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Thursday 19 October 2017

Coping with cost of natural disasters

Irma, a Category Five hurricane and the most powerful Atlantic Ocean storm in recorded history, has caused widespread destruction across the Caribbean and southern Florida in the US, reducing buildings to rubble and leaving at least a couple dozen people dead.

We are yet to assess and quantify the full impact of this hurricane on the Caribbean. The small island of Barbuda is said to now be "barely habitable" with recovery efforts expecting to take years. Other Caribbean islands also severely impacted include Anguilla, St Kitts and Nevis, the British Virgin Islands, the Turks and Caicos Islands, the Bahamas, Haiti and the Dutch and French dependencies. Trinidad and Tobago has already pledged to aid some of these countries.

The Caribbean is one of the most vulnerable regions in the world to natural disasters, which are also a major source of macroeconomic vulnerability. Intense hurricanes can cause damage that that can in turn wipe out an entire year of Gross Domestic Product (GDP) output, leaving countries with a fractured infrastructure, thousands of people affected, and governments scrambling to put together the necessary resources to finance emergency assistance and relief, recovery, and reconstruction.

The small countries that make up the Caribbean are especially vulnerable since their limited budgetary capacity prevents them from establishing sufficient financial reserves to absorb a relatively large negative shock. Additionally, the high debt level of most small economies limits their ability to access credit in the aftermath of a natural disaster, high transaction costs associated with the relatively small market limits access to private catastrophe insurance, and international assistance is often insufficient to cover the total losses. For example, when Hurricane Ivan struck the island of Grenada in 2004 causing over US $800 million in damages, the country was no longer able to finance its public service bill and was forced to introduce a number of revenue enhancing measures and delay efforts of recovery and reconstruction in order to deal with the immediate problem of the fiscal shortfall, thus likely further amplifying the long term effects of the hurricane.

According to a 2016 IMF Working Paper entitled Gone with the Wind: Estimating Hurricane Climate Change Costs in the Caribbean, the total damages experienced in the region over the past 65 years amount to US$52 billion for the 148 disasters that actually had information on damages. The average disaster caused damage of US$352 million with damage from more intense storms normally causing larger damages as expected. Those storms caused damage of 82 per cent of GDP on average, and for most islands, account for more than half of all the damage they have experienced over the last 65 years.

Some of the largest disasters in each island, particularly for the smaller territories, caused damage well above 100 per cent of GDP, with Montserrat leading the pack with 434 per cent of GDP in damage after hurricane Hugo hit the country in 1989.

The impact of a hurricane is felt mostly in the destruction of the capital stock; that is, damage to housing, agricultural crops, roads, buildings, etc. Since the capital stock, in monetary terms, is usually larger than the total production of a country on any given year, it is possible to have disasters that destroy more than a 100 per cent of GDP.

As large as tropical cyclone costs have been over the last century, they are expected to increase in this century with climate change. Climate scientists believe that there is a connection between climate change and tropical cyclone intensity. Emanuel (2005) finds a strong correlation between the potential destructiveness of hurricanes and warmer sea surface temperature. Furthermore, tropical cyclones need a deep layer of warm sea surface temperature above 26.5°C to form (Landsea, 2004). Therefore, as the climate warms, and sea surface temperature warms, it is expected that the average intensity of tropical cyclones will increase.

At present, there is a Caribbean Catastrophe Risk Insurance Facility (CCRIF), but operationally this is inadequate to meet the needs after a major Caribbean disaster. In addition, premium payments have to be made each year if there is no disaster after a year. This represents a loss of precious foreign exchange. More targeted solutions have to be adopted.

The Caribbean needs to consider three important concepts to treat with natural disasters. First, the adoption of a stabilisation fund. The purpose of this fund is to provide fiscal stability from falling revenues brought on by natural disasters for the countries of the Caribbean, that helps them address the issue of volatile and unpredictable revenues that can arise from these disasters which destroy part or all of their productive capacity. The benefit of a Caribbean fund versus an individual fund is that it pools resources and spreads risks thus allowing access to higher levels of financing. It can be viewed as a safety net for the Caribbean given their vulnerability to natural disasters.

Second, the establishment of a catastrophe fund in which Caribbean countries will contribute with assistance from international donors to address the replacement of destroyed infrastructure after a disaster without an increase in national debt. At present when a disaster hits the Caribbean and destroys infrastructure, the government in most cases must borrow to replace these. It is made worse if the government had a loan on the destroyed infrastructure.

Third, authorities throughout the Caribbean must start preparing for the current and future costs of storms with efforts needed to adapt the current infrastructure to sustain the more intense conditions as well as better building codes and stricter enforcement of these. The extent to which a hazard manifests itself as a disaster inevitably depends on the capacity of a country to cope. Indeed, the economic cost of disasters in the Caribbean is high; however, the cost of inactivity is even higher.


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