Abstract
The purpose of this study is to investigate the impacts of a natural disaster on a developing country’s economy. In that sense, we look at the impact of August 1999 earthquake in Turkey on two important macroeconomic indicators of the Turkish economy (Real Output and Employment) with recovery policies followed by the government and international donors. Our results indicate that the earthquake had a significant immediate negative impact on both output and employment growth in Turkey. While output growth reverted back to its pre-disaster pattern after the initial shock, employment growth did not recover. The earthquake had both a short run and long run influence on the Turkish economy. This study will develop understanding of the possible effects of future earthquakes. Also, it will help the Turkish Government evaluate already-applied mitigation measures (like Turkish Catastrophe Insurance Pool etc.) and guide the preparation for forthcoming disasters since scientists have reached a consensus that a major earthquake is expected in Istanbul.
Most previous studies of the impact of the 1999 earthquake on the Turkish economy were based on initial assessments done by institutions like the World Bank and State Planning Organization of Turkey (SPO). Selcuk and Yeldan (2001) provided the first empirical attempt to investigate the macroeconomic impact of the earthquake using a general equilibrium model to simulate the economy under four possible government recovery policies and levels of international support. The data were drawn from Kose and Yeldan (1996) and input-output table of Turkey (State Institute of Statistics, 1994). The results were based on four cases: (1) no policy change, (2) discretionary adjustments on indirect tax rates, (3) with flexible indirect tax adjustments, and (4) with foreign aid. They concluded that the initial impact of the earthquake on the value of GDP may range from -4.5% to 0.8%. Based on their measurements of expected consumer welfare, Selcuk and Yeldan recommend a policy of subsidies to individual sectors financed by international donors. Further, they find that an indirect tax generates further losses in output.
Other studies have concentrated on earthquake risk mitigation measures, including earthquake insurance policies in Turkey (Gulkan, 2002; Freeman and Kunreuther, 2002). In addition to an already existing required insurance called Turkish Catastrophe Insurance Pool (TCIP) these studies suggest supplementary mitigation measures that reduce the risk to new buildings as well as retrofitting to mitigate risk to existing structures.
In sum, the negative impact of the earthquake on the Turkish economy is estimated intuitively and with the assumption of “no policy change” by the World Bank and SPO, and using theory-driven simulation methods. However, the degree of the impact after the earthquake has not been analyzed with real data. This study represents an initial attempt to address the question, “What happened to the Turkish economy in general pre and post earthquake with already existing recovery policies and mitigation measures?”
The rest of the paper follows with recent history of Turkey’s experience with earthquakes, initial assessments of the August 1999 earthquake, available recovery policies and mitigation measures, statistical analysis of the impact, and finally conclusions.
II. RECENT HISTORY OF TURKEY’S EXPERIENCE WITH EARTHQUAKES
Turkey is geographically located at one of the most earthquake-prone areas of the world. A brief summary of recent urban earthquakes that have occurred in Turkey is presented in Table 1. According to Gulkan (2001) approximately 20,000 people have died in five urban earthquakes in Turkey during the past 10 years. As a result of these earthquakes, 70,000 buildings were damaged and 20,000 buildings were destroyed. The cost of the damage assigned only to the buildings that were destroyed is US$20 billion. Gulkan claims that the type of the construction of the multi-story apartments in Turkey is a very important factor and has exacerbated the losses.
17 August 1999 an earthquake that centered near Izmit was the most terrifying disaster in recent Turkish history. The earthquake had a moment magnitude of 7.4 in Richter measurement. The impact of the earthquake on the population and the economy was mainly felt in seven cities in the Marmara Region (Kocaeli, Sakarya, Yalova, İstanbul, Bolu, Bursa, and Eskisehir). The death toll was 18,373 with injuries to another 48,901 people. Reportedly 93,000 housing units and 15,000 small business units collapsed or were badly damaged. Another 220,000 housing units and 21,000 small business units sustained damage to a lesser degree (Erdik and Durukal, 2003).
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INSERT TABLE 1 (Gurkan, 2002)
III.INITIAL ASSESSMENT ON THE IMPACT OF THE EARTHQUAKE ON TURKISH ECONOMY
The Marmara Region, where the major impact of the earthquake occurred, is very important to the Turkish Economy both in terms of production and consumption capacities. This area accounts for 23% of the total population of Turkey. The seven cities Kocaeli, Sakarya, Yalova, İstanbul, Bolu, Bursa, and Eskisehir represent 34.7 % of Turkish GNP, further these cities produce 46.7% of total industry value added. The Marmara Region, mainly Kocaeli, Sakarya, and Yalova is the center for the Turkish oil, raw material for textile, automobile, petrochemical, and tire industries.
With an average income level per person that far exceeds the national average, the region also plays a very important role in terms of domestic consumption demand. According to published reports (RMS, 1999), the negative impact of the earthquake on capital accumulation and national product was declared to be approximately US$9-13 billion and the total estimated insured loss was US$1.5-3.5 billion. Johnson (200
reports that direct damage generated 70% of the total insured losses while business interruption accounted for the remaining 30%.
Impact of the Earthquake on Government Budget
The negative impacts of the earthquake on the Turkish government’s budget can be summarized in three points: (1) The cost of rehabilitation and reconstruction of public buildings damaged by the earthquake (2) The postponed taxes that should have been paid by the earthquake victims and (3) The increase in unemployment compensation. Under these circumstances, the negative effect of the earthquake on the government’s budget is estimated to be approximately US$6.2 billion of which US$3.5 billion went to build housing units or reconstruct the damaged ones for either temporary or permanent accommodations. The government decided not to collect principal and the interest for 3 years from people with loans from the state bank. In addition, low interest loans were offered to assist with the rebuilding effort.
The Impact of the Earthquake on Industry
The main heavy industry of Turkey is located in the Marmara Region for example, “automobile manufacturing, petrochemicals, motor and railway vehicle manufacture and repair, basic metal works, tire manufacturing, textile, sugar processing, paper mills, power plants and tourism” (Erdik and Durukal, 2003). Most of the roads, railways, pipelines, transmission lines, and energy distribution, communication channels were badly damaged and the cost of reconstruction is estimated to be US$200 million in the short-run and US$400 million in the long-run.
As a result of these, the estimated loss in the value added in the manufacturing industry was US$600 to 700 million and growth rate of the manufacturing industry was expected to decline by 1.6 points. The loss in production and sales is estimated to be approximately US$222.1 million in total for manufacturing, most of which are based on oil, coal, and gas production. Although there was no significant direct damage to the agricultural sector, public institutions (like Forestry Ministry, State Water Administration) that are directly involved in agricultural activities experienced a loss of around US$870 billion due to earthquake damage.
For medium and small enterprises, the cost is estimated to be in the range of US$1.1 and US$2.6 billion based on the World Bank report (1999). For the insurance sector with 41 insurance companies, the total industry reserves seemed adequate to cover domestic losses before the earthquake. However, the industry capacity was incapable of covering the losses from the earthquake (roughly 95% of the total losses were covered by international insurers). By September 1999, only 8,500 earthquake-related claims were submitted. “The most significant impact on the insurance sector will be in the form of lost revenues due to increased premiums for Turkey and ……. since most policy coverage is paid by foreign insurance companies, the timing of the payments of claims to the beneficiaries depend upon the funding capacity of foreign insurers. ” (World Bank, 1999)
In the case of the banking sector, the negative impacts can be summarized as:
1. Further worsening of the performance of loan portfolios of the commercial banks.
2. Difficulty of the financial status of state banks because of the increased maturity mismatch and liquidity squeeze due to the deference of the existing loans up to 3 years, providing interest rate subsidies.
3. Increased risk of default.
When we look at the cost of earthquake damage on social sectors like education, health, environment, and employment, the magnitude of the negative impact of natural disasters on a country’s economy becomes more obvious but harder to quantify. In the Marmara Region, 43 schools collapsed and 377 schools were badly damaged. The total damage cost to school facilities is estimated to be US$107 million in rehabilitation. The reconstruction cost of hospitals is estimated totaling US$19 million.
The cost of the earthquake on industries can be summarized as: (1) business interruption, (2) loss of labor supply (3) reduction in capital (due to damaged buildings, machines, stocks, etc.), (4) reduction in production and sales when factories had to shut down temporarily, (5) psychological distress, (6) a reduction in tax revenue (7) an increase in unemployment compensation.
Risk Management in Turkey
The tremendous loss from the August 1999 earthquake forced the Turkish government to seek out and apply risk management strategies. The risk management program has followed five main courses of action. First, research on monitoring and forecasting the earthquake risk in the area of earthquake engineering has been expanded. Second, with the help of many research centers specified on earthquake and media, public awareness about the risk was propagated. Third, distributing the international donations to proper sectors/places where needed most has been coordinated. Fourth, Indirect taxation has been implemented by the government. Lastly, in terms of market instruments, risk (monetary loss) of earthquake is being transferred by an obligatory government insurance policy called the Turkish Catastrophe Insurance Pool (TCIP).
The first two actions are beyond the scope of this study. As for international funding, according to the World Bank report (1999), US$3 billion is identified to be as “exceptional external financing”. In order to compensate the earthquake costs, US$2.5 billion has come from international foundations. “Claims paying capacity of TCIP for year 2002 is approximately US$1 billion including reinsurance (US$840 million), premium reserves and the credit obtained from the World Bank” (Gulkan, 2002). Most arrangements for distributing these funds are made by the Treasury Department of Turkey.
Indirect taxation to increase the rehabilitation budget was unique in many ways. The Turkish military authorities allowed male citizens that have not completed their military obligation to do their service for 28 days (instead of 8-18 months). The only requirement to gain this right is to be willing to pay 15,000 Mark (US$2000 in year 2000 when this law was applied) to the government (SPO Report, 2001).
The Turkish government made earthquake insurance mandatory for residences starting from September 27, 2000 (Decree No.587, Compulsory Earthquake Insurance). The insurance was designed by the Undersecretariat of the Treasury and administered by the Natural Disaster Turkish Authority (DASK in Turkish). Also, the government rescinded legislation that requires it to extend credit and construct buildings for the public in case of an earthquake as of March 27, 2001. According to TCIP that is sold by 33 authorized insurance companies, “all existing and future privately owned property, except for engineered rural housing and fully commercial buildings, is required to contribute to TCIP” (Freeman et al. 2002). TCIP covers only a portion of the value of a residence and contents of the dwellings are not covered (Gulkan, 2002).
As for the sanction power of TCIP, all new homeowners must present valid TCIP policy to complete ownership process. Starting 15 April 2003, a TCIP policy is required in order to subscribe to water and natural gas supplies in 5 cities. Although it was estimated that 10 out of 14 million households will be under TCIP coverage, until now only 2.4 million homeowners have purchased this insurance (Gulkan, 2002). The total commitment of TCIP through 2002 was US$26 billion. Up through 2002, TCIP has paid approximately 1,634,000 US dollars for claims.
According to Gulkan (2001), there is a need for alternative mitigation measures as a supplement to TCIP. He notes that according to the statistics of the recent earthquakes, the most common type of construction in Turkey (multi-story, concrete frame etc.) is especially vulnerable to damage or collapse. So, he suggests reducing the risk to new buildings with the help of the current Turkish earthquake code and retrofitting existing buildings as well. That way, there will be a reduction not only in the property damage, but also the number of lives lost. At the same time, that may decrease the transaction cost of having earthquake insurance either from TCIP or a private insurance company. In addition, he suggests better coordination between different governmental units as well as laws that emphasize disaster policies and mitigation.
All the recovery policies and mitigation measures described above may not be enough but they are important in a sense that they represent a concerted scientific effort to protect Turkey from future hazards. The justification for such a concerted effort comes from a more complete understanding of the economic impact of the earthquake on Turkey in order to see how important risk management strategies can be for the economic recovery. The next section focuses on the statistical analysis of the earthquake impact on real output and employment of Turkey.
