What are the options? I don’t buy the Leeson-Sobel notion that cutting FEMA aid will improve long-term performance in disaster-stricken areas. The real question is what we should do ex ante.
Howard Kunreuther and Mark Pauly promote a traditional idea:
This paper explores options for programs to be put in place prior to a
disaster to avoid large and often poorly-managed expenditures following
a catastrophe and to provide appropriate protection against the risk of
those large losses which do occur. The lack of interest in insurance
protection and mitigation by property owners and by public sector
agencies prior to a disaster often creates major problems following a
catastrophic event for victims and the government. Property owners who
suffer severe damage may not have the financial resources easily at
hand to rebuild their property and hence will demand relief. The
government is then likely to respond with costly but poorly targeted
disaster assistance. To avoid these large and often uneven ex post
expenditures, we consider the option of mandatory comprehensive private
disaster insurance with risk based rates. It may be more efficient to
have an ex ante public program to ensure coverage of catastrophic
losses and to subsidize low income residents who cannot afford coverage
rather than the current largely ex post public disaster relief program.
The goal is to make people internalize the social costs of placing their assets in a vulnerable position. If you own a home by a questionable levee, you have to buy insurance. Maybe the price of that insurance will tell you not to keep the home. I have two problems with this idea. First, in distributional terms we will essentially end up confiscating the homes of many poor people. Second, insurers can be notoriously reluctant to write policies for high-risk areas, or they will write policies with exorbitant non-expected-utility-based rates. (Is any of this regulatory? Why don’t the markets pool out the risk? Is there a principal-agent issue within the insurance company?) It might lead to far more confiscation or abandonment than is efficient.
The correct ex ante policies toward disasters remain an underexplored are of microeconomics. And why private insurance doesn’t do a better job of insuring against long-run risks..well…that is perhaps the leading question of applied microeconomics today.