The Macroeconomic Impacts of Natural Disasters: New Evidence from Floods

Summary

We analyze the economic impacts of floods using new data on 3,184 large flood events in 118 countries between 1985 and 2008. We use panel vector auto-regressions to trace the dynamic response of output to three types of flood shocks. Our results indicate that flood shocks tend to have a positive average impact on GDP growth, that this impact is limited to developing countries, that the effect is not confined to the agricultural sector, and that it is stronger when it is accompanied by an increase in gross fixed capital formation.

Situation

In addition to the immediate cost of natural disasters in terms of mortality, number of displaced people and infrastructural damage, and partly due to these immediate costs, natural disasters may have a lasting effect on economic output and growth. Among all the types of natural disasters, analyzing the macroeconomic impacts of floods is particularly relevant for at least two reasons. First, between 1985 and 2009, floods were the most common natural disaster, accounting for 40 percent of all natural disasters (another 31 percent were storms). Combined, floods and storms represented 44 percent of the deaths, 67 percent of the number of people affected and the bulk of economic damages caused by natural disasters. Second, if climate change results in an increase in the frequency and intensity of extreme weather events, including storms and floods, knowing whether or not floods have net permanent effects on economic output and the details of the adjustment path may prove very useful to direct adaptation efforts. Recent attempts to evaluate the long-run impact of natural disasters on GDP offer an inconclusive picture regarding the sign of the impacts of disasters on GDP growth.

Response

We compiled an unbalanced panel with annual data on the number and physical intensity of floods, and macroeconomic variables to trace the output growth response in the year of and the years after a flood shock, for 118 countries during the period 1985-2008. Our paper uses a new flood-specific disaster dataset to analyze. Our contribution to the literature is twofold. First, we use three alternative definitions of flood shock: experiencing an additional 'typical' large flood event, experiencing an exogenous increase in the magnitude of the average flood, and an increase in the death toll. Most of the papers on the economics of natural disasters define severity of a disaster as a function of the number of people killed or affected by floods, which, although arguably correlated with the physical intensity of a disaster, might be determined by a country's macroeconomic and institutional setting. Second, we explore potential channels through which floods may affect economic output levels and growth. We distinguish between agricultural and non-agricultural output growth and separate our sample into developing and developed countries. In addition, we control for availability of domestic credit to the private sector to measure the degree to which households can borrow to self-protect against (and perhaps take advantage of) floods. We also control for the quality of governance proxied by indicators of corruption and ethnic conflict, as these may determine the efficiency of the public response to large flood events. Finally, we control for fixed capital formation that could follow when large floods damage preexisting infrastructure that needs to be fixed or replaced.

Impact

Our results show that flood shocks tend to have positive impacts on GDP growth rates. These positive impacts are not experienced on the year of the flood. The delay in the overall growth response seems to be driven by the agricultural sector and, as Fomby et al. (2009) point out, could be due to potentially beneficial effects of floods on land productivity that manifest on the following harvest cycle. The increase on agricultural growth in the year after the flood is larger and more persistent in developing countries which typically rely on more traditional, less intensive forms of agriculture. Developed countries do not experience a positive impact of floods on overall growth, the positive impact on agricultural growth in developed countries does not to spill over to the manufacturing and service sectors. These results contradict the conventional wisdom that disasters are more likely to have negative growth effects in developing countries. At least for floods in this new dataset, the mean response of GDP growth for developing countries is positive. This could be due to the larger relative importance of the agricultural sector on overall GDP, as implicit in the argument of Fomby et al. (2009). But looking more in-depth at potential transmission mechanisms, our results suggest the importance of an investment channel: the impact of growth in developing countries is stronger when accompanied by gross capital formation.

State Issue

Other Issue

Details

• Year: 2011
• Geographic Scope: International
• County: Clarke
• Program Areas:
  • Agriculture & Natural Resources