Unmitigated disasters? Risk-sharing and macroeconomic recovery in a large international panel

Forthcoming in the Journal of International Economics  

Summary

Focus

When disaster strikes, the immediate destruction and tragic loss of life are plain to see in the media. But the aftermath of the disaster has unseen consequences that shape economic activity for years. This paper estimates these indirect effects, where foregone growth can add to the overall cost of disasters. A novel aspect of our analysis is that we take into account how risk transfer in the form of insurance mitigates the macroeconomic cost of disasters.

Contribution

This paper examines the patterns of macroeconomic recovery after natural disasters in a panel with global coverage from 1960 to 2011. It uses a larger sample and better loss data than previous studies. It also provides a unified approach to measuring output costs over time. Related research has found that wars and political and financial crises have permanent effects when a weak recovery leaves the economy below its earlier trend. Natural disasters present a cleaner case of cause and effect. All these types of large macroeconomic shocks can have permanent output costs. 

Findings

We find that major disasters reduce growth by 1% to 2% on impact and over time produce an output cost of 2% to 4% of gross domestic product. This is on top of the initial damage to property and infrastructure. But uninsured losses drive the macroeconomic cost. Insured losses are not as harmful overall; they can even stimulate growth. By helping to finance the recovery, insurance mitigates the macroeconomic cost of disasters. Even so, there is very little international sharing of disaster risk. Many countries lack the capacity to (re)insure themselves and would benefit from more international risk-sharing.

Abstract

This paper examines the patterns of macroeconomic recovery following natural disasters. In a panel with global coverage from 1960 to 2011, we make use of insurer-assessed losses to estimate growth responses conditional on risk transfer. We find that major disasters reduce growth by 1 to 2 percentage points on impact, and over time produce an output cost of 2% to 4% of GDP, on top of the initial damage to property and infrastructure. Akin to wars and financial crises, natural disasters have permanent effects, in the sense that output losses are not fully recovered over time. But it is the uninsured losses that drive the macroeconomic cost; insured losses are less consequential in the aggregate, and can even stimulate growth. By helping to finance the recovery, insurance mitigates the macroeconomic cost of disasters. Many countries lack the capacity to (re)insure themselves and would stand to benefit from international risk sharing.

JEL classification: G22, O11, O44, Q54

Keywords: natural disasters, growth, recovery, risk transfer, reinsurance, development