| By: |
Timothy J. Goodspeed (Hunter College and Graduate Center of CUNY, Department of Economics, 695 Park Avenue, New York, NY 10021);
Andrew Haughwout (Research and Statistics Group, Federal Reserve Bank of New York, 33 Liberty Street, New York, NY 10045) |
| Abstract: |
Recent experience with disasters and terrorist attacks in the US indicates
that state and local governments rely on the federal sector for support after
disasters occur. But these same governments are responsible for investing in
infrastructure designed to reduce vulnerability to natural and man-made
hazards. This division of responsibilities – state governments providing
protection from disasters and federal government providing insurance against
their occurrence – leads to the tension that is at the heart of our analysis.
We explore these tensions building on the model of Persson and Tabellini
(1996). We show that when the federal government is committed to full
insurance against disasters, states will have incentives to underinvest in
costly protective measures. We then show that when the central government
cannot verify state investment choices, the optimal insurance system would be
designed to reward states that succeed in avoiding disasters and punish those
that do not, thereby giving states an incentive to increase investment in
protective infrastructure. However, this raises the question of whether the
central government can credibly commit to such a scheme, and we find in a
simple political model that it cannot. In our political model, the central
government will decrease transfers ex-post if a state provides protective
infrastructure that increases its expected uncertain income, generating a
soft-budget constraint for states. This provides an additional incentive for
states to underinvest in protective infrastructure. We discuss these results
in light of disaster policy in the US. |
| Date: |
2006–11 |
| URL: |
http://d.repec.org/n?u=RePEc:ifr:wpaper:2006-14&r=ias |