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06 Sep 17 01:05

Harvey just finished its devastating path over the country – last as a tropical depression – and hurricane Irma is developing into a real threat to Florida and the Caribbean. The danger from major hurricanes is back to the headlines after a couple of more benign years for the US. Now that the focus shifts towards clean-up and re-building, questions about the economic impact are arising. Natural disasters are never good for the economy since they cause massive destruction to assets and disrupt business. But they can cause a temporary increase to GDP during the process of rebuilding. How do these economic effects relate to each other?

Let's look at the size of losses first. Thus far, estimates of Harvey's damage fall in a wide range and their seemingly inevitable upward creep has begun. Therefore, all preliminary estimates should be taken with a grain of salt. Nevertheless, it seems clear by now that Harvey will rank as one of the top 10 hurricanes to hit the US since 1980. The table in the window on the top right of the article lists economic and insured losses in 2017 dollars.

Total losses in this table are all the financial losses directly attributable to a major event, i.e. damage to buildings, infrastructure, vehicles etc. The numbers also include losses due to business interruption as a direct consequence of property damages. Insured losses include government schemes, especially the National Flood Insurance Program (NFIP). The economic loss figures shown here do not include indirect financial losses from supply chain disruptions or shortfalls in demand.

The next important question is who bears the burden of these losses. Swiss Re Institute data show that an average of 50% of the top 10 US hurricane losses remained uninsured. The size of the protection gap differs by peril and the share of uninsured losses is likely to be much higher with hurricane Harvey. Windstorm losses are better covered by standard homeowners policies; although there may be significant hurricane deductibles that apply. Flood, which is the main cause of destruction in the current disaster, is excluded from the standard homeowners policy and needs to get insured by a separate policy – usually the NFIP. The take-up rate for flood policies is low; and about 80% of private homes in the greater Houston area are without such a policy. Flood damage to cars is also not insured under mandatory liability policies but only under comprehensive motor policies. Businesses usually have a higher degree of protection against flood. There will also be significant claims for business interruption and contingent business interruption.

The primary economic effect of a major disaster is the destruction of people's assets and firms' capacity to produce. A secondary effect is the temporary disruption of economic activity because of road closures, disrupted utility services, customers' and employees' inability to get to work etc. For example, the Texas Gulf Coast represents about 20% of the nation's oil refining capacity, and large parts of offshore energy production needed to be shut down.  Both effects are negative but only the second one will show up as a temporary blip in GDP and employment metrics. Some of this disruption in economic activity will simply be postponed (e.g. consumption of durable items); some is lost permanently.

GDP gets a temporary boost after the initial destruction and disruption in the months after a natural disaster. This is the statistical reflection of emergency relief efforts and re-building that comes after the disaster. Clean-up, repairs and rebuilding all increase the demand for construction, building supplies, labor, etc. The need to replace flood-damaged cars gives a boost to the sale of new vehicles. These activities show up as an slight increase in total GDP in the months or few quarters after the disaster. While the additional economic activity is real; the effect is deceptive since overall we are not better off. The additional economic activity will only get us back to the pre-disaster status quo. GDP captures the fixing, but not the breaking.

The degree of insurance coverage is important for the speed of recovery. Rebuilding homes and restoring businesses is dependent on funding. Insurance provides a permanent transfer of resources into the recovering region. Without this transfer of resources, the rebuilding needs to be financed through loans and divestment of assets; which will reduce the funds available for consumption in the future and curb growth then. The majority of Federal disaster relief comes in the form of loans which need to be paid back later. Insurance-funded reconstruction boosts GDP without a payback through diminished future growth. 

Lack of funding can have a drastic impact on the ability to rebuild. This can be seen with the example of New Orleans 12 years after Katrina. The city is still 20% smaller since large numbers of people chose or were not able to return and rebuild.

Major natural disasters generally do not have a major long-run effect on the USD 19 trillion US economy and GDP on a national level. This is largely because the US economy is large and even the most severe natural disasters only directly affect a small portion of the economy. However, the impact of Harvey on the state and regional economy is large. There will also be a more serious impact on government budgets and the taxpayer because Harvey is likely to generate tens of billions of dollars in emergency federal aid and NFIP claims.

But above all, Harvey is a humanitarian disaster.

Category: Climate/natural disasters: Disaster risk, Floods/storms

Location: United States


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