Published 04/18/11

Nature's curse or blessing in disguise?

post-quake damage in Chile

In the aftermath of the 2010 earthquake in Chile, businesses had an incentive to embrace new technologies. (Photo by Claudio Núñez)

SMITHFIELD, R.I. (April 18, 2011) -- Though it is difficult to imagine anything positive arising from the devastation and loss of life caused by intense earthquakes in China, Haiti, Chile and now Japan, massive destruction caused by such natural disasters can lead to innovation.

Such a statement may seem counterintuitive in the wake of the human toll these disasters take. But in two recently-published research papers on the topic, Andrés Ramirez, assistant professor of finance in the College of Business, has found support for the hypothesis of creative destruction.

In developing economies, businesses that by all measures appear to have been wiped out by a natural disaster may in fact have gained a unique opportunity to change or improve their technology.

In 1942 Joseph Schumpeter argued that "the fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers, goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates."

Ramirez and his research colleague, Nezih Altay at DePaul University in Chicago, say businesses that by all measures appear to have lost everything -- buildings, equipment, employees, customers -- in fact have gained a unique opportunity to change or improve their technology and adapt in ways that Schumpeter says keeps economic engines in motion.

 Take businesses in Chile as an example, where an earthquake of magnitude 8.8 struck on February 2010. Before the quake, many businesses in this developing country employed low technology such as mules for farming or land lines for telephone communications. In the aftermath, as they rebuild, Chilean businesses have an incentive to adopt the next level of technology-turning to tractors and Wi-Fi.

As a result, Chilean wineries could adopt new technologies - from bottling equipment to inventory software. Such innovations induce a large jump in productivity. These increases are then reflected in higher business market valuation and operational cash flows.

So what about Japan? The unfortunate reality is that earthquakes are a blessing in disguise only in developing economies, Ramirez says. Companies based in Japan will have a far more difficult time improving their market capital because they already use the latest technology to produce high-value-added products and services, Ramirez says, and their gains will be marginal. Toyota can rebuild its damaged plants but it is unlikely that productivity will increase dramatically. The same can be said about Fujitsu or Sony. For these companies, the costs (even after insurance payments) will greatly exceed the benefits. The only good news for a developed open economy such as Japan's is that its multinational firms will fare better; they will experience a lower decrease in cash flows, Ramirez says.

His research is based on an analysis of 299 earthquakes between 1990 and 2004 and their impact on almost 150,000 companies in 50 countries. Among the findings:

  • A business will experience increases in market capitalizations even three years after an earthquake hits its country. A closer look, however, shows that this result is valid only for companies in less developed countries, particularly those from non-G8 countries.
  • Regarding operational cash flows, businesses in Latin America and Asia - the two regions most prone to earthquakes - see an increase in cash flows; companies in other regions see a decline.
  •  Earthquake damage generates a great deal of uncertainty about the future to which companies respond by increasing their cash holdings, even three years after the event. This cash hoarding can be detrimental to reconstruction efforts.

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