Building Resilience to Natural Disasters: An Application to Small Developing States

Abstract

We present a dynamic small open economy model to explore the macroeconomic impact of natural disasters. In addition to permanent damages to public and private capital, the disaster causes temporary losses of productivity, inefficiencies during the reconstruction process, and damages to the sovereign's creditworthiness. We use the model to study the debt sustainability concerns that arise from the need to rebuild public infrastructure over the medium term and analyze the feasibility of ex ante policies, such as building adaptation infrastructure and fiscal buffers, and contrast these policies with the post-disaster support provided by donors. Investing in resilient infrastructure may prove useful, in particular if it is viewed as complementary to standard infrastructure, because it raises the marginal product of private capital, crowding in private investment, while helping withstand the impact of the natural disaster. In an application to Vanuatu, we find that donors should provide an additional 50% of pre-cyclone GDP in grants to be spent over the following 15 years to ensure public debt remains sustainable following Cyclone Pam. Helping the government build resilience on the other hand, reduces the risk of debt distress and at lower cost for donors.

Macroeconomic Outcomes in Disaster-Prone Countries

“…thus assuming that the two types of public capital are perfect substitutes as in Marto et al (2018). Similarly to private capital, the actual standard public capital stock k g,t is the previous period's stock k * g,t−1 net of natural disasters:…”

“…If η = 0, as we assume in the baseline calibration, then the interest rate is constant. This modeling choice is justified by evidence suggesting that following a natural disaster, disaster-prone countries lose access to credit markets or see their financing costs skyrocket because their fiscal sustainability is at risk (see, e.g., S&P, 2015, Marto et al, 2018 andKling et al, 2018). Higher interest rates on public debt worsen the fiscal position further making the interest burden larger.…”

“…between 1.5 and 2.5 notches. While notches of change in sovereign creditworthiness cannot be linearly translated into changes in interest rates, Marto et al (2018), e.g., assume that a 1.5 notches downgrade implied a 15% increase in the interest paid by the government of Vanuatu following Cyclone Pam in 2015. Kling et al (2018) estimate that countries vulnerable to natural disasters pay, on average, a 1.17% higher cost of debt relative to countries less exposed to climatic events.…”

“…While most of the contributions introduce emissions and treat climate change as a negative externality that has to be taxed (see, e.g., Golosov et al, 2014;Hassler et al, 2016), we look at a particular consequence of climate change-weather-related natural disasters-which we consider exogenous to countries that have no material impact on emissions. From this point of view, the closest contributions to ours are those of Bevan and Adam (2016) and Marto et al (2018). The former focus on the reconstruction of public capital in the aftermath of a natural disaster and on forms of insurance at the government level, while the latter focus on the trade-offs of investment in resilient capital versus post-disaster donor support.…”

“…Previous contributions have provided interesting insights using deterministic (perfect foresight) solutions (see, e.g.,Marto et al, 2018). 6 ©International Monetary Fund.…”