The Future of Public “Spatial Insurance”

Let’s define public “spatial insurance” as transfers from the federal government to geographical areas such as cities that have experienced natural disasters or terrorist attacks.  In this age of federal government deficits and the rise of the global insurance industry, should private insurance cover these events?

Here is a cross-post I wrote about the financing of rebuilding Southern Manhattan and the sweet deal that Goldman Sachs has received for remaining downtown.   This appears to be another example of cross-subsidization within a federal system.  The people of Nebraska’s taxes are used to help Manhattan compete against New Jersey in keeping Goldman in the Big Apple. 

When horrible things happen, who picks up the pieces?  Who picks up the bill?  If Goldman Sachs and friends doesn’t have to buy their own insurance, does this create  a spatial moral hazard effect as too much economic activity locates in geographical threat zones?

Author: Matthew E. Kahn

Professor of Economics at UCLA.

20 thoughts on “The Future of Public “Spatial Insurance””

  1. This seems an odd question – and possibly inappropriate on the anniversary of the attacks. These sort of libertarian hypotheticals are interesting in a way. But they also seem to, for me, highlight the degree to which libertarians seem to struggle in truly thinking through their supposed iconoclastic thinking. They always remind me of the kind of juvenile propositions a reactionary teenager often makes, i.e. why should I love my parents? I suppose they are developmentally useful, but not really serious, in that seriousness demands wisdom and experience with reality.

    So, it seems you’re taking the classic insurance model of distributed losses and applying It to a nation. But can we think this way about terrorist attacks, or natural disasters? In the case of floods or earthquakes, property holders are generally dependent on private insurance. But we also believe in providing aid in the form of state or federal responses. Not only is there a practical utility in this, but so to a moral one. These are our fellow countrymen, and one of the features of a nation is our contractual obligation to come to the aid of our fellow man – whether war, disaster, etc.

    There is still room for insurance. Fires and tornadoes happen frequently, and it is reasonable to ask people to assume a portion of their own risk. But the government still has a very important role to play in providing disaster relief, in a wide manner of forms. I suppose terrorism insurance is a reasonable idea – if a property owner feels it justified. But to argue that people in rural areas should not be asked to pitch in to help their fellow countrymen in times of need seems, well, unamerican. But that assessment depends on a degree of seriousness born of wisdom and experience with reality.

  2. I suspect this question is going to become more relevant as we enter into the ‘destruction years’ of the global climate crisis. If I live in a state with a well funded and well prepared Fire and Emergency entity, do I want my tax dollars going to Texas to subsidize rebuilding from what is probably preventable catastrophe. Or Alabama, where certainly, the people have elected representatives who shirk their Constitutional Duty when denying the existence of Global Warming. Will it be more cost effective to repair a degrading bridge spanning from Ohio to Kentucky? Or cheaper to ‘build a new one’ when the old one fall down?

    Any infrastructure entrepreneur should look into creating ferry services in large metropolitan zones to pick up the traffic when all the bridges fall down.

  3. Harold…

    Yes me too…
    Nebraska takes in more federal dollars than it gives out…
    http://www.taxfoundation.org/research/show/266.html

    But that is just a nit…

    Can you imagine if New Orleans had private insurance to cover against Hurricanes?
    Come Katrina, that insurance company would have vanished overnight, and the Fed. would have to bail out the water…
    Meanwhile Wall Street would profit on the insurance company bankruptcy as the credit default swaps it was based on, would be in need of taxpayer money…
    As ultimately our government ends up financing yet again capitalist crooks, capitalism’s cons, and capitalism’s worst cheats…

    In fact, capitalism doesn’t mix well with insurance. That is it’s Achilles heel…
    The market can barely manage auto insurance.
    “Like a good neighbor” my arse. More “like a tight-fisted miser with pitbulls for a neighbor”.

    Anybody trusting their municipalities and states to the likes of Kenny-boy and Co. is either a naif or sits on the Board…

  4. Robert Reich has written about this quite a bit, but the way Prof. Kahn writes it, he makes it seem as if it’s red, rural states helping support blue, urban states, whereas Reich points out that it’s almost always the opposite. Prof. Kahn’s example makes it seem as if taxpayers from red/rural states have legitimate grievances about tax “redistribution,” whereas Reich’s essays imply that red/rural fears about their money supporting decadent, “urban” lifestyles is absurd and that, in fact, a fairer spatial redistribution would harm red/rural states. Of course, Prof. Kahn seems to be ignoring overall tax transfers, which is what Reich uses, in favor of “public spatial insurance,” but that seems to skew the question of “cross-subsidization” and doesn’t imply the sorts of questions that Prof. Kahn thinks it implies.

  5. If the federal insurance were explicit, it could and should be rule-bound and non-discriminatory. 9/11 has been defined as an act of war, normally excluded from private insurance, and in wars there are explicit rules of compensation for damage to civilians. So Goldman Sachs got a sweetheart deal out of the rubble of 9/11 and policy confusion. Surprise me. That’s what giant vampire arbitrageur squid (or possibly termites) do. They have a fiduciary duty to suck the money from you taxpayers!

  6. “Can you imagine if New Orleans had private insurance to cover against Hurricanes?”

    If New Orleans had been totally dependent on private insurance for the last century and didn’t have other government enablers like the Army Corp of Engineers propping it up, it would be a very much smaller target for hurricanes and other natural disasters.

  7. As usual, the pinkos on this site have a much better grasp of economics than the libertarians.

    Private insurance markets are fragile as hell. We all know about moral hazard, and most of us know about adverse selection. And these are just the informational problems. The other problem with insurance is that it isn’t very good at intertemporal risk spreading: capital markets just aren’t thick enough. Insurance capital markets work okay when the risk variance within an accounting period isn’t very high–life insurance is a good example. (And life insurance often contains a war exclusion to eliminate the most common high-variance event.) Auto insurance is another good example: lots of little risks that average out over the year, so you can pay claims out of the premium stream without much of a chance it will draw on the insurers’ capital. But insurance markets can’t provide against enormous lumpy events like terrorism. (Hurricanes are about the limit, and the markets need a fair amount of public assistance for that.) Lord knows, the insurers have tried–reinsurance, cat bonds, what have you. But who wants to tie up big capital for a long time, with a good risk of losing all of it at once? And who is willing to pay the rates that would support it?

    The choice is between the government as the insurer of last resort and no insurer at all for the really big catastrophes. The former can lead to moral hazard. But the state has unique powers of mitigating moral hazard: housing codes, taxation and the like. The latter is something that only a teenaged Ayn Rand devotee can contemplate with equanimity. People, being people, are going to neglect tail risk. Hammering them with it once in a generation or two isn’t going to change things. That’s what governments are for.

  8. The state has unique powers. They can mitigate moral hazard, they can create it. How this nets out is something of an empirical question.

  9. Eb, I’m not sure what your point is, here. We’ve got this huge concentration of the financial industry in Wall Street. They all like it: they get to go to lunch together, they can set up their trading computers to take advantage of the millimicrosecond speed advantage of being close to the transaction point. There is some risk to the country that the financial sector (which does provide capital allocation services to the country, last I looked) is all in one place and vulnerable to a ‘place’ event – Hurricane Irene, or the Twin Towers, or something else. If they had to pay for insurance, they would face some real cost to themselves for this concentration decision, and some of them would up sticks to Charlotte, and Portland, and Chillicothe. If Humpty can just sit on his wall until there is a ‘place’ event and then the rest of us pay to put Humpty back together, that’s a kind of a subsidy. Good subsidy? Bad subsidy? Worth thinking about, anyhow.

    I tend to think bad subsidy, and sort of like providing Federally backed flood insurance for those chumps who build beach houses on barrier islands.

  10. I don’t really know what the background to this post is, but I do know this: there is no kind of federal spending I’m aware of that doesn’t involve some kind of redistribution. It can’t be done without redistribution. In fact, I’d be willing to bet that almost any spending of public money, at any level of government, involves redistribution. When City Hall buys stationery with my tax dollars, it’s a form of redistribution from me to a vendor I just might despise.

    Unless somebody can point out something I’m overlooking, I don’t think there *can* be geography-neutral, class-neutral, age-neutral, ethnicity-neutral, religion-neutral, gender-neutral, ideology-neutral, partisan-neutral, or anything-neutral government spending. And there have always been interests trying to take advantage of public spending for their own gain– during the Revolutionary War some land speculators in upstate New York lobbied mightily to get a military road built on their side of Lake Champlain so they could develop it without paying for the road they’d need. The only way out of that is to tax people and then give them their money back. Of course you’d then have no public goods at all, would you?

    None of that means you don’t do public spending. To me it means you acknowledge the redistribution inherent in all public spending and decide what you can put up with. And you make sure everybody’s aware that redistribution is going on, and you try to be as fair about it as humanly possible, and you work to limit insider access and privilege. But you don’t look for redistribution-neutral public spending.

  11. In theory, if the government buys stationary, it pays for said stationary, and gets the paper in return, and thus the transaction is not, (Setting aside the possibility of deliberately having negotiated a bad deal.) “redistribution”. It’s just a purchase. Rather unlike, for instance, taxing people in one place, in order to offer services someplace else.

    IOW, while you can define “redistribution” so broadly that everything is “redistribution”, you don’t do that unless you want to prevent any fruitful discussion concerning it.

  12. Dave,
    My point is just that it is economically silly to expect the private sector to insure sufficiently large catastrophes.

    And by the way, your financial services example isn’t too good. The industry wised up after 2001, and has backup centers all over the place. The solution isn’t completely ideal, because a few transactions require co-location to work (although their social utility is dubious), and some payments transactions require synchronization within a few tenths of milliseconds. Light travels a foot in a nanosecond, so a millisecond is a million feet: about 200 miles.

    Not that I disagree with your broader point: we have a lot of assets that probably aren’t located where they should be. But we can’t rely on the insurance industry to fix this. It can’t provide the insurance that would send out the necessary price signals. (And a lot of individuals would be insensitive to said signals: look at the many people who don’t bother with flood insurance because “it costs too much.”)

  13. Dave Schutz,

    I don’t understand what concentration has to do with the individual firms’ responsibility to self-insure. There are hurricanes, tornadoes, etc. lots of places. The “concentration risk” is a risk to the country, isn’t it, and not to the individual firms?

  14. The simple purchase of stationery is a spending of my tax pennies in a way that I would not spend my own pennies, and a spending from which the vendor and the vendor’s suppliers benefit. When the federal government decided to create a major aircraft industry for World War II and located much of it in SoCal, it redistributed tax money from all over the country into southern California. It “purchased” aircraft to be sure, but in fact it deliberately decided to spend the money to build up that industry in a specific region of the country that had only had a small aircraft presence up to that time, and the specific region benefited in spades. When the federal government paid 90% for construction of interstate highways it redistributed tax money disproportionately to rural and low-population states and regions. When the state of Pennsylvania provides more money per pupil to rural and small-town school districts than it does to suburban Philadelphia districts, it’s redistributing money within the state.

    I can think of no kind of government spending that does not have a redistributive effect. To put that another way, all spending is eventually somebody’s income. That’s the case whether goods are involved or not. Consumer spending is also redistributive; that’s the meaning of consumer choice, aka “voting with my dollars.” It’s why I don’t like sending my utility payments out of state.

    The difference between us here, and why this observation is not intended to end discussion but to be part of the accepted groundwork for real discussion, is that I don’t consider “redistribution” to be the kind of imprecation that will stop the hearts of the innocent. It’s not a curse. It’s a description of the reality of all public spending. Even spending I favor and think we should undertake.

  15. CharlesWT says:

    “If New Orleans had been totally dependent on private insurance for the last century and didn’t have other government enablers like the Army Corp of Engineers propping it up, it would be a very much smaller target for hurricanes and other natural disasters.”

    And a worse port for shipping.

  16. Ebeneezer: “…and some payments transactions require synchronization within a few tenths of milliseconds. Light travels a foot in a nanosecond, so a millisecond is a million feet: about 200 miles.”

    Note – that’s raw speed; what’s important here is network speed. At 200 miles, the signal has to go through a lot of machinery.

  17. Of course, we’re also ignoring the good things that go with concentration. Face-to-face contact is still important for a lot of enterprises, especially serendipitous ones. So clearly the people who chose to live in potentially-more-risky venues and pay the extra insurance burdens should be able to levy a tax on the rest of us to get their fair share of the increased overall economic activity that results from innovators living adjacent to one another (or whatever else the increasing-returns situation is). For New Orleans, consider the rather large increment that acrued to the entire mississippi river basin as a result of having a port near the mouth of that river.

    Or we could give up on the endlessly recursive adversarial beancounting (which always seems to start at a particularly favorable status quo ante for the proposer) and just pull together.

  18. If you want to see public and private insurance applied to a disaster, consider the
    earthquake in Christchurch, NZ. There, residential insurance is covered to the Earthquake Commission, which is supported by a (required) payment, and covered on the reinsurance market. Non-residential buildings get private insurance; and the infrastructure (there was a lot of damage to anything below ground) is local or general goverment. I don’t know how this has all worked out.

    I’ll add that, although NZ has plenty of earthquakes, this one would count as a rare event (every few thousand years at most).

    On the more general point, of course any collection and payment of funds by a government redistributes money: so what? The question is, does this make for a better country to live in? I also think that using entities like “Nebraska” confuses the issue. Some people pay more than they get; others get more than they pay. Why then group people by geography? If money is the issue, surely people should be grouped mostly by their economic characteristics.

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