Friday, September 02, 2005

New Orleans’ Breached Levees: Ex-Ante How Much Should Have Been Invested in the Levees and Whose Money Should Have Paid For It?

As could be expected in the midst of a crisis there is a lot of finger pointing right now. Who is to blame for exacerbating this tragedy? Paul Krugman knows who. He points his finger at the White House in today's New York Times piece ""A Can't Do Government"

I quote: "Second question: Why wasn't more preventive action taken? After 2003 the Army Corps of Engineers sharply slowed its flood-control work, including work on sinking levees. "The corps," an Editor and Publisher article says, citing a series of articles in The Times-Picayune in New Orleans, "never tried to hide the fact that the spending pressures of the war in Iraq, as well as homeland security - coming at the same time as federal tax cuts - was the reason for the strain.""

Putting on my cold economics hat, I have some questions for you and then I will discuss some simple economics of climate change and cities.

1. How much did the people of the New Orleans metro area invest in their own levees? Given that property owners and public safety in this metro area are the main beneficiary of such investments, why wasn't this sufficient incentive for the Mayor and the metro area's other political leaders to tax citizens collect the money and invest in better, more modern levees?

2. Were the political leaders of New Orleans aware that the levees were at risk to collapse? More formally, conditional that a major hurrricane struck near New Orleans what did they believe was the probability that there could be major flooding? In this state of the world, how much did they guess that New Orleans would suffer? Expected value theory would say that if the Mayor is risk neutral and he thinks there is a 5% chance of a billion dollar loss if the current levees are not improved then the expected benefits of improving the levees would be 50 million dollars. This could be compared to the costs of improving the levees and the net cost/benefit analysis would have determined ex-ante whether this was "good policy"?

To convince me that federal tax payer money was need for such a local project, you'd have to convince me that New Orleans was liquidity constrained (couldn't get a loan) or that there political leaders were over optimistic about the quality of the existing levees and thus were underestimating the benefits of upgrading the levees.

3. Repeating myself, everyone in New Orleans knew that their city was below sea-level why didn't the major property owners lobby for greater investments in "insurance policies" (i.e better levees) to reduce the probability of disaster? I realize that this is monday morning quarterbacking but it is an obvious strategy for a risk averse person and most people are risk averse.

4. Turning to climate change. Cities ranging from London to New York City are studying how climate change will affect their city's quality of life? Should such cities finance their own investments to pre-empt climate change impacts or should their federal governments subsidize such investments? Given that the major beneficiaries of such policies such as inhibiting flooding are land owners in these cities, a simple public finance argument would say that these cities should handle their own financing of "self protection" against mother nature.

I do not mean to "blame the victim" here. Instead, I'm hoping to stimulate myself here to think about what local environmental threats should be handled by local government versus when should costs be spread. There may be a terrible moral hazard here that the politicians of New Orleans delayed invested their own people's tax revenue in building up the levees because they were hoping that the Federal Government would pay the bill though the Corps Engineering program that Krugman talks about today. I hope I'm not right about this!