Monday, November 26, 2012

Benevolent Paternalists vs. Tough Love: The Case of Climate Change Adaptation

This is a blog post about climate adaptation and a spatial separating equilibrium played out in a sequential game.  In this game, government must make a choice to either embrace benevolent paternalism or engage in tough love.   There are two types of people.  One type is called "Mr. Spock" and the other is called "Homer Simpson".   After government has chosen its actions and after each type has chosen its action, Mother Nature then makes a move (a Hurricane Sandy or no Sandy) and payoffs are observed.

To keep this non-peer reviewed blog post short, I assume that a person's type is exogenously determined and that 50% of the population are Spock and 50% of the population are Homer.  The Mr. Spocks are 'University of Chicago" rational expectations men and women who form actuarial probabilities over random variables.  The Homer Simpsons are UC Berkeley behavioral economics people who are naive and do not update their probabilities of disaster as new information about climate change arrives.

The Chronology of this game is the following;

1.  Government chooses to defend the coast or not.
2.  People choose whether to live on the coast or not
3.  Mother Nature chooses to inflict a "Hurricane Sandy" on the coast.

Case #1:  A Low Cost Adaptation  Equilibrium:

Government chooses to not defend the coast.
The Spocks are risk averse and aware of the risks that the coastal city faces and they move to the "Higher Ground" safe city.  (We could make this model fancier if we allowed the Spocks and Homers to differ with respect to their love of living near the coast.  In this case, the subset of Spocks who love coastal living might live there even as the climate risk increases).
The Homers are naive but they know that the Spocks are smart and they engage in Banjeree herding and follow Spocks to Higher Ground.
In this case, regardless of whether Mother Nature inflicts a Sandy, no real damage is caused because
of the private self protection of migrating to the safe city.    The losers in this case are the land owners in the coastal city who will suffer a loss in asset value as aggregate demand falls.

Case #2:  The Darwin Equilibrium  (the spatial separating equilibrium)

Government chooses to not defend the coast.
The Spocks are risk averse and they move to the "Higher Ground" safe city.
The Homers drink their beer and ignore the pending danger and remain in the pretty coastal city.
In this case, if Mother Nature doesn't inflict pain, the Homers laugh at the Al Goreish Spocks for being Chicken Littles.  If a nasty Sandy Storm does take place,  the Homers suffer and the Spocks repopulate the planet.

Fear of Equilibrium #2 nudges the benevolent paternalists to invest national $ to protect the coastal areas in step #1.  This nudges some Spocks to remain in the coastal area and this is the moral hazard margin.

Case #3:  Climatopolis Logic 

Critics of my Climatopolis book have argued that I believe in  "every man for himself" in a sort of law of the jungle.  This is false. I want men and women to use decentralized free markets (where people do interact) to work to help folks to adapt.

If the Spocks anticipate that the Homers have placed themselves at risk by ignoring the increased risk of a major Sandy Storm, then out of entrepreneurial self interest, they have strong incentives to develop products to help the Homers live on in their risky coastal area.  Depending on the timing of how the shocks arrive, these Homers will have the time and motivation to purchase such products. This is endogenous innovation at work as an adaptation tool.  Researchers and environmentalists have not explored this channel.

If the "Homers" are too silly to recognize that they have made a risky choice that is growing riskier over time, then the Red Cross and other volunteer groups can work to help to protect this group.  The key issue here is whose $ is used to protect this group?  I do support benevolent paternalism in terms of using the zoning code to discourage individuals from living in the riskiest areas.   We are about to face a very interesting case of "buyer beware".  Do you view adults to be adults and thus responsible for their decisions?

In the second economy I presented above the Homers who live in the coastal city have their lifestyle subsidized by the Spocks who live in the safe city and pay national taxes.  The government Sea Walls are funded with national (not local) tax dollars.  When people go bungee jumping, do they expect a similar subsidy?  What is the difference between these different risk categories?

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