Private investment and government protection
AbstractHurricane Katrina did massive damage because New Orleans and the Gulf Coast were not appropriately protected. Wherever natural disasters threaten, the government—in its traditional role as public goods provider—must decide what level of protection to provide to an area. It does so by purchasing protective capital, such as levees for a low-lying city. (“Protection” also consists of prohibiting projects that raise risk levels, such as draining swamps.) We show that if private capital is more likely to locate in better-protected areas, as would be expected, then the marginal social value of protection will increase with the level of protection provided. That is, the benefit function is convex, contrary to the normal assumption of concavity. When the government protects and the private sector invests, there may be multiple Nash equilibria due to the ill-behaved nature of the benefit function. Policy makers must compare them, rather than merely follow local optimality conditions, to find the equilibrium offering the highest social welfare. There is usually considerable uncertainty about the amount of private investment that will accompany any level of protection, further complicating the government’s choice problem. We show that when deciding on the level of protection to provide now, the government must take account of the option value of increasing the level of protection in the future. We briefly examine but dismiss the value of rules of thumb, such as building for 1000-year floods or other rules that ignore benefits and costs. Copyright Springer Science + Business Media, LLC 2006
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Bibliographic InfoArticle provided by Springer in its journal Journal of Risk and Uncertainty.
Volume (Year): 33 (2006)
Issue (Month): 1 (September)
Contact details of provider:
Web page: http://www.springerlink.com/link.asp?id=100299
Risk; Disaster; Floods; Infrastructure; Option value; Levees; Global warming; Multiple equilibria;
Other versions of this item:
- Kousky, Carolyn & Luttmer, Erzo F. P. & Zeckhauser, Richard, 2006. "Private Investment and Government Protection," Working Paper Series rwp06-017, Harvard University, John F. Kennedy School of Government.
- Carolyn Kousky & Erzo F.P. Luttmer & Richard J. Zeckhauser, 2006. "Private Investment and Government Protection," NBER Working Papers 12255, National Bureau of Economic Research, Inc.
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Financing, Investment, and Capacity
- H54 - Public Economics - - National Government Expenditures and Related Policies - - - Infrastructures
- Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters
- R10 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - General
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Barro, Robert J, 1990.
"Government Spending in a Simple Model of Endogenous Growth,"
Journal of Political Economy,
University of Chicago Press, vol. 98(5), pages S103-26, October.
- Robert J. Barro, 1991. "Government Spending in a Simple Model of Endogenous Growth," NBER Working Papers 2588, National Bureau of Economic Research, Inc.
- Barro, R.J., 1988. "Government Spending In A Simple Model Of Endogenous Growth," RCER Working Papers 130, University of Rochester - Center for Economic Research (RCER).
- Barro, Robert J., 1990. "Government Spending in a Simple Model of Endogeneous Growth," Scholarly Articles 3451296, Harvard University Department of Economics.
- Andrew B. Abel & Avinash K. Dixit & Janice C. Eberly & Robert S. Pindyck, 1996.
"Options, the Value of Capital, and Investment,"
NBER Working Papers
5227, National Bureau of Economic Research, Inc.
- Andrew B. Abel & Avinash K. Dixit & Janice B. Eberly & Robert S. Pindyck, . "Options, the Value of Capital, and Investment," Rodney L. White Center for Financial Research Working Papers 15-95, Wharton School Rodney L. White Center for Financial Research.
- Abel, Andrew B., 1952-, 1995. "Options, the value of capital, and investment," Working papers 3843-95., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Charles M. Tiebout, 1956. "A Pure Theory of Local Expenditures," Journal of Political Economy, University of Chicago Press, vol. 64, pages 416.
- Murphy, Kevin M. & Shleifer, Andrei & Vishny, Robert W., 1989.
"Industrialization and the Big Push,"
3606235, Harvard University Department of Economics.
- Pindyck, Robert S., 1998.
"Irreversibilities and the timing of environmental policy,"
WP 4047-98., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Pindyck, Robert S., 2000. "Irreversibilities and the timing of environmental policy," Resource and Energy Economics, Elsevier, vol. 22(3), pages 233-259, July.
- Kunreuther, Howard & Heal, Geoffrey, 2003. " Interdependent Security," Journal of Risk and Uncertainty, Springer, vol. 26(2-3), pages 231-49, March-May.
- Levitt, Steven D, 1997.
"Using Electoral Cycles in Police Hiring to Estimate the Effect of Police on Crime,"
American Economic Review,
American Economic Association, vol. 87(3), pages 270-90, June.
- Steven D. Levitt, 1995. "Using Electoral Cycles in Police Hiring to Estimate the Effect of Policeon Crime," NBER Working Papers 4991, National Bureau of Economic Research, Inc.
- Kahneman, Daniel & Tversky, Amos, 1979.
"Prospect Theory: An Analysis of Decision under Risk,"
Econometric Society, vol. 47(2), pages 263-91, March.
- Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
- Joseph Persky, 2001. "Cost-Benefit Analysis and the Classical Creed," Journal of Economic Perspectives, American Economic Association, vol. 15(4), pages 199-208, Fall.
- Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August.
- Glaeser, Edward L. & Shapiro, Jesse M., 2002.
"Cities and Warfare: The Impact of Terrorism on Urban Form,"
Journal of Urban Economics,
Elsevier, vol. 51(2), pages 205-224, March.
- Edward L. Glaeser & Jesse M. Shapiro, 2001. "Cities and Warfare: The Impact of Terrorism on Urban Form," NBER Working Papers 8696, National Bureau of Economic Research, Inc.
- Hallstrom, Daniel G. & Smith, V. Kerry, 2005. "Market responses to hurricanes," Journal of Environmental Economics and Management, Elsevier, vol. 50(3), pages 541-561, November.
- Matthew E. Kahn, 2005. "The Death Toll from Natural Disasters: The Role of Income, Geography, and Institutions," The Review of Economics and Statistics, MIT Press, vol. 87(2), pages 271-284, May.
- Matthew E. Kahn, 2000. "Smog Reduction's Impact on California County Growth," Journal of Regional Science, Wiley Blackwell, vol. 40(3), pages 565-582.
- Klick, Jonathan & Tabarrok, Alexander, 2005.
"Using Terror Alert Levels to Estimate the Effect of Police on Crime,"
Journal of Law and Economics,
University of Chicago Press, vol. 48(1), pages 267-79, April.
- Jonathan Klick & Alexander Tabarrok, . "Using Terror Alert Levels to Estimate the Effect of Police on Crime," American Law & Economics Association Annual Meetings 1042, American Law & Economics Association.
- W. Kip Viscusi & Joseph E. Aldy, 2003.
"The Value of a Statistical Life: A Critical Review of Market Estimates throughout the World,"
NBER Working Papers
9487, National Bureau of Economic Research, Inc.
- Viscusi, W Kip & Aldy, Joseph E, 2003. " The Value of a Statistical Life: A Critical Review of Market Estimates throughout the World," Journal of Risk and Uncertainty, Springer, vol. 27(1), pages 5-76, August.
- Aldy, Joseph E. & Viscusi, W. Kip, 2003. "The Value of Statistical Life: A Critical Review of Market Estimates throughout the World," Working paper 282, Regulation2point0.
- Zeckhauser, Richard J, 1996. "The Economics of Catastrophes," Journal of Risk and Uncertainty, Springer, vol. 12(2-3), pages 113-40, May.
Blog mentionsAs found by EconAcademics.org, the blog aggregator for Economics research:
- Can Safe Public Parks Cause More Crime?
by Matthew E. Kahn in Environmental and Urban Economics on 2011-12-29 00:42:00
- Luttmer, Erzo F. P. & Zeckhauser, Richard & Kousky, Carolyn, 2006. "Permits to Elicit Information," Working Paper Series rwp06-049, Harvard University, John F. Kennedy School of Government.
- Raghav Gaiha1 & Kenneth Hill & Ganesh Thapa, 2012. "Have Natural Disasters Become Deadlier?," ASARC Working Papers 2012-03, The Australian National University, Australia South Asia Research Centre.
- Céline Grislain-Letrémy & Sabine Lemoyne de Forges, 2011. "Coordinating Flood Insurance and Collective Prevention Policies: A Fiscal Federalism Perspective," Working Papers 2011-07, Centre de Recherche en Economie et Statistique.
- Francois Salanie & Nicolas Treich, 2009.
"Option Value and Flexibility: A General Theorem with Applications,"
LERNA Working Papers
09.12.288, LERNA, University of Toulouse.
- Salanié, François & Treich, Nicolas, 2009. "Option Value and Flexibility: A General Theorem with Applications," TSE Working Papers 09-002, Toulouse School of Economics (TSE).
- Davlasheridze, Meri & Fisher-Vanden, Karen & Klaiber, H. Allen, 2012. "The Effects of Adaptation Measures on Hurricane Induced Property Losses," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington 124565, Agricultural and Applied Economics Association.
- Craig E. Landry & Paul Hindsley & Okmyung Bin & Jamie B. Kruse & John C. Whitehead & Ken Wilson, 2011.
"Weathering the Storm: Measuring Household Willingness-to-Pay for Risk-Reduction in Post-Katrina New Orleans,"
Southern Economic Journal,
Southern Economic Association, vol. 77(4), pages 991-1013, April.
- Craig E. Landry & Paul Hindsley & Okmyung Bin & Jamie B. Kruse & John C. Whitehead & Kenneth R. Wilson, 2009. "Weathering the Storm: Measuring Household Willingness-to-Pay for Risk-Reduction in Post-Katrina New Orleans," Working Papers 09-18, Department of Economics, Appalachian State University.
- Kousky, Carolyn & Kunreuther, Howard C., 2009. "Improving Flood Insurance and Flood Risk Management: Insights from St. Louis, Missouri," Discussion Papers dp-09-07, Resources For the Future.
- Kousky, Carolyn & Cooke, Roger M., 2009. "The Unholy Trinity: Fat Tails, Tail Dependence, and Micro-Correlations," Discussion Papers dp-09-36-rev.pdf, Resources For the Future.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Guenther Eichhorn) or (Christopher F. Baum).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.