How economic growth and rational decisions can make disaster losses grow faster than wealth

Assuming that capital productivity is higher in areas at risk from natural hazards (such as coastal zones or flood plains), this paper shows that rapid development in these areas -- and the resulting increase in disaster losses -- may be the consequence of a rational and well-informed trade-off between lower disaster losses and higher productivity. With disasters possibly becoming less frequent but increasingly destructive in the future, average disaster losses may grow faster than wealth. Myopic expectations, lack of information, moral hazard, and externalities reinforce the likelihood of this scenario. These results have consequences on how to design risk management and climate change policies.Hazard Risk Management,Natural Disasters,Labor Policies,Insurance&Risk Mitigation,Economic Theory&Research

A Cost-Benefit Analysis of the New Orleans Flood Protection System

In the early stages of rebuilding New Orleans, a decision has to be made on the level of flood protection the city should implement. Such decisions are usually based on cost-benefit analyses. But in such an analysis, the results are contingent on a number of underlying assumptions and varying these assumptions can lead to different recommendations. Indeed, though a standard first-order analysis rules out category 5 hurricane protection, taking into account climate change and other human-related disruptions of environment, second-order impacts of large-scale disasters, possible changes in the discount rate, risk aversion and damage heterogeneity may make such a hurricane protection a rational investment, even if countervailing risks and moral hazard issues are included in the analysis. These results stress the high sensitivity of the CBA recommendation to several uncertain assumptions, highlight the importance of second-order costs and damage heterogeneity in welfare losses, and show how climate change creates an additional layer of uncertainty in infrastructure design that increases the probability of either under-adaptation (and increased risk) or over-adaptation (and sunk costs).Cost-Benefit analysis; Hurricane risk; New Orleans; Climate change

The economics of natural disasters : concepts and methods

Large-scale disasters regularly affect societies over the globe, causing large destruction and damage. After each of these events, media, insurance companies, and international institu-tions publish numerous assessments of the"cost of the disaster."However these assessments are based on different methodologies and approaches, and they often reach different results. Besides methodological differences, these discrepancies are due to the multi-dimensionality in disaster impacts and their large redistributive effects, which make it unclear what is included in the estimates. But most importantly, the purpose of these assessments is rarely specified, although different purposes correspond to different perimeters of analysis and different definitions of what a cost is. To clarify this situation, this paper proposes a definition of the cost of a disaster, and emphasizes the most important mechanisms that explain and determine this cost. It does so by first explaining why the direct economic cost, that is, the value of what has been damaged or destroyed by the disaster, is not a sufficient indicator of disaster seriousness and why estimating indirect losses is crucial to assess the consequences on welfare. The paper describes the main indirect consequences of a disaster and the following reconstruction phase, and discusses the economic mechanisms at play. It proposes a review of available methodologies to assess indirect economic consequences, illustrated with examples from the literature. Finally, it highlights the need for a better understanding of the economics of natural disasters and suggests a few promising areas for research on this topic.Natural Disasters,Disaster Management,Economic Theory&Research,Hazard Risk Management,Climate Change Economics

When starting with the most expensive option makes sense : use and misuse of marginal abatement cost curves

This article investigates the use of expert-based Marginal Abatement Cost Curves (MACC) to design abatement strategies. It shows that introducing inertia, in the form of the"cost in time"of available options, changes significantly the message from MACCs. With an abatement objective in cumulative emissions (e.g., emitting less than 200 GtCO2 in the 2000-2050 period), it makes sense to implement some of the more expensive options before the potential of the cheapest ones has been exhausted. With abatement targets expressed in terms of emissions at one point in time (e.g., reducing emissions by 20 percent in 2020), it can even be preferable to start with the implementation of the most expensive options if their potential is high and their inertia significant. Also, the best strategy to reach a short-term target is different depending on whether this target is the ultimate objective or there is a longer-term target. The best way to achieve Europe's goal of 20 percent reduction in emissions by 2020 is different if this objective is the ultimate objective or if it is only a milestone in a trajectory toward a 75 percent reduction in 2050. The cheapest options may be sufficient to reach the 2020 target but could create a carbon-intensive lock-in and preclude deeper emission reductions by 2050. These results show that in a world without perfect foresight and perfect credibility of the long-term carbon-price signal, a unique carbon price in all sectors is not the most efficient approach. Sectoral objectives, such as Europe's 20 percent renewable energy target in Europe, fuel-economy standards in the auto industry, or changes in urban planning, building norms and infrastructure design are a critical part of an efficient mitigation policy.Climate Change Mitigation and Green House Gases,Climate Change Economics,Environment and Energy Efficiency,Energy and Environment,Transport and Environment

Why economic growth dynamics matter inassessing climate change damages: illustrationon extreme events

Extreme events are one of the main channels through which climate and socio- economic systems interact and it is likely that climate change will modify their probability distributions. The long-term growth models used in climate change as- sessments, however, cannot capture the effects of such short-term shocks. To inves- tigate this issue, a non-equilibrium dynamic model (NEDyM) is used to assess the macroeconomic consequences of extreme events. In the model, dynamic processes multiply the extreme event direct costs by a factor 20. Half of this increase comes from short-term processes, that long-term growth models cannot capture. The model exhibits also a bifurcation in GDP losses: for a given distribution of extremes, there is a value of the ability to fund reconstruction below which GDP losses increases dramatically. This bifurcation may partly explain why some poor countries that experience repeated natural disasters cannot develop. It also shows that changes in the distribution of extremes may entail significant GDP losses and that climate change may force a specific adaptation of the economic organization. These results show that averaging short-term processes like extreme events over the yearly time step of a long-term growth model can lead to inaccurately low assessments of the climate change damages.Dynamics; Extreme events; Economic impacts; Climate Change

Designing climate change adaptation policies : an economic framework

Adaptation has long been neglected in the debate and policies surrounding climate change. However, increasing awareness of climate change has led many stakeholders to look for the best way to limit its consequences and has resulted in a large number of initiatives related to adaptation, particularly at the local level. This report proposes a general economic framework to help stakeholders in the public sector to develop effective adaptation strategies. To do so, it lays out the general issues involved in adaptation, including the role of uncertainty and inertia, and the need to consider structural changes in addition to marginal adjustments. Then, it identifies the reasons for legitimate public action in terms of adaptation, and four main domains of action: the production and dissemination of information on climate change and its impacts; the adaptation of standards, regulations and fiscal policies; the required changes in institutions; and direct adaptation actions of governments and local communities in terms of public infrastructure, public buildings and ecosystems. Finally, the report suggests a method to build public adaptation plans and to assess the desirability of possible policies.Climate Change Economics,Wetlands,Climate Change Mitigation and Green House Gases,Adaptation to Climate Change,Science of Climate Change

A note on the economic cost of climate change and the rationale to limit it below 2°C

This note highlights a major reason to limit climate change to the lowest possible levels. This reason follows from the large increase in uncertainty associated with high levels of warming. This uncertainty arises from three sources: the change in climate itself, the change’s impacts at the sector level, and their macroeconomic costs. First, the greater the difference between the future climate and the current one, the more difficult it is to predict how local climates will evolve, making it more difficult to anticipate adaptation actions. Second, the adaptive capacity of various economic sectors can already be observed for limited warming, but is largely unknown for larger changes. The larger the change in climate, therefore, the more uncertain is the final impact on economic sectors. Third, economic systems can efficiently cope with sectoral losses, but macroeconomic-level adaptive capacity is difficult to assess, especially when it involves more than marginal economic changes and when structural economic shifts are required. In particular, these shifts are difficult to model and involve thresholds beyond which the total macroeconomic cost would rise rapidly. The existence of such thresholds is supported by past experiences, including economic disruptions caused by natural disasters, observed difficulties funding needed infrastructure, and regional crises due to rapid economic shifts induced by new technologies or globalization. As a consequence, larger warming is associated with higher cost, but also with larger uncertainty about the cost. Because this uncertainty translates into risks and makes it more difficult to implement adaptation strategies, it represents an additional motive to mitigate climate change.Climate Change Economics,Science of Climate Change,Climate Change Mitigation and Green House Gases,Adaptation to Climate Change,Transport Economics Policy&Planning

From growth to green growth -- a framework

Green growth is about making growth processes resource-efficient, cleaner and more resilient without necessarily slowing them. This paper aims at clarifying these concepts in an analytical framework and at proposing foundations for green growth. The green growth approach proposed here is based on (1) focusing on what needs to happen over the next 5-10 years before the world gets locked into patterns that would be prohibitively expensive and complex to modify and (2) reconciling the short and the long term, by offsetting short-term costs and maximizing synergies and economic co-benefits. This, in turn, increases the social and political acceptability of environmental policies. This framework identifies channels through which green policies can potentially contribute to economic growth. However, only detailed country- and context-specific analyses for each of these channels could reach firm conclusion regarding their actual impact on growth. Finally, the paper discusses the policies that can be implemented to capture these co-benefits and environmental benefits. Since green growth policies pursue a variety of goals, they are best served by a combination of instruments: price-based policies are important but are only one component in a policy tool-box that can also include norms and regulation, public production and direct investment, information creation and dissemination, education and moral suasion, or industrial and innovation policies.Environmental Economics&Policies,Climate Change Economics,Economic Theory&Research,Transport Economics Policy&Planning,Labor Policies

A dynamic model of extreme risk coverage : resilience and efficiency in the global reinsurance market

This paper presents a dynamic model of the reinsurance market for catastrophe risks. The model is based on the classical capacity-constraint assumption. Reinsurers choose every year the quantity of risk they cover and the level of external capital they raise to cover these risks. The model exhibits time dependency and reproduces a market dynamics that shares many features with the real market. In particular, market price increases and reinsurance coverage decreases after large shocks, and a series of smaller losses may have a deeper impact than one larger loss. There is a significant oligopoly effect reducing reinsurance supply, and the market is segregated into strategic large actors that influence market prices and price-taker smaller firms. A regulation trade-off between market efficiency and resilience is identified and quantified: improving the ability of the market to cope with exceptional events increases the cost of reinsurance. This model provides an interesting basis to analyze further capacity needs for the insurance industry in view of growing worldwide exposure to catastrophic risks and climate change.Markets and Market Access,Insurance&Risk Mitigation,Climate Change Economics,Debt Markets,Emerging Markets

Decarbonizing development: three steps to a zero-carbon future

This report lays out three steps for a smooth transition to a zero-carbon future and provides data, examples and policy advice to help countries makes the shift. Overview Getting to zero net emissions and stabilizing climate change starts with planning for the long-term future and not stopping at short-term goals. It means getting prices right as part of a broad policy package that can trigger changes in both investments and behaviors, and it requires smoothing the transition for those most affected. A new World Bank report walks policymakers through those three steps with data, examples and policy advice to help put countries on a path to decarbonizing their development in a smooth and orderly way. The solutions exist, and they are affordable – if governments take action today, the report says