The economics of a disaster: How the LA wildfires may impact the economy

It is difficult to put the devastation caused by the wildfires in Los Angeles County into words. The fires have caused at least 29 deaths, a similar number of injuries, the destruction of more than 16,000 structures, the damage or destruction of over 50,000 acres and thousands of evacuations. These wildfires are likely the worst in the history of California and the United States.

As of the evening of Friday, Jan. 31, fire crews have achieved 100% containment of the Palisades and Eaton fires—the two largest of the four total fires, according to the Los Angeles Times . Though the fires are now contained, rebuilding and recovering will be a long, difficult and costly process. AccuWeather estimated the total damage and economic loss to be between $250 billion and $275 billion . This latest estimate for the Lost Angeles wildfires surpasses the damage and economic loss numbers for the entire 2020 wildfire season—a very active U.S. wildfire season.

Roberto Duncan, Ph.D. says that from an economic perspective, the destruction of the LA wildfires has several dimensions. Damage from the fires will likely impact prices, the cost of living, employment, agriculture and the insurance markets of the LA area and the state of California. Duncan is an expert in macroeconomics, monetary policy and economic growth and an associate professor of economics in Ohio University’s College of Arts and Sciences .

Aside from direct effects the fires had on people’s lives and health as well as the environment, Duncan says the resulting decline in consumption, production and employment in the LA area may cause a serious economic deterioration of well-being.

With the large number private capital stock destroyed or severely damaged, market production and home production are impacted. Private capital stock is defined as the sum of the net stock of produced private assets for all private enterprises—including private homes, businesses and other productive structures, according to the U.S. Department of Treasury . The reduction in housing leads to a decrease in household wealth, which in turn diminishes household spending.

The wildfires also have a fiscal impact. State and local governments will collect less tax revenue while facing increased expenditures for emergency response and rebuilding efforts because of the disaster.

“The reduction in both the private capital stock and public infrastructure (e.g., roads and public utilities), combined with business closures and decreased customer activity, reduces production and employment,” explained Duncan. “Moreover, this unprecedented wildfire will lead to a rise in insurance premiums and temporary shortages of some products and services, including water supply and energy. These effects are likely to increase prices and the cost of living for Californians.”

While California is the largest economy within the United States, Duncan doesn’t think the wildfires will substantially impact the national economy. However, if the wildfires have damaged farmlands, this could reduce the supply of agricultural products that California exports to other U.S. states causing prices to rise.

“Given this and the fact that the economic shock was transitory and concentrated in part of the state, one could anticipate that its final effect on national economic growth will not be substantial,” Duncan explained. “The impact is clearly much stronger at local and state levels and in certain industries or productive sectors.”

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Preliminary data shows insurance companies have paid our more than $4 billion for losses from the two largest of the Los Angeles-area wildfires, according to Insurance Journal . Claims figures from insurers released by the California Department of Insurance on Jan. 30 show that 31,210 claims have been filed for home, business, living expenses and other disaster-related needs. Given the scale of this natural disaster, Duncan says it could have a significant, negative impact on the insurance market.

“Smaller local insurance companies are likely to be hit harder due to their limited production scale and inability to sufficiently diversify their portfolios,” he said. “More importantly, larger insurance companies will absorb the losses and gradually pass them on to their clients, particularly—but not exclusively—homeowners, in the form of higher premiums or reduced coverage conditions.”

Duncan added that homeowners may observe increased insurance premiums not only in California, but potentially nationwide.

Common sense suggests that reconstructing destroyed or damaged infrastructure is necessary. Houses must be rebuilt for living, and public infrastructure must be restored to enable normal life, but Duncan suggests that there is also an additional economic reason.

“While [rebuilding] is logical, a standard economic model provides an additional reason: it is also efficient,” emphasized Duncan. Standard economic models predict that increased investment after a disaster is a sound strategy.”

Duncan believes it is a good time to be in the construction industry for both companies and workers in California. Increased investment in rebuilding will generate jobs and spur economic activity. As a result, Californians can expect to see an economic recovery and potentially a boom in their construction sector.

“Given that the stocks of capital, both private and public, are below their previous, likely optimal, levels, businesses and the public sector have strong incentives to restore these levels. With regular access to credit, businesses will invest more because it becomes more profitable to do so,” Duncan explained. “Similarly, the public sector has incentives to stimulate reconstruction, ensuring that damaged public infrastructure becomes operational again. This, in turn, spurs economic activity and creates private-sector jobs, leading to increased tax revenues.”

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