Figure 1: Relationship Between Direct and Indirect Damages and Gains: Regional Perspective

This Figure maps all combinations of direct and indirect loss for a region.

The upper part of the diagram shows a ray from zero reflecting the income gains which occur as an unconstrained region rebuilds (100 percent financed by outside sources, i.e., insurance and federal aid). Economists will recognize this uppermost part of the envelope as simply the amount of reconstruction spending times the income multiplier for construction. At the extreme, sufficient alternate supplies and markets void any bottlenecks. This is the best the impacted region can hope for.

As more of the burden of financing reconstruction is shifted to the region's victims, the net positive effect of spending diminishes, and the ray rotates toward zero indirect gain. At the extreme, when all costs are borne internally, the gains from rebuilding are offset by reduced spending later on as households pay off disaster-related debt. This type of analysis is based on traditional input-output techniques and is all too familiar to regional economists.

The lower half of the diagram is not as simple to understand, at least initially. It reflects an economy with bottlenecks; the closer to zero, the less constraining these bottlenecks are. As in the explanation about indirect gains, the extremes are readily interpreted. Line segment A-C traces the outer edge of the loss envelope. Point B, the uppermost (where upper means the most negative) level of indirect loss, results from a maximum shock to the smallest sector, when no means of mitigating supply and demand shortages present themselves. At this point, the economy implodes to the level of output dictated by the constraining sector. Indirect loss can be a multiple of direct loss at B. Such an event is most likely when critical lifelines, such as power and water are lost. One might think of B as the terrorist's target of choice; the smallest amount of direct damage produces the greatest amount of economic disruption.

Point C on the indirect loss frontier shows no indirect loss when direct loss is total (100 percent). If all is lost then no forward or backward linked losses are possible. Line segment D-B shows the influence of (1) an increased variance in the pattern of loss (zero variance at D and maximum at B); and (2) reduced flexibility in the region's ability to mitigate shortages.

The line segment D-C shows the effect of a uniform damage pattern, which causes the economy to shrink proportionately. This occurs when all sectors are damaged proportionately, in which case forward and backwardly linked losses disappear. In this case, the economy remains balanced regardless of the amount of damage observed.

From a national accounting stance, indirect losses can be measured by deriving regional indirect impacts, adjusted for the liability the federal government incurs in providing disaster relief, and for offsetting increases in outputs elsewhere.

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