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

We demonstrate, using a simple two-period equilibrium model of the economy, the potential e?ects 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 e?ect 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 oper- ate in ?nancial autarky. Considering these extreme cases allows us to highlight the interaction of extreme events and economic under- development, manifested through poorly developed ?nancial markets. The theoretical analysis shows that, where agents face borrowing con- straints, the shock of an extreme event occurrence could have lasting e?ects 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 ?nd that natural disaster events exert a signi?cant negative impact on eco- nomic growth over the short-term. These e?ects 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 ?nd evidence in support of the hypothesis that credit constraints cause disaster events to have more persistent e?ects on economic growth.