Thursday, December 17, 2009

Local authorities under-invest in disaster prevention

In the United States, the individual states and local authorities are supposed to be in charge of disaster prevention and protection, while the federal government provides insurance against disaster occurrence. And as this insurance is fully with perfect commitment, prevention is sub-optimal.

Timothy Goodspeed and Andrew Haughwout look at the second-best insurance contract where the states provide prevention in a non-cooperative fashion and cannot be monitored. It turns out it is really difficult to coax states to provide appropriate prevention. Fundamentally, this is because of the time consistency problem of the federal government and its soft budget constraint. Once disaster has happened, it is difficult to say no to immediate aid. This is not unlike the problem of humanitarian aid, that keeps going to the same places because they provide no effort for prevention as they know they are insured. Or the banking system.

As long as the insurer wants good things for people, this time-consistency problem will remain. But it can be mellowed by applying a hard budget constraint. This takes strong commitment, which is unlikely in a democracy, as politician cannot afford to refuse emergency aid. Then, why not let the federal government be in charge of prevention investment as well?


Agent Continuum said...

You can't do better than having *one* benevolent planner solving a well-behaved problem, right? So any argument for not having a dictator need to be based on a failure of those assumption (benevolence, etc.)

I'm not sure we can make a case for prevention done at the local level being a second-best solution to some imperfection in federal government handling of prevention, but that would be one way to argue against centralization.

Economic Logician said...

I principle, decentralization is good. But it does not provide insurance.