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Disasters: Looking at the economic effect

The economy today is progressively becoming more interconnected. This means a natural disaster across the globe can have a financial impact here at home in Australia. As we know, recently there has been a spate of disasters which have wreaked havoc locally and globally.

It can be hard to predict the economic impact after a disaster. Often the first reaction is a sharp drop in the stock market. This can be a lasting downturn but sometimes it can recover quickly. When Hurricane Katrina hit the US in 2005 for example, the Dow Jones Industrial Average recovered in less than ten days. But the previous two hurricanes created lasting drops in the stock market.

When China’s Sichuan Province was hit by a huge earthquake in May 2008, the devastation was monumental, but the Chinese government say it ultimately helped their economy. Within a month of the quake, a massive rebuilding effort was underway and billions of dollars were pumped into the Chinese economy. This boosted the national economic growth by 0.3 percent during the period. This was particularly significant given that it was during the depth of the Global Financial Crisis (1).

Since the economic effects of a disaster can vary significantly, they’re not often well-captured by the simple headlines provided by the media. It’s important to delve a little deeper to properly understand the various impacts of a disaster and how they flow through the economy.

Direct damage

The loss of life is undisputedly the hardest part of any disaster. As people search for survivors, or even attempt to make areas safe, there is often a huge expenditure needed for relief and emergency response.

The second direct economic impact is the destruction. This is often the focus in mainstream media as they show horrific images of residential and business areas which have been hit by the disaster. There are substantial economic consequences in rebuilding these areas, but also in replacing finished and semi-finished goods, raw materials and spare parts.

An example of the massive cost of direct damage is in the recent Queensland floods, the Queensland State Government’s 2010-11 Mid Year Fiscal and Economic Review, has estimated that the cost of rebuilding public infrastructure will be $5 billion over 3 years (2).

(1) Source: Boston Globe, How disasters help, by Drake Bennett, July 6, 2008
(2) Source: Queensland State Budget 2010-11 – Mid Year Fiscal and Economic Review – www.treasury.qld.gov.au

Indirect damages

Goods and services that will not be produced because of a disaster can have a significant negative economic effect. It can take a lot of time to fix machinery and source new materials. Cost can increase even more if there is a need to use alternative means of production or distribution. As delays impact exporting, losses in revenue can impact international market shares.

One way disaster affected areas can mitigate this loss of income is to focus on sectors which were not as affected. For example, when Jamaica was hit by Hurricane Gilbert, instead of focusing on the decimated agricultural industry they rebuilt hotels. Within three months they had recovered the tourism industry and had minimised the loss of market share.

Secondary effects

Disasters can interrupt a country’s economy as a whole. Demand for building material, food and energy increases, at the same time as supply is restricted due to damaged infrastructure. This can cause spikes in inflation. Often, rebuilding efforts result in a shortage of skilled labour which forces wages to increase. This also impacts inflation.

Local and federal government finances often receive a double hit. Reduced economic activity results in lower tax revenues at the same time as they need to massively increase expenditure on infrastructure and disaster relief. These effects can be felt over a number of years as few governments budget for the unknown.

How might this affect your investments?

Many of the impacts of a disaster can have direct influence on your investment portfolio or superannuation. This is especially evident if you opt into a global share investment option or choose to own direct shares.

Another impact which can seem less obvious, but can have a huge impact on your day-to-day life, is the effect on commodity prices. An example of this is when petrol prices increased significantly in the aftermath of Hurricane Katrina.

The bottom line

Disasters can be heartbreaking and have a horrific impact. But when looking at the economic impact, there is a danger in automatically predicting doom and gloom, as the media is fond of doing.

When a disaster occurs, there will undoubtedly be a negative economic impact, but how long this lasts and how it effects your investments will depend on a large number of factors. Ultimately, rebuilding after the disaster will result in growth. It is best to assess the situation with your financial adviser to find the solution which suits your needs.

Many of the impacts of a disaster can have direct influence on your investment portfolio or superannuation.

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