Wednesday, September 3, 2008

The Economics of Flooding and Flood Relief

It would be a heartless soul who wanted to stop federal aid to places devastated by floods. Yet, are there any good economic reasons for appearing to be heartless?

Some areas are very prone to flooding (e.g. New Orleans) Because they are prone to flooding, house prices will be lower than average. Therefore, vulnerable areas of housing often attract low income households. Therefore, when floods hit the area, it is the poor who are disproportionately hit.

In response to devastating floods, the federal government may respond by guaranteeing the cost of rebuilding. This seems fair because:
  • The poor cannot afford to rebuild.
  • It spreads the cost of floods across the country.
However, although this has the best intentions, there is a problem of moral hazard. Because the government guarantees the cost of rebuilding, houses in these vulnerable areas more or less retain their value. It also encourages people to continue to live in vulnerable areas.

If the government, didn't secure them against flooding, their price would fall significantly; this would mean the poor who live there would have lower housing costs.

Therefore, the effect of Guaranteed government relief is:
  • Deals with short term problem
  • Makes long term house prices in vulnerable areas higher than they should be.
  • Encourages people to continue to live in unsuitable areas.

What Then Should The Government Do?

It is easy to point out problems of subsidising rebuilding, it is more difficult to suggest long term solutions.

Maybe the government could give those affected credits to buy housing anywhere they like. Many may take the opportunity to move elsewhere where the risk of flooding is less. Because the government isn't promising to rebuild in vulnerable areas; house prices would fall making it cheaper for those who continue to live there. But, people will be less inclined to live in a vulnerable areas where nobody is going to insure it.
  • Therefore, the next time the flood comes, the impact and cost will be much lower, because many people will have drifted away.
I am not arguing for a policy of laissez faire. Government should deal with catastrophes and disasters. I don't mind paying higher tax to fund disaster relief. At the same time, we should not be blind to the long term consequences of giving aid relief and insurance. It is good to give aid, but, it is better to give Aid thoughtfully and try to diminish the future problems of aid.


The inspiration for this article came from - "More Sex is Safer Sex" by Steven Landsburg.

Book Cover

"More Sex is Safer Sex" at

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