The tragic tornado in Oklahoma this week has economic considerations — at least judging by questions from readers. The central issues seem to be whether some government policies, such as buildings codes, might reduce loss of life and property damages and or whether others, like disaster relief, might actually increase them.
Let’s start with the second point. Does government disaster relief, especially money to replace destroyed property, encourage people to build in areas where they should not?
This is an extension of the argument that federally subsidized flood insurance and reconstruction grants for property destroyed by flooding in low coastal areas or flood plains encourage more construction and end up producing greater property destruction than otherwise.
In the flood scenario, much research shows these federal policies do have a perverse effect and do increase property losses over the long run. Reduce the expected out-of-pocket costs from flooding, and you have more construction in these areas. Eventually, greater losses occur.
If that is true for water, why not for wind? First of all, although people may expect government aid after tornadoes, just as after floods, no wind-damage program exists similar to federal subsidies for flood insurance, and it is this program that creates the greatest distortions in flood-prone areas.
Although the prospect of tornado recovery aid may create similar perverse incentives, these are small because the area of damage usually is smaller than that of flooding.
We hear a lot about tornadoes, particularly in states like Oklahoma and Kansas.
The area in which the storms can occur is enormous, stretching roughly from the Rockies to the Appalachians, and includes a lot of underpopulated land. Tornadoes cause hundreds of millions of dollars in damage every year, but the probability that any particular town or building will be hit in any year is low, much lower than that of flood damage in a river bottom or on a barrier island, which can occur every year.
That is why commercial, nonsubsidized wind damage insurance is available nearly everywhere and commercial flood insurance is not. The chance of someone filing a claim is low. Although rates may vary, it makes sense for companies to offer these policies.
The importance of government aid is a minor consideration compared to private insurance coverage, at least for households. Any perverse incentives stemming from the aid hence are small.
What about the issue of building codes? Why don’t more houses in this tornado-prone area have basements or safe rooms? Why did the destroyed Plaza Towers Elementary School in Moore apparently lack storm-proof spaces? Why don’t building codes in tornado-prone areas require greater provisions to protect human life?
One answer is that many houses and public buildings do have safe spaces even though geologic conditions make basements problematic. The death toll in Oklahoma would have been higher if not for the fact that many structures provided for shelter. This particular school reportedly is an exception. Most schools apparently are constructed with enough areas to shelter students and staff.
A second, more theoretical, response that libertarians would make, is that homeowners and school boards have better incentives than anyone else to weigh risks versus cost. If they judge that the expected value of probable damage is less than the cost of avoiding it, they are better off to simply run the risk, as some historically did. Having government second-guess such decisions by the people who bear both costs and benefits would simply make society poorer.
That view was common for decades in economics. And it resonates with those who place a high value on individual liberty.
But most economists would support zoning and building codes to the extent that they avoid the creation of external costs — or decisions by one person that harm others. Such measures obviously include requirements for setbacks from lot lines and limitation on the overall size of a building relative to lot area.
Similarly, economists support codes as an antidote to “imperfect information.” Not every aspect of a building is apparent to the eye of a buyer. Without codes, builders might skimp on strength, durability, energy efficiency or fire safety and the first or subsequent buyers would not know. There would be an incentive for developers to build inexpensive houses with hidden flaws. Codes can ensure that buyers can rely on some minimum standard of quality and safety.
However, that shifts the burden of weighing costs and benefits to government. Their decisions are not necessarily the same ones all homebuyers would make. Not everyone prefers to pay more initially for a highly energy-efficient house if it will take many years to amortize that extra outlay through lower bills. Ditto for reinforced concrete safe rooms in Oklahoma or sprinkler systems.
Economists find that safety is income-elastic. As incomes go up, people are increasingly willing to pay for safer houses and cars and to pay the taxes necessary for safer pubic buildings like schools.
There also is an element of what economists who study technological change call “learning by doing.” Beforehand, costs of safety measures like airbags, trench boxes for excavating or earthquake-resistant walls all seem high. Businesses can make the plausible argument that “consumers are not willing to pay for safety.”
But when compelled to undertake these measures, costs decline as producers develop less expensive ways of making safety devices, plus the economies of scale in production kick in. Moreover, over time, as exposure to such safety measures and appreciation of their benefits grow, buyers are more willing to pay for such measures.