The Moral Side of Disasters

Moral hazard is the most underrated driver of natural disasters. We know that it exists almost in every policy instrument or private strategy for managing the risk of natural disasters. For more than three decades, the literature has acknowledged and discussed extensively about the different types of moral hazard like the politician and the Samaritan dilemmas, and the market failure associated with traditional insurance. However, there is little progress achieved in this area. In short, the relationship between moral hazard and disasters may be taken from a couple of examples:

  1. Suppose that your house is located in a seismic area, you are aware of it AND have some idea that should an earthquake occur, it would likely damage or destroy, your house. The economic theory tells us that, since you are a rational individual (irrational does not mean–necessarily–that your make stupid decisions, rather that the theory is limited enough to understand your behavior), your risk aversion would have you opting into a strategy to protect your asset. For example, you buy insurance. (Note: one variable to which I am not paying strong consideration is your level of risk perception, or something that we can call “belief”. You may believe that the probability an earthquake hits the area and damages your house is nil and, then, investing in risk management is not worth it. That is a different story that I will be discussing about in another post).
    • OK. An earthquake occurs, you file a claim and the insurance company pays you enough money to rebuild. So far so good. The paid premium was insignificant compared with the amount of money you had to come up with with no insurance. However, life is not perfect, there is envy in this world and you became aware that the government disaster-fund is paying to those uninsured. Not considering house values both ex-ante the earthquake and ex-post the reconstruction (and different factors than monies), your neighbor that said “no” to insurance resulted to be a better planner and more financially benefited. Now, what are you going to do when the time for renewing your insurance policy comes–a policy that is likely to be more expensive because insurers tend to increase prices after the occurrence of the hazard? >MORAL HAZARD.
  2. You are the governor of the state with the highest exposure to floods per year in the country. Similar to the other case, you have to set your position regarding disaster risk management, but now you are affecting many more people with such decision. In this case, you could allocate public resources in prevention (e.g., relocating communities to safe areas), mitigation (e.g., building levees), or response and recovery capabilities (e.g., education to the community or a  financial instrument to finance reconstruction).  Let us suppose your administration decided for resettlement and relocation.
    • Needless to explain, this is not an easy choice to implement. It entails a huge effort of lobbying with communities, politicians, the million of activist that will be questioning the decision, and conducting environmental impact evaluations, risk maps, other analyses, etc. Should the flood happens and would had affected the relocated communities, your decision MAY be rewarded; conversely, it is SURE that your name will be written along with words like ineptitude or corruption and other beauties. The fact is that the investment in prevention and mitigation is tremendously expensive if the hazard does not occur. And let us remember: nature does not follow administrative terms. The disaster can happen this year or five years from now. Since disasters are low-probability phenomena, the vast majority of governments in developed and developing countries prefer options that yield more political capital. In fact, statistical studies in the US suggest that voters reward post-disaster actions, but punish or give little to investments in prevention. How many politicians–stereotypes apply, e.g., rolled sleeves, helmet, work footwear–you remember leading response in disaster zones or lobbying for international aid? On the opposite, how many politicians are remembered because of their effective investments in prevention? Furthermore, if you are head of a poor state or country, your incentives to invest in prevention are relatively low because of a consciousness of an external aid network that would mobilize resources in case of a disaster. Aid that generally is free.  Then, who wants to invest in disaster risk management if resources can be used to pay socially tangible infrastructure? >MORAL HAZARD.

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