The economics of disasters

In the past 31 days, there was the typhoon that hit Japan, a forest fire in California, floods and drought in parts of the Philippines, and most recently an earthquake in Mindanao. Disasters are inevitable in many parts of the world, especially in the Pacific “ring of fire” which hosts a number of volcanoes. The Philippines gets an average of 24 typhoons a year, some of them creating disaster-level damage. As most calamities are not preventable, the countermeasure is to minimize the cost of the damage and rehabilitation, and speed up the recovery. Since, this means the re-allocation of scarce resources, we have to understand the economics of disasters.

Disasters are either natural or man-made, although over the years this classification has blurred because the way humans have been exploiting/abusing nature have altered the course of nature and have made natural disasters more intense or stronger. A calamity has to be widespread, affect at least a thousand people, cause actual and recovery costs in the $2 million range or over, and a rehabilitation time of over 90 days. By this definition, the recent Mindanao earthquake, Japan typhoon, and the Marawi devastation are disasters.

In the micro level, disasters incur actual loss of goods and services, including lives. There is also destruction of productive capital assets like houses, buildings, factories, stores, farmlands, forests, and crops. Then, there are the opportunity losses in terms of production output, lost sales of goods and services, loss of earnings over a period of time. Each of the affected parties are economic units that contribute to the economy, and their actual and opportunity losses reduces their economic contribution to society. This affects the supply side of the Gross Domestic Product (GDP) as these reduce the output of the whole economy. Depending on the magnitude of the disaster, it could mean a reduction in the annual growth of the GDP by 1% to 2%, which would be significant for a developing country. And there is the consequent long-term effects of disasters which could be the loss of sizable forest cover, water resources, and human resources which will diminish the productivity of the country’s economy.

On the demand side of the economy/GDP, disasters decrease aggregate demand as the affected people lose purchasing power, current and fixed assets, and human lives. This lowers the consumption component of the GDP until such time as they recover their earning capacity. This is where the immediate response of the public and private sector comes in, since it will not only save lives but also restores purchasing power. In the case of typhoon “Yolanda” the amount of relief goods, services, and money that came in from local and international sources more than restored the affected families’ purchasing power. There were also enough post-disaster funds for rehabilitation. What was found wanting is the implementation of the rehabilitation funds.

Prevention of disasters may not be possible, so mitigating disasters and its effects are the next best thing. There is enough technology to pinpoint disaster-prone areas so locational guidelines and structural integrity recommendations have to be implemented. When the Philippines only had a population of 25 million, people were sparsely living and were not concentrated, so major disasters were minimal. Fires, earthquakes, floods, and typhoons affected lesser number of people and structures. As we have compressed over smaller areas, due to our numbers and economic opportunities, the potential for disasters increased.

Considering the size of the Philippine economy in terms of GDP, currently over P20 trillion and an annual national government budget of over P3 trillion, a disaster costing in actual, opportunity, and rehabilitation in the P10 billion range is livable and should not make a dent on the economy. Anything beyond P20 billion will be problematic.