Irrational Economist_ Making Decisions in a Dangerous World - Erwann Michel-Kerjan [136]
Irrational Behavior Following the Alaska Earthquake
I was introduced to the field of natural disasters, a focal point of much of my research over the years, in September 1964 when I began my first full-time job as a researcher at the Institute for Defense Analysis (IDA). Several economists had been involved over the preceding few months on an IDA study of the recovery of Alaska following an extremely strong earthquake in March 1964. They were surprised to find that food prices on perishable goods were either stable or had gone down despite shortages, and that rents declined despite limited supplies of housing. This strange behavior discouraged my colleagues from moving forward on the study and I was asked whether an analysis of the economics of natural disasters using Alaska as a case study would appeal to me. As a budding irrational economist, I jumped at this opportunity and with Douglas Dacy began a two-year research project that led to our book on The Economics of Natural Disasters in 1968.
The Alaska earthquake also marked a turning point with respect to government disaster relief policy in the United States. Following this disaster, special legislation was passed that provided low-interest loans and forgiveness grants to Alaskan homes and businesses that were affected by the earthquake. In the years following the Alaska earthquake there were a series of floods, hurricanes, and tornadoes that caused extensive damage in the continental United States. Congress passed special legislation following each of these disasters that was justified by representatives from the affected states each contending: “We don’t want any special treatment, just the same as was given to Alaska.”
Insurance or Disaster Assistance
Congress went to an extreme following Tropical Storm Agnes. Severe flooding from this storm occurred in June 1972 and affected northeast states that were critical battlegrounds for the upcoming presidential election. Very few of the disaster victims had purchased flood insurance, even though the National Flood Insurance Program (NFIP) had been in place since 1968 and premiums on existing structures were highly subsidized by the federal government. Following these storms, Congress provided the uninsured victims with $5,000 forgiveness grants and 1 percent low-interest loans for covering their losses. I undertook a study for the American Enterprise Institute on Recovery from Natural Disasters: Insurance or Federal Aid in which I was somewhat critical of this generous disaster assistance, arguing that insurance was a more effective way of dealing with the problem in advance of the disaster.
Dealing with Extreme Events
My interest in natural hazards has extended over the years to the broader question of how society can deal more effectively with low-probability, high-consequence (lp-hc) events. We have learned that those at risk often misperceive the likelihood and consequences of extreme events and act as if these disasters “will not happen to me.” Hence, they do not prepare for such contingencies by investing in risk-reducing measures or purchasing insurance. Only after a catastrophe do the key interested parties focus on ways to prevent the next disaster from occurring. And even this behavior is short-lived as the previous crisis fades into the background, as illustrated by the following examples.
Reducing Losses from Chemical Accidents
Edward Bowman and I were involved in a study of managerial behavior with respect to environmental risks at a large chemical company in the Philadelphia