# **1 Introduction**

With continuing greenhouse gas emissions in excess of the absorptive capacity of land and oceans, inexorably contributing to climate change, damages from extreme weather events are likely to increase in the coming decades (Emanuel, 2013; Mendelsohn et al., 2012). Governments in developing countries have a limited ability to smooth the shocks created by extreme weather events. In particular, budget reallocations following a disaster tend to be inefficient, and often result in costly liquidity crunches (Mahul, 2011). For these reasons, ex-ante risk financing instruments like national disaster funds are a primary focus of Sovereign Disaster Risk Financing efforts. Given the large resources required to set up these funds, a key question is whether disaster funds provide a cost effective tool to cope with the losses created by natural disasters. Taking advantage of a unique natural experiment and dataset, this paper provides some of the first evidence on the causal impact of disaster funds on economic recovery.

We circumvent endogeneity in the provision of rapid reconstruction funds by using a fuzzy regression discontinuity design that exploits the rules that govern municipal level eligibility to reconstruction funds from the Mexican disaster fund Fonden.<sup>1</sup> Since only municipalities that have officially experienced a disaster, as determined by event thresholds, are eligible for disaster funds, we recover causal estimates of the impact of disaster funds on local economic activity in three steps. In the first step, we compare the post disaster economic outcomes of municipalities that are just below and above the thresholds that define the occurrence of the disaster. In the second step, we account for data restrictions by estimating how moving from just below to just above the threshold increases the likelihood of being eligible for Fonden. In the third step, we recover the causal impact of Fonden on local economic activity by rescaling the coefficient derived in the first step by the coefficient derived in the second step.

We measure changes in economic activity at the municipal level using high resolution satellite imagery that allows us to measure the intensity of light as observed from outer-space. Because our night light measure is a good proxy of subnational level economic activity we are able to track the differential economic performance created by the rapid provision of reconstruction funds.

Our main finding is that municipalities with access to Fonden grew between 2 to 4% more than those without Fonden in the year following the disaster. Conservative benefit cost ratios, for the same time period, are in the 1.52 to 2.89 range. The paper additionally documents the impact of Fonden over the post disaster period. We find that the economic expansion triggered by the program peaks 15 months after the disaster, and that from this point onward municipalities without access to Fonden begin to catch-up. Consistent with the previous findings, the paper additionally documents a large and sustained increase in the growth of construction employment

> 1A municipality is a second level administrative unit in Mexico. There are currently 2461 municipalities.

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