Welfare Costs of Catastrophes: Lost Consumption and Lost Lives

Ian W. R. Martin and Robert S. Pindyck

April 2020

Most of the literature on the economics of catastrophes assumes that such events cause a reduction in the stream of consumption, as opposed to widespread fatalities. Here we show how to incorporate death in a model of catastrophe avoidance, and how a catastrophic loss of life can be expressed as a welfare-equivalent drop in consumption. We examine how potential fatalities affect the policy interdependence of catastrophic events and “willingness to pay” (WTP) to avoid them. Using estimates of the “value of a statistical life” (VSL), we find the WTP to avoid major pandemics, and show it is large (10% or more of annual consumption) and partly driven by the risk of macroeconomic contractions. Likewise, the risk of pandemics significantly increases the WTP to reduce consumption risk. Our work links the VSL and consumption disaster literatures.

Keywords: Catastrophes, catastrophic events, macroeconomic contractions, disasters, fatalities, value of life, willingness to pay, pandemics.

JEL Classification Numbers: Q5, Q54, D81