609 and 620-623]. The impact ofwar dashed any possible boost in growth through an increase in totalfactor productivity. Certainly, there is sufficient evidence to prove thatwars and internal conflicts decrease economic growth [Butkiewicz andYanikkaya 642-643; Levine and Renault 958; Barro 432, 437]. Growthin Ethiopia has been practically nonexistent to date, and Ethiopia is oneof the poorest countries in the world. The droughts and famines certainlycontributed to Ethiopia’s conflicts and its growth problems.

Droughts are a parasite to economically unhealthy nationswhereas other natural disasters are a shock. While droughts can have adirect effect on growth through losses of livestock, droughts can causefundamental negative changes to the economy. However, it isconceivable that recurrent droughts could promote growth in the long run.If international aid efforts succeed in feeding the population andpreventing migration, then droughts could serve as an impetus fordiversification. On the whole, it is likely that droughts do not affect thelong run growth of developed countries and negatively affect the long rungrowth of developing countries.

G. THE SIZE OF THE COUNTRY MATTERS: MONTSERRAT, MOTHER NATURE’S WHIPPING BOY

Montserrat is a prime example of the extreme effects that a naturaldisaster can have on a small country. It is a volcanic island in theCaribbean governed by the United Kingdom, and its territory covers abouthalf of the land area covered by Washington DC. About 13,000 people


inhabited the island before 1995, and about 80% of the economydepended on tourism [Auffret, 2003, 21]. It is a prime example of a smallisland economy dependent on a single industry to survive.

In 1989, Hurricane Hugo struck the island, and in addition to the$200 million in damages (over five times the annual GDP of the island atthe time) and damage to 98% of the housing on the island, the threelargest hotels closed for four months and severe damage occurred to theport facilities [Auffret, 2003, 2122]. The island did recover with time, soHugo did not prove to be a catastrophic blow.

In 1995, the catastrophic blow came. The Soufriere Hills volcanobecame active, and subsequent eruptions through 1998 rendered much ofthe island uninhabitable and destroyed Plymouth, the capital [Auffret,2003, 21-22; Thomas-Hope, 2001, 93]. The eruptions forced 90% of theislands inhabitants off the island, and only about half have returned.Besides the mass exodus of people, the financial system of Montserratnearly collapsed as well. The Montserrat Building Society, which was themost important bank on the island, nearly collapsed after the disaster.Insurance companies pulled out of the island, and the Monserrat BuildingSociety faced a bank run [Benson and Clay, 2003, 7]. Withoutinternational assistance, many refugees from Montserrat would have losttheir savings as well as their homes.

Montserrat is particularly vulnerable to natural disasters becauseof its small size and heavy reliance on tourism. Hurricane Hugodemonstrated Montserrat’s vulnerability to natural disasters in the shortrun, but its long run effects on growth were negated by the volcaniceruptions in the mid 1990’s. Much of the island remains uninhabitablebecause of the eruptions. The Soufriere Hills volcanic eruptionseffectively demonstrated Montserrat’s vulnerability in the long run.

Thus, tiny countries that depend on a single industry are the mostvulnerable to natural disasters. Most natural disasters produced severelocal effects and milder effects on a larger scale, so disasters tend not todecimate the economies of large nations. The economies of tinycountries, however, tend to have undiversified economies that leave themvulnerable to large-scale disasters and shocks to the industries on whichthey depend [Easterly and Kraay, 2000, 2013]. Broad statements abouthow natural disasters affect long run growth do not consider the extremecase. The volcanic eruption on Montserrat shows how a natural disastercan permanently harm long run growth by rendering the entire countryunlivable or undesirable.


Physical capital accumulation, human capital accumulation, andtechnology are the engines of long run economic growth (or lack thereof)relating to natural disasters. In each case, the theoretical effects of naturaldisasters on each of the variables are ambiguous on the whole.Understanding how institutions and the recovery process affect themacroeconomic variables is the key to determining how natural disastersharm long run growth. Countries with better institutions will see morepositive and fewer negative effects on the macroeconomic variables thancountries with poor institutions. Countries with better institutionsexperience greater long run growth because of natural disasters.

The type of disaster and the size of the country are also importantwhen determining the long run effects of disasters on growth. Theempirical evidence hints that geologic disasters and droughts have morenegative effects on long run growth than climatic disasters. Geologicdisasters may have a more significant effect on the infrastructure of acountry, which would hamper recovery efforts and hurt growth. Thereasons why droughts are not conducive to economic growth are clearer.Droughts do not positively affect technological progress and havedisproportionately negative effects in countries with weaker institutions.A smaller country is simply more vulnerable to natural disasters, evendisasters that may have only minor effects in a large country.

III. Other Impacts of Natural Disasters that Could Affect Long Run Growth

The most obvious effects of natural disasters are in the short run, andsome effects of disasters in the short run could yield some long runeffects. In particular, financial crises caused by disasters could hurt longrun growth through inflation. Natural disasters could psychologicallyharm the people who experience them, which could decrease theirproductivity. Also, new disaster warning and detection technologies mayaffect the rates of return to physical capital investment and thus affectphysical capital accumulation. The effects in this section are secondaryto the effects of the macroeconomic variables, but they are important tosome countries.

A. PREDICTING NATURAL DISASTERS WITH NEW TECHNOLOGY


Technology can increase the understanding of natural disasters and reducethe cost of the uncertainty about whether a disaster will occur. Thedisaster risk of an area is defined as the probability that a natural disasterwill damage or destroy physical capital [Skidmore and Toya, 2002, 676].Disaster risk adds to depreciation. The expected depreciation of capitalin a country is depreciation plus the effect of disaster risk on the value ofcapital. If disaster risk is high, then the expected depreciation of capitalwill be high as well.

If investors are rational, disaster risk is constant, and informationis perfect, then natural disasters will not affect physical capitalaccumulation. Investors will take into account the increased risk due todisasters and will invest to maximize their returns. Insurance markets willensure that governments and companies will have the resources to rebuildfollowing disasters. Ceteris paribus, an increased disaster risk in aneconomy decreases the rate of return on investment. If disaster risk isconstant, a single disaster should not affect the expected level ofdepreciation in the long run.

The world is not simple enough to allow such a neat analysis.Disaster risk can change quickly and drastically. Volcanoes can becomeactive without much warning, so disaster risk can change if a new threatdevelops or an existing threat subsides. Some natural disasters, such asfloods, have a nearly constant disaster risk. Other natural disasters canfeed off each other and may increase or decrease the risk of another typeof disaster. The disaster risk of an earthquake falls after the threat ofaftershocks subsides, because the earthquake releases the energycontained within the fault. Even if disaster risk does not change,knowledge about natural disasters changes. Before meteorologistsinvented weather satellites, limited data about hurricanes preventedmeteorologists from forecasting the number and severity of hurricanes inany given year. Recent evidence shows that climate cycles spanningdecades affect the tracks, frequency, and strengths of hurricanes [Abbott,2004, 310]. If meteorologists accurately predict the cycles, then disasterrisk would increase before the peak of the cycle and in areas near thepredicted tracks of hurricanes. Breakthroughs in the study of othernatural disasters will reduce uncertainty when predicting other naturaldisasters. Recent advances in fault monitoring allow geologists tomonitor the tension built up along faults, and they can use the data topredict the threat of an earthquake in any given area [Newshour, 2004,para. 4, 14-20].


As information about natural disaster occurrence increases,investors will benefit from precise measurements of disaster risk. Precisemeasurements of disaster risk over time will allow investors to adjust forthe changing risks posed by natural disasters through insurance.Insurance is the means by which investors can adjust for the risk of adisaster. While insurance is available in many areas affected by disasters,limited data about natural disasters forces insurance underwriters to addan uncertainty premium to policies [Skidmore and Toya, 2002, 677-678].As data about disasters and the likelihood that they will strike increasesbecause of new technology, the uncertainty premium should fall, andinvestors should see a greater return to their investments. Physical capitalaccumulation would increase, and economic growth would increase aswell. Hence, forecasting and detection technologies should increase longrun growth.

B. A NOTE ABOUT FINANCIAL CRISES CAUSED BY NATURAL DISASTERS

There are two possible sources of inflation in countries that suffer fromnatural disasters. First, inflation may result from the increased debtburden caused by the recovery. The recovery after a natural disasterproduces a cost to society, and governments pay much of the bill.Governments may not be able to afford the additional debt accumulatedbecause of the disaster. Officials may pressure the central bank to printmore money to help end a financial crisis, and the result of printing toomuch money is inflation. In countries with sound institutions, thegovernments cannot influence the policies of their central banks.Inflation will occur if the government forces the central bank to print offmoney to pay down the debt, but independent central banks ensure thatinflation will not result from the additional debt through direct influenceon the central bank. Less developed countries with poor institutions areat the greatest risk of problems associated with financial crises andinflation.

Financial crises certainly can occur following natural disasters.Governments do not necessarily have a budget set aside for recovery fromnatural disasters or other emergencies. Following a series of earthquakesin Turkey in 1999, the amount of taxes collected from the regions mostseverely affected fell substantially. A slowdown in the economy in theregion was not the only cause for the decrease in tax receipts; the disaster


hampered tax collection efforts as well. The government raised taxesacross the board in an effort to compensate for the loss in revenue[Akgiray et al, 2004, 84]. The government had sufficient resources tocompensate for the loss in revenue, because it had funding sources fromabroad as well. Various international agencies and countries, such as theEuropean Union, the World Bank, and the International Monetary Fund,offered Turkey over $2 billion in loans. The government spent about $6.4billion on recovery efforts; decreases in other areas of the budget of thegovernment allowed the government to spend more on recovery.Economists projected the total cost to the Turkish government, includingthe initial expense and interest, to be about $14 billion, which wasexpected to be a heavy burden on the government [Akgiray et al, 2004,85-86]. Such an expense caused hardship to the Turkish government, andthe same expense could cause inflationary pressures to governments witha higher amount of debt or less international cooperation.

Second, in areas that suffer damage to the infrastructure of theeconomy, inflation could occur because of market forces. Commodityprices can skyrocket after disasters, because natural disasters disrupt thesupply of commodities, such as food, housing, and energy. Demand forcommodities also increases, because disasters destroy personalpossessions and housing. Controlling commodity prices followingdisasters is tricky, because people would not want the price controls liftedfollowing the disaster, and it would be difficult to prevent black marketsfrom forming, especially across large regions or rural areas [Skoufias,2003, 1094]. Thus, the best way to control inflation caused byskyrocketing prices is to restore the infrastructure as soon after thedisaster as possible.

Whether the increase in inflation will have a significant effect onlong run growth is debatable. The literature on inflation and growth isvast, and there is evidence supporting both views. The conventional viewis that the effect of inflation on growth is negative. In addition to theeffects of inflation on investment inflation taxes an economy. At a highinflation rate, prices adjust more quickly, so people are not as sure thatthe cost of goods is reasonable. People also lose faith in the currency,which causes them to revert to inefficient barter to purchase goods. Also,businesses would need to change their prices more often, and changingprices costs money. People would want to hold less cash because of highnominal interest rates, and people would make more frequent trips to the


bank. The costs to an economy caused by inflation imply that inflationhurts growth.

Whether the negative effects of inflation last into the long run isdebatable. Bruno and Easterly [1995, 20-21] found that the relationshipbetween long run growth and inflation, even inflation crises, is negligible.Holding out the cases of high inflation, they found no evidence for adecrease in long run growth rates due to the inflation rate. In countrieswith high inflation and inflation crises, the economies reboundedfollowing a reduction in inflation rates, so there was no damage to longrun growth due to inflation. If the conventional wisdom that inflationhurts growth is correct, then financial crises could have an impact on longrun growth.

Inflation in poor countries could have short run effects notaccounted for in the previous studies that lead to long run consequencesto human capital accumulation. First, if wages do not keep up withinflation, then the real household income of a family falls during a periodof high inflation. Parents have an incentive to take their children out ofschool since schooling costs money in many countries. The longer theparents hold their children out, the greater the decrease in human capitalaccumulation. As discussed previously, older students might experiencethe opposite effect on human capital accumulation, because theopportunity cost of schooling falls if the real wage falls. The health ofchildren could deteriorate, because parents may not have enough moneyto provide the proper nutrition to their children. Empirical evidenceindicates that inflation causes an increase in malnutrition among children[Skoufias, 2003, 1091-1092]. If malnutrition causes permanent healtheffects in a sizable number of children, then the possible human capitalaccumulation for those children falls. Thus, financial crises that causeinflation could hurt long run growth directly or through human capitalaccumulation.

C. SOCIETAL EFFECTS NOT QUANTITATIVELY MEASURABLE

Natural disasters affect people first and foremost. Even if a disaster doesnot kill anyone, the emotional and physical effects of the disaster on thepopulation still harm people well after the actual disaster. Some survivorswill likely suffer permanent physical disabilities and psychologicalconditions, such as post-traumatic stress syndrome. Workers who sufferfrom psychological conditions and disabilities will not be as productive


as they were before the disaster, which could hurt growth if the disasteraffects enough people. International aid organizations address thepsychological needs of people and families, though their efforts do notnecessarily cure mental trauma. One suggestion from the Marmaraearthquake in Turkey to help avert the psychological effects of disasterswas to emphasize preparation for natural disasters on the community level[Akgiray et al, 2004, 90-92]. Communities prepared for disasters are ableto recover more quickly from the initial effects, and people will not feelas helpless following the disaster, which may help avert some of thepsychological trauma.

Some short run responses to natural disasters affect long rungrowth. Technology built to detect and warn against disasters decreasesthe uncertainty associated with insurance and the returns to investment.As information about disasters improves, the effect on long run growthshould be positive. In countries with poor institutions, inflation resultingfrom financial crises or poor infrastructure could harm long run growth.The effects of disasters on the mental state of the population areimportant. A demoralized and traumatized population is less productivethan a population who successfully endured a disaster. The short runresponses to disasters, excluding the direct effect of inflation on long rungrowth, have indirect effects on the macroeconomic variables thatdetermine long run growth. They are secondary to the more direct effectsof disasters on the macroeconomic variables.

IV. Conclusion

Natural disasters certainly have effects on long run growth. The keymacroeconomic variables that natural disasters affect are technology,human capital accumulation, physical capital accumulation, and thenatural resource stock. All four macroeconomic variables help increaselong run growth. Whether the net effect of natural disasters on long rungrowth is positive or negative depends on how the recovery progressesafter the disaster, where the disaster occurs, and the type of disaster thatoccurs. The theoretical discussion supports the empirical evidencecollected by Skidmore and Toya; natural disasters can increase ordecrease long run growth depending on the circumstances.

Sound institutions help ensure a healthy recovery following adisaster. A healthy recovery helps maximize the positive effects andminimize the negative effects of disasters on the important


macroeconomic variables. Also, sound institutions decrease the chanceof a financial crisis following the disaster and should minimize the shockto the population, both of which could harm long run growth. Sinceinstitutions and growth are symbiotic, countries cannot realisticallyimprove their institutions overnights. They are constrained by the amountof resources that they can put towards improving institutions. Still, anyeffort to improve institutional efficiency following a disaster should aidrecovery efforts and yield benefits in the long run.

Relatively mild disasters that occur over a small area in largecountries have little effect on long run growth in large countries, but thesame disaster in a small country could decimate the economy of the smallcountry. Montserrat provided an example of a country facing a such adisaster. The Soufriere Hills volcanic eruptions were not massive, but thesize of the island ensured that the long run implications of the eruptionwere significant. Any type of disaster, so long as it has devastatingeffects on a local scale and prevents recovery, could have the same longrun effects as the Soufriere Hills volcanic eruptions.

The empirical evidence from Skidmore and Toya showed that thetype of disaster that occurred had a significant effect on whether the effectof natural disasters long run growth was positive or negative. Theirevidence also showed that the link between climatic disasters and longrun growth was positive and that the link between geologic disasters andlong run growth was negative (though not consistently) across thecountries they studied. The exact reasons for the differences are unclear.Their evidence showed that the positive effects on human capitalaccumulation and total factor productivity, a crude measure of thetechnology embodied in capital, from climatic disasters were higher thanfor geologic disasters. It is possible that geologic disasters have a greatereffect on the infrastructure of a country, which would hamper initialrecovery efforts. While a drought is a type of climatic disaster, thetheoretical discussion and some historical evidence implied that droughtshave a predominantly negative impact on long run growth, exceptpossibly in countries that diversify their economies. Further studies usingSkidmore and Toya’s data or other sources of data on disasters wouldhelp economists further pin down the effects of different types of naturaldisasters in the long run.

Considering that there is only one source of in depth empiricaldata concerning the effect of natural disasters on long run growth, aneffort to develop a more precise data set for natural disasters and their


economic effects would be worthwhile. Specifically, Skidmore andToya’s analysis does not take into account differences in insurance acrosscountries, which they admit could affect the results of their analysis[Skidmore and Toya, 2002, 682]. They do not take into account droughts,which have significant effects when they strike less developed countries.With more precise data, economists could further analyze the effects ofdisasters on growth and empirically determine the impact of droughts onlong run growth.

For now, focusing on recovery efforts after natural disastersappears to be the most effective means by which countries andinternational organizations can encourage long run growth following anatural disaster. Since the relationship between growth and institutionsis symbiotic, countries cannot physically move or change their size, andcountries cannot choose the disasters that affect them, the only way bywhich countries can increase the likelihood that disasters will increaselong run growth before the disasters strike is to prepare for the disasters.Efficient preparation can affect long run growth in several ways.Countries that prepare for disasters should have a smoother recoveryeffort. Efficient preparation would also include provisions in thegovernment budget for emergency funding after a disaster, which wouldreduce the chance of a financial crisis. With a plan to keep commodityprices low following a disaster, provisions for emergency funding willreduce the probability that inflation will occur. Preparation on thecommunity level will emotionally prepare people for the traumaassociated with natural disasters and give them means by which they canhelp themselves. Psychologically, they will be more prepared for thedisaster and will not suffer as much from the stress following the disaster.In short, planning for the next disaster benefits long run growth inmultiple ways. Governments and relief agencies should continue toemphasize recovery after a disaster, and they should prepare for disastersbefore they happen.

References

Abbott, P. (2004), Natural Disasters, 4 edition. New York: McGraw Hill.th

Akgiray, V. et al. “The 1999 Marmara Earthquakes in Turkey,” in OECD, Large ScaleDisasters: Lessons Learned. Paris, France: OECD.

Auffret, P. (2003), “High Consumption Volatility: The Impact of Natural Disasters?”Working Paper 2962, The World Bank, EconLit.


Aron, J. (2000), “Growth and Institutions: A Review of the Evidence,” The World BankResearch Observer, 15: 99-135.

Barro, R. (1991), “Economic Growth in a Cross Section of Countries,” The QuarterlyJournal of Economics, 106: 407-443.

Bruno, M and Easterly, W. (2003), “Inflation Crises and Long-Run Growth,” WorkingPaper 1517, The World Bank, EconLit.

Butkiewicz, J. and Yanikkaya, H. (2005), “The Impact of Sociopolitical Instability onEconomic Growth: Analysis and Implications,” Journal of Policy Modeling, 27:629-645.

Benson, C. and Clay, E. (2003), “Disasters, Vulnerability and the Global Economy,” inKreimer, A., Arnold, M., and Carlin, A., Building Safer Cities: The Future ofDisaster Risk. Washington DC: The World Bank.

Easterly, W. and Kraay, A. (2000), “Small States, Small Problems? Income, Growth,and Volatility in Small States,” World Development, 28: 2013-2027.

Howell, T. et al. (1988), Steel and the State. Boulder, Colorado: Westview Press.Keller, E. (1992), “Drought, War, and the Politics of Famine in Ethiopia and Eritrea,”

The Journal of Modern African Studies, 30: 609-624.Levine, R. and Renelt, D. (1992), “A Sensitivity Analysis of Cross-Country Growth

Regressions,” The American Economic Review, 82: 942-963.Newshour with Jim Lehrer. (2004), “Online NewsHour: Predicting Earthquakes.” June

2, http://www.pbs.org/newshour/bb/science/jan-june04/earthquakes_6-2.htmlPlato. (1977), Timaeus. London, England: Penguin Books. Rasmussen, T. (2004), “Macroeconomic Implications of Natural Disasters in the

Caribbean,” Working Paper 04/224, International Monetary Fund, EconLit. Skidmore, M. and Toya, H. (2002), “Do Natural Disasters Promote Long-Run Growth?”

Economic Inquiry, 40: 664-688.Skoufias, E. (2003), “Economic Crises and Natural Disasters: Coping Strategies and

Policy Implications,” World Development, 31: 1087-1102.Temple, J. (1999), “The New Growth Evidence,” Journal of Economic Literature, 37:

112-156.The Tenerife News. (2005), “Delta Force in the Canaries” November 29 , 6 par,th

http://www.tenerifenews.com.Thomas-Hope, E. (2001), “The Role of the Environment in Caribbean Economic

Development,” Integration and Trade, 5: 83-104.Trickel, Ron. (2003), “Forest Damage Appraisal - Hurricane Isabel,” North Carolina

D i v i s i o n o f F o r e s t R e s o u r c e s ,http://www.dfr.state.nc.us/storm/HurricaneIsabelDamagereport1.pdf

the effects of natural disasters on long run growthbusiness.uni.edu/economics/themes/popp.pdf ·...

Documents