Are losses from natural disasters more than just asset losses?: The role of capital aggregation, sector interactions, and investment behaviors

Abstract

The welfare impact of a natural disaster depends on its effect on consumption, not only on the direct asset losses and human losses that are usually estimated and reported after disasters. This chapter proposes a framework to assess disaster-related consumption losses, starting from an estimate of the asset losses, and leading to the following findings. First, output losses after a disaster destroys part of the capital stock are better estimated by using the average—not the marginal—productivity of capital. A model that describes capital in the economy as a single homogeneous stock would systematically underestimate disaster output losses, compared with a model that tracks capital in different sectors with limited reallocation options. Second, the net present value of disaster-caused consumption losses decreases when reconstruction is accelerated. With standard parameters, discounted consumption losses are only 10% larger than asset losses if reconstruction is completed in 1 year, compared with 50% if reconstruction takes 10 years. Third, for disasters of similar magnitude, consumption losses are expected to be lower where the productivity of capital is higher, such as in capital-scarce developing countries. This mechanism may partly compensate for the many other factors that make poor countries and poor people more vulnerable to disasters.