Economic effects of natural disasters

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How can Australia's economy withstand financial effects of natural disasters?

Major natural catastrophes are a burden even to successful national economies like Australia's. The Australian government spends over half a billion Australian dollars annually on post-disaster relief and recovery, but only A$ 50m on pre-disaster prevention and mitigation. Is Australia adequately prepared for potential risks of change and the financial effects of natural disasters?

The development of the Australian economy is a remarkable success story. It has seen inflation-adjusted, average growth of over 3% every year for the last 20 years. Though it did not emerge totally unscathed, Australia even weathered the global financial crisis without slipping into recession. The country benefits from its wealth of natural assets and resources, particularly in the sectors of mining, tourism and farming. Iron ore and coal make up over one-third of its total export volume.

In fact, Australia is one of the world's largest coal producers and exporters. However, this economic strength is also what makes the country so prone to natural catastrophes. The situation is further compounded by a rising concentration of values in Queensland and Western Australia, and growing urbanisation in the coastal regions.

Australia hit hard by 2010/2011 floods

In late 2010 and early 2011, the Queensland floods, one of the costliest natural catastrophes ever to hit Australia, led to direct losses of A$ 6.8bn. While this is equivalent to just 1% of Australia's economic output, the overall economic effect of a natural catastrophe is not just the sum of direct damage to buildings, roads and mines.

Economic impacts of flooded mines in Australia

The indirect effects of natural disasters must also be taken into account, including the impact on economic activities not stemming directly from the natural catastrophe, such as production losses in flooded mines or a reduction in coal exports. Roughly 25% of the mines were temporarily inoperable, another 60% suffered severe restrictions.

The mining sector was hit hardest, with immediate production losses of A$ 6bn. Australian farming sustained crop losses of A$ 2bn while revenue losses in tourism came to A$ 400m.

Major natural catastrophes take a lasting economic toll

The immediate effects of natural disasters on a country's economic activities can easily be observed and measured, but do natural catastrophes also leave an enduring economic aftermath? It is often assumed that natural catastrophes (notwithstanding the tragic human consequences) can have a positive effect on an economy because reconstruction acts as an economic stimulus.

Empirical studies show, however, that the indirect, positive effects on overall prosperity do not compensate for the indirect losses. For example, “severe, devastating, major" natural catastrophes with over 100 fatalities and over US$ 250m (A$ 300m) in direct, inflation-adjusted losses were found to lead to a statistically significant reduction in real GDP of nearly 4% after five years, compared to real GDP growth without the catastrophe.

Financial burdens of natcat events in the long term

The financial burden of natural catastrophes is not immediately evident in economic growth rates, for instance because the costs of recovery work in the wake of a disaster are subsequently posted as income. Nevertheless, the long-term repercussions should not be underestimated. This applies in particular to government finances. As data from the International Monetary Fund indicate, Australia's general government debt, at 34% of GDP, is still relatively low by international standards, but has risen sharply since the global financial crisis. The debt level in 2007 was still below 10% of GDP.

The objective of balancing the budget has not been achieved to this day, due not least to support payments made to private households and businesses, as well as government expenditure on replacement investment following the natural disasters of recent years.

The comparatively low public debt is a critical advantage in global competition, but it is not enough to rely solely on prudent fiscal policy. In the case of a natural catastrophe, the state usually has little alternative but to provide generous support to the affected regions. A future increase in the loss potential from natural hazard events – resulting from a continued rise in the amount and concentration of values and the effects of climate change – would place a huge strain on the national budget and jeopardise this important competitive advantage.

Australia´s economy is far from immune

Australia has a stable, dynamic economy, a tried-and-tested natural disaster management system and a well-funded insurance industry. The country is therefore better equipped to cope with natural disasters than less developed nations. Nevertheless, events like the Queensland floods show that Australia is far from immune. This is true now more than ever, for although the growth outlook for the Australian economy is still positive.

However, things are not looking quite as rosy as in past years, when the Australian economy was boosted considerably by the mining boom and the tremendous dynamism of the Chinese economy. Accordingly, it will become more difficult for the Australian government and for private households to cushion the consequences of natural disasters. The coffers will not be quite as full.

Public investments and resilience measures in Australia

Hardly a year goes by in which Australia is not hit by a relatively severe natural catastrophe, not to mention frequent minor to moderate events. The Australian government currently spends an estimated A$ 560m annually on post-disaster relief and recovery, but only A$ 50m on pre-disaster prevention and mitigation.

Public investments in cost-efficient resilience and disaster reduction measures could reduce natural catastrophe costs by more than 50% by 2050, as estimated by the Australian Business Roundtable for Disaster Resilience and Safer Communities in June 2013.

The financial impact of climate change in Australia

Should climate change greatly increase the frequency and/or intensity of events, the prevention and recovery costs will pose an immense economic challenge. In Australia and New Zealand, the prevention and recovery costs will pose an immense economic challenge. In Australia and New Zealand, the increase in green­ house gas concentrations over the last 50 years has already led to a sig­nificant rise in average temperatures. They are expected to rise further in this century. The consequences could be more frequent hot extremes and increasing extreme rainfall related to flood risk in many locations.

Precisely because of the country’s impressive economic success story, Australia must arm itself against the changing parameters. Research shows that countries with higher insurance penetration suffer less from the economic impact of natural catastrophes. Insurance has an essential role to play in mitigating these adverse effects.

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