The Macroeconomic Consequences of Natural Disasters

1. The Macroeconomic Consequences of Natural Disasters Ilan Noy - University of Hawaii, Manoa

4. Economic Research on Disasters • Applied micro (development) research • consumption smoothing after disasters • ex ante insurance • risk-sharing • Costs of individual events • mostly to household incomes or labor and immigration choices • less frequently also macroeconomic costs such as the fiscal cost of reconstruction • Can we generalize from these results?

5. Macroeconomic Research on Disasters • Albala-Bertrand (1993) • 28 disasters • Rasmussen (2004) – the Caribbean • Skidmore and Toya (EI, 2002) • long-run impact of natural disasters • cross-sectional dataset • Yang (2006) • ex post international financial flows • more aid, more remittances • Raddatz (JDE, 2007) • explaining the importance of external shocks on output volatility in developing countries • VARs including natural disasters

6. The Research Questions:What are the macro-economic consequences of natural disasters?What determines these consequences?

7. In This Paper • About 450 disasters • Exact number depends on measure used. • Panel data: 1970-2003 • What is the short-run impact of natural disasters? • What determines this impact?

8. EM-DAT Data • 1900-2006 • 10 or more people reported killed • 100 people reported affected • declaration of a state of emergency • call for international assistance • Hydro-meteorological disasters • floods, wave surges, storms, droughts, landslides and avalanches • Geophysical disasters • earthquakes, tsunamis and volcanic eruptions • Biological disasters • epidemics and insect infestations • How accurate are these data?

9. EM-DAT Data • For each disaster we know: • number of people killed (507) % of population (t-1) • number of people affected (466) % of population (t-1) • amount of direct damage (428) % of GDP (t-1) • onset month • Disaster measure used:

10. Disaster Variables

11. The Specifications • Basic equation: • Further hypotheses:

12. Other Data on the RHS • GDP growth (lag) • GDP per capita (in PPP$) • CPI inflation • Unemployment rate • Population • Institutional strength • Investment growth • Domestic credit • Current account surplus • Imports • Foreign direct investment • Financial crises

13. Hausman-Taylor Estimation • Weighted instrumental variables estimation • Like in the Arellano-Bond GMM, the instruments are deviations from country-specific means. • Variances for coefficient estimates are obtained from a least-squares fixed-effects regression and a second-stage FGLS procedure. • We specify endogenous/exogenous variables • Classifying the disaster variables as either does not change the results.

14. Disaster Cost Regressions - Benchmarks

15. Benchmarks by Size and Income Level

16. Determinants of Disaster Costs – Real variables

17. Determinants of Disaster Costs – Financial variables

18. The Consequences of Disasters • Property damage does have an impact on ex post short-run output dynamics. • The effects on the population do not seem to matter for post-shock macroeconomic dynamics. • Developing countries and small economies are more vulnerable.

19. The Determinants of Costs I • Countries are better able to withstand the post-disaster economic shock when they have: • higher literacy rate • better institutions • higher per-capita income • larger public sector • higher degree of openness to trade • more foreign-exchange reserves • higher levels of domestic credit • Less-open capital accounts.

20. We did NOT find that • the size of the agricultural or mining/minerals sectors matters. • island economies are more vulnerable. • large countries are less vulnerable. • inflation increases following disasters • because of monetized deficit spending; or because of new credit creation coming from foreign-aid inflows. • unemployment changes following disasters. • results for trade and for investment were robust.

21. Caveats I - Exogeneity • Ramcharan (JIE, 2007) and Raddatz (JDE, 2007) use disasters (and assume exogeneity). • We use binary indicators. • We use an alternative proxy for the magnitude of the disaster: • for earthquakes – the Richter scale • for storms – wind speed. • We examine the control variables: whether there are any observable differences in their means between the disaster and non-disaster observations.

22. Caveats II • Mismeasurement. • Disasters often induce policy changes. • Fiscal spending priorities and crowding out of capital expenditures. • Lagged response of policy and therefore of disaster impact. • Aid inflows may hide the “true” cost of a disaster. • Different disaster types and risk probabilities will be associated with different degrees of ex ante preparedness and mitigation attempts.

23. Future Research • Fiscal impact of disasters • Neo-classical and endogenous growth • What are the channels through which a disaster affects growth? • Does insurance coverage matter? • Present-value model of the current account • Importance of capital account policies • Best responders: What are the right fiscal and monetary prescriptions? • The role of foreign aid: What is the impact of post-disaster aid surges? • Climate change anyone?

25. Disasters (1968-2002) Eisensee & Strömberg (QJE, 2007)

26. More Questions…

27. Mitigation III