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The Economics of Disaster

The Economics of Disaster

13.1.2012 16:26

Despite all of the gloomy economic news nowadays, if we thought that things couldn’t get much worse, we had a grim reminder this month that that no country is immune to the forces of nature and the havoc they wreak. Two years ago, on January 12, 2010, Haiti was struck by a devastating earthquake that killed more than 220,000 people and shattered the country’s prospects.

As strange as it may sound, traditional Chinese medicine has much to teach us about dealing with disasters – in particular, to pay more attention to prevention than to therapy. In the same way, it is best to focus on reducing natural-disaster risks through prevention.

According to a recent report released by the World Bank and the United Nations, Natural Hazards, UnNatural Disasters: The Economics of Effective Prevention, an ounce of prevention in planning for disasters is worth a pound of cure. So prevention pays, if done right. And that means getting incentives right.

Incentives at every level – international, government, and individual – can play an important role in helping to prevent natural hazards from turning into disasters. A report by Tearfund, a leading relief and development charity, provides an instructive example from Mozambique. In 2000, Mozambique requested $3-4 million from donor countries to help it to prepare for impending floods. It received only about half that amount. But, after the floods struck, donors gave Mozambique more than $100 million in relief alone, and pledged more than $450 million for recovery and reconstruction.

How donors channel aid matters. Investments in prevention often imply long-term development expenditures. Donors could specifically earmark development aid – as opposed to humanitarian aid, whose primary focus is immediate response and relief – for prevention-related activities.

But it is not only donors’ responsibility to get it right. Governments play a crucial role in preventing disasters – above all, by providing information, which is necessary to understand threats, to warn of impending hazards, and to ensure that markets and individuals reflect risks.

The technology to produce useful information exists, but, unfortunately, many countries are not fully taking advantage of it. For example, even though Japan and Indonesia have similar seismic exposure, Japan is equipped with more than 1,000 seismographs, compared to only about 160 in Indonesia, which is roughly five times larger.

But there is also the more fundamental issue of making already-existing information public and easily accessible, which too often does not happen, frequently on national-security, commercial, and privacy grounds. In the United States, for example, the Federal Emergency Management Authority updates coastal risk maps for the hazard-prone Gulf of Mexico, but there is resistance to their adoption because such information could reduce property prices.

But prices are precisely what individuals ultimately respond to, and there are many other examples of skewed incentives that contribute to disastrous outcomes where the correct incentives could help to promote a culture of prevention. If political pressure keeps insurance prices low, for instance, that encourages people to construct in hazard-prone areas, thereby increasing their exposure and vulnerability.

Another example of distorted prices comes from Mumbai, where rent control was pervasive. Landlords neglected maintenance for decades, because they could not recoup the costs by raising rents, causing buildings to crumble in the annual monsoon rains. Like rent control, insecure ownership also reduces individuals’ incentives to make long-term investments in prevention.

In Peru, land titling is associated with an almost 70% increase in housing renovation within four years. One implication is that governments should let land and housing markets work, but complement them with targeted interventions when necessary, because, when individuals have the right information and the correct incentives, they generally decide well for themselves.

These considerations are all the more important in light of rising exposure to disasters. By 2050, the number of people exposed to storms and earthquakes in large cities could more than double, to 1.5 billion – and that is without taking climate change into account. Growing cities and a changing climate are shaping the future of the disaster-prevention landscape. But debating whether the recent Thailand floods or Hurricane Katrina was a result of climate change diverts attention from policies that continue to misprice risk, subsidize exposure, and promote hazardous behavior in the long run.

The right incentives, supported by credible and reliable institutions at all levels, can ensure that rising exposure does not translate into increasing vulnerability. Natural hazards are inevitable, but at every level we have the power to ensure that they do not become unnatural disasters.

Justin Yifu Lin is Senior Vice President and Chief Economist of the World Bank. Apurva Sanghi is a World Bank senior economist and team leader of the report Natural Hazards, UnNatural Disasters: the Economics of Effective Prevention.

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