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PAGE ONE Economics
© ayax / iStock / Thinkstock

®

The Economics of Natural
Disasters
Barbara Flowers, Economic Education Coordinator

GLOSSARY
Asset: A resource with economic value that
an individual, corporation, or country
owns with the expectation that it will
provide future benefits.
Gross domestic product (GDP): The total
market value, expressed in dollars, of all
final goods and services produced in an
economy in a given year.
Insurance: Protection from specified losses
in return for a fee (premium).
Loan guarantee: A contract binding a third
party to pay off a loan if the borrower
defaults.
Metropolitan statistical area (MSA):
A densely populated geographic region,
with a city at its core, having strong
economic ties.
Opportunity cost: The value of the next-best
alternative when a decision is made; it’s
what is given up.
Peril: In insurance, a specific risk or cause
of loss.
Positive externality: A benefit to a third
party arising from a transaction between
two unrelated parties.

“What has so often excited wonder [is] the great rapidity with which
countries recover from a state of devastation; the disappearance, in a
short time, of all traces of the mischiefs done by earthquakes, floods,
hurricanes, and the ravages of war.”
—John Stuart Mill

May—the month of graduations, the unofficial start of summer vacation,
and tornadoes. You don’t live in an area threatened by twisters? Then perhaps to you May means the beginning of wildfire season. Or maybe you
are more concerned about hurricane season, which begins on June 1.
Regardless of where you live, there is barely a spot on this planet that isn’t
affected by wind, rain, fire, drought, flood, or earthquakes.
When natural disasters hit, the victims may feel as if there is no chance of
recovery. In fact, those far away may feel the same way. In 2017 the United
States experienced hurricanes Harvey, Maria, and Irma, which wreaked
destruction from Texas to South Carolina. The Thomas fire in California
destroyed more than 1,063 structures and burned an area greater than
440 square miles.1 Nearly 1,400 tornadoes ripped through central and
southern states, with nearly 300 in May alone.2 Flooding forced 188,000
residents to evacuate their homes near the Oroville Dam in California,
and later in 2017, heavy rain caused severe flooding in Missouri, Arkansas,
and Illinois. Observing the destruction of homes, businesses, infrastructure,
and the environment, one might wonder if it is possible to get back to
normal. In rare cases, the return to pre-disaster normal is impossible. It is
far more likely, however, that the recovery will ultimately make conditions
as good or better than they were before the disaster.
The costs of disaster can be difficult to assess for a number of reasons. For
example, a damaged business might relocate, permanently close, or rebuild.
The loss to the community is permanent in the case of relocation or closure,
but only temporary if the business rebuilds.3 Let’s take a look at various
types of costs.

Costs Associated with Direct Losses
Direct losses are a result of the immediate damage from a disaster. Such
losses can be broken into two types: market losses and non-market losses.4
May 2018	

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Direct market losses are losses to assets that have a market value, such as a house or a car. The dollar value of
these losses is relatively easy to determine. Direct non-­
market losses are losses of assets for which a price isn’t
easily determined because the asset isn’t bought or sold
in the marketplace. An example of a non-market loss is
a historic building that collapses in an earthquake. It is
possible to calculate the cost of rebuilding, but how do
you calculate the value of the historical significance of
the building?

Costs Associated with Indirect Losses
Indirect losses follow a disaster and are secondary to
direct losses. Say a business is destroyed in a fire. Direct
losses are the building and equipment. Indirect losses
are the wages that the workers will not earn because
the business is not operational and the output that will
not be available to consumers. Then there are infrastructure losses where positive externalities are lost,5 such
as a missing section of highway that increases workers’
commute time by an hour.

Opportunity Costs
Replacing capital reduces the amount available for new
capital elsewhere. Resources devoted to reconstructing
homes damaged in a disaster are not available for new
construction. Construction and utility workers are lured
to disaster areas by higher wages. The good news about
“demand surge” wage increases is that reconstruction in
the afflicted areas gets underway quickly.6 The bad news
is that these workers are not available elsewhere.

Who Shares in the Costs?
Imagine living in a coastal town in the path of a hurricane.
You and every neighbor would board up the windows
and secure anything that could blow away. Despite the
precautions, when the hurricane hits with winds up to
160 mph, your neighbor’s small frame home collapses.
Your roof is ripped away, along with those of most houses
and businesses. The roof debris along with tree branches
and power poles smash into buildings. The storm moves
inland, and the winds die down. Now, there is just rain—
for days. The waterways back up, and soon buildings
miles away from the coastline sit in three feet of water.
The disaster is obviously hardest on the homeowner,
the renter, the business owner, the property owner—

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the people and businesses displaced by the hurricane
and, later, the flood. They can’t live at home. Their workplaces are closed, or the roads to get there are flooded.
They suffer the direct losses from the immediate damage
plus the indirect losses in income.

Insured Direct Losses
These victims are often insured against the direct losses,
so insurance companies absorb a substantial share of
the cost. For example, a house collapsed by a hurricane
would be a covered peril. Some homeowners policies
name specific perils included in the coverage, while other
policies include all perils but note exceptions. Regardless
of which type the homeowner has, wind and fire damage
are covered; flood damage is not. And neither, by the
way, is earthquake damage. In the case of fire and wind
damage, depending on the type of policy a homeowner
has, most if not all of the cost to rebuild the house would
be covered. In addition, contents would also be covered,
up to certain limits. Insured businesses would have similar
coverage, and cars would be covered by comprehensive
car insurance.
According to Dave Jones, California’s insurance commissioner, insured claims arising from the California wildfires
in October and December were nearly $12 billion. These
included losses for homes and other types of dwellings
but also cars, boats, and aircraft. Sonoma County had
the largest number of claims for direct losses—21,286—
for a total loss of nearly $8 billion.7 This doesn’t count
indirect losses, such as the loss of output from the affected
wineries or the loss of tourism dollars.
Insured losses resulting from Hurricane Harvey more than
doubled those of the California wildfires, coming in at
$30 billion. However, insured losses were only a little
more than one-third of the $85 billion in total losses.8
The discrepancy between insured and uninsured losses
was, in part, due to the flooding caused by Harvey.
Houston, the fourth largest U.S. city, endured the brunt of
the storm. As Harvey became a tropical storm, it dumped
a quantity of rain in some areas that would be expected
only once every 1,000 years. More than 200,000 homes
and 250,000 vehicles were damaged or destroyed by
floods, but a water-damaged car is only covered if the
owner carries comprehensive car insurance and, of course,
flooding is not covered at all by the typical homeowners
policy.9 Flood insurance must come from the National

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Figure 1
FEMA Spending
Allocations, Obligations, and Expenditures for Hurricanes
Harvey, Irma, Maria, and California Wildfires 2017
(Cumulative)

($ in millions)

12,000
Allocations

10,000

Obligations
8,000

Expenditures

6,000

4,000

2,000

0

Hurricane Harvey

Hurricane Irma

Hurricane Harvey
Allocations

$

Obligations
Expenditures

5,138

Hurricane Irma
$

5,109
$

3,481

Hurricane Maria

3,151

Hurricane Maria
$

3,144
$

2,074

CA Wildfires 2017

10,108

CA Wildfires 2017
$

9,853
$

4,592

Total

1,366

$

1,326
$

629

19,763
19,432

$

10,776

This graph represents FEMA allocations, obligations, and expenditures as of February 28, 2018. Allocations are the amounts
of money allocated to cover the expenses of a particular disaster. The obligations are the known expenses FEMA will pay,
and the expenditures are the amounts of money FEMA has paid for the named disaster.
NOTE: Total obligations include prior year deobligations. The totals also include obligations for both major declarations and
emergencies.
SOURCE: U.S. Department of Homeland Security. Disaster Relief Fund: Monthly Report as of February 28, 2018. Federal Emergency
Management Agency, March 9, 2019. Financial information is from IFMIS.

Flood Insurance Program (NFIP), and few homeowners
and renters have it. In some cases, the insurance is
required. People who have received grants or loans from
the Federal Emergency Management Agency (FEMA) in
the past for flooding must carry the insurance or risk
having no assistance for future flood claims. Those who
live in a flood zone and carry a mortgage are also required
to have flood insurance. However, that wouldn’t have
helped much in Harris County. Flood zones are areas
surrounding rivers. In Harris County, where Houston is
located, only 17 percent of homeowners carried flood
insurance. Most of the flooding there wasn’t near a river,
so few people were required to carry flood insurance.

FEMA Help with Direct Losses
Remember the coastal town? The wind damage was
insured; the flood damage was not. This is where the
federal government enters the picture. FEMA, an arm of
the U.S. Department of Homeland Security, covers costs,

including direct loans and loan guarantees to households
and businesses. Even when most structures are insured,
as in the case of the California wildfires, FEMA offers
grants to pay for firefighting efforts and fire prevention.
FEMA also offers other benefits that may not be covered
by insurance.
Congress appropriates funds to FEMA, so ultimately, all
taxpayers also share the costs (Figure 1). In 2017, FEMA
issued 1,529 disaster declarations.10 Declarations are
issued to counties, and each declaration can include up
to four programs offered by the agency: Individuals and
Households, Individual Assistance, Public Assistance,
and Hazard Mitigation (see the boxed insert).
FEMA’s Disaster Relief Fund appropriation from Congress
was $7.3 billion for fiscal year 2017.11 As the number of
disasters grew, however, it became clear that the FEMA
budget was insufficient, and Congress issued a supplemental appropriation in excess of $15 billion.12 Then
came the wildfires, and a little more than a month later,

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FEMA Programs and Benefits
Program

Description

Benefits

Individuals and Households

Provides financial and direct services to eligible
individuals and households affected by a disaster
who have uninsured or underinsured necessary
expenses and serious needs.

• Housing assistance
• Personal property assistance
• Transportation assistance
• Moving and storage assistance
• Funeral assistance
• Medical and dental assistance
• Child-care assistance

Individual Assistance

Provides financial help or direct services to those
who have necessary expenses and serious needs
if they are unable to meet these needs through
other means. Financial help is limited to $33,000
(adjusted each year).

• Housing assistance
• Personal property assistance
• Funeral assistance
• Medical and dental assistance
• The cost of an NFIP group flood insurance policy

Public Assistance

Provides communities emergency assistance to
save lives and protect property and assists with
permanently restoring community infrastructure
affected by a federally declared incident.

Emergency work
• Debris removal
• Protective measures

Hazard Mitigation

Permanent work
• Roads and bridges
• Water control facilities
• Public buildings and contents
• Public utilities
• Parks and recreational and other facilities

Provides assistance supporting sustainable action
taken to reduce or eliminate long-term risk to
people and property from future disasters.

SOURCE: FEMA.

the House Appropriations Committee approved $36.5
billion more13 for disaster relief, the California wildfires
efforts, and NFIP payments to individuals.

Businesses and Charitable Services Contributions
Insurance companies are obligated to cover insured
perils. Government agencies are sometimes obligated
and often expected to help in times of disaster. However,
large sums of money can come from businesses, large
and small. Immediately following Hurricane Harvey’s
ravaging of Houston, businesses pledged more than
$157 million to help with relief and recovery.14 The
costs of disasters are also shared by hundreds of charities
that provide aid. The American Red Cross, for example,
estimated its assistance to Harvey victims would total
$318.5 million.15

Indirect Losses
It is too early to assess the extent of indirect costs stemming from the 2017 fires, floods, hurricanes, and tornadoes. For example, the wineries caught in the wildfires
suffered direct losses of the structures and vines, but the
interruption to their business, the indirect loss, is not clear.
Most grapes had been harvested, but even for those
grapes that survived on the vine, there was concern that
the smoke and heat had severely damaged their quality.
As past experience shows, the effects of disasters can
linger for years. Hurricane Katrina’s effect on the New
Orleans economy and environment during and after
2005 is a case in point. Employment in the New OrleansMetairie, LA, metropolitan statistical area (MSA) has
yet to rise to the pre-Katrina level (Figure 2), as thousands

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Figure 2
Employment Still Below Pre-Katrina Level

Figure 3
Labor Force Still Below Pre-Katrina Level

NOTE: Gray bars indicate recessions as determined by the National Bureau of
Economic Research (NBER).

NOTE: Gray bars indicate recessions as determined by the NBER.

SOURCE: U.S. Bureau of Labor Statistics. Retrieved from FRED®, Federal Reserve
Bank of St. Louis; https://fred.stlouisfed.org/graph/fredgraph.png?g=jtsH,
accessed March 30, 2018.

5

SOURCE: U.S. Bureau of Labor Statistics. Retrieved from FRED®, Federal Reserve
Bank of St. Louis; https://fred.stlouisfed.org/graph/fredgraph.png?g=jtsO,
accessed March 30, 2018.

Housing Units in New Orleans

Number of Households in New Orleans

240k

200k

220k

180k

200k

160k

Number of Households

Number of Housing Units

Figure 4
New Orleans Housing Units and Households Hadn’t Recovered 5 Years After Hurricane Katrina

180k
160k
140k

140k
120k
100k
80k

120k

60k

100k
2000

2005

2006

2007

2008

2009

2010

2011

2012

2013

2000

2005

2006

2007

2008

2009

2010

2011

2012

2013

SOURCE: U.S. Census Bureau. English, E. “New Orleans, 10 Years after Katrina.” Federal Reserve Bank of Atlanta Economy Matters, August 20, 2015;
https://www.frbatlanta.org/economy-matters/2015/08/20/new-orleans-10-years-after-katrina.

of residents that evacuated the city settled elsewhere
permanently. The area’s labor force is currently 603,883,
still down from the pre-Katrina level of 632,826 (Figure 3).

Natural Disasters and GDP
With the loss of life, homes, businesses, capital, and infrastructure, it would be reasonable to expect a decline in
economic growth after a disaster. New Orleans experienced severe economic disruption after Hurricane Katrina
(Figures 4 and 5). Yet, the gross domestic product (GDP)
of the New Orleans-Metairie, LA, MSA fell less than 3 percent before fully recovering to pre-Katrina levels in late
2007 (Figure 6). The economic recession of 2007-09 did
far more damage to the local GDP than Hurricane Katrina.

Although in some ways New Orleans has not fully
recovered, in many ways it has improved over pre-Katrina
conditions. One striking improvement is in infrastructure
in the form of raised levee walls and enormous flood
gates. As building continues and population increases
(Figure 7), housing and employment will increase.
Generally, a region’s economic activity recovers after a
natural disaster. Research suggests that only very large
disasters that are followed by political upheaval have
long-term negative effects on economic growth.16 GDP
may fall in the short run, but reconstruction has a positive
effect on GDP. Old capital is replaced with state-of-theart capital that increases productivity. New buildings are
constructed with energy efficiency in mind. People build

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Figure 5
Number of Businesses Surpassed Pre-Katrina Level by 2012

6

Figure 6
GDP Recovered to Pre-Katrina Level by 2008

Business Establishments: New Orleans-Metairie-Bogalusa, LA CSA
42k

Number of Establishments

41k
40k
39k
38k
37k
36k
35k
2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

NOTE: CSA (combined statistical area), an area of two adjacent MSAs with
connected labor markets.
SOURCE: U.S. Bureau of Labor Statistics. English, E. “New Orleans, 10 Years after
Katrina.” Federal Reserve Bank of Atlanta Economy Matters, August 20, 2015;
https://www.frbatlanta.org/economy-matters/2015/08/20/new-orleans-10years-after-katrina.

new homes and replace personal property, such as furniture, appliances, and cars. Houston area automobile
sales in the three weeks after Hurricane Harvey increased
109 percent over the three weeks prior to the storm.17
U.S. total vehicle sales spiked in September 2017 to the
highest monthly sales figure since July 2005.18 U.S. retail
sales of furniture and home furnishings climbed in
October and November 2017.19

NOTE: Gray bars indicate recessions as determined by the NBER.
SOURCE: U.S. Bureau of Economic Analysis. Retrieved from FRED®, Federal
Reserve Bank of St. Louis; https://fred.stlouisfed.org/graph/fredgraph.
png?g=j48w, accessed March 30, 2018.

Figure 7
New Orleans Population on the Rise
400,000
390,000
380,000
370,000
360,000
350,000
340,000

Conclusion
Natural disasters are painful and costly, and 2017 was
particularly devastating in terms of loss of life and property damage. Direct losses are immediately apparent in
the form of structures, vehicles, and furnishings that are
flooded, burned, or blown to pieces. Everyone with a
TV or computer is acutely aware of those losses. Indirect
losses, on the other hand, are the lingering effects on
income, business activity, and output that plague the
afflicted area while recovery is taking place. Then there
are the opportunity costs. For example, money spent to
replace a bridge in a city is money that cannot be used
to provide that city with new street lighting or to replace
a worn out bridge in another city. As reconstruction
begins, GDP may increase; but there is still loss. In the
words of economist Frédéric Bastiat, “To break, to spoil,
to waste, is not to encourage natural labour; or, more
briefly, ‘destruction is not profit.’”20 n

330,000
320,000
310,000
2010

2011

2012

2013

2014

2015

2016

2017

 

NOTE: The 2011, 2012, 2013, 2014, 2015, and 2016 population estimates have
been revised with the release of the 2017 population estimates.
SOURCE: The Data Center analysis of U.S. Census Bureau Decennial Census and
Population Estimates; https://www.datacenterresearch.org/data-resources/
population-by-parish/.

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Notes
1

CA.gov. Thomas Fire Incident Information. Cal Fire, final update March 7, 2018.

2

Rice, D.; Sergent, J.; Petras, G. and Loehrke, J. “2017 Could Tie Record for BillionDollar Disasters in a Year. Here’s Why.” USA Today, October 18, 2017;
https://www.usatoday.com/story/weather/2017/10/18/2017-could-tie-recordbillion-dollar-disasters-year-heres-why/763406001/.
3

Federal Reserve Bank of St. Louis | research.stlouisfed.org

13

U.S. House of Representatives Committee on Appropriations. “House Appro­
pri­ations Committee Moves Emergency Hurricane and Wildfire Legislation.” Press
release, October 10, 2017;
https://appropriations.house.gov/news/documentsingle.aspx?DocumentID=395054.
14

Yurieff, K. “Businesses Donate Over $157 Million to Harvey Relief Efforts.” CNN
Money, September 3, 2017; http://money.cnn.com/2017/08/30/news/companies/hurricane-harvey-corporate-donations/index.html.

Hallegatte, S. and Przyluski, V. “The Economics of Natural Disasters: Concepts
and Methods.” Policy Research Working Paper 5507, The World Bank, 2010.

15

4

Hallegatte and Przyluski.

16

5

Hallegatte and Przyluski.

6

Hallegatte and Przyluski.

7 The actual loss was $7,839.473.04. California Department of Insurance. “Statewide

Insured Losses from the October and December 2017 Wildfires.” January 21, 2018;
http://www.insurance.ca.gov/0400-news/0100-press-releases/2018/upload/
nr013-2018WildfiresUpdate013118.pdf.
8

Ellenrieder, T. “Hurricane Harvey: Record-Breaking Floods Inundate Houston.”
Munich RE Group. January 12, 2017;
https://www.munichre.com/topics-online/en/2017/12/hurricane-harvey.
9

Ellenrieder.

10

FEMA Declaration Set – Data As Of: 3/6/18. Data.gov. FEMADeclarations.3.6.18.

7

American Red Cross. “Massive Red Cross Response Continues in Wake of
Unprece­dented Flooding. Hurricane Harvey One-Month Update.” October 2017.
Cavallo, E.; Galiani, S.; Noy, I. and Pantano, J. “Catastrophic Natural Disasters
and Economic Growth.” Review of Economics and Statistics. December 2013, 95(5),
pp. 1549-61.
17 Rocco, M. “Houston Car Sales Spike After Harvey.” Fox Business, October 3, 2017;

https://www.foxbusiness.com/markets/houston-car-sales-spike-after-harvey.
18

U.S. Bureau of Economic Analysis. Total Vehicle Sales. Retrieved from FRED®,
Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/TOTALSA,
accessed March 30, 2018.
19

U.S. Bureau of the Census. Retail Sales: Furniture and Home Furnishings Stores.
Retrieved from FRED®, Federal Reserve Bank of St. Louis Fed;
https://fred.stlouisfed.org/series/MRTSSM442USS, accessed March 30, 2018.
20

Bastiat, F. “That Which is Seen, and That Which is Not Seen.” July 1850;
http://bastiat.org/en/twisatwins.html.

11

U.S. House of Representatives Committee on Appropriations. “Appropriations
Committee Releases Fiscal Year 2017 Homeland Security Bill.” Press release,
June 8, 2016;
https://appropriations.house.gov/news/documentsingle.aspx?DocumentID=394583.
12

U.S. House of Representatives Committee on Appropriations. “Emergency
Disaster Aid and Continuation of Government Funding Approved.” Press release,
September 8, 2017;
https://appropriations.house.gov/news/documentsingle.aspx?DocumentID=395049.

Please visit our website and archives at http://research.stlouisfed.org/publications/page1-econ/ for more information and resources.
© 2018, Federal Reserve Bank of St. Louis. The views expressed are those of the author(s) and do not necessarily reflect official positions of the Federal Reserve Bank
of St. Louis or the Federal Reserve System.

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Name___________________________________ Period_______
Federal Reserve Bank of St. Louis Page One Economics ®:

“The Economics of Natural Disasters”

After reading the article, select the best answer to questions 1-5 and then answer questions 6-8:
1.	 The following is an example of a direct loss:
	

a.	 Anthony’s workplace is closed for repairs after a storm, so Anthony isn’t being paid.

	

b.	 Quality Bakery can’t get deliveries of ingredients, so it can’t produce bread.

	

c.	 Gems and Jewels is closed for business until the road is repaired.

	

d.	 The Smith’s home sustained a damaged roof.

2.	 The following is an example of an indirect loss:
	

a.	 Anthony’s workplace is closed for repairs, so Anthony isn’t being paid.

	

b.	 The Smith’s home sustained a damaged roof.

	

c.	 Quality Bakery must get new ovens because they were submerged in two feet of water.

	

d.	 The glass in Gems and Jewels showcases was broken from falling debris.

3.	 The following is an example of an opportunity cost:
	

a.	 The Smith’s must pay a $1,000 deductible for their new roof, so they won’t be buying a new fridge.

	

b.	 The glass in Gems and Jewels showcases was broken from falling debris.

	

c.	 Quality Bakery can’t get deliveries of ingredients, so it can’t produce bread.

	

d.	 Anthony’s workplace is closed to repair damage to its machinery.

4.	 FEMA is an agency of the
	

a.	 American Red Cross.

	

b.	 U.S. Department of Homeland Security.

	

c.	 U.S. Insurance Commission.

	

d.	 U.S. Forestry Service.

5.	 Losses from the following are covered under the typical homeowners policy:
	

a.	 Wind and fires

	

b.	 Earthquakes and wind

	

c.	 Fires and floods

	

d.	 Earthquakes and floods

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NOTE: Gray bar indicates recession as determined by the National Bureau of Economic Research.
SOURCE: U.S. Bureau of the Census. Retrieved from FRED®, Federal Reserve Bank of St. Louis;
https://fred.stlouisfed.org/graph/fredgraph.png?g=juY9, accessed March 30, 2018.

6.	 Answer the following questions based on the graph above:
	

a.	 What happened to sales of furniture and home furnishings toward the end of 2017?

	

b.	 How do the sales of furniture and home furnishings in 2017 compare with their sales historically?

	 c.	 If the 2017 sales increase was due to households replacing furniture and home furnishings damaged in fires, 	
		 hurricanes, and floods, what would you expect of sales in early 2018?

7.	 If economic growth occurs after natural disasters, does that mean that natural disasters are good for the economy?

8.	 Who takes part in the recovery from a natural disaster, and what role do they play?

9


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