The Negative Effects of Natural Disasters on an Economy

Subject: Economics
Pages: 12
Words: 3612
Reading time:
14 min
Study level: PhD

Natural disasters constitute a serious detriment to the development of society. In addition to the obvious physical threat associated with these events, numerous effects are attributed to them that undermine the quality of life of the impacted population (Marshall & Schrank, 2014). The areas that raise greatest concerns are the economic and social development of countries impacted by the catastrophes. In some cases, the financial losses resulting from the disaster occurrence exceed the annual GDP of a country (Von Peter, Von Dahlen, & Saxena, 2012). Even more importantly, however, is the fact that numerous indirect effects of such events are observed in the long term, which, in some cases, can accumulate and eventually exceed the initial direct impact by several orders of magnitude (Toya & Skidmore, 2007). In other words, the aggregated economic outcome of natural disasters on the economy is to be acknowledged in order to reliably predict the performance of the country.

However, while the direct impacts of disasters are easy to quantify and confirm, the indirect effects are much more complicated. While numerous experts point out the most likely areas that serve as indicators of the influence of catastrophes, these suggestions lack consistency Kousky, 2012). In addition, some of the areas, such as the economic welfare of the population, are broad to the point where their measurement remains a point of debate in itself, which further complicates the matters. Next, even the studies that use comparatively similar frameworks and sets of indicators can come up with conflicting findings, which can be interpreted as evidence of the involvement of confounding variables that are overlooked. Finally, some evidence exists that despite the initial direct losses, the long-term effects on the economy are either neutral or, in the extreme cases, positive, primarily to the intensive recovery efforts and incentives from the governments and supporting organizations (Dahlhamer & Tierney, 1998). While several attempts were made to explain such wide variation in findings, no consensus is currently reached on the matter. Simply put, the indirect impact of natural disasters on the economy is not well understood, and there is no robust framework available that would allow a conclusive assessment.

Another important point is the relative efficiency of the mitigation actions and preventive actions meant to address the undesirable effects. Both areas are in active development, with a significant body of research intended to improve the understanding of the issue. Therefore, it would be reasonable to assume that the preventive capacity of these programs will increase over time. Counterintuitively, even the direct financial losses associated with the natural disasters have risen considerably in the last decades, indicating a counterproductive trend (Benson & Clay, 2004).

From the economic development perspective, the topic is important for several reasons. First, the accuracy of predicting the effects of natural disasters on the economy is important for long-term planning and a more rational allocation of resources to minimize the adverse impact. Second, improved understanding of the mechanisms behind the influence opens up the possibility for policymakers to develop more effective interventions and ignore the aspects that have little influence on the matter. Finally, the alleged positive long-term effect on the national economy, as well as the priority of the preventive techniques, contains the potential for improvement that can then be applied in related economic segments.

The following paper aims at identifying existing gaps in knowledge on the impact of natural disasters on the economy as well as the areas of potential improvement of the issue through a systematic review of literature. The findings are expected to contribute to the development of the theoretical background for the research of the issue and hopefully provide useful insights for policymakers and researchers.

Negative Effects of Natural Disasters on Economy

Major Dimensions and Costs

A disaster is a naturally occurring event which due to its scope and magnitude has a profound effect on human activities (Nakagawa & Shaw, 2004). From the economic perspective, such events contain numerous risks to economies on a massive scale. In some cases, such as in the recent example of Gujarat earthquake of 2001, the lasting effect of a disaster can set back the development of the country’s economy for several years (Nakagawa & Shaw, 2004). In addition, due to the multitude of factors involved in the process, the exact dimensions and costs of the event can be hard to quantify conclusively. For instance, according to Marshall and Schrank (2014), the assessment and recovery process of the effects of natural disasters must acknowledge the connections between smaller entities in addition to the major factors. More specifically, the small businesses in the areas affected by major natural disasters seem to be impacted harder and recover slower and less efficiently than the larger corporate entities, to the point where the latter display growth over large time span whereas the former are often damaged besides the possibility of recovery (Marshall & Schrank, 2014). Since the majority of researchers tend to approach the issue by aggregating the economic data, the results usually do not adequately represent the scope and gravity of impact for individual vendors. Nevertheless, even on a large scale and in aggregated form, the economic and social costs associated with the disasters are significant. According to Toya and Skidmore (2007), the decline of income caused by the disruption is neither the only nor the most significant effect of natural disasters on national economy. The analysis made by the research team revealed that educational attainment, openness, and overall strength of the financial sector have an inverse relationship to the damage dealt by the natural disaster (Toya & Skidmore, 2007). While it opens up the possibilities for preventive action, it also suggests a reverse effect, where the decline in educational opportunities undermines the economic viability of the country in the long run.

Benson and Clay (2004) state that the dimensions and costs associated with natural disaster have been steadily increasing in the recent years. The average annual losses resulting from the catastrophes were estimated at US$66 billion, with the peak in 1995, when the Kobe earthquake in Japan has led to record losses of $178 billion (Benson & Clay, 2004). However, according to Benson and Clay (2004), even these costs are not representative, since the analysis is usually focused on the assessment of apparent physical damage. It should also be mentioned that one of the possible reasons for the steady increase in losses associated with natural disasters is the fact that most mechanisms of risk mitigation and coping become obsolete and decline in efficiency.

Numerous approaches have been put forward by the scholars in an attempt to include all relevant costs and dimensions. Cavallo, Galiani, Noy, and Pantano (2013) derive the information from comparative case studies to quantify the effects of natural disasters on subsequent economic growth. In addition, they account for the political effect of the revolutions that followed in two cases. Interestingly, once all variables were controlled for, no significant impact of disasters on economic growth was observed. These findings, however, are inconsistent with the results derived by the majority of scholars. A similar approach was chosen by Dahlhamer and Tierney (1998), who suggested a model for predicting business recovery after the Northridge earthquake of 1994. Several important determinants were identified that could serve as predictors, including business size, earthquake intensity, utilization of postdisaster aid, and the level of business operations disruption. Most of the findings were consistent with the expectations (e.g. the intensity of the earthquake had a reverse relationship with the business recovery rate) (Dahlhamer & Tierney, 1998). However, a counterintuitive reverse relationship was also established between the use of postdisaster aid and the recovery of businesses. Dahlhamer and Tierney (1998) argued that this correlation could be explained by the fact that seeking aid was already an indicator of severe damages – in other words, the businesses that were reluctant to seek help had a better chance of coping with the aftermath in the first place.

A study by Carter, Little, Mogues, and Negatu (2007) focused on the impact of natural disasters on low-income groups. According to the authors, an analysis of two disasters in Ethiopia and Honduras produces different results when analyzed due to numerous social and political differences. However, the impacts on poor households are highly similar, showing what is termed “poverty trap” – a scenario that aggravates poor conditions and makes it harder for the impacted populations to recover. In this example, the Ethiopian drought of 1998-2000 resulted in relatively modest direct impact but demonstrated an eventual decline in welfare of the population (Carter et al., 2007). A study by Guimaraes, Hefner, and Woodward (1993) investigated the potential increase in income that allegedly occurred in some industry segments. The researchers concluded that while some sectors, such as retail and construction, experienced a surge in activity following the disaster, the actual level of economic activity did not exceed the estimates predicted without the occurrence of the natural catastrophe, and some sectors remained below the modeled numbers (Guimaraes et al., 1993). In other words, the claims that the disaster is a positive economic force were disproven.

A comprehensive review of empirical literature by Kousky (2012) reveals several tendencies that clarify the causes of discrepancies in data. For instance, as was mentioned above, despite the major financial losses, the impact of natural disasters on economic growth is relatively minor. However, once disaggregated, this data provides a more uneven landscape. The developing countries and those with higher quality of education are usually impacted harder and recover for a longer time. This tendency is also observable on a lower level, with groups characterized by higher quality of life usually demonstrating greater resilience and possibly benefitting during the recovery phase (Kousky, 2012). Considering these implications, it would be reasonable to conclude that local governments have the most capacity for disaster mitigation, including the adverse economic effects (Kusumasari, Alam, & Siddiqui, 2010).

Another attempt to explain the inconsistencies in the results was made by Von Peter et al. (2012), who suggest that while the losses associated with the initial impact are relatively uniform, the long-term effects are greater for uninsured firms, whereas significantly insured ones do not experience adverse consequences.

Vorhies (2012) highlights additional factors that have significant influence on the impact evaluation, namely extreme data limitations and theoretical problems. The author suggests that unless a methodology is developed to conclusively estimate these factors, the assessment of economic impact remains incomplete (Vorhies, 2012).

Major Theories

As can be seen from the information above, the lack of a unified approach is one of the reasons behind the discrepancies in findings of different researchers. According to Chang and Rose (2012), several gaps currently exist in the existing approach to researching the impacts of natural disasters. The most common include the lack of systematic data on patterns and variations in business recovery, the absence of research on effectiveness of resilience strategies and policies both for individual entities as well as the local economies, and the scarcity of testable theoretical frameworks that would contribute to the reliability of results. It should also be mentioned that the assessment requires the incorporation of operational definitions of economic phenomena. At the same time, several theories to business development (Goulet, 2014). One that is most commonly utilized is the traditional neoclassical growth theory, focusing on the GDP as a most significant variable (Kousky, 2014). Nakagawa and Shaw (2004) attempt a different approach by prioritizing human capital as an indicator of growth, thus pertaining to the endogenous growth theory (Goulet, 2014). Finally, there is evidence that structural change model receives more attention in the recent years, since the authors often point to the fact that the level of economic development is a major predictor of the expected damage. Nevertheless, this approach is still not applied meaningfully, so the use of this theory is still in early conceptual stage.

Since there is no consensus among researchers regarding the preferred approach or evidence that some of them have certain advantages over others, it would be unreasonable to expect the compatibility of results. Nevertheless, a growing number of researchers turn to the political economy perspective as a theoretical framework that can address the majority of shortcomings. Wilkinson (2012) argues that such approach offers better focus on policies that influence the economic outcome and the institutions that develop them.

Numerous studies parallel these conclusions. A research by Scanlon (1988) provides evidence of uneven impact of natural disasters within the community. However, by incorporating the political context, the author identifies a relationship between the decisions made by the policymakers and the outcomes experienced by the individuals, groups, and communities (Scanlon, 1988). Interestingly, unlike those reviewed in the previous section, the studies that utilize a political perspective show greater uniformity of results. An article by Stehr (2006) provides evidence of significant political impact on planning and facilitation of the disaster mitigation approaches. According to the author, the diversity of incentives from various local, state, and federal parties, as well as conflicts emerging from the competing priorities complicate urban hazard planning to the point where it becomes impossible to reach a constructive solution. Based on this finding, Stehr (2006) points to the necessity of finding a balance between the political and economic dynamics to achieve a desirable level of disaster resilience.

A political economy model of disaster prevention suggested by Cohen and Werker (2008) provides an opportunity to evaluate the preparedness of different governments for natural disaster. Since the preparedness and response are the most significant determinants of the long-term impact of the catastrophe, such model essentially measures the expected outcome for the population. Based on their findings, the authors provide several suggestions on how to address the existing gaps, such as decentralization of relief, political development, and rewards for non-disaster, all of which are evidently tied to the political domain.

Neumayer, Plümper, and Barthel (2014) further clarify the issue by explaining that disaster propensity has a direct effect on larger damages but is relatively ineffective for averting smaller ones. They also exemplify the possibility of significant losses despite the large initial investment by analyzing the 2011 Tōhoku quake, which nearly destroyed the local economy despite the considerable prevention and mitigation efforts.

Finally, Garrett and Sobel (2003) point out that certain political factors significantly affect not only the allocation of resources by region but also the disaster declaration rate based on the political significance of the state. These results cast doubt on the altruistic model and raise the questions regarding the roles of private and government entities in disaster prevention. Overall, it is evident that despite the absence of a robust theory, the incorporation of political perspective remains the most viable approach to evaluation of the effects of natural disasters on economy and provides highly consistent results across the field.

Recent Examples

According to the example by Skoufias (2003), short-term shocks that follow a disaster, create numerous risks for future generations. The author thus argues that preventive measures are more economically viable than mitigation approaches since they also address poverty and increase welfare of the population and provides several examples to support his claim, with Argentina’s financial crisis of 2002, allegedly tied to several smaller crises in the region, being the most recent one.

Vorhies (2012) brings up a recent example of a disaster in Colombia, where the hydro-meteorological events continuously disrupt the financial stability of the national economy via a series of frequent shocks (approx. US$1 million 50 times per year and US$100 million at least once every six years, among others).

Vigdor (2008) outlined massive impact of Hurricane Katrina on the economy of the region. After disaggregation, several areas of impact were identified, including labor market, well-being of the population, and housing market, among others. The negative impact could be observed in each of the categories, with a clear correlation with the natural event. While, according to Vigdor (2008), such setting has contributed to the unique cultural setting of the region, there is little doubt that the accompanying adverse economic effects were responsible for the decline in population.

Von Peter et al. (2012) compare two recent examples of earthquakes in New Zealand and Haiti in 2010. While the majority of relevant factors were nearly identical in both cases, the Haitian economy suffered dramatic direct losses equivalent to 126% GDP as well as a decline in GDP from 3.5% to -5.1% in the following year. In New Zealand, on the other hand, the direct losses amounted to 5.3% GDP, and an actual 1.1 to 1.7% growth in GDP in the following years (despite another earthquake in 2011). (Von Peter et al., 2012).

Evaluation and Analysis

Based on the information from the reviewed literature, several tendencies can be identified. First, despite consistent efforts made by the researchers to determine a definitive approach to assessment of natural disasters’ impact on economy, the results of studies vary significantly. Some explanations have been put forward by the research teams to account for the differences, including the socioeconomic background of the country, the level of well-being of its residents, the insurance coverage of the businesses, the balance between the preventive and mitigation measures, and the intra-group differences in welfare (Carter et al., 2007; Kousky, 2014; Marshall & Schrank, 2014; Toya & Skidmore, 2007). All suggestions were supported by coherent ad reliable evidence, so it is reasonable to conclude that each of these factors is at least partially influencing the economic performance. However, the weight of each of the suggested variables is still unclear, and the possibility still exists that other important factors remain overlooked.

Second, some evidence exists that suggests the relative insignificance of the long-term impact of disasters on economic growth, to the point where an increase in productivity can be observed several years after the event (Cavallo et al., 2013; Dahlhamer & Tierney, 1998; Von Peter et al., 2012). While the majority of findings do not support these suggestions, this possibility requires further inquiry since it may reveal components responsible for a more successful prevention and mitigation of the disaster impact.

Third, the body of literature demonstrates a notable lack of robust theoretical framework that would be flexible enough to be applied in different settings without sacrificing the compatibility of the results (Chang and Rose, 2012). While the tools and methods for assessment of direct losses are fairly established, means of indirect effects evaluation are for the most part designed with a specific setting in mind and thus produce results that have little value for verification, let alone economic modeling. The incorporation of the political economy approach seems to produce the least contradictory results but require further refinement and unification before they can be used as a working theory.


The research on impact of natural disasters on economy is still in the active phase of development and continues to produce conflicting reports. Nevertheless, some conclusions can be reached based on the available information. There is little doubt that natural catastrophes have tremendous direct negative impact that is observable, measureable, and verifiable. The major causes of this impact are structural damage, human casualties, and costs of mitigation efforts (Scanlon, 1988). The majority of evidence also suggests the presence of a larger indirect detrimental impact in the form of declining business opportunities and decreased socioeconomic possibilities of individuals. The latter effect is especially important since it is sometimes lost during the aggregation of data. Recently, a growing number of researchers have pointed to the fact that poorer population segment absorbs the most damage while groups characterized by higher level of welfare emerge unscathed and, on rare occasions, benefit from the scenario (Carter et al., 2007). The same principle is observed on larger scale, where wealthier and more financially stable economies manage to retain growth faster while the developing countries are more prone the onset of financial crisis (Kousky, 2012). There is also a possibility that at least in some cases the country’s economy actually benefits from the intensive postdisaster aid and demonstrates increased growth in the long run (Dahlhamer & Tierney, 1998). However, these claims need to be further investigated since they conflict with the majority of studies on the matter.

It also appears certain that the preventive measures are more likely to be successful than those designed to mitigate the postdisaster economic effects. However, it should be acknowledged that this principle is also subject to several exceptions, including the magnitude of the event and the number of the minor factors involved. In other words, while there is a certain degree of predictability to the payoff of investment into disaster management segment, it is still possible to receive a disproportionately strong impact.

Finally, there is an apparent need for an enhanced understanding of the mechanisms behind the phenomenon, since currently only some areas of research produce results of acceptable level of consistency. However, such enhancement is unlikely without the creation of a well-defined theoretical framework that would incorporate the significant variables established by the existing body of research.

Therefore, two perspective directions can be established. For the researchers, it is necessary to review the currently accepted parameters of the research of the effects of the natural disasters with considerations of the recent advances in understanding of the matter in order to establish their relative weight and verify the consistency of the results. This would contribute to the creation of the robust theoretical framework and, by extension, improve our understanding of the phenomenon. For the policymakers and organizations directly involved in disaster prevention and mitigation, it would be reasonable to concentrate on prevention rather than postdisaster mitigation, and diversify the coverage to include a variety of social aspects, such as education and poverty reduction, since such approach appears to produce greater resilience and minimize adverse economic effects in the scenario of the natural disaster.


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