Disasters and Development: Natural Disasters, Credit Constraints and Economic Growth

36 Pages Posted: 18 May 2011 Last revised: 8 Feb 2013

See all articles by Thomas K. J. McDermott

Thomas K. J. McDermott

SEMRU, Whitaker Institute, NUI Galway; London School of Economics & Political Science (LSE) - Grantham Research Institute on Climate Change and the Environment

Frank Barry

Trinity College (Dublin) - School of Business Studies

Richard S. J. Tol

The Economic and Social Research Institute, Dublin; Institute for Environmental Studies, Free University Amsterdam

Date Written: September 29, 2011

Abstract

We demonstrate, using a simple two-period equilibrium model of the economy, the potential effects of extreme event occurrences – such as natural or humanitarian disasters – on economic growth over the medium- to long-term. In particular, we focus on the effect of such shocks on investment. We examine two polar cases; an unconstrained economy where agents have access to perfect capital markets, versus a credit-constrained version, where the economy is assumed to operate in financial autarky. Considering these extreme cases allows us to highlight the interaction of extreme events and economic under-development, manifested through poorly developed financial markets. The theoretical analysis shows that, where agents face borrowing constraints, the shock of an extreme event occurrence could have lasting effects on economic growth.

The predictions of our theoretical model are then tested using a panel of data on natural disaster events at the country-year level, covering the period 1979-2007. In line with recent literature, we find that natural disaster events exert a significant negative impact on economic growth over the short-term. These effects appear to be compounded by a lack of access to credit. Looking at the medium-term dynamics of the interaction between disasters, credit constraints and economic growth, we find evidence in support of the hypothesis that credit constraints cause disaster events to have more persistent effects on economic growth.

Keywords: natural disasters, financial development, economic growth

JEL Classification: O11, O15, Q54, Q56

Suggested Citation

McDermott, Thomas K. J. and Barry, Frank and Tol, Richard S. J., Disasters and Development: Natural Disasters, Credit Constraints and Economic Growth (September 29, 2011). Available at SSRN: https://ssrn.com/abstract=1843494 or http://dx.doi.org/10.2139/ssrn.1843494

Thomas K. J. McDermott (Contact Author)

SEMRU, Whitaker Institute, NUI Galway ( email )

University Road
Galway, Co. Kildare
Ireland

HOME PAGE: http://https://thomaskjmcdermott.wordpress.com

London School of Economics & Political Science (LSE) - Grantham Research Institute on Climate Change and the Environment ( email )

Houghton Street
London, WC2A 2AE
Great Britain

Frank Barry

Trinity College (Dublin) - School of Business Studies ( email )

AAP College Green
Dublin 2
Ireland
353-1-896-2311 (Phone)

Richard S. J. Tol

The Economic and Social Research Institute, Dublin ( email )

Whitaker Square
Sir John Rogerson's Quay
Dublin 2
United States

HOME PAGE: http://www.esri.ie

Institute for Environmental Studies, Free University Amsterdam ( email )

De Boelelaan 1115
Amsterdam, 1081 HV
Netherlands

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