# **1 Introduction**

From an economic perspective, a natural disaster can be defined as a natural event that causes a perturbation to the functioning of the economic system, with a significant negative impact on assets, production factors, output, employment, or consumption. There are multiple formal definitions. The Center for Research on the Epidemiology of Disasters (CRED) at the Catholic University of Louvain defines a disaster as a natural situation or event which overwhelms local capacity and/or necessitates a request for external assistance.<sup>3</sup> When it happens, however, the perturbation affects the economic system in a way that goes beyond the loss of assets and the monetary expenditures to replace damaged property. Additional consequences include the loss of output and production, rationing in some sectors, loss of employment and tax revenues, etc.

Even though the most immediate consequences of natural disasters are obviously the fatalities and casualties they cause, the economic consequences need to be accounted for to assess the disaster impact on the population’s well‐being and welfare.

This paper discusses the economic consequences of natural disasters. It summarizes the most important mechanisms that determine the cost of disaster, and explains why the direct economic cost, i.e. the value of what has been damaged or destroyed by the disaster, is not a sufficient indicator of disaster seriousness and why estimating indirect losses is crucial. Then, it discusses the methodologies and the models that are able to measure indirect losses and proposes a simple rule of thumb to take them into account when time and resources do not allow for a full modeling exercise. Finally, the paper discusses the tools that are available to increase the resilience of the economic system, i.e. to make it better able to recover and reconstruct and to reduce the indirect consequences of disasters.

Throughout this paper, boxes will present an application of the methodologies on one case study conducted in an OECD project, on flood risk in Mumbai.<sup>4</sup> The study investigates the vulnerability to heavy precipitations of the city of Mumbai, a rapidly‐growing coastal city in a developing country. The complete study is available in (Ranger et al., 2011), and a longer version with a survey of the slum dwellers affected during the 2005 floods in Mumbai is in (Hallegatte et al., 2010).

# **2 The economic cost of a disaster**

## **2.1 Defining the economic cost of extreme events**

Defining the economic cost of a disaster poses different theoretical and practical challenges. After each large‐scale disaster, media, insurance companies and international institutions publish numerous assessments of the “cost of the disaster.” These various assessments are based on different

> 3 For a disaster to be listed in the EM‐DAT database, at least one of the following criteria should be met: (i) 10 or more people are reported killed; (ii) 100 people are reported affected; (iii) a state of emergency is declared; (iv) a call for international assistance is issued.

> 4 The study was carried out by a consortium including the OECD, Risk Management Solutions, CIRED, Météo‐France, NATCOM PMC, and the Indian Institute for Technology Bombay at Mumbai, and published in Ranger et al. (2011).

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