In April of this year the nation was rocked by a devastating earthquake in the Sichuan province. The quake, which hit a 7.0 magnitude on the Richter scale, killed more than 200 people and left tens of thousands without a home. It is clear that besides the tragic human cost, such disasters have a profound impact upon a nation’s socioeconomic stability with huge financial implications. On an even more frightening note, some scientists are arguing that factors such as climate change, environmental deterioration and increasing populations are making natural disasters more frequent and more costly. Furthermore, with the interlinked and interdependent nature of the world’s economies, the impact of natural disasters in any given country is now a global problem. 

 

So what exactly are the major economic outcomes of such events, and moreover, how should policymakers allocate resources and prepare the nation’s financial infrastructure for future disasters?

 

 

The earthquake in Lushan earlier this year is the latest in a series of colossal natural disasters since the start of the 21st century. Besides the other earthquakes that have hit China and countries such as Haiti, the 2004 Indian Ocean Tsunami, Hurricane Katrina in 2005, and the Fukushima disaster in 2011  have had devastating social and economic impacts that are still felt today. 

The extent to which this affects the national economy depends primarily on the magnitude and location of the crisis. With regards to the recent Lushan quake, whilst the damage and costs will be substantial, commentators and policymakers are hopeful that the event won’t have too much of an impact on the region’s productive capacity. On a comparative basis, analysts at Bank of America Merrill Lynch have pointed out that during the 2008 Wenchuan earthquake many of the province’s big manufacturing and power production sites were hit hard.  

 

The unfortunate placement of the earthquake and subsequent tsunami which hit Southeast Asia in 2004 didn’t just impact nearby Indonesia, but also wiped out coastal towns in several other countries in the region. In fact, it is fair to say hundreds of resort towns which contribute to Thailand’s world renowned tourism industry have only just got back on track; others have never recovered from the disaster. The tourism sector as a whole accounts for somewhere between 10-15% of the country’s entire GDP according to most estimates.

 

 

Measuring the exact economic impact of these crises is extremely difficult. In the short term, the relief effort requires a great deal of human and financial capital which needs to be diverted away from the mainstream economy. The amount of personnel, heavy duty machinery and physical resources which go into the rescue and rebuilding processes is staggering. However, these costs often only take a slight toll on a nation’s overall financial well being.

 

In the longer term, big natural disasters can reshape a nation’s entire economy. Although it is still too early to fully evaluate the impact of the Fukushima disaster, it is clear that the economic aftermath has stretched far beyond the USD 200 billion damages bill. It is no understatement to say that the shocking events which have taken place since the initial disaster on 11 March 2011 have changed investment habits in the global energy sector. Following the crisis, anti-nuclear sentiments in countries such as Germany, Italy and India have increased so significantly that governments have had to rethink plans for future power generating facilities.

 

In addition, the recovery effort had a profound impact upon Japan’s monetary and fiscal policy framework. In an effort to provide financial support for the victims and the area that were devastated by the tsunami, the debt ridden country’s central bank had no other option than to pump billions into the nation’s financial infrastructure and to offer special loans at very low interest rates. As a result, Japan’s public debt levels hit 230% of GDP in 2011 and have remained dangerously high ever since.

 

 

Despite the very obvious devastating effects of earthquakes, tsunamis, hurricanes and other such natural phenomenon, some economic thinkers have suggested that such disasters can actually lead to economic growth and increased productivity in the long term. The Sichuan earthquake in 2008 is an interesting case in this regard. Following the earthquake, and in light of the global financial crisis which was sparked in the same year, China’s State Information Centre released a report which claimed that the investment put into rebuilding the province’s crisis zone would give a much needed boost to the overall economy. This was echoed in a recent news report by Bon TV China which pointed out that “in part due to the boost in investment from rebuilding, Sichuan’s growth accelerated to 14.5% in the following years, up from 11% in 2008”. 

 

Reasons cited for increased productivity following natural disaster recovery programs range from the bolstering of the construction section to the improvements made to aging factories, roads, housing, bridges and other infrastructure. Mark Skidmore, economics professor at Michigan State University, argues that "When something is destroyed you don't necessarily rebuild the same thing that you had… You might use updated technology and you might do things more efficiently”. He refers to cases of earthquakes and hurricanes in the US whereby the disaster hit areas have benefited greatly from new infrastructure and innovation.

 

But does the notion that natural disasters are a catalyst for economic growth and prosperity really stand up to common sense and logical reasoning? The answer may well have been put forward by the prolific economic thinker and philosopher Frederic Bastiat whose ‘Broken Window Fallacy’ theory is often referred to by economists when trying to disprove the economic benefits of damage inducing events such as wars and natural disasters. The central premise of the argument is that we cannot definitively claim that net economic gain has occurred as a result of rebuilding damaged property because in order for the process to happen in the first place, resources must be redirected from other areas of the economy. Thus, whilst the crisis zone may benefit from reconstruction, other areas lose out.

 

It is a fairly straightforward assumption that the resources and  human capital that go into rebuilding a crisis-hit area could have been put to different, and potentially better, uses. There are also other implications to consider. Since the Fukushima incident, commodity prices and production systems have been very unstable. Whilst the disaster relief effort has certainly not been the only factor in play, the surge in demand for industrial metals, the decline in Japanese oil imports and the ongoing disruption to the country’s agricultural sector have undoubtedly hit consumers hard.

 

 

Whilst the governments of China and other earthquake-prone nations make budgetary preparations for future events, it remains a tremendously difficult aspect of financial planning. The Chinese government is well aware of the dangers posed by earthquakes and other natural disasters. The country’s leaders know all too well about the financial implications of rebuilding after such devastating events. In January this year, the government announced a CNY 1.36 billion (USD 217 million) fund in order to “help victims of natural disasters fight starvation and low temperatures in winter and the coming spring”, according to Xinhua. This policy measure is not only aimed at earthquake victims, but has also been established to assist citizens in severe winter or drought conditions, and in the event of other geological incidents such as landslides. 

 

The recent moves come at a time when China’s economic outlook remains fairly bleak and financial commentators are increasingly expressing concern over the levels of public debt. Pre-emptively allocating funds and setting up financial schemes aimed specifically at natural disaster relief is a smart move given that a Japan-style post-disaster stimulus package would require a swift reallocation of resources away from capital markets that could potentially disrupt the already tentative Chinese business sector.