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Private Investment and Government Protection

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  • Carolyn Kousky
  • Erzo F.P. Luttmer
  • Richard J. Zeckhauser

Abstract

Hurricane 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. We show that if private capital is more likely to locate in better-protected areas, 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, due to the ill-behaved nature of the benefit function, there may be multiple Nash equilibria. 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 investment that will accompany any level of protection, further complicating the government%u2019s choice problem. We show that when deciding on the current level of protection, the government must take account of the option value of increasing the level of protection in the future.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12255.

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Date of creation: May 2006
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Handle: RePEc:nbr:nberwo:12255

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Blog mentions

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  1. Can Safe Public Parks Cause More Crime?
    by Matthew E. Kahn in Environmental and Urban Economics on 2011-12-29 00:42:00
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Cited by:
  1. Salanié, François & Treich, Nicolas, 2009. "Option Value and Flexibility: A General Theorem with Applications," TSE Working Papers 09-002, Toulouse School of Economics (TSE).
  2. 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.
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  7. 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.
  8. 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.

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