metadata: authors: 0: author: Dieppe,Alistair Matthew
1: author: Kilic Celik,Sinem
2: author: Okou,Cedric Iltis Finafa
count: World
docna: 0: docna: Implications of Major Adverse Events on Productivity
docty: Policy Research Working Paper
subtopic: Armed Conflict,Natural Disasters,Labor Markets,Public Health Promotion
teratopic: Conflict and Development,Environment,Social Protections and Labor,Health, Nutrition and Population
abstracts: cdata!: Since 2000, there have been three major
            global slowdowns, with the latest and most pronounced
            episode triggered by the COVID-19 pandemic. At the same
            time, many countries have faced major adverse events
            including natural disasters, wars, and financial crises, all
            of which can lead to long-lasting harm to productivity. Wars
            inflict particularly severe damage to productivity, while
            financial crises also lead to substantial losses, especially
            accompanied by a rapid build-up of debt. The greater
            frequency of natural disasters, especially climate
            disasters, means that they have the largest aggregate impact
            on productivity, as natural disasters have occurred most
            often and their frequency has doubled since 2000. Global
            adverse events can have large sustained negative effects on
            productivity through dislocating labor, tightening of
            credit, disrupting value chains, and decreasing innovation.
            Policies to counter the negative consequences of adverse
            shocks include accommodative fiscal policies, such as
            reconstruction spending on resilient infrastructure;
            transparent governance; efficient use of relief funds; as
            well as growth-friendly structural reforms. Appropriate
            policies and regulations concerning finance, construction,
            and environmental protection can help reduce the frequency
            of adverse shocks.
repnme: repnme: Implications of Major Adverse Events on Productivity
display_title: Implications of Major Adverse Events
            on Productivity
listing_relative_url: /research/2020/09/32424569/implications-major-adverse-events-productivity
topicv3: Political Violence and War m1327310 2462,Pandemics m1327520 2167,Natural Disaster m1503325 3138,Labor Productivity m1504060 2756,Coronavirus (COVID-19) m1939478 4828
publishtoextweb_dt: 2020-09-22T00:00:00Z
historic_topic: Conflict and Development,Environment,Social Protections and Labor,Health, Nutrition and Population
origu: EFI - Prospects Group (EPGDR)
no_of_pages: 44
author_keys: 0: author_key: 1674011
1: author_key: 1502855
2: author_key: 1670071
model_extractions: Policy Research Working Paper 9411 Implications of Major Adverse Events on Productivity _Alistair Dieppe Sinem Kilic Celik Cedric Okou_ Prospects Group September 2020
Policy Research Working Paper 9411

# **Abstract**

Since 2000, there have been three major global slowdowns, with the latest and most pronounced episode triggered by the COVID-19 pandemic. At the same time, many countries have faced major adverse events including natural disasters, wars, and financial crises, all of which can lead to long-lasting harm to productivity. Wars inflict particularly severe damage to productivity, while financial crises also lead to substantial losses, especially accompanied by a rapid build-up of debt. The greater frequency of natural disasters, especially climate disasters, means that they have the largest aggregate impact on productivity, as natural disasters have occurred most often and their frequency has doubled since 2000. Global adverse events can have large sustained negative effects on productivity through dislocating labor, tightening of credit, disrupting value chains, and decreasing innovation. Policies to counter the negative consequences of adverse shocks include accommodative fiscal policies, such as reconstruction spending on resilient infrastructure; transparent governance; efficient use of relief funds; as well as growth-friendly structural reforms. Appropriate policies and regulations concerning finance, construction, and environmental protection can help reduce the frequency of adverse shocks.

This paper is a product of the Prospects Group. It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world. Policy Research Working Papers are also posted on the Web at http://www.worldbank.org/prwp. The authors may be contacted at alistair.dieppe@ecb.europa.eu, skiliccelik@worldbank.org, and cokou@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
of Adverse Events on Implications Major Productivity<sup>_∗_</sup> Alistair Dieppe,<sup>_†_</sup> Sinem Kilic Celik _‡_ , and Cedric Okou<sup>_§_</sup>

**Keywords** : Productivity, local projections, disasters. **JEL classification** : C1, E3, O44, O47

> _∗_ This paper is based on Chapter 2 of the book Global Productivity: Trends, Drivers and Policies, edited by Alistair Dieppe, published by the World Bank. We are indebted to Ayhan Kose, Franziska Ohnsorge, Carlos Arteta, St ́ephane Hallegatte, Davide Furceri, Chris Papageorgiou, Annabelle Mourougane, Christopher Towe, Kevin Clinton, Graham Hacche, Markus Eberhardt and Peter Nagle for helpful discussions. We thank Xinyue Wang, Yi Li and Xi Zhang for excellent research assistance. We gratefully acknowledge financial support from the PHRD fund. This work was undertaken when Alistair Dieppe was at the World Bank. The paper reflects the views of the authors and should not be attributed to the institutions to which the authors are associated.

> _†_ ECB alistair.dieppe@ecb.europa.eu

> _‡_ World Bank skiliccelik@worldbank.org

> _§_ World Bank cokou@worldbank.org
# **Contents**

|**1**<br>**Intr**|**oduction**|**2**|
|---|---|---|
|**2**<br>**Adv**|**erse events: Literature and stylized facts**|**5**|
|2.1|Natural disasters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .|. . . .<br>6|
||2.1.1<br>Transmission channels of natural disaster shock to productivity . . . .|. . . .<br>6|
||2.1.2<br>Stylized facts for natural disasters<br>. . . . . . . . . . . . . . . . . . . .|. . . .<br>7|
|2.2|Wars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .|. . . .<br>9|
||2.2.1<br>Transmission channels of war shock to productivity. . . . . . . . . . .|. . . .<br>10|
||2.2.2<br>Stylized facts for wars . . . . . . . . . . . . . . . . . . . . . . . . . . .|. . . .<br>10|
|2.3|Financial crises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .|. . . .<br>11|
||2.3.1<br>Transmission channels of fnancial crisis shock to productivity . . . . .|. . . .<br>12|
||2.3.2<br>Stylized facts for fnancial crises<br>. . . . . . . . . . . . . . . . . . . . .|. . . .<br>13|
|2.4|Comparing across types of adverse events<br>. . . . . . . . . . . . . . . . . . . .|. . . .<br>13|
|**3**<br>**Em**|**pirical strategy**|**15**|
|3.1|Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .|. . . .<br>15|
|3.2|Methodology<br>. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .|. . . .<br>16|
|**4**<br>**Res**|**ults**|**17**|
|4.1|Impacts of natural disasters . . . . . . . . . . . . . . . . . . . . . . . . . . . .|. . . .<br>17|
|4.2|Impacts of wars . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .|. . . .<br>20|
|4.3|Impacts of fnancial crises . . . . . . . . . . . . . . . . . . . . . . . . . . . . .|. . . .<br>21|
||4.3.1<br>Comparison across types of events<br>. . . . . . . . . . . . . . . . . . . .|. . . .<br>22|
||4.3.2<br>Severe adverse events<br>. . . . . . . . . . . . . . . . . . . . . . . . . . .|. . . .<br>23|
||4.3.3<br>Global adverse events<br>. . . . . . . . . . . . . . . . . . . . . . . . . . .|. . . .<br>24|
|**5**<br>**Wh**|**at policies can mitigate the efects of adverse events?**|**24**|
|**6**<br>**Con**|**clusions**|**27**|
|**A Dat**|**a, sources and defnitions**|**29**|
|**B Rob**|**ustness**|**32**|

1
# **1 Introduction**

The aftermath of the 2007-09 global financial crisis (GFC) witnessed a broad-based slowdown in labor productivity growth lasting over a decade. This follows a typical pattern associated with adverse events such as natural disasters, wars and financial crises. These events often result in protracted economic losses through declines in both the level and growth rate of output, as well as persistent losses in labor productivity, measured as output per worker.<sup>1</sup> Among natural disasters, the COVID-19 pandemic—a major epidemiological disaster—is an adverse event on a massive global scale, and could have a large and persistent impact on global productivity.

The damage from adverse events comes through a variety of channels. Natural disasters and wars may damage key infrastructure and disrupt value chains (Acevedo et al., 2018; Cerra and Saxena, 2008). Financial crises increase uncertainty, damage confidence, impede access to finance, and lower corporate earnings—all developments that are likely to reduce investment. More generally, adverse events can dampen labor productivity by causing a loss of skills, and reducing the efficiency of job matching, as well as by disrupting knowledge creation, transfer, and acquisition. The growth of labor productivity is therefore likely to be impeded by declines in both the growth of total factor productivity (TFP) and capital deepening.<sup>2</sup> Severe global biological disasters such as COVID-19 can damage labor productivity by affecting both supply and demand. Adverse supply-side effects can occur through the depletion of labor force; the tightening of financial conditions; and the disruption of supply chains, which are an important measure for the diffusion of innovation. The COVID-19 pandemic is also weighing sharply on aggregate demand, by depressing consumer demand for goods and services, eroding business confidence and investment, and raising financial costs (Baker et al., 2020; Ludvigson et al., 2020; Ma et al., 2020). Weaker aggregate demand can reduce the incentive for product innovation, quality improvement, slow technological progress and lower productivity. Furthermore, these negative impacts can be amplified by other factors such as cross-border spillovers, lingering financial vulnerabilities and the compounding effects of recessions. An analysis of economic developments around previous, smaller-scale epidemiological disasters can provide a framework for understanding the channels through which productivity could be affected by COVID-19, and the potential persistence of its effects (Dieppe, 2020).

The productivity losses that result from adverse events in emerging markets and developing economies (EMDEs) can reduce the rate of convergence to the advanced economy technology frontier. However, the effects of adverse events on labor productivity and output hinge not only on their magnitude, duration, and frequency, but also on country characteristics and circumstances, including the policy response and the pre-shock buffers established by policy makers. Large-scale

> 1See Blanchard et al. (2015); Cerra and Saxena (2017); Furceri and Mourougane (2012b); Hall (2014); Jord`a et al. (2013); Kilic Celik et al. (2019); Ray and Esteban (2017).

> 2TFP growth captures growth in production not explained by increases in factor inputs (essentially capital and labor). Under a standard growth accounting decomposition, which relies on a number of special assumptions, TFP growth may be computed as a residual of labor productivity growth after deduction of the estimated contribution of the growth of capital per unit of labor (capital deepening). Labor productivity growth is prone to measurement issues, especially in countries where services, government or informal sectors account for large shares of the economy, but estimates of TFP growth depend additionally on a number of special assumptions, including that factors of production (labor and capital) are paid their marginal products, presumably under conditions of perfect competition and constant returns to scale (See Annex B).

2
and severe disasters are typically more damaging to labor productivity and output. Low-income countries (LICs) and countries that are already affected by fragile and conflict-affected situations (FCS) have generally been less able than other countries to cope with wars and climate disasters such as droughts. If sufficiently severe, natural disaster can trigger financial crises—particularly in countries with high levels of debt—or lead to conflicts and wars. Policies should be geared toward both reducing the likelihood of adverse shocks and alleviating their impacts. Depending on available policy space, countercyclical macroeconomic policies can help counter negative effects on investment, and labor markets. Successful examples include the fiscal and monetary stimulus undertaken after the GFC, and the COVID-19 pandemic in 2020 by many advanced economies and EMDEs and the international assistance provided for reconstruction in the aftermath of recent natural disasters in some FCS countries.<sup>3</sup> Structural policy frameworks—such as the quality of governance and business climates—can facilitate faster adjustment, protect vulnerable groups, and mitigate long-lasting damage to productivity.

This paper examines a wide range of adverse events to assess the extent to which they have had protracted effects on labor productivity and TFP. This study aims to shed light on the following questions:

- How frequently and through what channels have adverse events affected productivity?

- How have adverse events differed in the scale of their impact on productivity?

- What policies can help to mitigate the impact of adverse events on productivity?

This paper makes several contributions to an expanding literature on the impact on productivity of adverse events.

**Systematic cross-country evaluation of adverse events on productivity.** This paper is the first to undertake a systematic study of the effects of a broad range of adverse events—natural disasters, wars, and financial crises—on alternative productivity measures across a wide range of advanced economies, EMDEs, and LICs.

**Comprehensive explorations of persistent effects on productivity.** One key aspect of the effects of adverse events on productivity is their persistence. Several studies have documented protracted losses in output or productivity following business cycle downturns, recessions or financial crises.<sup>4</sup> This paper builds on and broadens previous work (Easterly et al., 1993; Mourougane, 2017), by assessing the channels, the magnitude of the losses, and the speed of recovery across a wide range of different types of adverse events.

**Comprehensive discussion of supportive policy framework.** This study analyzes feasible policies to mitigate the corrosive effects of negative shocks. It discusses the role of structural policies and reforms that can support productivity following adverse shocks. It also highlights the importance of fiscal space in building a cushion that can be used to counter productivity loss in a country hit by adverse events.

> 3The effectiveness of such assistance depends on the government’s ability to efficiently spend the relief money where it is needed. Designing and deploying a disaster-response infrastructure with well-defined rules and procedures before disasters hit improves resilience and boosts the effectiveness of reconstruction efforts (Hallegatte and Rentschler, 2018).

> 4See Blanchard et al. (2015); Cerra and Saxena (2008); Hall (2014).

3
**Main findings.** The estimated results, broadly consistent with the literature, include the following:

- **Natural disasters have occurred more often than wars or financial crises and their frequency has increased since 2000.** Natural disasters can be subdivided into several distinct types: climate disasters such as floods and cyclones, biological disasters such as epidemics or insect infestations, and geophysical disasters such as earthquakes and volcanoes. In the period 1960-2018, the number of episodes of natural disasters was 25 times that of wars and 12 times that of financial crises. Climate-related events were the most frequent type of natural disaster, with a doubling of their frequency after 2000. LICs, and particularly SubSaharan Africa (SSA), were most affected by natural disasters. Biological and geophysical episodes are less frequent and are often more geographically contained.<sup>5</sup>

- **Severe disasters have lasting effects on productivity.** While wars inflict particularly severe and long-lasting damage to both capital and total factor productivity, the high frequency of climate disasters increases their importance as a source of damage to productivity. On average during 1960-2018, climate disasters reduced annual contemporaneous labor productivity by about 0.5 percent—about one-fifth of the impact of a typical war episode. However, climate disasters have occurred 25 times as frequently as wars, meaning their cumulative negative effects on productivity are larger. Moreover, while the frequency of severe natural disasters has stabilized since 2000, they have strong negative effects on productivity. After three years, severe climate disasters lower labor productivity by about 7 percent, mainly through weakened total factor productivity. Severe disasters can also trigger other types of adverse events such as financial crises and wars, thus compounding the corrosive effects on productivity.

- **Productivity is highly vulnerable to financial stress, especially when accompanied by a rapid build-up of debt.** Financial crises weigh heavily on productivity growth through a wide range of channels. During debt accumulation episodes associated with financial crises, cumulative productivity gains three years into the episode were 2 percentage points lower than in episodes without crises in EMDEs. The rapid build-up of debt in EMDEs since the GFC increases vulnerabilities to financial crises and limits the ability of countries to cope with other types of adverse events. The current COVID-19 is likely to exacerbate those vulnerabilities by further stretching public and private balance sheets.

- **Appropriate policies can help to prevent and to mitigate the effects of adverse events.** A rapid policy response to adverse events, including countercyclical macroeconomic policies and reconstruction spending when appropriate, can help to mitigate the negative effects on productivity. Improving institutions and the business climate can also help increase the pace of recovery following an adverse event. Appropriate policies and regulations with respect to finance, construction, and environmental protection can help reduce the frequency of adverse events. Fiscal space allows economies to fund recovery efforts after natural disasters, and sound fiscal policies tend to limit the likelihood of a financial crisis. Fiscal stimulus also helps cushion the severity of large adverse events such as severe biological disasters.

> 5The coronavirus epidemic is one of the very rare pandemics which has affected almost every country and region. This might be a signal of future pandemics with increasing international mobility of people (Jord`a et al., 2020).

4
<!-- Start of picture text --> Number of episodes<br>150 = Natural disasters<br>= = Wars<br>= Financial crises<br>100<br>50<br>0<br>1960-79 1980-99 2000-18 1960-2018<br><!-- End of picture text --> <!-- Start of picture text --> Years .<br>6 m= Mean Median<br>5<br>4<br>3<br>2<br>1<br>0<br>Natural disasters Financial crises Wars<br><!-- End of picture text -->
# **2.1 Natural disasters**

Three types of natural disasters are considered: climate events (such as storms, floods, droughts, and periods of extreme temperature), biological events (such as epidemics and insect infestations), and geophysical events (such as earthquakes and volcanoes). Natural disasters, unlike financial crises, are typically measured in terms of the number of deaths and casualties, the number of people otherwise affected, and property damage.<sup>7</sup>

## **2.1.1 Transmission channels of natural disaster shock to productivity**

Natural disasters can affect productivity through various channels:

- **Erosion of human capital.** The human cost of natural disasters can be substantial. They often lead to many fatalities and large population displacements. They also tend to degrade hygiene conditions in affected areas, increase the risk of large-scale outbreaks of infectious diseases and epidemics, and aggravate health challenges. In the case of a global pandemic such as COVID-19, the disruption of labor supply is exacerbated by containment measures that make it difficult for workers to get to their places of employment or work in close physical proximity with each other. Moreover, prolonged natural disasters can disrupt schooling, undermine learning conditions, and erode human capital through degraded work environments, sickness, etc. (Acevedo et al., 2018).

- **Destruction and misallocation of physical capital.** Natural disasters can destroy critical physical assets, damage major infrastructures, cut supply lines, and discourage private investment (Kunreuther, 2006). For the period 2000-12, the annual cost of natural disasters worldwide has been estimated to have been in excess of $100 billion (Kousky, 2014).<sup>8</sup> Moreover, major pandemics such as the COVID-19 hinder capital accumulation due to a substantial increase in uncertainty (World Bank, 2020). Natural disasters tend to reduce and degrade the capital stock, and can lead to a misallocation of the residual capital, since undamaged roads or offices (residual capital) often cannot be readily used in the way they had been, or used to replace or repair other damaged assets such as bridges or factories. This misallocation of capital weighs on labor productivity (Hallegatte and Vogt-Schilb, 2019).

- **Disruption of innovation.** Beyond the immediate loss of lives and damage to physical assets, natural disasters can lead to delayed or canceled investments in new technologies. The disruption of global value chains can also impede the creation, transfer, and adoption of new technologies (Asian Development Bank, 2019; Bloom et al., 2010). This was exemplified by the containment measures of the COVID-19 that have limited mobility, compressed trade and to some extent restricted the diffusion of innovation. Conversely, effective reconstruction efforts can boost investment and enhance productivity via upgraded capital, health improvements

> 7The number of people affected (excluding those killed) is usually considered to be the sum of people injured, made homeless, and otherwise requiring immediate assistance. Property damage includes damage to crops and livestock as well as real estate ( **Annex A** ).

> 8In assessing the economic cost of a disaster, it is important to avoid double-counting losses: the value of the damaged machine and the subsequent lost production should not both be counted as a loss.

6
# and widespread use of new technologies.<sup>9</sup>

In addition to supply effects, due to the many unknowns, epidemics and pandemics can weigh on productivity through demand-side channels, by raising uncertainty, eroding consumer and business confidence, weakening investment and depressing demand (Dieppe, 2020).

Table 1: Number of episodes by type of events

||AEs|EMDEs|LICs|World|
|---|---|---|---|---|
|**Natural disasters**|**1031**|**4699**|**1098**|**5730**|
|Climate disaster|843|3054|651|3897|
|Biological disaster|50|953|369|1003|
|Geophysical disaster|138|692|78|830|
|**Wars**|**45**|**191**|**55**|**236**|
|Intra-state war|45|191|55|236|
|External war|45|68|9|113|
|**Financial crises**|**54**|**390**|**83**|**444**|
|Banking crisis|34|113|27|147|
|Currency crisis|18|208|44|226|
|Sovereign debt crisis|2|69|12|71|

Note: Natural disasters include climate, biological, and geophysical disasters (EM-DAT). Wars include intra-state and external (extra-state and inter-state) wars (COW and PRIO). Financial crises include banking crisis, currency crisis, and sovereign debt crisis (Leaven and Valencia 2018). Sample is restricted to the observations where labor productivity growth data exist for the period 19602018. For each country-year pair, the episode dummy of a specific type of event is 1 if the event occurs at least once ( _≥_ 1), 0 otherwise. The total number of episodes (in bold) for each group of events (all financials, all disasters, all wars) may include events that occur simultaneously. The events are defined in **Annex A** . AEs = advanced economies, EMDEs = emerging markets and developing economies (including low income countries), LICs = low income countries.

# **2.1.2 Stylized facts for natural disasters**

**Increase in frequency of climate and other natural disasters.** Climate disasters accounted for around 70 percent of natural disasters during 1960-2018, occurring twice as often as biological and geophysical disasters combined ( **Figure 2** ). From 1960-79 to 2000-18, there was a large increase in the number of natural disaster episodes.<sup>10</sup> Increases occurred in all three categories, but most

> 9The overall impact of a natural disaster depends partly on initial economic conditions. A disaster may be more economically damaging in periods of high employment and capacity utilization because the increase in output needed for reconstruction may not be feasible, and the increase in demand generated may induce inflation. By contrast, a disaster that occurs when the economy is depressed may cause less economic damage as the stimulus effect of reconstruction will activate unused resources (Cuaresma et al., 2008; Hallegatte and Vogt-Schilb, 2019; Skidmore and Toya, 2002).

> 10To some degree, the increase in the number of recorded events may reflect improved measurement of natural disasters, particularly for small events.

7
markedly in climate disasters, the frequency of which tripled between 1960-79 and 2000-18.<sup>11</sup> Over 2000-18, natural disasters affected some 200 million people, costing on average more than 60,000 lives each year (Ritchie and Roser, 2020). In 2000-18, the average number of climate disaster episodes per year doubled relative to 1980-99, while the frequency of biological and geophysical disaster episodes increased by 40 and 10 percent respectively ( **Figure 2** ). Also in 2000-18, a natural disaster was 80 percent more likely to occur in LICs, and 35 percent more likely to occur in EMDEs, than in advanced economies.

**Pandemics.** Global pandemics such as the COVID-19 (2019-20) are rare events. There were only a few pandemics in the 20<sup>_th_</sup> century including the Spanish flu (1918-19), Asian flu (1957-58), Hong Kong flu (1968-69), HIV/AIDS (1980s). Since 2000, the major epidemics were SARS (2002-03), swine flu (2009-10), MERS (2012), Ebola (2014-15), Zika (2015-16), which affected over 115 EMDEs and advanced economies (Dieppe, 2020). The COVID-19 (2019-20) outbreak has affected virtually all countries around the world and led to a sudden stop of the global economy.

**Regional distribution.** SSA seems to be more exposed to natural disasters than other EMDE regions. In both 1980-99 and 2000-18, SSA had the highest frequency of natural disasters among EMDE regions. And in 2000-18, SSA experienced the largest increase in the frequency of natural disaster episodes relative to 1980-99. EAP and LAC were hit by at least 20 natural disaster episodes per year over 2000-18 ( **Figure 2** ). While climate events were relatively more frequent in East Asia and Pacific (EAP), Latin America and Caribbean (LAC), and SSA, historically, the largest number of biological disasters such as epidemic outbreaks occurred in SSA. The region least frequently affected by natural disasters was Middle East and North Africa (MNA).<sup>12</sup>

> 11Climate disasters refer to extreme weather events. Exposure to an adverse weather event will depend on the size of the population and total asset value located in at-risk areas. Vulnerabilities materialize when weather events hit exposed populations and assets, leading to economic losses (Cavallo and Noy, 2011; Costanza and Farley, 2007).

> 12Regions with large geographical areas can be exposed to more natural disasters than regions with small geographical areas.

8
<!-- Start of picture text --> Number of episodes<br>100 = Climate disaster<br>80 == BiologicalGeophysicaldisasterdisaster<br>60<br>40<br>20<br>0<br>1960-1979 1980-1999 2000-2018<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes TM 1960-1979<br>10 = 1980-1999<br>8 = 2000-2018<br>6<br>4<br>2<br>0<br>Climate Biological Geophysical<br><!-- End of picture text --> <!-- Start of picture text --> Percent of total<br>400 mEAP mECA @LAC &MNA @&SAR &SSA<br>75<br>50<br>25<br>0<br>1962 1970 1978 1986 1994 2002 2010 2018<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes<br>1.2 m Advanced economies<br>1.0 =m EMDEs<br>a LICs<br>oe<br>,<br>0.6<br>0.4<br>0.2<br>0.0<br>1960-1979 1980-1999 2000-2018<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes TM 1960-1979<br>1.5 =TM 1980-1999<br>= 2000-2018<br>1.0<br>0.5<br>0.0<br>Climate Biological Geophysical<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes = 1960-1979<br>40 = 1980-1999<br>= 2000-2018<br>30<br>20<br>10<br>0<br>EAP ECA LAC MNA_ SAR _ SSA<br><!-- End of picture text -->
state wars).<sup>13</sup> The destruction, disruption, and diversion effects of wars can cause sharp reductions in the labor force and physical capital, and dampen productive investment and innovation.<sup>14</sup>

# **2.2.1 Transmission channels of war shock to productivity**

- **Reduced and disrupted labor forces.** Conflict-related losses of lives, coupled with population displacements, dampen output directly and disrupt the functioning of labor markets (Field, 2019).<sup>15</sup> Worldwide, about 68.5 million people—or 1 percent of the world’s population—were in forcibly displaced situations in 2017 due to conflicts.<sup>16</sup> Moreover, many displaced persons are relatively well educated and skilled.

- **Weakened capital deepening.** Violent conflict destroys physical assets, holds back productive investment, provokes capital flight, and causes capital and finance to be diverted to less productive uses, including expenditure on armaments (Hutchinson and Margo, 2006). Wars have been estimated to have lowered the ratio of investment to GDP in Eastern Europe by about 5 percent over 1986-90 (Knight et al., 1996).

- **Hindered innovation.** Wars can have adverse effects on innovation and the adoption of technology.<sup>17</sup> They can lead to large-scale institutional disfunction, weakening of property rights, and sharp reductions in R&D investment, and they can also impede global value chains. All these effects can slow technological progress (Reynaerts and Vanschoonbeek, 2018; Rodrik, 1999). Wars can be particularly pernicious in LICs and FCV countries, partly because of their weak R&D capacity.

# **2.2.2 Stylized facts for wars**

**Intra-state wars in EMDEs, external wars in advanced economies.** Between 1980-99 and 2000-18, the number of intra-state and external wars fell by almost 70 percent and 25 percent, respectively ( **Figure 3** ). EMDEs and LICs were mainly hit by intra-state conflicts, whereas advanced economies mainly experienced external wars ( **Table 1** ). A typical LIC was twice as likely to experience any kind of conflict as a typical EMDE. In 2000-18, the frequency of wars dropped in all regions. In 1960-2018, intra-state armed conflicts mainly occurred in SSA, whereas external wars mainly occurred in EAP and MNA.

> 13Intra-state wars are conducted between a state and a group within its borders. Extra-state wars take place between a system member and a non-state entity (not a system member). Inter-state wars are conducted between members of the interstate system.

> 14See Easterly et al. (1993); Field (2008); Raddatz (2007); Rodrik (1999).

> 15For instance, during the 2007 post-election violence in Kenya, the labor force in the affected areas was reduced by as much as half owing to deaths, injuries, and lack of security for workers, and as a result wages rose by 70 percent (Ksoll et al., 2010).

> 16United Nations High Commissioner for Refugees (2018).

> 17In some cases, such as the Manhattan project undertaken during World War II, conflicts can stimulate innovation and R&D.

10
<!-- Start of picture text --> Number of episodes a Intra wars<br>3 = External wars<br>2<br>1<br>0<br>1960-1979 1980-1999 2000-2018<br><!-- End of picture text --> <!-- Start of picture text --> Percent of total<br>100 m=SSA mSAR =MNA ®LAC SECA ®EAP<br>80<br>60<br>40<br>20<br>9<br>Intra wars External wars<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes<br>0.06 m Advanced economies<br>= EMDEs<br>0.04 mesLIC:<br>0.02<br>0.00<br>1960-1979 1980-1999 2000-2018<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes = 1960-1979<br>15 = 1980-1999<br>= 2000-2018<br>1.0<br>0.5<br>0.0<br>EAP ECA LAC MNA SAR SSA<br><!-- End of picture text -->
# **2.3.1 Transmission channels of financial crisis shock to productivity**

**Sovereign debt crises.** These can be particularly detrimental to output and productivity. They generally originate from the excessive accumulation of government debt. Before a crisis occurs, higher government debt tends to increase the burden of interest payments in the government budget, and to raise borrowing costs, which may crowd out private investment (Kose et al., 2020; Oulton and Sebasti ́a-Barriel, 2017; Reinhart and Rogoff, 2010). Excessive growth of government debt erodes the country’s ability to borrow, degrades private as well as public creditworthiness, and often leads to a curtailment of credit from institutional investors (Aguiar and Gopinath, 2006; Arellano, 2008). Elevated government debt can affect productivity growth via several channels:

- **Increased probability of financial crises.** Rising government debt will increase the risk of a financial crisis when it raises doubts about its sustainability. One of the ways this may occur is that higher debt may lead governments to adopt lower-cost but higher-risk debt management practices, including issuing debt with shorter maturities or denominated in foreign currency (Kalemli-Ozcan et al., 2018). Such practices can sharply raise risk premia on government debt, increasing borrowing costs and the risk of crisis (Arellano, 2008). Moreover, high sovereign debt constrains the ability of governments to exercise counter-cyclical fiscal policy (Eberhardt and Presbitero, 2015). Given the close interconnectedness between sovereign, banking, and foreign exchange sectors, sovereign debt crises can precipitate (or be caused by) banking and currency crises, compounding the damage to output and productivity.<sup>19</sup>

- **Misallocation of resources.** If used to fund productive investments with high rates of return, debt can have positive effects on productivity and growth. However, debt accumulation can impede productivity if it is associated with a misallocation of resources towards projects that yield only short-term returns or purely political gains.<sup>20</sup> Such misallocation is more likely if projects are being funded on unrealistic, possibly politically biased, expectations of rapid future growth (Claessens et al., 1997; Claessens and Kose, 2017, 2018).

- **Policy uncertainty.** High government debt can increase uncertainty about prospects for economic growth (Kose et al., 2020). For investors, the fear may be that high debt could eventually compel the government to hike taxes (including taxes on future investment returns), curtail growth-enhancing spending, crowd out productive investment (debt overhangs), or delay reforms that could support innovation and productivity growth.<sup>21</sup>

**Banking and currency crises.** Other types of financial crises, including systemic banking crises and currency crises, can also do lasting damage to productivity<sup>22</sup> The disruptions to financial intermediation that occur in banking crises impede investment, curb the funding of productivityenhancing technologies and typically trigger recessions (De Ridder, 2017). In periods of protracted economic weakness, prolonged and elevated unemployment erodes human capital.<sup>23</sup> Because of

> 19See Aghion et al. (2000, 2009); Kalemli-Ozcan et al. (2018); Morris and Shin (1998).

> 20See Checherita-Westphal and Rother (2012).

> 21With regard to private sector debt, at the firm level, a large outstanding debt stock can weigh on investment and, hence, the productivity that technology embedded in this investment can generate (De Ridder, 2017). At the government level, debt service on high debt may crowd out other productivity-enhancing spending, including for education, health or infrastructure (Kose and Ohnsorge, 2019).

> 22See Blanchard et al. (2015); Cerra and Saxena (2017); Oulton and Sebasti ́a-Barriel (2017).

> 23Blanchard and Wolfers (2000); Furceri and Mourougane (2012a); Hall (2014).

12
their shorter duration, currency crises are typically less harmful to productivity than other financial crises (Cerra and Saxena, 2008).

## **2.3.2 Stylized facts for financial crises**

**Productivity losses during rapid debt accumulation episodes.** Long-term productivity gains during rapid debt accumulation episodes have been considerably lower when these debt accumulation episodes were accompanied by financial crises. In a debt accumulation episode preceding a crisis, the cumulative growth rate of median productivity three years into the episode was 3 percent ( **Figure 4** ). This is statistically significantly less than the median increase during a debt accumulation episode that was not associated with a crisis (5 percent). The difference may be interpreted as a measure of the short-term damage to productivity from financial crises.

# **2.4 Comparing across types of adverse events**

**Climate disasters are the most frequent.** Globally, natural disasters accounted for more than 90 percent of the recorded adverse events in 1960-2018 ( **Table 1** ). Over this entire sample, natural disaster episodes were about 25 times more frequent than wars despite the decline in natural disasters over the last 10 years ( **Figure 1, 5** ). Financial crises occurred twice as frequently as wars ( **Figure 5** ).

**Wars are typically protracted.** The average duration of wars was almost six years. Nearly half of financial crises last for more than two years. Natural disasters are typically much more shortlived ( **Figure 5** ). Some climate disasters last for just a few days while others, such as droughts, can last for several months. The cumulative loss of productivity can be larger if the adverse events last for a more extended period of time or if reconstruction efforts are delayed (Cerra and Saxena, 2008).<sup>24</sup>

> 24 Reconstruction pace may be slowed by financial, physical and transaction constraints (Hallegatte and Rentschler, 2018).

13
<!-- Start of picture text --> Number of episodes = Banking crisis<br>8 = Currency crisis<br>= Debt crisis<br>6<br>4<br>2<br>0<br>1960-1979 1980-1999 2000-2018<br><!-- End of picture text --> <!-- Start of picture text --> Percent of total<br>mEAP mECA @LAC =MNA @&SAR &SSA<br>100<br>80<br>60<br>20<br>0<br>Banking Currency Debt<br>Percent of episodes<br>60<br>40<br>20<br>0<br>All Banking Currency Debt<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes<br>= Advanced economies<br>0.12 = EMDEs<br>=LICs<br>0.08<br>0.04<br>0.00<br>1960-1979 1980-1999 2000-2018<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes TM 1960-1979<br>6 TM 1980-1999<br>5 = 2000-2018<br>4<br>3<br>1<br>)<br>EAP ECA LAC. MNA_ SAR _ SSA<br><!-- End of picture text --> <!-- Start of picture text --> Index, t=100<br>108 = Not associated with crisis<br>= Associated with crisis<br>106<br>104<br>“<br>102 *<br>100<br>t+1 t+3<br><!-- End of picture text -->
<!-- Start of picture text --> Number of episodes<br>150 == Wars Natural disasters<br>= Financial crises<br>100<br>50<br>0<br>1960-79 1980-99 2000-18 1960-2018<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes TM 1960-1979<br>120 = 1980-1999<br>100 = 2000-2018<br>80<br>60<br>40<br>20<br>0<br>Natural disasters Wars Financial crises<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes = 1960-1979<br>= 1980-1999<br>30<br>= 2000-2018<br>20<br>10<br>0<br>Natural disasters Wars Financial crises<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes = Natural disasters<br>5 = Wars<br>4<br>3<br>2<br>1<br>0<br>1960-79 1980-99 2000-18 1960-2018<br><!-- End of picture text --> <!-- Start of picture text --> Number of episodes TM 1960-1979<br>25 TM 1980-1999<br>= 2000-2018<br>20<br>15<br>10<br>5<br>0<br>Natural disasters Wars Financial crises<br><!-- End of picture text --> <!-- Start of picture text --> Years mMean Median<br>6<br>5<br>4<br>3<br>2<br>1<br>0<br>Natural disasters Financial crises Wars<br><!-- End of picture text -->
geophysical (earthquakes, tsunamis, volcanoes) disasters. Wars include internal (intra-state) and external (inter- and extra-state) armed conflicts that are identified using the Correlates of War (COW) and Peace Research Institute Oslo (PRIO) databases. Financial crises include banking, currency and debt crises and are based on the Laeven and Valencia (2018) database. For additional details on the definition of the events and data, we refer the reader to **Annex A** .

# **3.2 Methodology**

To assess the effects of adverse events on productivity, the local projection method (LPM) is used, with country productivity level, measured as output per worker, as the dependent variables (Jord`a et al., 2013; Jord`a, 2005).<sup>25</sup> The LPM approach provides an estimate of the response of labor productivity (and TFP) to adverse events over various horizons. It also helps to identify key transmission channels, assess how countries’ resilience to adverse events has changed over time and analyze the role of policies in mitigating their effects. The advantage of this approach is that it avoids the problem of dimensionality inherent in other approaches such as vector autoregressions.<sup>26</sup> However, it does not directly take into account the severity of the adverse event.

The dependent variable is the cumulative change in labor productivity, TFP or output levels between horizons _t −_ 1 and _t_ + _h_ , measured as difference in the natural logarithms _yt,j_ . The explanatory variables include the event dummy and controls. For a specific type of event, the explanatory variable of interest is an episode which equals 1 if the event occurred at least once in a particular country in a year and 0 otherwise. The baseline model is given by where _h_ = 0 _,_ 1 _,_ 2 _, · · ·_ is the horizon, _α_ ( _h_ ) _,j_ and _τ_ ( _h_ ) _,t_ are country j and time fixed effects, and _u_ ( _h_ ) _t,j_ is an error term. The coefficient of interest _β_ ( _h_ ) captures the dynamic multiplier effect (impulse response) of the dependent variable with respect to the event dummy variable _Et,j_ . The number of lags for each variable is denoted by p and set to 1 for the estimation. The specification controls for (i) country-specific trends, (ii) lagged event dummies, (iii) future values of the event dummy between time _t_ and _t_ + _h −_ 1 to correct for possible forward bias (Teulings and Zubanov, 2014), and (iv) past changes ∆ _yt−s,j_ .

The event dummies are lagged to help attenuate the potential endogeneity bias caused by contemporaneous interactions between productivity (TFP or output) and crises. In some cases, weak productivity accompanied by a sharp decline in output can trigger financial crises and wars. To guard against such possible endogeneity or reverse causation between productivity and the event,

> 25Labor productivity is measured as output per worker, with the number of employees used as the unit of labor input. This has the advantage of wide availability across countries. Its disadvantage rests in the failure to account for the quality and intensity of labor input.

> 26Vector autoregressions approaches entail modeling and estimating a large number of time series, whereas LPM focuses on the dynamics of the variable of interest—productivity in this case.

16
lagged productivity is used as a control. The regressions are estimated separately for natural disasters, wars, and financial crises over 1960-2018. Additional controls for country-specific interactions and non-linear effects such as the presence of a positive fiscal space in a country are also included in alternative specifications.

# **4 Results**

This section analyzes the effects of natural disasters, wars and financial crises on both labor productivity and TFP.

## **4.1 Impacts of natural disasters**

Natural disasters can lead to significant contemporaneous losses in labor productivity in both advanced economies and EMDEs (Figure 6). The estimates indicate that immediately after a natural disaster, labor productivity tended to decline by 0.5 and 0.3 percent in advanced economies and EMDEs, respectively. These results are consistent with those found in the literature (Dell et al., 2012; Fomby et al., 2013; Str ̈omberg, 2007). As well as the destruction of the capital stock, which weakens labor productivity, natural disasters also adversely affect TFP (Skidmore and Toya, 2002). However, the magnitude of the estimated effect of natural disasters on TFP may be expected to be smaller than that on labor productivity, because of the effect on the latter of the loss of physical capital. Indeed, the estimates indicate that natural disasters led to a 0.3 percent decline in TFP in advanced economies, in the first year of the disaster, with no significant effect in EMDEs. This may reflect possible offsetting productivity gains resulting from investment by governments and firms in new and more technologically advanced capital—investment induced by the natural disaster—leading to improvements in both TFP and labor productivity (Hallegatte and Dumas, 2009; Skidmore and Toya, 2002).

**Climate disasters.** Among the different types of natural disasters, climate disasters have been particularly detrimental in terms of lost labor productivity. The estimates for both advanced economies and EMDEs indicate that climate disasters contemporaneously reduced labor productivity by about 0.5 percent and have persistent effects in both advanced economies and EMDEs. For EMDEs however, the estimated longer-term drag on productivity is smaller and subject to a wider margin of error. In fact, many previous studies have found that economies hit by climate disasters have been able to recover, especially after smaller-scale events (Hallegatte et al., 2007; Loayza et al., 2012).

17
<!-- Start of picture text --> Percent<br>0.4 m Labor productivity = TEP<br>0.2<br>0<br>-0.4<br>-0.6<br>-0.8<br>-1.0 World Advanced EMDEs<br>economics<br><!-- End of picture text --> <!-- Start of picture text --> Percent0<br>5<br>-10<br>-15 .<br>m Labor productivity<br>-20 = Total factor productivity<br>-25<br>t t+1 t+2 t+3<br><!-- End of picture text --> <!-- Start of picture text --> Percent .<br>1.0 m Advanced economics m= EMDEs<br>0.5<br>1.0<br>15<br>-2.0<br>-2.5<br>-3.0<br>t t+1 t+2 t+3<br><!-- End of picture text --> <!-- Start of picture text --> Percent15 mlnvestment Output<br>10<br>5<br>0<br>5<br>-10<br>-15<br>t t+1 t+2 t+3<br><!-- End of picture text -->
are mainly driven by uninsured losses, subsequent institutional instability, or regime changes.<sup>29</sup> This is supported by the analysis here, which suggests that larger shocks can have a positive effect on productivity in advanced economies, which likely benefit from better emergency response, more effective reconstruction plans, and deeper insurance markets (Annex A).

In the analysis here, severe climate disasters are defined as those that caused at least 100 deaths per one million inhabitants. The results support the intuition that severe climate disasters have larger and more persistent effects on productivity in EMDEs than less severe ones. Labor productivity fell initially by about 2 percent and more than 7 percent below baseline, three years after a severe climate disaster (Figure 6). The estimates show that lower labor productivity is mainly accounted for by weaker total factor productivity rather than reduced investment.<sup>30</sup> Possibly because after a severe disaster, firms delay or trim down RD spending, which impedes the creation, transfer, and adoption of new technologies, and hinders global value chains. On the other hand, overall investment may remain more resilient as reconstruction spending partly offsets some reduction in other types of capital spending.

The effects of biological and geophysical events are found to be not statistically significant. However, the estimates are for the average event, which could be localized or for other reasons affect only a limited number of people. Large biological or geophysical events may have large negative effects on productivity, including by constraining economic activity and human interaction, disrupting global value chains, and depressing demand, as exemplified by the COVID-19 outbreak. **Effects of epidemics.** Epidemics lead to large and lasting negative effects on labor productivity.<sup>31</sup> There were five epidemics during the period 2000-2018: SARS (2002-03), Swine flu (2009), MERS (2012), Ebola (2014-15), and Zika (2015-16). These four major epidemics, excluding the Swine flu since it coincides with global financial crisis to avoid compounding effects, lowered labor productivity initially by 1 percent, and by 4 percent cumulatively after three years (Dieppe, 2020). These severe epidemics seem to adversely affect labor productivity primarily through investment, which declined by 9 percent after three years due increased uncertainty.

**Cascade effects.** Natural disasters can trigger other types of adverse events such as debt crises and wars, thus compounding the effects on productivity. Studies show that countries hit by major disasters can experience a sharp widening of the budget deficit, which can then increase the likelihood of a sovereign debt crisis. Moreover, natural disasters can widen inequalities and exacerbate political tensions in affected countries. (Besley and Persson, 2011) estimated, for a sample of 97 countries in the period 1950-2005, that natural disasters increased the probability of wars by about 4 percentage points.

**LICs.** Fragile states and LICs are among the countries most exposed to natural disasters ( **Table A3** , Figures 2).<sup>32</sup> Although land-locked LICs have tended to experience fewer natural disasters

> 29For example, some have found that the adverse macroeconomic effects of natural disasters dissipate after five years and that climate disasters explain a very small portion of the variance in real per capita GDP (Raddatz, 2007).

> 30The impact on investment can be noisy due to possible mismeasurements in capital stock.

> 31Epidemics are different than typical biological disasters in the sense that they last longer and are accompanied by elevated uncertainty.

> 32There are 41 natural disasters episodes per country in LICs compared to 34 in EMDEs in the whole sample

19
than non-land-locked LICs, the impacts of such events on LICs have generally been considerably larger than in other income group economies, with more deaths as a percentage of the population and larger losses of output. This is partly because a larger proportion of workers are in primary sectors—agriculture and mining—which are more susceptible to natural disasters. Moreover, infrastructure in LICs tends not to be as robust as in advanced economies. LICs also often lack the ability to quickly cope with natural disasters and thus tend to suffer additional losses stemming from disease and displacement (Kahn, 2005). LICs that are more often hit by natural disasters tend to have lower labor productivity and TFP level than LICs that are less frequently hit by them. The disruptive effects of natural disasters may substantially delay—or even derail—the convergence process in LICs.

# **4.2 Impacts of wars**

The analysis here focuses on the effects of wars on EMDEs.<sup>33</sup>

**Intra-state wars.** On average, EMDEs that experienced intra-state wars are estimated to have suffered a reduction in labor productivity of roughly 5 percent three years after the beginning of the war ( **Figure 7** ). Although there was some recovery subsequently, the loss was still around 3 percent after five years.<sup>34</sup> Significant negative effects on TFP occurred with more of a time lag. Based on other research, the loss of TFP may have been partly the result of negative effects on health, especially of children, disruptions to education, and weakened trade (Ades and Chua, 1997; Akresh et al., 2012; Collier and Hoeffler, 2004). The decline in TFP reaches around 6 percent three years after the beginning of the war.

**External wars.** These refer to both inter-state and extra-state wars combined. The losses from these two kinds of external wars have been much more pronounced than those from intra-state wars. This may be accounted for partly by the fact that international trade and FDI have been found to decline more in times of external conflict (Bayer and Rupert, 2004; Busse and Hefeker, 2007). Three years after the onset of an external war in an EMDE, the estimated decline in labor productivity exceeds 12 percent on average. The estimated negative effects on TFP are, not surprisingly, somewhat smaller than on labor productivity given that labor productivity, but not TFP, is affected by the loss of capital (Hutchinson and Margo, 2006). The estimated decline in TFP after three years is 10 percent, with only a modest subsequent recovery ( **Figure 7** ).

( **Table A3** ).

> 33The focus here is on EMDEs since there have in recent years been no civil wars in advanced economies and the estimates suggest that the effects of inter-state wars for advanced economies are ambiguous.

> 34Easterly et al. (1993) found, for 80 countries during the 1970s and 1980s, that war-related casualties per capita is correlated significantly negatively (-0.3) with GDP per capita growth. Rodrik (1999) extended this study and found larger declines in GDP per capita growth for countries with high ethnolinguistic fragmentation.

20
<!-- Start of picture text --> Percent<br>5 mintra-wars = External wars<br>-5<br>-10<br>“15<br>-20<br>t t+1 t+2 t+3<br><!-- End of picture text --> <!-- Start of picture text --> Percent<br>10 mg intra-wars External wars<br>-5<br>-10<br>“15<br>-20<br>t t+1 t+2 t+3<br><!-- End of picture text -->
<!-- Start of picture text --> Percent<br>-2<br>3<br>-4<br>5<br>-6<br>-7<br>t t+1 t+2 t+3<br><!-- End of picture text --> <!-- Start of picture text --> Percent m Advanced Advanced economics s» EMDEs EMDEs<br>2<br>-4<br>6<br>.55<br>-10<br>t t+1 t+2 t+3<br><!-- End of picture text --> <!-- Start of picture text --> Percent Percent m Advanced Advanced economics s» EMDEs EMDEs<br>00<br>4<br>2<br>-2<br>3 -4<br>-4 6<br>5<br>-6 .55<br>-7 -10<br>t t+1 t+2 t+3 t t+1 t+2 t+3<br>Percent mBanking Currency Sovereign debt Percent0 mBanking Currency Sovereign debt<br>0 -4<br>-4<br>-8<br>-8<br>12 -12<br>-16 -16<br>-20 -20<br>World Advanced EMDEs World Advanced EMDEs<br>economics economics<br><!-- End of picture text --> <!-- Start of picture text --> Percent mBanking Currency Sovereign debt<br>0<br>-4<br>-8<br>12<br>-16<br>-20<br>World Advanced EMDEs<br>economics<br><!-- End of picture text -->
with the events, as well as the effectiveness of the mitigation efforts. However, comparing the costs of different types of shocks is challenging, since the identification of events depends on the threshold used for metrics such as the size of financial losses and the number of casualties. Moreover, the impact of future events may differ from past ones of the same type because of changing socioeconomic environments. In EMDEs, according to the estimates, wars have been about 10 times more detrimental to productivity on impact than natural disasters, and 1.5 times more detrimental than a financial crisis. An average financial crisis has thus tended to reduce productivity much more than a typical natural disaster ( **Figure 9** ). The results, which are broadly in line with the literature, show that on average financial crises induce a loss of about 2 percent in output per capita one year after their onset. This is twice the magnitude of the one-year productivity loss following an average natural disaster. Over a longer horizon, according to estimates from the literature, wars appear to be most disruptive at the 5-year horizon, reducing output per capita by an average of about 9 percent. However, there is a wide range of estimates, with some as high as 20 percent (Barro, 2009). This may stem from differences in the criteria used to identify adverse events such as definitions, thresholds for damage and casualties, country coverage, the sample period, and estimation approach (e.g., counterfactual analysis, panel regressions, local projection). When estimating the overall impact of different types of disasters and considering policy design, it is critical to consider not only the average impact of an average shock but also the frequency of different events ( **Figure 10** ). While climate disasters tend to have small effects on productivity, they are much more frequent than financial shocks or wars; they also typically affect the poorest countries most. Because of the relatively high frequency of climate disasters in EMDEs, the expected annual loss of labor productivity resulting from them is well above the expected loss from financial crises. On the other side, wars and epidemics tend to be infrequent and to affect only a few countries, so that the average expected losses are small. However, the effects of infrequent wars and epidemics on the countries affected tend to be severe, which underscores the importance of implementing proactive policies to address tail risk events. These results are useful to gauge where risks are relatively high and provide guidance to prioritize mitigation policies.

# **4.3.2 Severe adverse events**

Rare and severe events may have disproportionately large impacts on the afflicted countries compared to the small and frequent ones (Hallegatte and Przyluski, 2010; Loayza et al., 2012). Largescale natural disasters tend to cause larger damage to capital, employment and output. Severe wars and intense armed conflicts with large death tolls also cause outsized damage to physical capital, labor and output (Hutchinson and Margo, 2006). The negative effects of severe events on labor force participation and human capital are particularly more acute among the most vulnerable population groups such as women and younger workers.

23
<!-- Start of picture text --> Percent @ Disasters| TM Wars ® Financial crises<br>0.0<br>-0.5-1.0<br>-1.5<br>-2.0<br>-2.5<br>-3.0<br>Labor productivity TFP<br><!-- End of picture text -->

<!-- Start of picture text --> Percent<br>mRange Mean -EMDEs (World Bank)<br>o omg<br>-105 A | * | ia Gg<br>“18<br>-20<br>1year 5year|1year 5Syear 1year 5 year<br>Disasters Wars Financial crises<br><!-- End of picture text -->
<!-- Start of picture text --> Percent<br>-0.040.00<br>-0.08<br>-0.12<br>-0.16<br>£&2 8 2 or8 2B 8 84<br>s) Re}Fs8 z*®© iit}25 €as 3g¢5 9<br>Disasters Wars Financial crises<br><!-- End of picture text --> <!-- Start of picture text --> Percent<br>0.0<br>-0.1<br>-0.2<br>-0.3<br>-0.4<br>-0.5<br>ioO gn isoO wo2 f=D >Ss 68at<br>& 6s @ @ € g 9<br>Ss) Ke)es 2g wi5 a$ 35<br>Disasters Wars Financial crises<br><!-- End of picture text --> <!-- Start of picture text --> Percent<br>-0.040.00 a ] a fj a<br>-0.08<br>-0.12<br>-0.16<br>sooO £Nn swoO wi€ £€DoD @> B85<br>is)£& Re}S€ 26§ wigsiy €a$ 3g5 4<br>Disasters Wars Financial crises<br><!-- End of picture text --> <!-- Start of picture text --> Percent<br>0.1<br>0.0<br>-0.1<br>-0.203<br>-0.4<br>-0.5<br>3so 6|(CSn isoO og f=D >8 3><br>&£& &§ 86 gs € gs 4<br>is} he}2 zg wihi as 35<br>Disasters Wars Financial crises<br><!-- End of picture text -->
and effectiveness of governance and improve the business climate can reduce the likelihood of some adverse events and also help to limit the damage caused by those that occur. Governments that have improved labor and product market flexibility, strengthened legal systems and property rights, fostered effective competition, and addressed inequality will have laid the foundations for more effective private sector adjustment to adverse events (Anbarci et al., 2005). Good regulations and institutions can improve risk-sharing and the prevention and mitigation of financial crises and some natural disasters. They can also reduce the probability of wars, which can be rooted in inequalities, unresolved grievances, and greed (Collier and Hoeffler, 2004). Reform-driven productivity gains critically depend on the sustainability, timing, size, mix, and duration of such interventions.

**Building fiscal space.** Emergency responses and reconstruction efforts after wars or natural disasters can be costly. Deep financial crisis may require a sizable fiscal response as well—several advanced economies and EMDEs implemented fiscal stimulus to counter the negative consequences of the 2008 global financial crisis. This underscores the importance of having adequate fiscal buffers to be able to counter negative shocks as well as effective, transparent governance to ensure that funds are spent effectively and in appropriate amounts (Reinhart and Rogoff, 2010; Oulton and Sebasti ́a-Barriel, 2017; Hallegatte and Rentschler, 2018).<sup>39</sup> Fiscal space may be defined as a government’s ability to fund expansionary fiscal policies without undermining sustainability of public finances. When the previously described LPM regressions were amended to introduce an estimate of fiscal space as a variable (Jord`a, 2005; Duval and Furceri, 2018), it was found that countries with positive fiscal space tended to experience smaller detrimental effects on productivity after banking or currency crises, or climate disasters ( **Figure 11** ). The estimates suggest that positive fiscal space provides support to productivity of around 0.9 percent in the case of currency crises, and 0.8 percent in banking crises. Positive fiscal space is also estimated to help alleviate the detrimental effects of climate disasters on productivity, although to a smaller degree. There are similar effects on TFP. In addition, fiscal space is found to help reduce the likelihood of adverse events.

39Not only do needs for emergency and reconstruction expenditures rise after natural disasters but also government revenues tend to fall.

26
<!-- Start of picture text --> Percent 7 Effect of fiscal space = Without fiscal space<br>¢ With fiscal space<br>-1<br>-2<br>3<br>-4<br>Climate Banking Currency<br><!-- End of picture text --> <!-- Start of picture text --> Fercent m Effect of fiscal space = Without fiscal space<br>¢ With fiscal space<br>|<br>-1<br>-2<br>-3<br>-4<br>Climate Banking Currency<br><!-- End of picture text -->
economy technology frontier and may undermine hard-won gains in poverty reduction in LICs and FCS countries. Macroeconomic and other policies are important tools to counter the adverse effects of natural disasters, financial crises, and wars. Policies are warranted to reduce the pace of global warming, and to better protect vulnerable areas and populations against natural hazards, as well as to encourage relocation from, and hazard-resistant building in, disaster-prone areas. Enhanced regulatory frameworks can help to reduce the likelihood of financial crises, as well as to mitigate their harm. Appropriate institutional and business climates, including good governance, can also alleviate the initial effects of adverse events, and increase the pace of economic recovery. Fiscal space and transparent governance enable reconstruction efforts, after a natural disaster or armed conflict, to get underway in a timely and effective fashion as well as helping to prevent financial crises. Future research could explore in greater detail the relationship between country characteristics and vulnerability to adverse events. This paper found that countries with rising government debt tend to suffer more from financial crises. A deeper dive could reveal more information about the importance of characteristics such as governance, infrastructure quality, and regulatory quality for mitigating the impact of disasters, and provide insights to build greater resilience to these types of negative shocks.

28