German government agrees on emergency fund against flood damages

Yesterday, the government agreed on an €8bn emergency fund to tackle the damages from the severe floods. Despite individual tragedies, the overall impact from the floods on the entire economy should remain limited.

For more than two weeks, Germany has been suffering from flooding of several rivers which have devastated parts of southern and eastern Germany. The extent of the flooding seems to exceed the so-called “100-year flood” which hit the country in 2002. As so often in these moments of human tragedies, the question of the macro-economic impact of such natural disasters pops up.

The answer is almost always the same and bare statistics tell a rather heartless story: the macro-economic impact of most natural disasters remains rather limited. Looking at industrial production and GDP growth during the floods in 1993, 1997, 2002 and 2010, it hardly shows any abnormal developments that could be related to the floods. In our view, the macro-economic impact of major floods in Germany over the last 20 years has been close to zero. This can mainly be explained by two factors: i) floods in Germany mostly hit rural and agricultural regions but not the backbone of the economy, the industry; and ii) natural disasters have a negative one-off impact on the wealth and/or the capital stock of an economy, which does not show in the GDP data. Subsequent reconstruction works, however, often lead to a pick-up in economic activity.

Sometimes, the pick-up in economic activity is interpreted as the fact that natural disasters have a paradoxically positive impact on growth. This interpretation, however, should be taken with a pinch of salt as it does not take opportunity costs into account and ignores the fact that reconstruction works have to be financed.

Returning to the current floods, Germany’s federal and state governments agreed on an emergency fund to tackle the costs of the floods and to launch reconstruction works. The fund should reach €8bn (around 0.3% of GDP). Officially, the financing of the fund has not been decided, yet, but judging from official statements, the €8bn should be financed by new debt and not by new taxes. In fact, the floods could prevent Germany from recording the second consecutive year with a fiscal surplus. In addition, Germany can also hope for some aid from the European Investment Bank, which earlier said it would consider loans to countries affected by the flooding amounting to around €1bn.

All in all, as in the past, the current flood will not come without costs and individual tragedies. Lost homes, production facilities or damaged infrastructure will trigger damage claims for insurance companies, wealth losses for households and companies and/or reconstruction work. The growth path of the total economy, however, should hardly be affected.