An Overview of the Issues

7/27/2019 An Overview of the Issues

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AnOverviewoftheIssues

The theoretically correct measure ofeconomic impactsfrom a natural disasterwouldbe the

change in welfare that occurred asa result ofthe event. Welfare can be evaluated ex post,

asthe compensation required to avoid loss, or ex ante, which accountsforuncertainty

(Rose 2!2". #lthough thin$ing in termsofhypotheticalwelfare measurescan be

instructive, a complete welfare analysisisusually quite difficult empirically and would

require ma$ing a numberof assumptionsand simplificationsin analysis. %fsociety were

ris$&neutral, ex ante welfare could be evaluated with the expected economic loss(Rose

2!2". 'cholarsinterested in empirical estimates(asopposed to modeling results, which

can be useful in estimating welfare calculations"have attempted to measure observable

disasterdamagesand follow&on economic impactsasa rough approximation ofthe neteconomic costsofa disaster.

ariouslistsand typologiesofdisasterimpactshave been created. )ost scholarsof

disastershave generally classified disasterimpactsinto direct and indirect impacts. *irect

impactshave been described asthe physical destruction from a disaster, and indirect impacts

(some authorspreferthe term higher-orderimpacts"are considered the consequencesofthat

destruction (+ational Research ouncil !---". %n thisway, direct damagesreferto damages

to structures, contents, and infrastructure that occurasa direct result ofexperiencing the

haard. *irect impactsalso include mortality and in/ury caused directly by the haard.

%ndirect damagesreferto lost economic activity, such aslossofpotential production,

increased costsofproduction, lossin expected income, and otherwelfare losses, which occur

asa result ofthe initial damage. *irect and indirect damagesinclude nonmar$et impacts,

such asdeclinesin the quality oflife, environmental degradation, orlost recreational

amenities, forexample. %n theory, it should be possible to sum up all direct and indirect

lossesto generate a measure ofthe total economic costsofa disaster. %n practice, thisisquite

difficult, forseveral reasonsdiscussed in thissection.

The approach ofdividing disasterimpactsinto direct and indirect damagesand

summing them appearsto be a theoretically straightforward accounting method forestimating

the total economic impact ofnatural disasters0 however, the difficulty in practice hasled much

ofthe literature to focusinstead on the impact ofdisasterson macroeconomic variables. This

approach isanotherlensthrough which to viewdisastersand isclearly not additive with direct

and indirect damages (1# 23" The assumption is that direct and indirect effects would


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be reflected in macroeconomic accountsifthe disasterwassignificant. The focuson

macroeconomic variables isprobably due in part to the fact that good data are available on

them, but the ease ofdata availability doesnot imply that macroeconomic variablesare the

best measure ofdisaster impacts, as%discussfurtherbelow.

DirectandIndirectImpactsfromaDisaster

%ndirect lossesinclude businessinterruption coststo those businessesthat did not

sustain direct damage but may not be able to operate because, forexample, theirsupplier

wasdamaged, theirwor$ersevacuated, orthey lost power. %t also includesthe multiplier

effectsfrom reductionsin demand orsupply (more on these below". %n addition to causing

businessinterruption, lossofinfrastructure orotherlifelines(e.g., power, sewage, orwater"

can lead to utility lossto householdsin termsofa diminished quality oflife orcould cause

both householdsand businessesto adopt costly measures(such asincreased commuting

time asa result ofdamaged roadsorthe extra costsofrunning a private generatorwhen the

electricity isout".

Twomain complicationsarise when trying to measure the full economic costsin each

ofthe categoriesin Table !. 4irst, it isnecessary to be very clearabout the spatial and

temporal scale being examined because a different drawing ofthe boundariesofthe analysis

can lead to different results. 4orexample, considerthe economic costsofa disasterfrom the

point ofviewofa homeownerwho lost herhome. 'ome direct losses, such asthe home, are

reimbursed by insurance oraid from government orothergroups, and some lossesare un

reimbursed and borne fully by the victims. That is, assetsthat are replaced (some may not be"

are eitherfrom inter temporal transfersofthe individual orinterpersonal transfersfrom one

person to another(+ational Research ouncil 25". %fthe individual receivesdisasteraid

from the government, the economic cost ofthe disasterto that person will be the value ofthe

lost home minusthe amount ofthe aid. 4rom the perspective ofsociety, however, the aid is

/ust a transferfrom one taxpayerto anotherand thusshould not be added orsubtracted from

the direct damage to the home.

Temporal boundariescan also matter. #san example, it hasbeen shown (see below"

that construction sectorscan experience a boom right aftera disasteraspeople rebuild. #couple ofyearsafterward, however, they may face a lull because people will underta$e


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upgradesduring the post&disasterreconstruction that they would have deferred until further

into the future. oo$ing only one yearpost&disastermay suggest a benefit to the construction

sector, but loo$ing overthree yearsmight diminish thisbenefit. #nd to highlight again the

point made in the preceding paragraph, although the construction sectormay get a benefit,

had the disasternot occurred, the fundsspent on rebuilding would have been spent elsewhere

in the economy, with a higherutility to the homeowner0 thus, post&disasterspending should

not simply be counted asa benefit to the disaster.

The second challenge isthat it isquite easy to double&count losses. 4orexample,

assume a machine isdamaged irreparably in a flood. The value ofthat machine isthe net

present value ofthe future returnsfrom itsoperation. Thusthe value ofthe machine and the

lost production ofit should not both be counted asa loss(Rose 26". #sanotherexample,

one would not want to count both the aid disbursed by government and the rebuilding costsbecause much ofthe aid isprobably used forthe rebuilding.

'o, given these difficulties, what would be the most preferable measure ofdirect and

indirect damages7 The next three sectionsdiscussin more detail the challengesconfronting

an analyst, who must comprehensively assessthe economic lossfrom a natural disaster, in

arriving at a total estimate ofthe disasterimpacts.

DirectDamages

The economic cost that usually first comesto mind when thin$ing about natural

disastersisdamage to buildingsand contents. Though seemingly straightforward to measure,

getting the precise economic costsofthisimpact isnot theoretically trivial. onsidera house

that iscompletely destroyed. The economic losscould be measured aseitherthe mar$et value

ofthe house right before the disasterhit orthe replacement cost to rebuild it. The most

appropriate measure isthe mar$et value at the time ofdisasterimpact. The replacement cost

could be higherorlowerforseveral reasons. 8ost&disaster, some materialsmay be in short

supply and more expensive substitutesused orhigherpricescharged, forexample, orlabor

may be in short supply and thuswageshigher, driving the cost ofrebuilding above what it

would have been before the disaster(9lsen and 8orter2:". Thisisoften referred to as

demandsurge. #lthough these highercostsare a lossto the homeowner, they are a gain to the

suppliersand builders0 therefore, from the point ofviewofsociety asa whole, they are

;/usttransfers. 9n the flip side, if businessinterruption issevere and more laborersare

loo$ing fortemporary wor$, rebuildingcostscould be lower. Thisagain wouldbe a savings

to the homeownerthat, from the perspective ofsociety asa whole, would offset the lossto the

wor$er


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Thispicture iscomplicated by government disasteraid payments. 4orthe individual,

aid will lessen the economic impact ofa disaster. 4rom the point ofviewofsociety, the

government aid isa transferfrom one taxpayerto another, asstated above. The dead eight

lossoftaxation ispositive, however, and the marginal opportunity cost ofa dollarof

government spending isin most casesli$ely to be greaterthan

to include thiscost ofgovernment spending. =owever, it isnot necessarily the case that

disasteraid will require newtaxation because fundsmay instead be diverted from anotheruse.

%n such a case, it ispossible that thisdiversion could lessen the dead eight lossoftaxation if

the aid waslessdistortionary than the fundsin theirnon disasteruse. %fthe fundswere from

increased government borrowing, thiscost offederal borrowing would need to be included.

The homeownercould also receive insurance payoutsifhe orshe had disaster

insurance. Thiswould again lessen the negative wealth shoc$ to the homeowner. #ssuming

ris$&based pricing ofinsurance and well&diversified companies, claimspayoutsshould not be

considered a cost ofa disaster. They are often used asa proxy foreconomic costs, however,

asthey should theoretically be closely correlated with the lost value ofthe homesand

structures>at least in areaswith high ta$e&up ratesofinsurance. 4urther, insurance

companiesusually $eep extremely good recordsand so are an excellent data source.

%n addition to the cost ofthe lost home, otherdirect lossesto the homeownerinclude

the time lost to the rebuilding effort, emotional trauma orstress, and lossofnonmar$et items

ofvalue, such asbaby photographsorfamily $eepsa$es. These lossesare rarely included in

disasterdamage estimates.

*estruction to the buildings, contents, inventory, and capital offirmscan be similarly

analyed. 4ordestroyed capital, depreciation must also be considered, and the correct

measure ofeconomic lossisthe depreciated value ofthe lost asset. %fproduction islost from

the delay in replacing damaged capital, then the lost production from delay should also be

counted asan economic loss. The literature examining possible positive impactsofdisastersis

premised on the notion that replaced capital could be more productive than the capital

destroyed ifthere hasbeen technological change (discussed in 'ection ? below". This

productivity bump could not be so high asto ma$e the firm betteroff, orelse they would

have already upgraded the capital. 'till, the productivity increase will offset some ofthe

economic loss. %fthe firm receivesdisasteraid such that the upgrade is, in a sense, free to the

firm then it could in theory be better off post disaster if the productivity bump is great


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enough. #gain, though, from the point ofviewofsociety, the aid issimply a transfer.

%nfrastructure damage isanothercategory ofdirect lossfrom a natural disaster. #gain,

the depreciated value isthe correct measure ofeconomic loss. *elaysin repairand rebuilding

can triggerindirect costs, discussed next, through an interruption in use orservice.

1specially in the developing world, lossoflife and in/ury from disasterscan be large,

and these are direct costsofa disaster. #n enormousdebate centerson howto value lossof

life and in/ury, and %will not rehash that here, except to note that a value&of&a&statistical life

('"estimate based on disasterris$ explicitly would be the best measure. To my

$nowledge, very few, ifany, ' estimateshave loo$ed explicitly at natural disasterris$,

although one comparative stated preference study findsthat willingnessto pay (WT8"toreduce mortality ris$ isgreaterforterrorism than fornatural disastersand that reducing the

mortality ris$ from natural disastersisvalued about the same asthat from traffic accidents,

even though the latterisa much higherris$ (iscusi 2-". %n/ury and illnesscan be measured

in quality&ad/usted life&yearsorsimilarmeasures.

*irect damagescan also include environmental degradation. 4orsuch nonmar$et

losses, an estimate ofsociety@stotal WT8to have avoided the lossex ante isa measure oftheeconomic loss. #gain, a large literature addressesnonmar$et valuation techniquesthat can be

applied to obtain such estimates, which will notbe discussed here (see, forexample, 4reeman

23".

4inally, emergency response and debrisclean&up could also be considered direct costs

of a disaster. Thiswould include the opportunity cost ofpeople@stime spent hauling away

debris, forexample, orthe costsofevacuation. )any ofthese costsare borne by

governments, and ifthe interest isin total economic impactsto society asa whole, care must

be ta$en in correctly estimating these costs. %ssuesthat must be considered include whether

newtaxation was required, ifgovernment indebtednessincreased, andAorwhat the funds

would have been spent on in the absence ofa disaster.

#lthough thispaperisfocused exclusively on economic impacts, previouswor$ has

examined broaderimpacts, including demographic shiftspost&disaster. 4orexample, it was

found that after=urricane #ndrew, low&income groupsmoved into areasthat had been

damaged (potentially because these areaswere cheaper", the proportion ofmiddle&income

groups in damaged areas declined and the wealthy remained (perhaps because insurance and


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self&protectionwere more affordable forthisgroup0 ('mith etal.25". 'uch changescould

have welfare effects.

IndirectDamages

*isasterscan be viewed asa negative capital shoc$ to a region. Thishasfollow&on

economic consequencesin addition to the value ofthe lost assets. 4irst, economic lossesarenot exclusive to firmsorhouseholdsthat sustain direct physical damage. %felectricity or

wateris lost, forinstance, it can cause businessinterruption to even firmsthat are not

themselvesdirectly damaged. Thisisa widely recognied disastercost. 'imilarly, the lossof

such servicescan lead to a decline in the quality oflife forhouseholds, and thusa utility loss,

and could also lead to the need forcostly measuresto compensate, although thisisrarely

discussed in the literature. 'uch compensating actionscould involve longertravel timesdue

to a road outage orthe purchase ofbattery&powered lighting in response to a lossof

electricity, forinstance. These are indirect damagesto include in estimatesoftotal costs.

#ttention in the literature hasfocused on possible multipliereffectspost&disaster.

onsumerdemand post&disastermay be higherforsome sectors>such asconstruction,

particularly ifaid orinsurance isfunneled to rebuilding>and lowerforothersasconsumers

forgo some expendituresto use theirfundsforrebuilding. These typesofexpenditure changes

could have economic multipliereffectswithin the community (positive ornegative". #

similarstory can be told forbusinessinterruption. Thiscould decrease demand forinputsand

reduce outputs, having negative ripple effectsin the supply chain0 although here, aid and

insurance could mute these impactsifsuch fundsallowfora fasterresumption ofnormalbusinessactivity.

4rom the perspective ofthe whole economy, however, multipliereffectsmay well be ero,

with positive andnegative impactscancelling out (+ational Research ouncil !---". 4or

instance, ifa firm failsto produce an output, itscustomermay simply purchase the good

elsewhere. Thisisa lossforthe disaster&impacted firm but a gain fora competitor, and thusa

wash from the point ofviewofthe whole economy. #sanotherexample, touristsmay avoid a

hurricane&stric$en coast, but instead ofnot traveling, they may /ust frequent anotherarea.

#gain, thismay be a wash from the point ofviewofthe entire economy, but clearly thedistributional impactscould be quite large and could have significant consequencesfor

individuals, firms, orcommunities.

%fa government doesma$e changesto taxation orresource allocation post&disaster,

thiscould have indirect economic effects. 4orhard&hit countries, particularly small orpoor

countries, thisisa distinct possibility and would need to be evaluated. ountriescan also

receive international assistance (which, again, would be a transferfrom a global perspective".

ase study evidence suggeststhat donorsdo not necessarily provide additional aid aftera

disaster, but simply reallocate aid budgets(Benson and lay 26".

)ortality or illness could also occur as a result not of the haard but of the initial


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damage. 4orinstance, ifwaterbecomescontaminated asa result ofthe shutdown ofa

treatment plant and thisleadsto illness, it would be an indirect cost ofthe disaster. #fter

hurricane Catrina, an increase in mortality rateswasobserved because the storm destroyed

much ofthe health infrastructure ofthe city ('tephens2D". These would be deaths

classified asan indirect cost.

4inally, disasterscould causepeople to altertheirris$ perceptions. Thiscould then

induce behavioral responsesand a reallocation ofresources. These could have

economic consequences, such aswor$ersrequiring a ris$ premium post&disaster(on

thispoint in the context ofterrorism, seeE Rose 2!2", but are not furtherconsidered in

thisreview. 'imilarly, utility functionsmay be state dependent and may change aftera

disaster, such that ex ante valuationsare not the same asex post valuations.!#

complete welfare assessment would need to considerthese possibilities.+otably,

positive utility gainscould occurvia public aid post&disasterifpeople feel good abouthelping those in need and reassured that ifthey are victims, aid will be forthcoming.

i$ewise, utility lossescould be associated with any increasesin fear(or other

negative emotions", which #dler(26"arguesshould be measured and included in

regulatory costFbenefit analysiswhen relevant.

1conomistsexhibit some hesitancy regarding estimationsofhigher&ordereffects, and

the complicationsdiscussed above hint at why. Rose (26"notesthe following concernsE

indirect effectsare hard to verify, modeling them can be difficult, the sie ofthe impactscan

very substantiallydepending on the resiliency ofthe economy and pace ofrecovery, and themodeling ofsuch effectscould be manipulated forpolitical purposes(e.g., inflating the

multiplier". 'till, when calculated carefully, they are a true cost ofthe disasterand should be

included in any complete accounting. )ost estimatesoftheirmagnitude have been done

through modeling ratherthan empirical analysis.

MacroeconomicApproaches

The ma/ority ofeconomic studies, instead ofattempting to estimate direct or

indirect costs, evaluate the impact ofnatural disasterson macroeconomic indicators,

primarily grossdomestic product (G*8". %t isthusworth saying a word about howthese

estimatesofdisasterimpactsrelate to estimatesofdirect and indirect economic effects.

%t ispossible that the direct andindirect effectsofa disastercould be large enough to

have macroeconomic effects, includingimpactson economic growth, balance ofpayments,

fiscal revenues, levelsofindebtedness, and investment rates(1# 23". %fdamagesare

severe, output could decline. 9utput could also increase from post&disasterreconstruction. %t is

unclear, on net, howthese effectswould balance out. *amagesto firmscould alterimports

and exports. Government spending foremergency response, ifhigh enough, could change

indebtedness. Tax revenue could be impacted. %fseriousprice increasesresult from the

disaster this could fuel inflation 4oreign direct investment could fall if companies see too


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great a ris$ ortoo much damage.

'ome ofthese impactsare essentially indirect economic impactsthat should be counted in

total economic impact estimates. )ore often, however, macroeconomic variablesare used as

aproxy forthe direct and indirect impacts/ust discussed. 4orexample, government spending

isoften used asa measure ofthe damagesfrom a disasterbut need not be directly related to

economic losses. 'imilarly, G*8isoften used to capture total economic impacts. %t isworth

stressing, however, that G*8issimply a measure ofeconomic activity, not ofwealth or

welfare. The usual argumentson thispoint extend to the case ofnatural disasters. The

literature on the G*8impactsofdisastersisreported here, but with thisstrong note ofcaution

that it isa poorproxy foreithertotal economic costsorwelfare impactsofa disasterevent.

MeasurementProblems

The thorny theoretical problemsinvolved in estimating the economic consequencesofdisastersare coupled with extreme data limitationsthat ma$e actual estimatesfarfrom

what would be the hypothetical ;truedisastercosts. )any scholarshave stressed the need

for reliable, comprehensive, systematicallycollected disasterlossdata (e.g., Thomas2!".

Good data on disasterlossesare needed fora range ofpurposes, including costFbenefit

analysisofmitigation measures, government preparednessplanning, calibration ofloss

models, and ris$ analysisforinsurersand otherentities. 1ven in highly developed countries

with generally good record&$eeping, comprehensive disasterlossdata are difficult to come

by. The Hnited 'tates doesnot $eep systematic recordsin one location oflossesassociated

with natural haards. )any expertshave called forsuch a database to be developed and

maintained by the federal government (e.g.,+ational Research ouncil !---", but thusfarit

hasnot occurred.

%n general, the data available on disasterimpactsare on those thingsthat are easily

observable ex post. 4orinstance, depreciated replacement value isthe best estimate of

damage to structuresand assets, but isnot available in most data sets()ileti !---"0

replacement cost ismore li$ely to be observed. Because public expendituresare fairly easy to

observe and often are already measured in some form in most countries, they are frequently

used asa proxy forlosses0 but, asalready mentioned, public expenditureson reconstruction

may not match the magnitude oflossesto capital (avallo and+oy 2!". )ost disasterdata

setsdo not include indirect lossesordamagesto nonmar$et goodsand services0 therefore,

most disasterlossdata probably underestimate the full economic impact ofdisasters()ileti

!---0)itchell and Thomas2!".

#notherdifficulty with disasterdata isthat many high&magnitude eventsare complex,

with multiple interrelated perils(Cron et al. 2!2". 4orinstance, strong hurricanesbring

with them high winds, torrential rain, and storm surge0 these could furthertrigger

landslides. 'evere stormscouldinclude damage from wind, hail, flooding, lightening,

and tornadoes 1arthqua$escan trigger tsunamis or fires This ma$es classifying


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disastersforcomparison acrosseventsdifficult.

4inally, some countrieshave much betterrecord&$eeping than others. 'ome countries

may not have institutionsthat are tas$ed with damage estimation, and in some placespost&

disasterassessmentsmay be difficult. 4urther, developing countriesmay have an incentive to

exaggerate damagesto gain international aid and, regardless, obtaining good damage

estimatesin developing countriescan be a challenge because insurance penetration islow,

boo$ $eeping isoften poor, and much economic activity occursin informal sectors(Toya and

'$idmore 2D". ery little is$nown empirically about disasterimpactson informal sectorsof

the economy.

Thus, all disasternumbersshould be interpreted with some degree ofcaution. %n

addition, the nature ofthe database can influence the conclusionsdrawn about disasterlosses,

asnoted by Gall et al. (2-". 4orinstance, different databasesinclude different itemsin the

estimate ofdamages(e.g., /ust direct damages, orboth direct and indirect", which can causedifferencesin ran$ingsofevents. %n theircomparison ofdisasterdamage estimatesin the

Hnited 'tatesacrossthree different databases, Gall et al. (2-"find that, although all three

databasesagree that hurricanesand tropical stormsare the most damaging haard in the

Hnited 'tates, they differon which haard isran$ed second>earthqua$es, severe weather, or

floods.

#t an international scale, three primary data setsare available forcross&country,

multiple&haard analysis. These are the entre forResearch on the 1pidemiology of*isasters@

(R1*@s"1mergency 1vents*atabase (1)&*#T", 'wissRe@s'igma, and )unich Re@s+atat'1R%1. 1)&*#T hasa humanitarian focus, and the reinsurance databases('igma

and +atat'1R%1", not surprisingly, focuson insured and material losses. The databases

have different thresholdsforthe inclusion ofevents(Cron et al. 2!2". 1)&*#T includes

eventswith more than ! fatalities, more than ! people affected, a declaration ofa state of

emergency, ora call forinternational assistance. 1ventsare included in 'igma ifoverall losses

exceed H'< :5.5 million, insured lossesexceed H'< 63.3 million (both in 2! dollars", or

there are 2 ormore fatalitiesormissing persons.+atat'1R%1 includesany event in

which harm to people orproperty damage occurs. #ll ofthese databasesacquire information

from a variety ofsources.

1)&*#T ispublicly accessible, whereasthe reinsurance databasesare not, althoughstatistical

analysesare published by the firms. Thismeansthat foralmost every cross&country,

multihaard paper, the 1)&*#T data are used. Because ofthis, a fewthingsshould be $ept in

mind about these data. 4irst, given the threshold forinclusion mentioned above, small events

are not included, even though frequent lower&impact eventscould still cause substantial

economic costs. 'econd, 1)&*#T isfocused on aiding humanitarian response. #ssuch, it has

no threshold fordamages, so eventsin more developed countrieswith a high level ofdamage

but lowlossoflife and no call forinternational aid may fail to be included. 4inally, 1)&*#T

data are compiled from multiple sources and are only as good as those sources 'ources


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include the Hnited+ations, governmental and nongovernmental organiations, insurance

companies, research institutes, and the press. The sourcesare ran$ed according to their

trustworthinessin providing accurate and complete data. ollecting disasterdata isa difficult

process, and R1*should be commended on the wor$ done to create and maintain this

database. %t isthe best source forconsistent, multicountry natural disasterdata available. That

said, we would be more confident in ourestimatesofthe economic impactsofnatural

disastersifmultiple data sourcesall found the same results. With so much ofthe literature

relying on thisone data source, any problemswith the data will propagate through all

analyses.


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An Overview of the Issues

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