Economic incentives and disaster mitigation

Andrew S. Natsios

Policymakers can probably change social behavior more effectively through market incentives than by threatening punishment for failure to comply with rules. Lower insurance premiums and lower taxes for those observing building codes could be the best way to encourage disaster-resistant construction. Loan qualifications could be determined partly on the basis of risk assessment. Farm families could be given incentives to plant and care for trees, as part of reforestation projects. Consumers could be taught to ask for and expect disaster-resistant construction. The state, instead of policing such cooperation, could direct its funds and energies toward such necessarily public services as providing effective early warning systems for disaster.

In 1976 Charles Schultze, chairman of the Council of Economic Advisors under President Carter and now professor of economics at Harvard University, gave the Godkin Lecture at Harvard, perhaps the most celebrated lecture series in the United States. His remarks were later published by the Brookings Institution in the 1977 book The Public Use of Private Interest. I would like to apply the model of analysis described in that book to disaster prevention, mitigation, and preparedness. The results may offend some scientists and practitioners as it suggests that some of their work has not been productive. But the disaster mitigation strategies we now pursue need to be reviewed critically and, I believe, need to take some new directions.

Schultze argued that domestic public policy in the United States had failed to provide much of what it had promised both in public services and regulatory reform. He wrote:

There is a growing body of objective evidence that government is not performing its new tasks effectively. The counterproductivity of governmental regulation of transportation is well documented. Efforts to improve the environment, while far from a failure, are unnecessarily expensive and increasingly bogged down in Rube Goldberg regulations, legal snarls, and games between regulators and industry as enforcement deadlines draw near. While Medicare and Medicaid have improved access to health care for the poor and the aged, government attempts to deal with rapidly escalating health costs have produced only burgeoning volumes of regulations and no results. Professional evaluations of manpower training, work experience, and related federal job programs usually find that their payoffs are low. Although the compilation of absurdities perpetrated in the name of industrial safety often emanates from suspect sources - the industries being regulated - even the sympathetic observer finds it hard to recognize many of the regulations as anything but absurdities. The current debate over long-term energy policy shows how very difficult it is for government to deal with complicated price and resource-allocation problems.

A growing body of research has been done primarily by economists comparing the measurable consequences of government programs and regulatory schemes with the specific objectives those policy interventions sought to achieve. This research has shown a wide gap between promise and reality. Public policy in the United States has frequently had general consequences few anticipated, some of which were quite pernicious, others of which were irrelevant and unrelated to the explicit goals of the interventions, and most of which cost either government or particularly the private sector a good deal of money that could have been much more productively used elsewhere.

One example will suffice to indicate the flavor of much of this research (though this particular example is taken from a study done after Schultze’s book). Richard Zeckhauser, an economist at the Kennedy School of Government at Harvard University, studied OSHA regulations (the Occupational Safety and Health Administration), a regulatory invention of the late 1960s to reduce accidents and health risks in the workplace. He found that while OSHA itself estimated just one of its regulations would cost American industry $10.5 billion to implement, “it seems reasonably certain... that the gains have not been major” in improving safety or health in the workplace. Zeckhauser explained this discontinuity between objective and result by suggesting that what appeared dangerous to regulators caused few accidents and that OSHA does not have the staff to police American industry. He suggested instead raising the cost of accidents to industry by taxing them at a rate sufficiently high that managers would, without any regulation, find out how to reduce the accident rate in their workplace. The moral of the case study is that appearances in public policy are usually deceiving: those conditions on the workplace that appeared to cause accidents did not. We did much damage to the competitiveness of American industry but accomplished little for the American worker by imposing this regulatory scheme (Nicholas and Zeckhauser 1977).

Schultze and Zeckhauser suggest that social and economic forces are much more complex and mysterious than any scholar could understand. As the complexity of these forces increases, our ability to regulate their operation declines. People find ways to take financial advantage of programs and to evade regulations that frustrate the most brilliant policy and program analyst. Human behavior is not as simple or as controllable as some policymakers think.

In many respects the disaster preparedness discipline faces the same discontinuities that domestic policymakers now confront in the United States. Our early warning systems for droughts, hurricanes, volcanos, and floods sometimes include no system for evacuating the vulnerable population from the affected area. Sometimes even when evacuation plans are prepared they are not implemented or, worse still, the vulnerable population ignores the warnings. We had ample evidence of the latter phenomenon in the Bangladesh flood of 1988. Building codes with earthquake engineering standards in many, if not most, developing countries are as a rule, I suspect, ignored. Building codes are often ignored in developed countries. Why expect more regulatory rigor from developing countries? So much for earthquake engineering. Little research has been done on whom we train in our preparedness instruction, what they learn, how effective the training is, and how long those we train remain in relevant positions of authority. More distressing, we train people to respond to disasters after the event occurs - when the damage has already been done (except for evacuation procedures). Too many carefully done vulnerability assessments and statistical probability analyses have been carefully filed away and forgotten rather than used to affect public policy decisions before a disaster occurred. Western donors and multilateral institutions have spent money and used their technical advice on institution-building in developing countries with little to show for it. The institutions collapse without western assistance or when they continue are often dysfunctional or poorly managed - they are ineffective for the same reasons Schultze attributes to western institutions.

Schultze’s central thesis was that public policy objectives are best carried out by altering the structure of the marketplace rather than issuing regulations in the fashion of a command and control economy. Put differently, policymakers can change social behavior much more effectively by changing the incentives of the marketplace - the public use of private interest - than by threatening punishment for failure to comply with voluminous rules. Positive incentives work better than negative incentives. Indicating a policy’s desired outcome and leaving how to achieve that outcome to the economic actors will yield the best solution to public problems. The marketplace will direct economic resources to their most efficient use. This approach to policymaking allows the use of technological and managerial innovation for a single policy objective.

This model has useful applications for disaster management. The goal of disaster prevention, mitigation, and preparedness is to save lives and protect economic resources. One application of the Schultze model would be to build into the casualty insurance industry - for the few developing country investments covered by insurance - a strong premium differential for earthquake- and hurricane-resistant construction. We have been doing risk vulnerability studies for some time; the data should now be put to good economic use. I suspect many insurance companies in the developing world do not include disaster vulnerability data in their premium structure or in some cases simply exclude from coverage damage done to a building by a natural disaster. Much higher premiums for poorly engineered buildings and lower premiums for earthquake- and hurricane-resistant construction will act as an economic stimulus to protect a country from the effects of these sorts of disasters. Different insurance premiums would also create an incentive for retrofitting existing structures to protect them from disasters. I suspect the financing of building construction by whatever means in developing countries seldom includes risk assessment data for loan qualification. It should. Both of these approaches would require little if any regulatory intervention by the state. Both would be private market rather than command and control solutions.

These market solutions might well not provide enough of an incentive to cause actors in the marketplace to factor disaster mitigation into their planning, investment, and construction processes. Probably more economic incentives must be added to the cost of dealing with disasters before economic actors will actually change their behavior - which is what incentives are designed to do. One economic intervention developing countries might consider is a property or excise tax on new construction located in chronic flood-prone areas or near active volcanos, and on buildings that are not earthquake-or storm-resistant. The proceeds from the tax could be put into a fund to pay for retrofitting vulnerable buildings to make them more disaster-resistant.

Too many development projects seeking to mitigate environmental damage do not deal with the cause of the problem. Reforestation projects try to repair the damage done by villagers cutting trees for firewood - a practice that increases the frequency and severity of flooding, landslides, and desertification. Replanting forests is a waste of money without creating incentives to protect seedlings from further cutting or providing a fuel substitute for firewood.

The U.S. Agency for International Development initiated an agroforestry project in Haiti predicated on the assumption that for reforestation programs to succeed farm families must have economic incentives to plant and care for trees. Since benefits from planting trees are not realized for at least 18 months, the Haiti program initially provided a small subsidy to farmers to plant and care for the trees they owned and planted on their land. After a two-year period there was no longer a need for the subsidies because the farmers began benefiting from various products. Fruits, charcoal, animal feed, pesticides, and woodproducts (lumber for construction and tools) were either sold or used for domestic consumption. The net effect was that farmers saw that it was in their interest to protect and care for the trees that would otherwise have suffered the same fate as the original forests. This program made a significant impact on slowing down the deforestation of Haiti’s dwindling forest resources, and is a fine example of a marketlike disaster intervention to protect a damaged environment.

Even these reforms in our strategic approach to disasters will not reach deeply enough into the social and economic structure of a developing country to change people’s behavior. Our office is now reviewing another approach to hazard mitigation: training small contractors in simple, relatively inexpensive construction techniques to protect against earthquakes and storms. This strategy would reach what Hernando de Soto, the Peruvian businessman and economist, calls the informal sector or what economists term the black market, underground economy. De Soto’s research in Peru (1989) indicates that these contractors produced as much as 69 percent of the housing in Lima in 1985. Because of the extralegal nature of their work they are likely to be outside the financial and casualty insurance system. Training these contractors on how to increase the value of what they build without increasing their cost would increase mitigation in this structurally unintegrated portion of developing country economies. These informal contractors might begin advertising the resistance of their work to common natural disasters consumers have come to fear. Making technical information available to consumers can create a market for a product, including disaster protection. The resulting competition might well persuade unenthusiastic contractors to adopt the same building standards.

This use of marketlike incentives to encourage more energetic hazard mitigation will not work for all types of risk. I suspect that this approach must be reserved for protecting economic assets, because it will do little to protect human life. Unless some creative economist can think up a unique marketlike intervention, I do not see how early warning and evacuation systems for storms, volcanos, floods, and tsunamis can be built into the marketplace. These systems must be managed by the state as a public service. In that case we should examine early warning systems to ensure they work properly - that the technology provides timely warning of an impending disaster, that the information is quickly disseminated to the general public, that a tested evacuation plan is in place, that personnel can execute the plan, and that people respond to the evacuation order by leaving their houses. Any disconnect in any step will render the entire system inoperable. Every hypothesis used in an early warning system must be tested to see if it works. Too many lives are at risk to leave this to chance.

The International Monetary Fund and the World Bank must often assess the economic effects of disasters and environmental degradation. Developing countries whose economies are highly vulnerable to disasters would benefit from serious mitigation measures. The World Bank should seriously consider introducing market-based disaster mitigation conditionalities into its programs with these countries.

Many of us in the disaster response business hope the International Decade for Natural Disaster Reduction will help make disaster preparedness an integral part of development. This will require integrating disaster preparedness into the economic structure of developing countries. So long as this is a highly specialized, arcane discipline separate from the work of business managers, financiers, insurance actuaries, and construction superintendents it will be ineffective, misunderstood, or, worse, irrelevant.