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Group Provision Against Adversity: Security By Insurance vs. Protection

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  • Toshihiro Ihori

    (Faculty of Economics, University of Tokyo)

  • Martin McGuire

    (Department of Economics, University of California-Irvine, Irvine)

Abstract

We investigate the structure of interactions among countries exercising voluntary uncoordinated choice but sharing a common "risk profile" --- a vector comprised of chance of adversity/emergency and magnitude of loss under adversity/emergency. We use the term "emergency costs" to refer to the vector and/or its components. Countries strive to reduce emergency costs (a) by providing mutual self-insurance against loss and (b) mutual self-protection against risk. Because of their common risk profile each country's security spending whether on self-insurance or on self-protection provides a public good (pure or impure) to all in the group --- hence our term "mutual." We show that under expected utility maximization the normality or inferiority of such public goods depends crucially on hitherto unrecognized interactions between preference functions and status quo risks. Moreover we discover that these interactions differ systematically between insurance and protection with important policy implications for comparing the two instruments. Furthermore, we demonstrate that configurations where security is inferior are not at all unlikely. In such case the provision of international public goods can easily face an endogenous obstacle, an "inferior good barrier," under Nash-Cournot behavior and under Leader-Follower behavior with Stackelberg outcomes. (These, however, display novel and desirable properties even when the public good is inferior.) When improvements in risk profile generate not pure public goods, but instead imperfect, ambiguous, or even negative benefits among partners, who is an ally and who an adversary, itself becomes ambiguous. For this configuration where the emergency risk profile differs among allies, we show how spillovers from emergency cost reduction and their effects on welfare will be depend critically on the sign of income effects.

Suggested Citation

  • Toshihiro Ihori & Martin McGuire, 2006. "Group Provision Against Adversity: Security By Insurance vs. Protection," CARF F-Series CARF-F-086, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
  • Handle: RePEc:cfi:fseres:cf086
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    File URL: http://www.carf.e.u-tokyo.ac.jp/pdf/workingpaper/fseries/87.pdf
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    References listed on IDEAS

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    1. Alberto Alesina & Enrico Spolaore, 1997. "On the Number and Size of Nations," The Quarterly Journal of Economics, Oxford University Press, vol. 112(4), pages 1027-1056.
    2. McGuire, Martin C & Pratt, John & Zeckhauser, Richard, 1991. "Paying to Improve Your Chances: Gambling or Insurance?," Journal of Risk and Uncertainty, Springer, vol. 4(4), pages 329-338, December.
    3. Ihori Toshihiro, 1994. "Economic Integration of Countries with International Public Goods," Journal of the Japanese and International Economies, Elsevier, vol. 8(4), pages 530-550, December.
    4. TOSHIHIRO IHORI & MARTIN C. McGUIRE, 2007. "Collective Risk Control and Group Security: The Unexpected Consequences of Differential Risk Aversion," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 9(2), pages 231-263, April.
    5. Tim Lohse & Julio R. Robledo & Ulrich Schmidt, 2012. "Self‐Insurance and Self‐Protection as Public Goods," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 79(1), pages 57-76, March.
    6. Alesina, Alberto & Perotti, Roberto, 1998. "Economic Risk and Political Risk in Fiscal Unions," Economic Journal, Royal Economic Society, vol. 108(449), pages 989-1008, July.
    7. Vicary, Simon, 1990. "Transfers and the weakest-link : An extension of Hirshleifer's analysis," Journal of Public Economics, Elsevier, vol. 43(3), pages 375-394, December.
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    9. Boadway, Robin & Hayashi, Masayoshi, 1999. "Country size and the voluntary provision of international public goods," European Journal of Political Economy, Elsevier, vol. 15(4), pages 619-638, November.
    10. Martin McGuire, 2006. "Uncertainty, Risk Aversion, And Optimal Defense Against Interruptions In Supply," Defence and Peace Economics, Taylor & Francis Journals, vol. 17(4), pages 287-309.
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    12. Andreoni, James & McGuire, Martin C., 1993. "Identifying the free riders : A simple algorithm for determining who will contribute to a public good," Journal of Public Economics, Elsevier, vol. 51(3), pages 447-454, July.
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    Cited by:

    1. Toshihiro Ihori & Martin McGuire, 2010. "National self-insurance and self-protection against adversity: bureaucratic management of security and moral hazard," Economics of Governance, Springer, vol. 11(2), pages 103-122, April.

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