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On the optimal design of disaster insurance in a federation

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  • Timothy Goodspeed

    ()

  • Andrew Haughwout

    ()

Abstract

Recent experience with disasters and terrorist attacks in the US indicates that state and local governments rely on the federal sector for support after disasters occur. But these same governments invest in infrastructure designed to reduce vulnerability to natural and man-made hazards. We show that when the federal government is committed to full insurance against disasters, regions will have incentives to under-invest in ex-ante protective measures. We derive the structure of the optimal second-best insurance system when regional governments choose investment levels non-cooperatively and the central government cannot verify regional investment choices. For low probability disasters this will result in lower ex-post intergovernmental transfers (and hence less ex-post redistribution) and greater ex-ante investment. However, the second-best transfer scheme suffers from a time-inconsistency problem. Ex-post, the central government will be driven towards full insurance rather than the second-best grants, which results in a type of soft budget constraint problem. Sub-national governments will anticipate this and reduce their investment in protective infrastructure even further. The result is that the central government may be better off suffering the underinvestment that results with first-best transfers because investment is even lower under second-best transfers when the central government is unable to commit.

(This abstract was borrowed from another version of this item.)

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Bibliographic Info

Article provided by Springer in its journal Economics of Governance.

Volume (Year): 13 (2012)
Issue (Month): 1 (March)
Pages: 1-27

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Handle: RePEc:spr:ecogov:v:13:y:2012:i:1:p:1-27

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Related research

Keywords: Risk-sharing; Redistributive transfers; Federalism; Intergovernmental relations; Grants;

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References

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  1. Cornes, Richard C. & Silva, Emilson C. D., 2000. "Local Public Goods, Risk Sharing, and Private Information in Federal Systems," Journal of Urban Economics, Elsevier, vol. 47(1), pages 39-60, January.
  2. David Wildasin, 2007. "Disaster Policy in the US Federation: Intergovernmental Incentives and Institutional Reform," Working Papers, University of Kentucky, Institute for Federalism and Intergovernmental Relations 2007-01, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  3. Horst Raff & John Wilson, 1997. "Income Redistribution with Well-Informed Local Governments," International Tax and Public Finance, Springer, vol. 4(4), pages 407-427, November.
  4. Lockwood, Ben, 1999. "Inter-regional insurance," Journal of Public Economics, Elsevier, vol. 72(1), pages 1-37, April.
  5. Caplan, Arthur J. & Cornes, Richard C. & Silva, Emilson C. D., 2000. "Pure public goods and income redistribution in a federation with decentralized leadership and imperfect labor mobility," Journal of Public Economics, Elsevier, vol. 77(2), pages 265-284, August.
  6. Nobuo Akai & Emilson Silva, 2009. "Interregional redistribution as a cure to the soft budget syndrome in federations," International Tax and Public Finance, Springer, vol. 16(1), pages 43-58, February.
  7. Neil Bruce & Michael Waldman, 1986. "The Rotten-Kid Theorem Meets the Samaritan's Dilemma," Working Papers, Queen's University, Department of Economics 650, Queen's University, Department of Economics.
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  11. Martin Besfamille & Ben Lockwood, 2008. "Bailouts In Federations: Is A Hard Budget Constraint Always Best?," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 49(2), pages 577-593, 05.
  12. Thomas A. Garrett & Russell S. Sobel, 2003. "The Political Economy of FEMA Disaster Payments," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 41(3), pages 496-509, July.
  13. David E. Wildasin, 2008. "Disaster Policies," Public Finance Review, , vol. 36(4), pages 497-518, July.
  14. Gilberto Turati & Luigi Buzzacchi, 2009. "Optimal risk allocation in the provision of local public services: can a private insurer be better than a public mutual fund?," Working Papers 2009/21, Institut d'Economia de Barcelona (IEB).
  15. Persson, Torsten & Tabellini, Guido, 1996. "Federal Fiscal Constitutions: Risk Sharing and Moral Hazard," Econometrica, Econometric Society, Econometric Society, vol. 64(3), pages 623-46, May.
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  17. Melitz, Jacques & Zumer, Frederic, 2002. "Regional redistribution and stabilization by the center in Canada, France, the UK and the US:: A reassessment and new tests," Journal of Public Economics, Elsevier, vol. 86(2), pages 263-286, November.
  18. Timothy Goodspeed, 2002. "Bailouts in a Federation," International Tax and Public Finance, Springer, vol. 9(4), pages 409-421, August.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Local authorities under-invest in disaster prevention
    by Economic Logician in Economic Logic on 2009-12-17 21:24:00
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
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Cited by:
  1. Kai A. Konrad & Marcel Thum, 2012. "The Role of Economic Policy in Climate Change Adaptation," CESifo Working Paper Series 3959, CESifo Group Munich.
  2. Tim Lohse & Julio R. Robledo, 2013. "Public Self-Insurance and the Samaritan’s Dilemma in a Federation," Public Finance Review, , vol. 41(1), pages 92-120, January.
  3. Luigi Buzzacchi & Gilberto Turati, 2009. "Collective Risks in Local Administrations: Can a Private Insurer Be Better than a Public Mutual Fund?," Working papers, Former Department of Economics and Public Finance "G. Prato", University of Torino 3, Former Department of Economics and Public Finance "G. Prato", University of Torino.
  4. Tim Lohse & Julio R. Robledo, 2012. "Public Self-Insurance and the Samaritan‘s Dilemma in a Federation," Ruhr Economic Papers, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen 0330, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
  5. Baskaran, Thushyanthan, 2013. "Do bailouts buy votes? Evidence from a panel of Hessian municipalities," MPRA Paper 48228, University Library of Munich, Germany.
  6. Gilberto Turati & Luigi Buzzacchi, 2009. "Optimal risk allocation in the provision of local public services: can a private insurer be better than a public mutual fund?," Working Papers 2009/21, Institut d'Economia de Barcelona (IEB).
  7. Hikaru Ogawa & David Wildasin, 2007. "Think Locally, Act Locally: Spillovers, Spillbacks, and Efficient Decentralized Policymaking," Working Papers, University of Kentucky, Institute for Federalism and Intergovernmental Relations 2007-06, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  8. David Wildasin, 2007. "Pre-Emption: Federal Statutory Intervention in State Taxation," Working Papers, University of Kentucky, Institute for Federalism and Intergovernmental Relations 2007-05, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  9. Christos Kotsogiannis & Robert Schwager, 2006. "Fiscal Equalization and Yardstick Competition," CESifo Working Paper Series 1865, CESifo Group Munich.
  10. Baskaran, Thushyanthan, 2014. "Bailouts and austerity," Center for European, Governance and Economic Development Research Discussion Papers 212, University of Goettingen, Department of Economics.
  11. Timothy J. Goodspeed, 2013. "Decentralization and Natural Disasters," CESifo Working Paper Series 4179, CESifo Group Munich.

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