Natural disasters: economically speaking, are they net contractionary or stimulative events?

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Witness the March 2011 triple disaster in Japan. Will the end result be a raft of new infrastructure and other spending that proves to be a net stimulus to the Japanese economy? Or has the catastrophe produced such a dark cloud of gloom over the country, itself that the net result is contractionary? What about the recent natural disasters in the heartland of the United States--flooding, tornados, wildfires? Economically speaking, are these net stimulative events, particularly for the construction trades? Or do these events create a sense of uncertainty, highlighting the uncertainties of the debate over climate change? How does Haiti fit into this discussion? The state of Louisiana after Katrina?

The views of 17 important thinkers.

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SAMUEL BRITTAN

Columnist, Financial Times

This is not a difficult question. A tsunami or severe flood or storm reduces national wealth--a once-for-all effect. The only exception would be if it hit a completely barren and uninhabited place, but such areas are now extremely rare. It also reduces, on impact, the annual flow of output and income.

Any stimulus results from the rebuilding efforts. This will be the case whether the reconstruction efforts are privately or publicly financed. The only exception is if the government offsets its reconstruction expenditure with a one-for-one increase in taxation to pay for it; but that is extremely unlikely, especially in the early stages.

What happens next depends on the initial state of the economy. If it has been working well below capacity, the effect is to stimulate output and employment. Indeed, on some assumptions multiplier effects could lead to a higher real national income than before the disaster. But care is needed in defining "below capacity." Such a state of affairs does not exist simply because businesses would like more orders. It exists only if output could be increased without an acceleration in the rate of inflation.

If on the other hand the economy is already against the limits of capacity, the main effect would be an increase in the inflation rate and probably some reduction in the exchange rate or a deterioration in the balance of payments. As the economy is usually somewhere between the two extremes, there is ample room for argument; but this is no different in principle from the disputes occurring in normal times between, for instance, the doves and the hawks on the Federal Reserve Open Market Committee. But the doves are more likely to win because of the psychological atmosphere created by the disaster.

The whole story was rehearsed in large scale in World War II when at last the U.S. economy fully recovered from the Depression and moved onto a rapid growth trajectory. Some of this effect may be explained by wartime controls, for example on prices, which enabled the economy to sustain a higher level of activity than it otherwise would. But this is by no means the whole story.

One is left wondering why peacetime budget deficits to reduce unnecessary slack in the economy are greeted in some quarters with hysterical opposition while much larger deficits to pay for wars and destruction are greeted with equanimity.

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AGUSTIN CARSTENS

Governor, Bank of Mexico

Natural disasters are associated with the destruction of physical and human capital, translating into an immediate decrease in GDP. However, the question of whether natural disasters have a positive or negative impact on short- and long-term growth rates remains open, theoretically and empirically. Indeed, the Solow-Swan model of growth predicts that growth rates will increase immediately after a disaster and will return to their steady state once GDP attains its pre-disaster trend. Nevertheless, the endogenous growth framework does not have such clear implications. For instance, assumptions such as increasing or decreasing returns to scale on the knowledge production function could lead to either a decrease in the long-run growth rate or to an unchanged steady state, respectively. Furthermore, rigorous empirical studies have not reached a consensus with respect to the transitory and permanent impacts of a natural disaster (Cavallo and Noy, 2010).

In spite of the apparently inconclusive evidence, the economic effect of a natural disaster seems to depend on the reconstruction capacity of a country. Empirical evidence suggests that in some cases, mostly for developed economies, a natural disaster could even result in a higher long-run GDP growth rate (Crespo, Cuaresma et al., 2008). If a country has the ability to use the opportunity to get rid of outdated technologies and invest in new ones when the reconstruction effort takes place, the adoption of these innovations could lead to higher production, lower costs, and a more efficient use of the nation's resources. However, this possibility of renovating infrastructure seems to arise only when specific factors come together.

The literature has pointed at some of the most important factors that enable technology absorption following a disaster (Beasley and Burgess, 2002; Kahn, 2005; Toya & Skidmore, 2007; Crespo Cuaresma et al. 2008; Noy, 2009; Noy and Vu, 2010). In particular, strong institutions that generate the right incentives for firms and households to adopt better technologies, such as contestable and open markets, in both inputs and goods, seem to be fundamental for a successful reconstruction. Another instance is a deep and solid financial system, which allows the swift shift of resources to the areas in greatest need and to the projects with the highest social returns. In the same vein, more skilled human capital will facilitate the employment of new technologies. In addition, government accountability is required to guarantee the best use of available resources. All of these elements seem to enable the efficient use and coordination of resources for reconstruction.

It is relevant to note that the factors that help recovery from a natural disaster are crucial in mitigating the initial drop in GDP in the first place and, more importantly, in promoting growth in normal times. Hence, although there is not enough evidence to predict the net effect of a natural disaster on economic activity, it seems that the best manner in which to face a disaster is to promote policies that increase productivity at all times.

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CHARLES WOLF

Distinguished Corporate Choir in International Economics, RAND Corporation, and Senior Research Fellow, Hoover Institution

In the near-term, natural disasters are unambiguously contractionary. Japan's triple earthquake, tsunami, and nuclear disasters since March 2011 have contracted Japan's GDP by 2-3 percent.

But in the medium and longer terms, and under favorable conditions, natural disasters can be stimulative (for example, following China's Chengdu earth quake in 2008, Indonesia's Sumatran tsunami in 2004, and South Korea's separation from the North in the 1950s--the latter both a natural and unnatural disaster).

So, perhaps it may be better to pose the question another way: Under what conditions are natural disasters likely to be net stimulative?

In addition to a longer time horizon, the stimulative conditions include: (a) possibly enhanced motivations for both government and the private sector to mobilize expanded investment to meet priority needs; (b) opportunities to modernize technology and increase productivity along with the package of replacement and repair of damages wrought by the disaster; (c) galvanized foreign assistance (both financial and technical, and from both governmental and non-governmental sources); and (d) unity and cohesion of political leadership, public solidarity, and public policy (perhaps supplanting a pre-disaster regimen of divisiveness and wrangling).

Absent these stimulative conditions, the contractionary effects of natural disasters may well endure, including persistently weakened consumer demand resulting from lingering fears and uncertainties induced by the disaster, more risk-averse investors enfeebled by the disaster's after-effects, and possible emigration of "best and brightest" from the impacted country or area.

As a wild guess, I'd opine that the stimulative effects are likely to predominate in Japan, the contractionary effects more likely to predominate in Haiti, while the effects in the United States lurk somewhere in between.

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JAMES E. GLASSMAN

Senior Economist and Managing Director, J.P. Morgan Chase & Co.

It is often said that, aside from the human toll, natural disasters can bring economic benefits. The rebuilding of damaged facilities generates new economic activity, faster growth, and more jobs. Indeed, many may be tempted to see this year's speedy rebuilding from the destruction caused by the Great East Japan Earthquake and tsunami of 2011 as an example of the economic benefits that can come from a natural disaster. In addition, some believe that natural disasters, by clearing away aging infrastructure and equipment, allow newer and more efficient capital to replace older vintages, in the same way that forest fires clear the way for new growth. Some credit the stimulus provided to repair earthquake damage for California's eventual recovery following the 1991 national recession.

Nonetheless, claims that natural disasters can bring economic benefits are far-fetched. If this were so, governments could counteract economic downturns and spur new growth simply by destroying property.

For sure, the recovery from a natural disaster creates new activity and jobs for a while, but such activity can never replace the lost output caused by a natural disaster. At best, the rebuilding effort will only return economic output back to where it was before the natural disaster. That's because the destruction of productive facilities temporarily lowers the level of economic output until the damage is repaired. In other words, natural disasters produce a V-shaped...

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