Natural Disasters and Capital Accumulation: The Role of Precautionary Saving and Capital Market Openness

Abstract We quantitatively investigate the macroeconomic effects of natural disasters using a standard RBC model with a focus on their impact on capital accumulation. Natural disasters can have ambiguous effects on domestic capital accumulation, through their two opposing effects on households’ incentives for domestic capital accumulation. On the one hand, natural disasters hurt domestic capital accumulation due to their destructive nature. On the other hand, a high natural disaster risk leads households to increase precautionary savings, which can increase the long-run capital stock when it is invested domestically. Our quantitative results show that in a closed economy, the long-run capital stock exhibits a “U” shape with respect to the intensity of natural disasters, and that in a small open economy, the long-run capital stock monotonically decreases with respect to the intensity of natural disasters. This result can provide an explanation to Skidmore, M., and H. Toya. 2002. “Do Natural Disasters Promote Long-Run Growth?” Economic Inquiry 40 (4): 664–87 puzzling empirical finding: Lack of observed negative long-run relationship between natural disasters and long-run capital stock/economic output. Moreover, in the event study analysis on the short-run macroeconomic dynamics during the natural disaster crises, we find that households’ capital flight can exacerbate output costs of the natural disasters. This finding is also in line with Noy, I. 2009. “The Macroeconomic Consequences of Disasters.” Journal of Development Economics 88 (2): 221–31 puzzling finding that capital market openness adversely affects the short-run output cost of natural disasters.