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On the optimal design of disaster insurance in a federation

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  • Timothy J. Goodspeed

    ()
    (Hunter College and Graduate Center of CUNY.)

  • Andrew F. Haughwout

    ()
    (Federal Reserve Bank of New York)

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 are responsible for investing in infrastructure designed to reduce vulnerability to natural and man-made hazards. This division of responsibilities – regional governments providing protection from disasters and federal government providing insurance against their occurrence – leads to the tensions that are at the heart of our analysis. We show that when the federal government is committed to full insurance against disasters, regions will have incentives to under-invest in costly 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. Normally (though not always) this will result in lower intergovernmental transfers and greater investment. However, the second-best transfer scheme suffers from a time-inconsistency problem. Ex-post, the central government will be driven towards equalizing 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. We discuss these results in light of recent disaster policy outcomes in the US.

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Bibliographic Info

Paper provided by Institut d'Economia de Barcelona (IEB) in its series Working Papers with number 2009/25.

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Length: 43 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:ieb:wpaper:2009/10/doc2009-25

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Keywords: insurance; disasters; federalism; transfers; grants;

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References

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Citations

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
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Cited by:
  1. Hikaru Ogawa & David E. Wildasin, 2009. "Think Locally, Act Locally: Spillovers, Spillbacks, and Efficient Decentralized Policymaking," American Economic Review, American Economic Association, American Economic Association, vol. 99(4), pages 1206-17, September.
  2. 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.
  3. Lohse, Tim & Robledo, Julio R., 2012. "Public self-insurance and the Samaritan's dilemma in a federation," Discussion Papers, Research Professorship & Project "The Future of Fiscal Federalism", Social Science Research Center Berlin (WZB) SP II 2012-103, Social Science Research Center Berlin (WZB).
  4. Christos Kotsogiannis & Robert Schwager, 2006. "Fiscal Equalization and Yardstick Competition," Working Papers, University of Kentucky, Institute for Federalism and Intergovernmental Relations 2006-15, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  5. Thushyanthan Baskaran, 2013. "Do bailouts buy votes? Evidence from a panel of Hessian municipalities," Economics of Governance, Springer, Springer, vol. 14(3), pages 257-278, August.
  6. Baskaran, Thushyanthan, 2014. "Bailouts and austerity," Center for European, Governance and Economic Development Research Discussion Papers 212, University of Goettingen, Department of Economics.
  7. 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.
  8. Timothy J. Goodspeed, 2013. "Decentralization and Natural Disasters," CESifo Working Paper Series 4179, CESifo Group Munich.
  9. 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, Institut d'Economia de Barcelona (IEB) 2009/21, Institut d'Economia de Barcelona (IEB).
  10. Kai A. Konrad & Marcel Thum, 2012. "The Role of Economic Policy in Climate Change Adaptation," CESifo Working Paper Series 3959, CESifo Group Munich.

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