Economic growth under catastrophes

Abstract

The chapter analyzes effects of catastrophes on economic growth and stagnation. The economy is a complex system constantly facing shocks and changes with possible catastrophic impacts. A shock is understood as an event removing from the economy a part of the capital. We show that even in the case of wellbehaving economies defined by the Harrod-Domar model, persistent in time shocks implicitly modify the economy and may lead to various traps and thresholds triggering stagnation and shrinking. The stabilization of the growth must then rely on ex-ante risk reduction and risk transfer options, such as hazard mitigation and the purchase of catastrophic insurance, as well as ex-post borrowing. The coexistence of ex-ante (risk averse) and ex-post (risk prone) options in the proposed model generates a strong risk aversion even in the case of linear utility functions. In contrast to the traditional expected utility theory, it assesses and explains tradeoffs and benefits of ex-ante and ex-post management options.