Natural Disasters and Growth— Going Beyond the Averages

By Norman Loayza, World Bank; Eduardo Olaberria, University of Maryland; Jamele Rigolini, World Bank; Luc Christiaensen, UNU-WIDER The World Bank, East Asia and Pacific Social Protection Unit, Development Research Group World Bank Policy Research Working Paper no. 4980

Apart from concern over the horrifying human tragedy in Japan, there has also been much speculation about the economic impact, both short- and long-term, of the catastrophe there. Analysts have a precedent in the Kobe earthquake that ravaged the island nation in 1995, but then there are many who say things are very different this time. This World Bank research paper studies several such disasters in both developed and developing countries over the period 1961-2005 to determine their impact on growth. Their focus is on the impact of growth in the medium term, over five years.

Illustration by Jayachandran/Mint.

But here’s what the paper has to say about the effect of earthquakes: “Earthquakes may have a positive impact on industrial growth. Although they severely affect both workers and capital, earthquakes particularly destroy buildings, infrastructure, and factories. The capital-worker ratio is then sharply diminished, the average (and marginal) product of capital increases, and output grows as the economy enters a cycle of reconstruction. Moreover, if destroyed capital is replaced by a vintage of better quality, factor productivity increases, leading to a further push to higher growth."

That’s why most analysts (and there is no shortage of armchair analysts on natural disasters these days, they have mushroomed like radiation after a nuclear disaster) have said that while there will be a short-term negative impact on the Japanese economy, longer-term growth will be positive as reconstruction starts.

Storms, on the other hand, have negative effects on agricultural growth, as crops are destroyed, but their impact on industrial growth is positive, again because of the destruction of capital, which has to be rebuilt later.

The authors say that while droughts affect the greatest number of people, earthquakes cause the most destruction. The results also depend on the severity of the natural disaster. The authors point out that “while moderate earthquakes and storms can have a beneficial ‘reconstruction’ effect on industrial growth, severe events are so devastating that the loss of capital cannot be compensated by increasing capacity, thus dissipating the potential gains. Overall, any potential positive effects on growth from natural disasters appear to disappear when natural disasters are extreme".

And finally, the economies of developing countries are more affected by natural disasters than those of developed countries and the poor are affected the most. The study more or less confirms what is suggested by common sense. But perhaps the most worrying effect of the disaster in Japan has been the danger of radioactive leakage from nuclear plants. If this leads to a shift away from nuclear energy to oil, that could well have much more far-reaching impact, not only on the Japanese economy, but globally as well.

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