Natural disasters and the effects of reconstruction expenditure on output

Using a panel of 116 advanced, emerging market and developing economies over the period 1990-2022, we examine the direct effects of natural disasters on economic activity and public finances and the medium-term effects of post-natural disaster reconstruction, through public spending, on economic activity. As anticipated, we find that natural disasters negatively affect both economic activity and public finances with the output effects being more pronounced in the case of extreme vis-Ã -vis major natural disasters. Employing a panel local projection methodology combined with an instrumental variable approach, and after conducting a series of robustness checks to address endogeneity concerns, the results reveal that reconstruction spending can serve as an effective driver of medium-term growth. Specifically, a 1% increase in real cyclically adjusted government expenditure following an extreme natural disaster leads to a 2.49% increase in real output five years after the shock. Moreover, the effects of reconstruction spending are found to be stronger in countries with lower public debt, lower trade openness, higher financial development, fixed exchange rate regimes, emerging market rather than advanced or least developed economies, countries with higher old-age dependency ratios, and lower agricultural or tourism dependence.