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Working Paper G Economic Aspects of Earthquake Loss Estimation The economic consequences of an earthquake are presented in most loss studies only as direct property losses, usually estimated as a percentage of replacement cost. While these estimates do provide some indication of the financial resources needed for reconstruction, another reason for often quoting direct losses in dollar terms is one of convenience. For planning, preparedness, and recovery purposes, one could just as easily use only estunates of the numbers and the types of structures with varying qualitative degrees of damage. The study of natural hazards has long been dominated by engi- neers, sociologists, geographers, and social psychologists (Cochrane, 1984~. Few economists have engaged in this field of study, leaving a large gap in knowledge of the overall economic accounting of the consequences of catastrophic earthquakes or other natural hazards. This does not mean, however, that these consequences are insignif- icant. Rather, it reflects the difficulties involved in conducting a comprehensive economic accounting of the effects of an earthquake. The preceding working papers clearly demonstrate the complex- ities surrounding procedures for estimating direct earthquake losses. Efforts to estimate the indirect economic effects can complicate the study procedures significantly, particularly with respect to collecting additional information about structures and identifying the interrela- tionships among sectors in the economy and how they would change after the event. It is unlikely that these extended analyses will soon 216

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217 be incorporated into large-scale, general-purpose loss estimate stud- ies. Interest in better understanding the economic consequences of earthquakes, however, led FEMA to sponsor an ambitious study, ATC-13 (Applied Technology Council, 1985), to lay the groundwork for estimating these impacts in a comprehensive fashion. This paper attempts to place a number of ATC-13's procedures in perspective, to discuss the current feasibility of doing such comprehensive eco- nomic analyses, and to outline briefly a research agenda that might enhance the feasibility of future studies. CHARACTE1tIZING ECONOMIC [OSSElS The economic consequences of an earthquake can be classified in several ways, but for purposes here, three types are delineated: (~) direct losses due to damage; (2) losses due to premature death or injury, and (3) indirect losses due to business disruption. Estimates of the direct property losses follow in a straightforward fashion from damage estimates, but the other two types of losses warrant some further discussion. As a first approximation to losses from premature mortality, Sorkin (1982) suggests multiplying the expected number of deaths by the present value of expected future earnings foregone, considering the likely age, sex, and occupational profiles of the victims and their effects on expected future earnings. The indirect costs of injuries are reflected in foregone earnings and medical costs. In extremely severe earthquake events, these economic losses could be substantial and certainly tragic for the victims' families. Estimates of this kind may also be important for insurance purposes or other questions of legal liability. However, the majority of these losses are in the form of foregone future earnings, rather than immediate out-of-pocket costs. For this reason, in addition to the tre~nendous uncertainties surrounding casualty estimates, these losses should not be a major focus of economic loss studies. The public concern should be with the casualties themselves and efforts to reduce them, rather than foregone future earnings. However, the same conclusion cannot be applied to indirect busi- ness losses stemming from physical damage and disruptions clue to the earthquake. These indirect losses are immediate and can persist throughout the recovery effort. They can affect the entire region and spill over to other states and regions of the country. For a variety of reasons, ranging from hazard mitigation and recovery to concerns

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218 about national security and increased vulnerability after the event, these indirect losses are potentially of major concern to the local economy and to the federal government. MEASURING INDIRECT ECONOMIC IMPACTS FEMA's ambitious study to identify in a comprehensive fashion the economic consequences of a catastrophic earthquake has two ma- jor components. The first, ATC-13, involves a damage estimation technique that integrates geocoded seismic intensity simulations and inventories of buildings and other facilities with damage functions, relating seismic intensity and construction characteristics to dam- age estimates. The second component is designed to determine the overall economic impact by using the results from the damage evalu- ation methodology in conjunction with recently developed economic interindustry modeling capacities. ATC-13 describes only the first component of FEMA's study design. Its loss estunates are confined to the direct effects of the earthquake (e.g., damage from ground motion and collateral hazards) along with estimates of casualties, property loss (measured as a percentage of replacement cost), and loss of function. From this standpoint, its objectives are not that much different from those of other studies or approaches. However, the procedures by which estimates of these losses are produced differ significantly from what others have done. One major difference is the level of detail attempted in terms of the number of construction classes and the classification of economic and social function. The attempt to add detail to the damage relationships by consulting a number of experts was unique, as was the attempt to generate a comprehensive inventory from socioeconomic data in automated form available from FEMA. The rationale for the inven- tory procedures was in part due to a desire for consistency in studies throughout the country. Shortcomings of FEMA's methodology stem from the large num- ber of construction and use classifications and the fact that the it- erative process used with the experts led to distributions that may underestimate the true variability in damages. The accuracy of infer- ring structural information from the social and economic functions of buildings Is questionable and has not been empirically verified. In terms of the damage relationships, it is probably true that little would be lost by considering a smaller number of separate

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219 damage curves or matrices. If this were done and the estunates were not revised through this iterative process, the damage relationships would probably not be too much different from those used in other studies. The real shortcorn~ng of the method is in having to relate economic and social function to structure type at such a disaggregate level at the level of each individual building or other facility. One way that the procedures could be improved ~ to invest more time and money in collecting more detailed information about the use of structures in the inventory. Art alternative might be to conduct some general field research to determine if there is any systematic relationship concerning economic function, geographic location, and age and type of structure. Why was such a high level of disaggregation needed in the ATC- 13 study? The answer derives from FEMA's interest (or that of the National Security Council, which requested the study) in identifying the impact of an earthquake on any one of up to 470 economic sectors identified by the Standard Industrial Classification (SIC) code used by the Bureau of Economic Analysis (Executive Office of the President, 1972~. This motivation ~ probably related more to the national security implications of loss of function to specific defense or related high-technology industries than it is to education, mitigation, and planning efforts. If the first phase of the ATC-13 methodology could be imple- mented at this level of detail, then some initial estunates of loss of function to defense related or other ~critical" industries might be possible. However, these direct damage and loss estimates ignore im- portant secondary effects throughout the economy after catastrophic events. (This is true regardless of the level of disaggregation in the analysis.) These secondary impacts are due to a variety of things. Probably most important is the loss of productive capacity from damage to physical plant and equipment. This reduces the capacity of the economic sectors to produce goods for final consumption as well as for use as intermediate inputs (some of which might have strategic value) in other productive activities. Because of the damage to the area's productive capacity, a larger fraction of the area's continuing demands for goods and services need to be imported from other regions of the country, at least during the recovery period. Employment and income in those sectors damaged by the event are reduced also, and this in turn reduces the demand for goods and services in many of the region's economic sectors. However, recovery

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220 activities bring with them an influx of financial resources (e.g., from government recovery and relief efforts, and insurance cIaims) that increases the demand for the output of certain sectors, particularly construction. These new demands are either met by the remaining productive capacity of the area or through interregional imports. The purpose of the second phase of FEMA's study is to attempt estimates of these secondary impacts at the four-digit SIC level. In theory, this is possible by using an interregional interindustry mode! of the U.S. economy. The most complete description of the mode! intended for use In conjunction with ATC-13 ~ In a paper by Wilson (1982~. The methods to be used in this phase of FEMA's study can be described in abbreviated fashion through simple equations. The basic interindustry, input-output (~-O) mode! developed initially by Leontief (1951) is described In numerous economic books and in a summary by Wilson (1982~. The mode} ~ developed essentially from a double-entry bookkeeping description of an area's economy that records purchases and sales of goods from one sector to another, as well as imports and sales to final users (e.g., to final demand). Total sales or output of any sector (e.g., agriculture, manufac- turing, and services) of an e-sector model are recorded along the rows of the transactions table and are expressed as ~Xij+Yi=Xi(i=l' ...), j=1 (1) where xij is the value of the output of sector i purchased by sector j, pi is the final demand for the output of sector i, and xi is the value of the total output of sector i. To complete this set of balance equations, the entries down the columns of the table also add to the value of a sector's output. I` xij + pj = Xj(j = 1, ~ n)' i=1 (2) where pj is the final payments (purchases of imports and primary factors of production by sector j], Xj is total outlay (purchases) of sector j, and ~ equals Xj for all i= j. From this transactions table, a matrix, A, of direct input re- quirements from sector i (in dollars) per dollar of sector jets output is given by

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221 A = As = { $i] } (i, j = 1, . . ., n). (3) Substituting (4) into (~) yields n Xi = ~ aijxj + yi(i = 1, . . ., n), (4) j=1 which may be expressed more compactly as X= AX+Y, where Ax x2 X= . -On - I all al2 a21 a22 ~ ... al" a2" , A= . a"1 at . ann" (s) IY1 - , and Y = An . (6) Rearranging tints set of equations, it is easy to see that gross output minus intermediate use equate the net output or final use of the system XAX= (IALEX= Y. (7) In the econorn~cs literature, much of the policy analysm that uses interindustry models is focused on the fact that this set of equations can be used to estimate the total output in the economic system required to meet any given set of final exogenous demands (e.g., consumer demand, government purchases, and exports). That is, if one knows the specific values for the components of Y. one can solve for required output by X= (IA`J-iY. (8) In the planned second phase of the economic study, FEMA would make use of the direct damages and loss estimates coming out of the AT~13 method. The first task would be to estimate the interindustry mode} for the geographic area of interest (e.g., estimate the predisaster A matrix). Historically, this has been done either through extensive questioning of a sample of local businesses (Bills and Barr, 1968), or through systematic adjustments to the national

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222 interindustry table based on some measure of the region's economic activity in a particular sector to that of the nation (Boisvert and Bills, 1976; Hwang and Maki, 1979; Lofting and Davis, 1973~. To estimate economic losses from natural hazards, these nonsur- vey techniques are the only feasible approach, and FEMA chose to use the procedures developed by Lofting and Davis (1973), which are based on a biproportional matrix-balancing technique (RAS) devel- oped by Stone (referred to in Wilson, 1982 and Boisvert and Bills, 1976~. The procedures by Lofting and Davis, and Hwang and Maki, accommodate the development of integrated interindustry models that account directly for trade flows across more than one region and can trace the impact to other regions in the country. Wilson (1982) discusses this extension of the model. Once the interindustry mode] is in place, on the basis of the initial direct loss estimates, procedures would be developed to estimate new levels of fin e] demand, Y. in the postdisaster situation. This would require establishing estimates of the loss in income due to the event and the projected influx of resources due to recovery efforts, as well as estimates of how these changes affect final demand for each sector's output. Projecting changes in final demand as a result of disruptions in an economy (be they due to economic or other factors) is not an easy task, but it is something that is done frequently in interindustry studies. The third task would be to modify the interindustry tables for the region. That is, in most interindustry studies, it is assumed that the intermediate input requirements, the A matrix, is invariant to the initial change in economic activity. This, of course, could not be assumed after an earthquake because of the damage to plant and equipment and the corresponding reduction in productive capacity. In general, this would mean that many of the components of the matrix A would be reduced indicating that more of a sector's in- termediate input requirements from other sectors would be imported from outside the region. There has been very little, if any, work attempting to modify interindustry models to account for an imme- diate structural change in intermediate input flows caused by a major disaster. SUMMARY AND CONCLUSION Little comprehensive analysis of the overall economic impact of earthquakes on a regional economy exists but an economist's general

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223 knowledge of a region's interindustry relations would suggest that the secondary (or indirect) eEects stemming from the initial damage are likely to be substantial. It would be useful to link our estimates of damage to buildings and other facilities with their economic function. This information could assist recovery by helping to set priorities for reconstruction of essential services and perhaps to identify the location of industries that use toxic or other hazardous substances that could be released during the earthquake. The key question is, however, At what cost? Data to imple- ment the procedures do not exist, en c! if the inventory of facilities had to include data on economic function, the costs of this phase would increase substantially (by as much as 40 percent by one esti- mate). furthermore, even if there were reliable estimates of direct losses to structures by economic function, serious problems remain in trying to relate direct losses to changes in final demand and other interindustry relationships. These difficulties can only be resolved through additional research. Regardless of how rapidly some of the research problems are resolved, it is unlikely that comprehensive economic analysis will be viewed in the near future as an integral part of what has been called Type ~ studies (general purpose, large scale) in Working Pa- per A. This does not mean that the procedures used in future loss estunation studies should be insensitive to the data requirements of more complete economic analysis of the consequences of catastrophic earthquakes. At a minimum, researchers should collect inventory information that relates construction class to economic and social function or undertake specific research to establish any systematic relationships that Knight exist. Furthermore, to be useful for hazard reduction, emergency plan- ning, and recovery planning efforts, the level of detail in terms of econorn~c and social function does not need to be fine enough to differentiate all 470 sectors. A reasonable objective would be to look initially at the 25 to 30 major economic classifications defined by the SIC, with the expectation that there might be a Landfill of impor- tant individual industries in any region that could be exaTruned in greater detail. These would depend on the location being studied and the purpose of the study. Major defense contractor plants and military bases could be studied in greater detail if the purpose is defense-related, as In the case of ATC-13.