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National Adversity: Managing Insurance and Protection

  • Toshihiro Ihori

    (Faculty of Economics, University of Tokyo)

  • Martin McGuireb

    (Department of Economics, University of California-Irvine)

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    This paper concerns self-insurance and self-protection that countries may implement at a national level in pursuit of their security. The distinctions self-insurance, self-protection, and market insurance were first made by Ehrlich and Becker (1972). Nevertheless, extension of their models to international security where market insurance for entire countries is usually unavailable is surprisingly sparse. We show that, in the absence of market insurance, self-insurance alone raises important new issues as to the definition of "fair pricing" and as to the relations between pricing, optimization, risk aversion, and inferiority that are significantly different from standard, conventional market analysis. We also discover a hitherto unrecognized tendency for misallocation between selfprotection and self- insurance when both are available and considered together. Because of external effects running from self- protection to self-insurance, governments trying to find the right balance face incentives that encourage extreme, self-inflicted moral hazard, to the detriment of self-protection. Moreover, rather innocuous assumptions concerning countries' preferences lead to pervasive goods inferiority for both insurance and protection. Consequently, unlike the conventional wisdom in the economic theory of alliances with its neat interior Nash-solutions, we show when "defense" or "security" is disaggregated into more realistic categories such as protection and insurance that instabilities and corner solutions will be the conventional standard. The resulting perverse incentives that we discover point to conflicts and other difficulties among agents trying to cooperate in their management insurance and protection must overcome. Moreover the analysis implies that the paradigm Olson-Zeckhauser model (1966) model for alliance allocative behavior was fundamentally insufficient for the problem it was designed to address.

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    File URL: http://www.cirje.e.u-tokyo.ac.jp/research/dp/2008/2008cf554.pdf
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    Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-554.

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    Length: 47 pages
    Date of creation: Apr 2008
    Date of revision:
    Handle: RePEc:tky:fseres:2008cf554
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    1. 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, 04.
    2. Rudolf Kerschbamer & Clemens Puppe, 1998. "Voluntary contributions when the public good is not necessarily normal," Journal of Economics, Springer, vol. 68(2), pages 175-192, June.
    3. Cornes, Richard, 1993. "Dyke Maintenance and Other Stories: Some Neglected Types of Public Goods," The Quarterly Journal of Economics, MIT Press, vol. 108(1), pages 259-71, February.
    4. 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 329-38, December.
    5. Richard Cornes & Juni-ichi Itaya, 2004. "Models With Two Or More Public Goods," Department of Economics - Working Papers Series 896, The University of Melbourne.
    6. Todd Sandler, 2005. "Collective versus unilateral responses to terrorism," Public Choice, Springer, vol. 124(1), pages 75-93, July.
    7. Ulrich Schmidt, 2010. "Self-Insurance and Self-Protection as Public Goods," Kiel Working Papers 1613, Kiel Institute for the World Economy.
    8. 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.
    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.
    11. Cornes, Richard & Sandler, Todd, 1984. "Easy Riders, Joint Production, and Public Goods," Economic Journal, Royal Economic Society, vol. 94(375), pages 580-98, September.
    12. Ehrlich, Isaac & Becker, Gary S, 1972. "Market Insurance, Self-Insurance, and Self-Protection," Journal of Political Economy, University of Chicago Press, vol. 80(4), pages 623-48, July-Aug..
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