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Blogging about liberty, anarchy, economics and politics

If You Subsidize It…

November 5th, 2008

In Defining Anarchy, root-striker Mark Davis comments on the State-failure that was the aftermath of Hurricane Katrina:

[T]he catastrophe in New Orleans was not caused by the hurricane, but by the flooding that followed the failure of the dikes. Were these dikes built and maintained by private organizations, as they would be under anarchy (if built) or by statist-government agencies? The Army Corp of Engineers built and maintained the dikes after politicians decided it was a good idea to build a city below sea level. The failure of the Army Corp of Engineers to build dikes that would withstand a commonly known potential risk as well as their failure to maintain these dikes is not anarchy.

Agreed, kind of. I’ve said some of the same things (about FEMA).

However, if moral hazard can’t be overcome, insurance ceases to work, and a levee is simply a sort of insurance. Someone with more brains than you or I knows or presumes to know with great accuracy, the relative frequency and distribution of catastrophic events (like floods). The idea is to spend less money on prevention and avoidance than the expected economic loss. A neighborhood might spend $1,000 per househould, per year. People do things like this, because they’d rather pay $1,000 per year, than run the risk that they’d suffer a total loss, even once.

When “insurance” programs are subsidized, the effects of Moral Hazard are amplified, which creates the negative feedback loop: losses are staggering, therefore more subsidies are needed, consequently future exposure to economic loss is even greater. In the flood/levee example, floodplain insurance is generally subsidized, as is the maintenance of the levees in question. These factors combine to increase the population density, and therefore increase significantly the expected loss for any catastrophic event.

See how this works? It’s like that old line from Field of Dreams, “If you build it, they will come.”

We have to recognize the very real possibility, that in a free market, where catastrophes happen with too great a concentration, unpredictable concentration and/or severity, it’s quite likely that in New Orleans, or locales prone to wildfires like parts of California, development on such a large scale as we see at present would never have been undertaken in the first place, thus mitigating the severity of any economic loss due to such unpredictable perils.

For the most part, I wholeheartedly endorse Davis’ arguments, but we can’t content ourselves to argue, “A free market would’ve built better levees!” when the reality is that a free market might never have built any levees in the first place.

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For further reading on moral hazard, especially as it pertains to socialized quasi-insurance schemes underwritten by the government and funded almost entirely (at the very least, disproportionately) by taxes confiscated from people who will never be at risk for loss, see also my post On Social Insurance Programs from May of 2007.

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no third solution

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