The economics of natural disasters

Flooding in Australia in 2011 was particularly devastating in Queensland, with the flood hitting one of our capitals, Brisbane. Thankfully, the effect of the flooding was rather minimal on human life. However, there were significant short-run effects on the economy, and some of them were realised with a contraction in economic growth for the first quarter of 2011 of 1.2 per cent (ABS, 2011).

As a result of the floods, many mines for coal and iron ore flooded, while there was also significant damage to vital infrastructure, such as roads and railways, used by mining companies and agriculture business. Similarly, many of the crops that were growing, such as sugar cane and cotton, were destroyed – leaving farmers with little but wasted production. As a result, a significant reduction in exports would be expected, contributing to a reduction in Aggregate Demand and thus Gross Domestic Production.

Of consideration also are the effects of private consumption on economic growth. Comparatively, the effect of consumption spending would be anticipated to be small compared with the significant loss in exports. This is because there was a loss in retail trading days in Queensland due to the flooding, and a reduction in spending on luxuries, as households coped with the immediate challenge of the floods.

As the floods abated, a return to normal retail spending due to the replacement of damaged household goods would have been expected, supporting private consumption spending (RBA, 2011).

Natural disasters also tend to have a significant impact on productivity in the short-run. For the first quarter of 2011, there was a significant decrease in the output per hour worked, or productivity. Two factors may be behind this. Firstly we would expect in many cases for there to be decreased capacity for work. If a mine is flooded for instance, there is not much miners can do until the water has been pumped out, or has evaporated. Similarly, significant damage and loss of capital stock or infrastructure means workers are unable to complete their jobs quickly or efficiently in the short-run, as workers no longer have the relevant equipment. Their output per hour worked would be expected to decrease.

Looking at the long-run implications of local disasters, there is some good news, as it is probable that the long-run negative effects of the flooding are likely to be minimal, providing that there is a timely, well managed rebuilding process.

For households the rebuilding process involves construction of new homes to replace those damaged beyond repair, or repair. This in itself would be expected to provide a boost to private consumption and GDP in the long-run, with plenty of work for construction workers (RBA, 2011).

Findings by Skidmore and Toya (2002) show that for climatic disasters such as flooding, in the long-run there is a positive correlation between natural disasters and economic growth.

Disasters offer opportunities for the replacement of old infrastructure with new and improved infrastructure that results in improved productivity and promotes economic growth over time.

Natural disasters are a once-off event and thus their effects are limited to the short-term. With a timely rebuilding process, productivity and infrastructure return to pre-flooding levels, therefore returning aggregate supply to pre-flooding levels.

Interestingly, and quite optimistically, economic analysis of the effects of natural disasters shows that contrary to the picture of destruction and trauma shown by the media, natural disasters may have only minimal effects on the economy in the longer term. There may be significant infrastructure damage and loss of life with negative implications on the economy in the short-term, however in the long-term a well organised rebuilding process can return entire towns and suburbs to normality, while providing opportunities to build new and better infrastructure.

http://www.fbe.unimelb.edu.au/ [2]