Open Questions About the Unintended Consequences of Federal Policy Activism for Adapting to Place Based Disasters
A New Look at John Lennon and Yoko Ono's Song "Imagine"
Imagine if there is no FEMA or other federal subsidized federal disaster insurance.
Imagine if everyone is a renter (who holds a globally diversified portfolio of assets).
Imagine if the Federal Government invests in public goods such as basic climate research of providing satellite images and super-computing and allows for an open source competition between climate modeling teams.
Imagine if there are no insurance laws limiting “price gouging” on the price of various insurance products.
Under these rules of the game, we would be much better able to adapt to climate change and face less economic damage and loss of life when the next Hurricane Ian occurs.
In this post, I will borrow ideas from my 2010 Climatopolis book, my 2017 Hamilton Project piece and my 2021 Adapting to Climate Change book to explain my microeconomic logic.
Under the assumptions listed above, people are free to choose where they want to live in the United States. Improvements in pinpoint Climate Science would inform their locational choices. Our new work with Redfin highlights that home buyers are influenced by spatial risk information (and both Democrats and Republicans respond to this information).
A state like Florida represents a bundle. It has low taxes, plenty of sunshine, warm winters and natural disaster risk. Adults will plan accordingly. Under the rules sketched above, if the state does a bad job coping with risk then people and jobs will move away and real estate prices will fall. Local land owners have strong incentives to elect local officials and Governors who work together to co-ordinate private/public investments to defend the area. Note, that they are using their OWN Money. When people spend their own money, this focuses the mind and less waste occurs.
Under my assumptions sketched above, Governors will not be re-elected if their jurisdiction fails to adapt. Past research has documented that elected officials are rewarded for bringing home the pork after disasters rather than in ex-ante resilience efforts. That’s not a great incentive system!
Under the rules sketched out above, Governors would nudge local officials to up zone in areas that are relatively safer. Real estate developers and architects would have greater demand for building designs that are more resilient in the face of severe shocks. The state would adopt building codes to drive capital upgrades. Accountability would be achieved because the alternative is to suffer repeatedly from Mother Nature’s punches and suffer the resulting brain drain.
REITs and private equity would own the land and rent it out to people. These entities lose $ value if the assets are not “safe assets”. Renter are implicitly insured against shocks to local quality of life because rents will decline if an area’s quality of life declines. Why? People can always migrate to a safer place and this means that in spatial equilibrium —- risky places feature lower rents.
In the aftermath of Hurricane Ian, many are worried that the insurance industry will collapse. Under my proposed rules of the game, private investors would face the place based risk. They can diversify this risk by selling contracts on global markets or by holding a spatially diversified set of assets. They would have strong incentives to hire experts to help them to reduce the natural disaster risks posed to their assets. Their deep pockets and large scale given them great incentives to pursue this adaptation strategy.
For places such as Florida that face increased risk, free market firms will design resilience products if the scale of demand is high enough. Many non-economists miss this point. The expectation of misery actually triggers innovation that offsets the problem. Climate Change adaptation will offer a high stakes test of this claim.
Our current rules of the game create a moral hazard effect and discourage efficient risk taking. We are adults and we can choose where we want to live. Basic finance theory tells us not to put all of our eggs in one basket. Rising climate risk makes this lesson even more relevant.
Back in 1976, Robert Lucas published his “Lucas Critique”. In recent years, I have argued that this old point is now more relevant than ever as many non-economists are convinced that climate change will decimate our world. An irony. Since I am so worried about climate change, this actually increases my optimism that we can adapt! We have been slow to adapt in large part because of perverse government incentives that discourage adaptation. As we phase out these “bad rules”, the standard logic of microeconomics will re-emerge and people and firms will change their behavior and future Hurricane Ians will pose less damage. That’s adaptation.