Natural Disasters: Economically Speaking, Are They Net Contractionary or Stimulative Events?

The International Economy, Summer 2011 | Go to article overview

Natural Disasters: Economically Speaking, Are They Net Contractionary or Stimulative Events?


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.

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