The Tsunami and the Economics of Catastrophic Risk

The Indian Ocean tsunami illustrates a type of disaster to which policymakers pay too little attention�a disaster that has a very low or unknown probability of occurring, but that if it does occur creates enormous losses. Great as the death toll, physical and emotional suffering of survivors, and property damage caused by the recent tsunami are, even greater losses could be inflicted by other disasters of low (but not negligible) or unknown probability. The asteroid that exploded above Siberia in 1908 with the force of a hydrogen bomb might have killed millions of people had it exploded above a major city. Yet that asteroid was only about 200 feet in diameter, and a much larger one (among the thousands of dangerously large asteroids in orbits that intersect the earth�s orbit) could strike the earth and cause the total extinction of the human race through a combination of shock waves, fire, tsunamis, and blockage of sunlight, wherever it struck. Other catastrophic risks include, besides earthquakes such as the one that caused the recent tsunami, natural epidemics (the 1918�1919 Spanish influenza epidemic killed between 20 and 40 million people), nuclear or biological attacks by terrorists, certain types of lab accident, and abrupt global warming. The probability of catastrophes resulting, whether or not intentionally, from human activity appears to be increasing because of the rapidity and direction of technological advances. The fact that a catastrophe is very unlikely to occur is not a rational justification for ignoring the risk of its occurrence. Suppose that a tsunami as destructive as the Indian Ocean one occurs on average once a century and kills 150,000 people. That is an average of 1,500 deaths per year. Even without attempting a sophisticated estimate of the value of life to the people exposed to the risk, one can say with some confidence that if an annual death toll of 1,500 could be substantially reduced at moderate cost, the investment would be worthwhile. A combination of educating the residents of low-lying coastal areas about the warning signs of a tsunami (tremors and a sudden recession in the ocean), establishing a warning system involving emergency broadcasts, telephoned warnings, and air-raid-type sirens, and improving emergency response systems, would have saved many of the people killed by the Indian Ocean tsunami, probably at a total cost below any reasonable estimate of the average losses that can be expected from tsunamis. Relocating people away from coasts would be even more efficacious, but except in the most vulnerable areas or in areas in which residential or commercial uses have only marginal value, the costs would probably exceed the benefits. For annual costs of protection must be matched with annual, not total, expected costs of tsunamis. In my book Catastrophe: Risk and Response (Oxford University Press 2004), I try to be more precise about how one might determine the costs of catastrophes. There is now a substantial economic literature inferring the value of life from the costs people are willing to incur to avoid small risks of death; if from behavior toward risk one infers that a person would pay $70 to avoid a 1 in 100,000 risk of death, his value of life would be estimated at $7 million ($70/.00001), which is in fact the median estimate of the value of life of an American. Because value of life is positively correlated with income, this figure cannot be used to estimate the value of life of most of the people killed by the Indian Ocean tsunami. A further complication is that the studies may not be robust with respect to risks of death much smaller than the 1 in 10,000 to 1 in 100,000 range of most of the studies; we do not know what the risk of death from a tsunami was to the people killed. Additional complications come from the fact that undoubtedly more than 150,000 people have died or will die�and the total may never be known�and that there is vast suffering and property damage that must also be quantified, as well as estimates needed of just how effective precautionary measures of various scope and expense would have been. The risks of smaller but also still destructive tsunamis that such measures might protect against must also be factored in; nor am I confident about my �once a century� risk estimate. Nevertheless, it seems apparent that the total cost figure of the recent tsunami will come in at an amount great enough to indicate that there were indeed precautionary measures to take that would have been cost-justified. Why, then, weren�t such measures taken in anticipation of a tsunami on the scale that occurred? Tsunamis are a common consequence of earthquakes, which themselves are common; and tsunamis can have other causes besides earthquakes�a major asteroid strike in an ocean would create a tsunami that would dwarf the Indian Ocean one. There are a number of reasons for such neglect. First, although a once-in-a-century event is as likely to occur at the beginning of the century as at any other time, it is much less likely to occur in the first decade of the century than later. Politicians with limited terms of office and thus foreshortened political horizons are likely to discount low-risk disaster possibilities, since the risk of damage to their careers from failing to take precautionary measures is truncated. Second, to the extent that effective precautions require governmental action, the fact that government is a centralized system of control makes it difficult for officials to respond to the full spectrum of possible risks against which cost-justified measures might be taken. The officials, given the variety of matters to which they must attend, are likely to have a high threshold of attention below which risks are simply ignored. Third, where risks are regional or global rather than local, many national governments, especially in the poorer and smaller countries, may drag their heels in the hope of taking a free ride on the larger and richer countries. Knowing this, the latter countries may be reluctant to take precautionary measures and by doing so reward and thus encourage free riding. Fourth, countries are poor often because of weak, inefficient, or corrupt government, characteristics that may disable poor nations from taking cost-justified precautions. Fifth, people have difficulty thinking in terms of probabilities, especially very low probabilities, which they tend therefore to write off. This weakens political support for incurring the costs of taking precautionary measures against low-probability disasters. The operation of some of these factors is illustrated by the refusal of the Pacific nations, which do have a tsunami warning system, to extend their system to the Indian Ocean prior to the recent catastrophe. Tsunamis are more common in the Pacific, and most of the Pacific nations do not abut on the Indian Ocean, but even if the risk of an Indian Ocean tsunami was only a tenth of that of a Pacific Ocean tsunami (a figure I have seen in a newspaper article), it was still worth taking precautions against; but there is a tendency to write down slight risks to zero. An even more dramatic example of neglect of low-probability/high-cost risks concerns the asteroid menace, which is analytically similar to the menace of tsunamis. NASA, with an annual budget of more than $10 billion, spends only $4 million a year on mapping dangerously close large asteroids, and at that rate may not complete the task for another decade, even though such mapping is the key to an asteroid defense because it may give us years of warning. Deflecting an asteroid from its orbit when it is still millions of miles from the earth is a feasible undertaking. In both cases, slight risks of terrible disasters are largely ignored essentially for political reasons. In part because tsunamis are one of the risks of an asteroid collision, the Indian Ocean disaster has stimulated new intereset in asteroid defense. This is welcome. The fact that a disaster of a particular type has not occurred recently or even within human memory (or even ever) is a bad reason to ignore it. The risk may be slight, but if the consequences should it materialize are great enough, the expected cost of disaster may be sufficient to warrant defensive measures.

Comments

[Brian]

"Scarcity is a marketing tool. It is a construct of the capitalists."

Wow, you have a nano-assembler? Mind making a copy for me?

"The day that we begin to run a cost-benefit analysis on human lives is the day that we lose our humanity."

In that case, we ceased to be human the day life insurance was invented, and probably well before that. You and I make a cost-benefit analysis of human lives every time we get in a car.

[David]

Corey - scarcity is an unfortunate fact of life. Neither individuals nor governments are infinitely rich, and they cannot afford everything. Both public and private actors must make decisions about how to manage their resources, and that's where economics comes in.

BUT, we must remember that economics is a tool, not a cure-all ideology. A cost-benefit analysis does not tell us what we are willing to pay, politically or privately, for any particular benefit. That has to come from another source, and in politics, perhaps it derives from our notions of "right," "humanity," "fairness," and "efficiency" (among other things). We can debate what an ideal society should look like. Economics merely allows us to understand the trade-offs.

[David Pittelli]

Corey: "So I should assume that you agree with 1% of the population controlling 40% of the wealth?

Better that 1% of the population should control 40% of the wealth than that the government should redistribute this wealth, given that:

1) Such a redistribution relies on coercion/force.

2) Total wealth and growth are negatively impacted by such schemes. It's not a coincidence that only Alabama and Mississippi are as poor as Western Europe (and explicitly socialist countries are much poorer still).

[Rob]

ok, so there has been a lot of silliness from both ends of the spectrum here. Just wanted to point out that

(1) "redistribution" relies on no more force than is required to enforce private property rights (maintaining police units, etc.)

(2) There are good arguments for thinking that Western Europe is richer than some U.S. states besides Alabama and Mississippi. In as much as we can think of an area as large and diverse as Western Europe as being monolithically rich or poor, it does pretty well. There are also studies that people care more about relative wealth than the overall wealth of their countries; that is, contentment in one's finances is tied more to the former than the latter.

and to be fair

(3) Scarcity of resources is not a capitalist invention, though capitalist markets do result in resources being scarcer for some than for others. If ifs and buts were candies and nuts, we'd all have a wonderful christmas.

now on with writing other crazy things

[Corey]

Ok, I'll change my statement to: "scarcity is sometimes a construct of the capitalists." Examples being whatever toy you can't find at Christmas, anything with the words "limited edition" in front of it, and things you can't afford that we agree everyone should be able to afford.

And I take no issue with the existance of economics. I take issue with the program of the "Law and Economics" movement which seeks to make cost-benefit the primary mode of jurisprudential analysis because of some idea that doing so is more rational than say... case by case application of democratic jury decisions.
I take issue with appointed judges presuming to decide issues of social policy based on a formula that only works when we "assume that the probability of X is .5"

"redistribution relies on coercion/force."

Yeah, well, SO DOES WEALTH ACCUMULATION! You just don't see it because most of the coercion happens in places like Indonesia.

I want to take Warren Buffet's money, what stops me? Well the government will arrest me on his behalf and lock me away. If you are so against force, why allow the government to use it to protect the status quo wealth distribution. Is it because the current distribution is fair? If it isn't fair, then isn't my case stronger. If the government is going to use force and police power then they should do so on behalf of those who have need, not the other way around right?

Either Warren deserves to have 20 billion, or he has accumulated more than his share. Either he is 10,000 times more productive and smart than anyone posting here, or else wealth is not distributed according to merit. If we can agree that his wealth is undeserved, then we have to ask what forces operate to allow him to hoard cash while Indonesians starve and die, while American children go hungry! We could all go to Omaha and take his money, there are enough of us to pull it off. Why does no one try? Those are some pretty strong laws at work. People will choose to let their kids be underfed and go to substandard schools rather than hit the streets and shake their pitchforks at the rich. Reading history, I am continually impressed by the effectiveness of all this.

[Corey]

"2) Total wealth and growth are negatively impacted by such schemes."

I'm sorry, but that is WRONG.

During the 60s, when the highest tax rate was 70%, the GDP growth rate was higher than the last decade. Not suprisingly, during the 60s, income inequality was as narrow as at any point during the century.

In 1967, with the highest tax rate at 70%, the American GDP grew just over 10%, In 2004, with the Bush top tax rate of 31%, the GDP grew just under 4%. Neato. But many economists don't think growth is correlated to the tax rate at all.

Here is a web site with some fun facts:
http://www.huppi.com/kangaroo/L-taxgrowth.htm

Note the western european countries with twice our tax rate that are growing faster. hmmm...

[Fred]

I am strongly in favor of 1% controlling 40% of the wealth (or whatever silly figures you come up with) if it's because 1% are creating greater productivity. A world where initiative is rewarded is a world where the average person does better too. Let me put it as starkly as possible, so Corey can understand. If you oppose a world where 1% controls 40% of the wealth, then you favor a world of massive poverty where starvation and disease are the rule and the average person has almost no chance of doing well no matter how much the effort.

[Michael]

What about the implications of all the private donations of people to relief organisations and whether their use is directly aimed at the destroyed regions or not?!
I'd very much a appreciate a comment on that from both!

[Rob]

"If you oppose a world where 1% controls 40% of the wealth, then you favor a world of massive poverty where starvation and disease are the rule and the average person has almost no chance of doing well no matter how much the effort."

False dichotomy: presenting two unrelated options as the sole possible outcomes in any given scenerio. See above. Also:

"If you oppose a world in which I am the richest, most-sexed man alive, you favor a world in which the entire human population is decimated by a painful skin disorder"

And:

"If you oppose a world in which you give me your wallet, you favor a world in which I beat you about the head."

Make your own:

"If you oppose a world in which [A], you favor a world in which [any letter you would like]."

Granted, none of this has to do with Posner or Tsunami relief, or anything intelligent, but it is good to know.

Now, please, write more crazy things.

[Rob]

I desire more crazy talk. For this exercise, I will assume the role of the crazy liberal:

There wouldn't be any tsunamis if not for capitalism. Capitalist scientists invented tsunamis in their secret laboratories so as to sell the masses cheaply produced parkas at astronomical prices. You should all feel very ashamed.

And capitalists aren't only to blame for tsunamis. They are also at fault for the extinction of the money tree, the golden-egg producing duck, and the woodchuck made of chocolate, with the creamy banana center. Without such awful meddling, we would live in a land of good&plentys; we would all have flat tummies with ripped abdominal muscles, and we would cavort in the meadow giving and taking from the good earth.

I await the crazy conservative response. I will start you off: "unless you agree that the poor should die hungry in the streets ... (I can't do all of your work for you). Engage.

(apologies to our esteemed Posner, who no doubt desires an intelligent discourse, but crazy talk is what he has engendered and there is no turning back)

[Corey]

"apologies to our esteemed Posner, who no doubt desires an intelligent discourse"

Perhaps if you didn't "esteem" him so much, HIS op-eds would look like crazy talk to you also.

I didn't think I sounded crazy except in juxtaposition with the Econ For Neo-Cons, but if you think so, then you think so.

What's your position on wealth distribution and economic policy? Is it MODERATE? I hear moderate is the new black. All the cool dudes and chicks be wearin it. I've been thinking of going on a makeover show, so I can learn be a funny disaffected moderate too. Who can tell what we should do, its all been said before, let's have a chai, oh, that belt is hot!

[John Hall]

A long time ago, I was told that you could not use risk benefit analysis to factor in the possibility of remote catastrophe.

As a practical matter, INFINITY * EPSILON where EPSILON is > 0 but not distinguishable from it is ambiguous.

[Palooka]

"Either Warren deserves to have 20 billion, or he has accumulated more than his share."

99% of his wealth is in his company, Berkshire Hathaway. He doesn't have it locked in a vault so he can count it every night. He doesn't have 13 homes (like a recent presidential candidate). He doesn't evade paying income taxes through every tax loophole available (like a recent presidential candidate's wife).

Moreover, he is a Democrat and he plans on giving the vast majority of his wealth to charity upon his death.

The real question is why you'd object to someone like Warren Buffet, Corey. I think it has something to do with your inherent dislike of inequality per se. You'd prefer all of us live in squalor than for us to live here in these United States with--gasp--inequality.

Does the thought of a billion dollar corporation keep you awake at night? Because that is all Warren Buffet's wealth is. Does the thought of wealth accruing at double digit rates annualy for the eventual dispersement to charity really disturb you? If it does, I'd really like to know why.

Maybe you should think a little less about who "has more than his fair share" and a little more about how this world actually operates.

I try not to respond to your every trollish comment, Corey (though I have, again, lapsed in that goal). Whether income redistribution is a "good" thing or not is an interesting topic, but it seems you deliberately avoid the specific issue, prefering to rail against The Great Capitalist Machine instead.

So, if you would, why is it not necessary to place a dollar value on human life? How else can a bureaucracy find a reasonable amount of expenditure on a given health or environmental issue? Pull a number out of a hat? After sitting on that for awhile, maybe you'll begin to understand how empty your rhetoric is.

[Anonymous]

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With love :-), Theo.

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