download EOD Lesson 3 Outline (including graphs and source citations)
|incentives||public choice thoery||public good|
|bureaucracy||comparative advantage||moral hazard|
Standard 4: People respond predictably to positive and negative incentives.
Standard 16: There is an economic role for government to play in a market economy whenever the benefits of a government policy outweigh its costs. Governments often provide for national defense, address environmental concerns, define and protect property rights and attempt to make markets more competitive. Most government policies also redistribute income.
Standard 17: Costs of government policies sometimes exceed benefits. This may occur because of incentives facing voters, government officials, and government employees, because of actions by special interest groups that can impose costs on the general public, or because social goals other than economic efficiency are being pursued.
|“The fury of nature seemed to cause the institutions on which our society is based – those of government, commerce, and civil society – to crumble. First responders appeared overwhelmed as accounts of widespread looting, vandalism, theft, assault, and murder headlined newspapers and as the images of our fellow citizens literally swimming for their lives appeared on television and computer screens. The slow and seemingly inept responses of government at all levels both in preparation for and recovery from the storm infuriated Americans.” (Chamlee-Wright & Rothschild, 1)|
The fury of nature followed by the fury of citizens railing at government ineptitude – in this case, the aftermath of Hurricane Katrina – is a disturbingly familiar scenario. The frequency of public dissatisfaction with government response to major disasters raises two important questions for the well-being of our republic: “Is public fury justified?” and, perhaps more importantly, “Is railing at government the best approach to ensuring effective action in the next disaster?” This lesson examines contemporary expectations of government in the wake of disaster and the prevailing assumption that only government is big enough to deal with major disasters by first looking at those tasks that government does well. Then, we will turn our attention to when and why government is unlikely to meet our expectations.
Because human society has shown great resiliency through the ages (See Introduction), we can learn from those instances where it has not. Events like Hurricane Katrina, which spawned the “storm [that] infuriated Americans” referenced above, provide a body of evidence to help us evaluate what government can do when its citizens are struck by disaster. Implicit in asking what government can do is a second question: “What can’t government do?” Also implied is the assumption that government should do only those things it can do well, and should not do those things for which it is, by nature, ill-suited.
Historically in the United States, disaster response and relief has not been considered the responsibility of government, and most especially not the federal government. People caught in natural calamities turned to family and to community organizations like churches and private charities for support. State and local governments readily engaged in rescue operations and the task of re-establishing and enforcing civil order when necessary, but the federal government maintained a hands-off stance until the early 20th century. The 1906 San Francisco earthquake and fire prompted the first-ever federal allocation of disaster aid. Congress appropriated $2.5 million* in disaster aid – a small gesture compared to modern FEMA response – to cover the cost of food, blankets, tents and other relief supplies requisitioned from West coast Army depots. While President Roosevelt telegraphed California Governor Pardee and San Francisco Mayor Schmitz to express concern and offer “assistance,” the assistance consisted mainly of sending Secretary of Commerce Victor Metcalf to the city to keep the White House informed of developments. Tellingly, Roosevelt declined assistance and donations from abroad, saying that the U.S. had sufficient resources, and he directed offers of domestic assistance from such sources as the city governments of Chicago, Boston, New York, and from John D. Rockefeller and Andrew Carnegie to go to the Red Cross rather than to the notoriously corrupt San Francisco city government. (Strupp, 18-23)
From that small initial aid “reimbursement,” the federal role in disaster relief has grown – some would say exponentially. In 1950, Congress gave the President the power to designate “disaster areas.” The designation triggers the availability of federal funds for rebuilding infrastructure and public buildings like schools, courts, libraries, police and fire departments, and other public institutions. In 1969, the Disaster Relief Act made federal aid available to individual citizens. In 1979 President Jimmy Carter issued the executive order that created FEMA, the Federal Emergency Management Administration.
The disasters of the 20th and 21st centuries can be studied as real world experiments, generating data to analyze and evaluate how effective the government is in the growing number of disaster-relief roles it has taken on. We have chosen Hurricane Katrina as the case-study focus of this lesson. (Please see entry in the “Catalogue of Disasters” appendix to the Introduction for background data on Hurricane Katrina.) Katrina may seem unique in our contemporary national experience of major disasters, but in the larger historical perspective, this is true only in the specifics of time and place. The story of inadequate and failed government response has been told and retold, and the anecdotes circulating in the media and on the Internet are disturbingly like those from the last disaster and the one before that. We recognize that the nature and quality of the information to be gleaned from anecdotes varies and that care must be taken when using anecdotes as evidence. To that end, the Katrina stories selected to illustrate points of analysis in this lesson are those we believe to be representative of modern government disaster response and relief.
The key points in Lesson 3 are divided into two categories. Part 1 identifies disaster-related activities in which the benefits of government action clearly do outweigh the costs. Part 2 uses economic analysis to explain the obstacles to success in the disaster-relief activities where government frequently falters.
*(Comparable to $300 million (nominal GDP per capita) or $1 billion (relative share of GDP) in 2006 dollars.) It is worth noting that, to some extent, this aid can be considered a case of the federal government’s hand being forced. The acting commander of the Presidio, Army General Frederick Funston, ordered his troops into the city to begin rescue operations without contacting either his superiors or city officials. Additionally, he requisitioned and distributed supplies from West coast military depots before being given authority to do so. Although he did subsequently gain after-the-fact permission from Secretary of War Taft, the eventual allocation of aid by Congress does have the air of being essentially a “reimbursement” for the expenses he initiated.
Part 1: What Government Should Do
1. The challenge for government in disaster response and relief is determining when it should take a “hands-on” role and become actively involved, and when the goal of recovery is best-served by stepping back in favor of other institutions better suited to the task.
- The rule of rational choice directs decision-makers to choose the alternative with the greatest excess of benefits over costs. This rule applies not only to private decision-makers but also to government decision-makers: Governments should undertake those activities for which the expected benefits outweigh the expected costs.
- There is general agreement among economists that those instances in which the benefits of government action outweigh the costs include:
- maintaining and enforcing the rule of law, and
- providing public goods.
- Economists distinguish between “public goods” and “publicly-provided goods.” Both are paid for by government spending of tax and other revenues. Public goods are those that would not be provided by private firms because they are non-rivalrous (consumption by one person does not diminish consumption by others) and non-exclusive (non-payers, or “free riders” cannot be excluded), making them not profitable. National defense is an example.
- Many other publicly-provided goods might well be profitable for private firms in the absence of government provision, but we have, collectively, made a decision to pay for their production with public funds. Public schooling is an example.
2. As institutionalized in the United States, the basic role of government is to establish and enforce the “rules of the game” by maintaining civil order and the rule of law.
|“The robustness of . . . markets and civil society depends crucially upon the social rules we tend to take for granted – rules of private property, the rule of law, contract enforcement, and basic rights of self-determination. As crucial as these rules are for day-to-day interaction, they are all the more important to ensure in the wake of disaster. [emphasis added]. . . By enforcing property rights and contracts or restraining inflation, for example, governments help to clarify and enforce ‘the rules of the game’ for our daily interactions with one another. When good rules such as these are clear and well-enforced, the signals that emerge in markets and other social interactions tend to be robust and allow the interactions between members of society to be more fruitful and peaceful. Citizens of liberal democracies tend to take these ‘rules of the game’ for granted, but they are vital to our daily interactions and overall well-being.” (Chamlee-Wright, 15-17)|
- The immediate benefits of using military and police presence to keep the peace, deter violence, and protect property are quite clear, but it is also important to recognize the long-term benefits of re-establishing civil order.
- By enforcing the rule of law when disaster strikes, government provides a stable foundation of expectations upon which individuals can make choices among the alternatives they face – even, and especially, when their alternatives are limited or undesirable.
- When the rule of law is uncertain and when the rules of the game are inconsistent or subject to constant change, people and businesses delay decisions about whether to leave or return to the disaster area, whether to try to re-establish their businesses or give them up, whether to move back or move away.
- Re-establishing and maintaining the rules of the game stabilizes social institutions like schools and churches that are essential to attracting people and businesses back into disaster-damaged communities
- Restoration of civil order empowers non-government response, through which other institutions begin to re-establish the normal activities of the community.
- On some occasions, government can help to re-establish the rule of law and civil order by temporarily altering the old rules of the game to fit the needs of the current situation.
- The April 18, 1906, San Francisco earthquake and subsequent fire was one of the greatest natural catastrophes in North American history. (See addendum to Introduction for details of the disaster devastation.)A quick change in the rules of the game by California Governor George Pardee helped to prevent the financial collapse of a major American commercial center.Pardee declared every day between April 18 and June 3, 1906, a legal holiday.Since banks may not operate on legal holidays, he made it possible for businesses to postpone payment dates. His insightful action prevented the financial chaos that might have ensued in the initial panicked realization that most business and banking records had burned up. By June, banks and businesses were able to reconstruct records and reconnect with customers to set accounts right. (Strupp)
- More recently, the federal government’s decision to change the rules of the game in the market for fuel helped to prevent a gasoline crisis in the aftermath of Hurricane Katrina.
- The combined impact of Hurricanes Katrina and Rita was to greatly reduce American oil refining capacity.At the peak of the shutdowns, refineries were processing 5 millions of barrels of oil less per daythan before the storms hit.(For statistics detailing the damage to Gulf Coast production capability, please see the Case Study: “The Gasoline Market Coped with Supply Shock . . .” in Lesson 2.)
- Mercatus analyst Alastair Walling argued that the federal government helped to avert an oil crisis simply by getting out of the way.
When the Government Hands-Off Helps: Averting a Katrina Oil-Crisis
“. . . [W]hile the media fixated on the federal government’s failures, they ignored the quiet successes achieved by the regulatory restraint shown in the wake of the disaster. At both the state and federal level, government waived or relaxed many regulations whose strict upholding would have imposed additional hardship on the people of the Gulf Coast and hindered recovery efforts.
. . . Gasoline evaporates easily during the warm summer months and, subsequently, produces more smog. In order to remain compliant with environmental regulations, refineries produce blends of summer gasoline that, although harder to make, evaporate less easily than winter gasoline. As Hurricane Katrina was knocking out refining capacity left and right, previously refined stocks of perfectly good, but at the time illegal, winter gasoline sat waiting. The EPA . . . simply authorized the early use of winter gasoline, which instantly increased the gas supply available to the market.The early release of winter gasoline may not have been enough if inadequate supplies of diesel fuel, combined with increased demand associated with trucking relief supplies to the Gulf Coast, ended up immobilizing the heavy-duty tanker trucks needed to transport it. Worried that a diesel shortage might immobilize transportation, the EPA also lifted restrictions on high-sulfur diesel fuel . . . [used by trucks carrying relief supplies].
. . . Refiners design boutique fuels for use in markets that cannot meet federal air quality standards without specialty fuel. These markets may be as small as a single city or as large as most of Southern California . . . . While boutique fuels may produce cleaner air, they have definitely fractured the national market for gasoline. If stocks of a particular boutique fuel run low in its given market, then suppliers cannot simply ship in non-conforming blends from other markets.
. . . Following Hurricane Katrina, the EPA moved quickly to issue waivers suspending boutique fuel requirements. Not only did this make gasoline fungible again, but it opened the American market to foreign refiners, who usually do not produce EPA-mandated fuels. (Walling, 10-11)
3. A second role for which government institutions are well-suited is providing the public goods that form the infrastructure of a community. In disasters, public goods may include such activities as search-and-rescue operations and evacuation coordination.
- The non-rivalrous, non-exclusive characteristics of true public goods makes them subject to the “free-rider” problem and thus not profitable for private producers.
- Exclusivity, the ability to withhold from people the benefits of a good or service for which they have not paid, is the source of entrepreneurs’ profit and of their incentive to produce. When a good or service is non-exclusive, private firms are unlikely to produce it, because free-riders can benefit without paying the producer. Government, however, can compel payment in the form of taxes.
- The classic example of a true public good is national defense: It is non-rivalrous, meaning that the amount of national defense provided to one citizen does not reduce the amount available to others. And, national defense is non-exclusive; once it has been produced, it cannot be withheld from those “free riders” who choose not to purchase.
- It is also likely that as a practical matter, search and rescue operations are a public good. In principle, one can imagine private search and rescue firms who, for subscription fee, or payment for services rendered, could provide many of the services now provided by the Coast Guard.
- Indeed, when it comes to protection of physical property, many firms offer such services, for example private firms that tow into ports boats that have become disabled at sea.
- But when it comes to the preservation of human lives, it is unlikely to see such services on a widespread scale. Consider the owner of such a firm who receives a rescue call that happens to come from a non-subscriber or from someone who cannot afford the charges. Could the owner really bring himself to let a person die under such circumstances? And even if he could, what would be the legal (or even the public relations) ramifications of doing so? Under such circumstances, many in the community would simply refuse to subscribe, reasoning that they are likely to be rescued in any event. Thus, as with national defense, there appears to be a valid role for the government offering such services, paid for out of mandatory taxes.
News coverage of police and national guard putting their own lives in danger to rescue and protect citizens in the chaos of Hurricane Katrina vividly memorialized the important functions that government performs in times of disaster – and perhaps we need to be reminded of the value of the civil order and stable rule of law that we have the luxury of taking for granted. But we began this lesson with reference to the fury of nature being followed by the fury of citizens at their government’s ineptitude. Part 2 of this lesson considers the source of citizen’s fury. In emergencies, we have a tendency to call on government to do things we do not expect in normal times, and in doing so, we often overlook the lessons of the rule of rational choice.
Part 2: What We Should Not Ask Government to Do and Why
4. Based on the rule of rational choice, government should not undertake in disasters those activities for which the benefits do not outweigh the costs – activities like getting supplies to victims and rebuilding disaster-stricken communities.
- Government’s poor performance in disaster relief is best explained not by reference to venal and/or incompetent officials but instead by the centralized nature of government and the incentives that accompany government decision-making.
- Economic analysis of the dismal record of federal, state, and local agencies in disasters like Hurricane Katrina suggests that part of our disappointment is an inevitable result of expecting government to perform functions for which it is ill-suited. Public choice economists have identified key factors that explain why government cannot – and, perhaps, should not be expected to – perform well the growing list of relief and rebuilding tasks it has been assigned over the last century:
- Centralized institutions like governments cannot efficiently gather, process, and act upon the widely dispersed, localized information that is key to disaster response.
- Government’s difficulty harnessing knowledge is exacerbated by bureaucratic institutional structure.
- Government lacks an effective feedback mechanism for evaluating whether their disaster relief efforts are succeeding in meeting the needs of disaster victims.
- The incentives that face managers and employees in government agencies reduce effectiveness in disaster response.
- Government attempts to shelter people from disaster or to ameliorate their losses afterwards create moral hazards and perverse outcomes.
- Government disaster-relief programs are prone to unintended consequences.
5. Government agencies have difficulty providing for people’s wants and needs in disaster because they are unable to overcome what economist Friedrich von Hayek famously identified as the knowledge problem – that “. . . knowledge of the circumstances of which we must make use never exists in concentrated or integrated form, but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess . . . . “(Hayek, 519-20)
- Centralized disaster response thus faces two significant obstacles:
- The difficulties of gathering and communicating the fragmented, chaotic, and dispersed information from the disaster-stricken area to those responsible for responding
- People who are familiar with the local conditions, needs, and available resources will not be involved in the decision-making. (Hayek, 521-24)
- Economists Russell Sobel and Peter Leeson of the non-profit Mercatus Center at George Mason University illustrate Hayek’s contention that centralized direction cannot overcome the knowledge problem as they describe FEMA relief and recovery efforts after Hurricane Katrina.
FEMA Failure – More Than Bad Leadership
“. . . Information is fragmented, diverse, and often contained in inarticulate forms, held separately and locally by the many individuals who compose society. . . . [T]he foremost obstacle that every effort at social coordination must overcome is somehow tapping into this dispersed information and processing it in forms that individuals can use to mutually achieve their ends.
. . . We argue that natural disaster management is no different in this regard than coordinating individuals in ‘normal’ economic contexts. Following a natural disaster there are ‘relief demanders’ – individuals who desperately need disaster relief supplies, including evacuation, food, shelter, medical attention, etc. On the other side, there are ‘relief suppliers’ – individuals ready and willing to bring their supplies and expertise to bear on the needs of relief demanders. On both sides of this ‘market’ information is decentralized, local, and often inarticulate. Relief demanders know when relief is needed, what they need, and in what quantities, but not necessarily who has the relief supplies they require or how to obtain them. Similarly, relief suppliers know what relief supplies they have and how they can help but may be largely unaware of whether relief is required and, if it is, what is needed, by whom, in what locations and quantities. (pp. 2-3)
. . . When government substitutes central planning for markets, essential information is generated in an untimely fashion, generated inaccurately, or not generated at all. Because of this, central planning cannot effectively coordinate decision making among numerous and dispersed individuals with different endowments, wants and needs.
. . . There is no reason to think that FEMA, or any other government agency charged with FEMA’s task, is immune to the information problem.
. . . Our finding that an inability to overcome the information problem is the root cause of government’s failure to effectively manage natural disaster relief casts doubt on recent explanations of FEMA’s failure following Hurricane Katrina. One strand of argument, for example, suggests that an unfortunate succession of ‘bad directors,’ culminating in the leadership of former FEMA director Michael Brown, is the reason for this failure. Our analysis suggests that although incompetent directorship may exacerbate government’s inability to effectively manage natural disasters, it is of subsidiary importance to Hayek’s knowledge problem. . . . Even the most benevolent and effective of directors cannot overcome this problem, which stems from inherent organization of government management, which is centralized.
. . . [B]ad leadership does not help, but neither does it explain the core failure of the system. Replacing Stalin with Mother Theresa or Albert Einstein would have been no more help for the Soviet economy than replacing Michael Brown or the current FEMA director with one of these individuals would be.” (Sobel &Leeson, “The Use of Knowledge,” 2, 3, 21-23)
- The United States is one of many economies that have achieved high levels of well-being by choosing not to rely on central planning. We have created a system that incorporates Hayek’s insight – government is inherently incapable (not unwilling) of overcoming the obstacle of dispersed economic information. Logically, we should also recognize that the knowledge problem that restricts government effectiveness in normal times does not disappear in crisis. Instead, it escalates.
- Beyond the obvious difficulties imposed by damage to transportation and communication infrastructure, disasters exacerbate the knowledge problem by further fragmenting information. Additionally, disaster conditions vary considerably from locality to locality, increasing the volume of critical information.
6. Government’s inability to effectively harness knowledge and information is further exacerbated by bureaucratic institutional structure.
- Bureaucratic structures are characterized by detailed procedures, strict protocols, and line-of-command decision-making.
- Nobel laureate Gordon Tullock reasoned that bureaucracy is an effective (some would argue, necessary) mechanism for centrally-directed institutions where people’s choices are not constrained by competition for profit, as they would be in a market.
- One of the problems inherent in carrying out government policies is to organize subordinates so that they will behave as their superiors want them to behave – that is, by contributing to the goal that has been identified through the political process. Bureaucratic structures create incentives for employees to contribute: benefits accrue to those who follow procedures and protocols and costs are borne by those who do not.
- Nobel laureate Gordon Tullock reasoned that bureaucracy is an effective (some would argue, necessary) mechanism for centrally-directed institutions where people’s choices are not constrained by competition for profit, as they would be in a market.
- While the bureaucratic incentive structure may, indeed, be necessary to the functioning of government, it is a cumbersome method of dealing with the knowledge problem and – as was clearly evident during Hurricane Katrina – inevitably slows disaster response.
The Knowledge Wedge: Note to FEMA – Turn on the TV!
“From the view of political actors charged with relieving disaster, there is no disaster to respond to until the President, who is reached in the final stage of the bureaucratic procedure, has officially declared as much. This is true even if a disaster requiring assistance has already struck; the disaster is readily acknowledged and visible in the media, etc. Unavoidable bureaucracy inherent to government management creates a separation between what might be called ‘private knowledge’ of disaster and ‘political knowledge’ of the same disaster.This bureaucracy-created ‘knowledge wedge’ severely limits the goals that can be successfully achieved using government. . . . The more monumental the task in terms of coordination, the greater the problem the knowledge wedge that bureaucracy generates becomes, and thus the less likely government is to effectively complete the task. Since . . . the coordination problem to be solved increases as the division of knowledge increases, this means that for endeavors in which information is more fragmented and localized, such as natural disaster relief management . . . government is an increasingly less effective tool to accomplish the goal.
The bureaucracy-created ‘knowledge wedge’ . . . explains why, though the citizens of New Orleans, the media, and countless others were aware of the impending and eventual disaster caused by Hurricane Katrina, key government . . . figures were not . . . . The secretary of the Department of Homeland Security, Michael Chertoff, for example, did not declare Hurricane Katrina an ‘incident of national significance’ until 36 hours after it made landfall . . . despite the fact [that] . . . two days before Katrina’s arrival the National Hurricane Center predicted Katrina would hit the Gulf Coast.
. . . As a useful point of comparison, contrast the government’s ability to learn about disaster with the private sector’s information . . . . ‘The private-sector planning began before Katrina hit. Home Depot’s ‘war room’ had transferred high-demand items – generators, flashlights, batteries and lumber – to distribution areas surrounding the strike area. Phone companies readied mobile cell towers and sent in generators and fuel. Insurers flew in special teams and set up hotlines to process claims.” (Sobel and Leeson “The Use of Knowledge. . . ”7-9)
7. The political process lacks an effective feedback loop from victims to the decision-makers responsible for allocating resources in a disaster.
- The information necessary to determine which programs are working, which are not, and what other resource uses would be valuable is not communicated directly from consumer (disaster victims) to supplier (government). Instead, decision-makers have only the (insufficient and mostly incomplete) information that comes to them through the political process.
- While we might reasonably expect that government decision-makers have good information about the costs of the programs they create, it is hard to imagine how they could be expected to have accurate knowledge of the benefits or of the potential benefits of alternatives; information that is communicated by price in the private sector.
- The results of government agencies facing neither profit nor loss from their allocation of resources are the all-too-familiar stories of ineptitude that disaster relief spawns.
Sample Illustrations: No Feedback
It Seemed Like A Good Idea At the Time
Gulf Coast relief fiascos in 2005 exemplified the problems government agencies face because of inadequate knowledge and ineffective feedback – problems that refuse to subside in the face of well-meaning compassion. Consider, for example, FEMA’s well intentioned effort to provide temporary housing for the homeless. It seemed like a good idea to move them outside the devastated area. It resulted in trailer parks that went “virtually unused.”
FEMA spent $1.3 billion on 95,000 trailers for hurricane victims, and in some cases $38,000 per lot to make parks trailer ready – double the cost of the trailers themselves. Because FEMA chose to locate the trailers in remote places, away from cities and jobs, FEMA . . . [also planned] to spend millions to cook meals and provide bus service and security for trailer parks. In the not-too-distant future, FEMA will turn around and pay yet again to tear the parks down. FEMA’s incredible misallocation carries little penalty or consequence for FEMA decision makers . . . . In fact, FEMA’s failure was rewarded with billions of additional dollars in funding for the agency’s continued work.” (Sobel & Leeson, “The Use of Knowledge . . .,” 19-20)
Sometimes, it does not take rocket science to figure out what disaster victims need – ice after a hurricane on the Gulf Coast in August, for example. Just knowing “what” however, does not solve the allocation problem. The feedback necessary for the seemingly simple task of getting ice to New Orleans did not happen. Though these failures seem funny after the fact; at the time, it was simply a waste of resources and a missed opportunity to help victims.
“FEMA ordered 182 million pounds of ice to be delivered to stranded families and aid workers. Yet some of the ice ended up in Portland, Maine, more than 1,500 miles away from the disaster area. The cost of shipping and storing the 200-plus truckloads of the Portland-bound ice was $275,000.
. . . NBC News reported that it had found trucks full of ice in . . . Maryland, Missouri, Georgia, and Tennessee. Some of the trucks had been driving and/or sitting idle with their full loads for two weeks.
. . . A truckload of ice even ended up at the Reid park Zoo in Tucson, Arizona. The driver of the ice truck got so many conflicting commands from government relief officials that he ended up traveling through 22 states without ever delivering a single bag of ice to a hurricane victim. Instead, he ended up donating it to the Tucson zoo to be enjoyed by the polar bears.” (Sobel & Leeson, “Flirting . . .” 5)
While it is certainly true that private firms also make mistakes, the key point is that they bear a cost for their mistakes, and FEMA does not. Having to “donate” misallocated ice to polar bears would reduce profits for a private supplier and that is a strong incentive to improve procedures. FEMA officials face no such incentive.
It bears repeating here that these scenarios cannot be explained away by laughing at officials’ “stupidity” or lack of “effort.” Even efforts to learn from past mistakes are often doomed to ludicrous failure by the lack of feedback and the ever-changing specifics of time, place, and event. Look at what happened when Florida Emergency Management officials tried to learn from Hurricane Katrina, determined not to get caught without ice “next time.”
“Minneola – Need some ice for that big Super Bowl party? How about some frozen daiquiris? Or maybe you just miss the ice and snow from up North. Whatever the case, here’s your hookup:
The small Lake County city is looking for ways to use nearly 600,000 pounds of ice cubes – 15 truckloads in all – to be delivered . . . by the state Division of Emergency Management. The chilly delivery is part of a colossal effort to get rid of nearly $2 million in relief supplies . . . .
. . . Altogether, the state is storing about 225 truckloads, or a total of 9 million pounds, of bagged ice cubes in two large warehouses . . . . The glacier-sized supply was left over from relief efforts after Hurricane Wilma in 2005.
Emergency officials held onto the unused ice, expecting a busy hurricane season last year. That never happened. The cost of keeping almost 5,000 pallets of bagged ice in cold storage is about $90,000 a month.” (Sargent)
8. As disaster response extends beyond immediate rescue and relief, incentives for both elected and appointed government workers result in increasingly poor resource use.
Public choice theory, the application of economic reasoning tools to political decision-making, teaches us that government disaster-relief activities are prone to serve the wants and needs of politicians rather than those of disaster victims.
- The key insight of public choice theory is that elected decision-makers’ pursuit of self-interest is dependent upon their ability to gain and remain in office.
- Regardless of how altruistic or depraved a politician’s self-interest, he cannot pursue it in the political arena unless he is in office. This reality creates strong incentives for politicians to be most responsive to those individuals and groups with the greatest ability to affect their political tenure. Thus, when government relief efforts extend beyond the immediate emergency, they tend to be politically allocated.
Unelected government employees also face incentives that frustrate effective disaster response. Because they are not motivated by profit – their civil service salaries are unaffected by any calculation of the amount and effectiveness of the assistance they provide – they have little incentive to respond effectively and efficiently to the needs of disaster victims.
- It is important that the analysis of incentives not be read as primarily an indictment of government workers’ character.
- Loyal, hardworking, caring employees know that they are likely to be commended for carefully following and documenting procedures and criticized for taking risks – incentives arguably ill-suited to disaster conditions.
- On the other hand, employees know that they risk reprimand for skipping steps, abandoning procedures, and trying something new and different, despite the urgency of abnormal conditions.
Accountability and the close-scrutiny and second-guessing to which public agencies are subject make them prone to “type two” errors, errors that result from being overly cautious.
Perverse Incentives – FEMA and Katrina: A Comedy of (Type 1 or Type 2?) Errors
“Economists distinguish between two types of policy mistakes: ‘type-one’ and ‘type-two’ errors. Type-one errors are mistakes that result from not being cautious enough. . . . Type-two errors, on the other hand, are mistakes that result from being too cautious. . . . [P]ublic choice theory informs us that government agencies like . . . FEMA are overly prone to commit type-two errors.
. . . Both type-one and type-two errors can result in injuries or harm to the public. However, the visibility and public backlash are likely larger for type-one errors. . . .[I]f a disaster is declared and FEMA jumps the gun by getting involved immediately, it may commit a type-one error. Because type-one errors are overt mistakes, they are highly visible and are therefore accompanied by a higher likelihood of admonishments from citizens, the press, and possibly, other government agencies.
Suppose, for example, that FEMA allows rescue workers to enter a disaster zone and those workers get hurt. FEMA could be blamed for letting them in prematurely. Thus, bureaucratic hesitancy has always been an operational assumption of FEMA. Indeed, as the Senate report points out, ‘FEMA has a longstanding policy of not putting its emergency responders in the path of a storm so that they will not be in need of rescue themselves.’
Type-two errors, in contrast, are less visible, and thus less likely to result in admonishment. . . . If FEMA waits too long to enter a disaster zone, it may be blamed for acting too slowly as it was in the case of Katrina. But that blame is likely to be less than what FEMA might receive if it entered a disaster zone immediately, before a plan was worked out, and consequently bungled its relief effort in a more overt fashion. FEMA . . . has an incentive to delay action even if more disaster victims are harmed by its not entering than would be harmed if it entered prematurely. Victims lost before FEMA enters because it delays action are less obviously linked to FEMA’s lack of action.” (Sobel & Leeson, “Flirting . . . “ 6-7)
Additionally, some of the ineptitude and escalating cost of government relief programs can be explained by the incentives associated with what the late Nobel laureate Milton Friedman famously called the “other people’s money” syndrome.
- Friedman identified four categories of spending, noting that the incentive to get value for money is very high when you spend your own money on yourself, but that it falls when you spend your own money on someone else or especially when you are spending other people’s money on someone else. (See appendix 1 following this lesson: “The Other People’s Money Syndrome,” for Friedman’s four categories of spending and how they help us to understand government inefficiency in the wake of disaster.)
9. Government programs to shelter people from disaster or to help victims afterwards tend to be characterized by escalating costs because they create moral hazards and perverse “Good Samaritan” effects.
A moral hazard exists when people are shielded from the full costs of risk, thereby creating an incentive for them to engage in more risk-taking behavior. While moral hazards occur in both the private and the public sector, they are more likely to persist in public sector programs.
- Insurance is the classic example of an industry in the private sector that is affected by moral hazards. At the margin, insurance creates incentives for people to be less careful because their losses are covered by insurance.
- However, because they are in business to make profit, private insurance companies are well aware of moral hazard. They incorporate their awareness in rate calculations and in pre-requisites for coverage – smoke detectors as a condition for home-owners insurance, for example
- Government programs do not have the incentive of profit, so there is no incentive to mitigate moral hazards. Government-funded disaster insurance programs, for example, continue to experience escalating real costs as a result of their inability to discourage building in disaster-prone areas of the country.
- The “Good Samaritan” paradox refers to the distortion in decision-making that occurs when people come to expect generous disaster assistance.
- The intention of assistance is to help people get through an unexpected tough time and regain their former independence. The perverse outcome of institutionalizing ongoing government disaster relief is to increase the number of people who make choices knowing that the availability of government assistance reduces their risk of loss.
Sample Illustrations – Moral Hazards & Good Samaritan Effects
10. Disaster-relief windfalls are associated with increases in corruption.
Recent studies by development economists have established the relationship between natural-resource and foreign-aid windfalls and increases in corruption. Disaster relief creates similar windfall conditions and similar increases in corruption.
Intrigued by this relationship, University of West Virginia economists Peter Leeson and Russell Sobel studied the effect of FEMA-provided disaster relief on public corruption in the United States. They found a positive relationship between the amount of FEMA disaster relief received and public corruption in the state.
- Defining corruption as “political officials’ abuse of public authority for private gain,” the researchers used data from the Department of Justice on corruption-related federal criminal convictions per state from 1990-99.
- They found that “. . . [An] additional $1 per capita in average annual FEMA relief is associated with a 1.9 percent increase in public corruption in the average state.Alternatively, moving from a state that has experienced no natural disasters and received no FEMA relief to the average state in our sample increases public corruption 17 percent.”(Sobel & Leeson, Weathering . . . , 16)
Disaster Relief and Corruption
- (Importantly, Sobel and Leeson are not comparing public corruption to private fraud or denying that fraud in the private sector is absent during disaster. Nor are they arguing that public corruption is inevitably associated with government spending. The important variable in their study is the windfall of FEMA relief.
- The researchers also studied the relationship between corruption and changes in non-FEMA related state and federal government spending and found no significant increases in corruption.)
11. Government disaster-relief efforts are prone to unintended consequences. Just because a program is well-intentioned does not guarantee that it will produce the desired outcomes.
Disorganization, policy changes, and conflicting policies create uncertainty, which discourages private and commercial recovery efforts.
Well-intentioned government-financed assistance that persists beyond the immediate emergency hampers private and commercial recovery efforts. Once the immediate crisis point of a disaster has passed and basic human needs such as food and shelter are being met, government provision of goods tends to slow down recovery.
Sample Illustrations: “Signal Noise”
Government ineptitude during natural disasters may be good fodder for comedians and radio talk-show hosts, but the pertinent lesson is more about the need to adjust our expectations than the need for “better” government. Throughout the 20th century, we demanded that government take on more and more responsibility for citizens’ well-being with relatively little consideration of whether or not political institutions are inherently capable of meeting the lengthening list of expectations. The tendency to think that big problems – like natural catastrophes – can best be dealt with by big institutions, like government, is understandable. Persisting in that belief in the face of continuing evidence to the contrary is not. If we expect governments to perform functions for which they do not have the necessary knowledge, incentives, and mechanisms, we not only invite disappointment, but risk undermining their ability to perform the vital tasks for which they were created: restoring civil order, maintaining the rule of law, and providing those few public goods necessary for other economic and social institutions to operate.
Lessons 2 and 3 have given us a framework for a “division of labor” between our political and economic institutions in responding to natural catastrophes. However, sitting back and letting markets and governments do their jobs does not satisfy our personal desire to do “something” when disaster strikes. The next lesson turns from the big picture of institutional response to the human desire to help others. How can we, as individuals, best reach out to disaster victims in ways that not only satisfy our emotional needs but also the real needs of victims? Lesson 4, “When Disaster Strikes, What Can We Do?” examines the institutional dynamics of charitable giving.
Appendix 1: “Other People’s Money”
In 1979, Nobel laureate Milton Friedman and his noted-economist wife, Rose, published their best-seller, Free to Choose, containing what has become recognized as a classic analysis of the incentive problems associated with government spending. Below is an excerpt of their explanation of the perverse incentives that face people spending other people’s money – the “OPM Syndrome.” As you read this excerpt, mentally substitute “disaster relief programs” where they refer to “welfare.” Their insight is as useful in our contemporary consideration of the role of government in disasters, as it was when written in the context of welfare reform three decades ago.
When you spend, you may spend your own money or someone else’s; and you may spend for the benefit of yourself or someone else. Combining these two pairs of alternatives gives four possibilities summarized in the following simple table:
YOU ARE THE SPENDER
On Whom Spent
Category I in the table refers to your spending your own money on yourself. You shop in a supermarket, for example. You clearly have a strong incentive both to economize and to get as much value as you can for each dollar you do spend.
Category II refers to your spending your own money on someone else. You shop for Christmas or birthday presents. You have the same incentive to economize as in Category I but not the same incentive to get full value for your money, at least as judged by the tastes of the recipient. You will, of course, want to get something the recipient will like – provided that it also makes the right impression and does not take too much time and effort. (If, indeed, your main objective were to enable the recipient to get as much value as possible per dollar, you would give him cash, converting your Category II spending to Category I spending by him.)
Category III refers to your spending someone else’s money on yourself – lunching on an expense account, for instance. You have no strong incentive to keep down the cost of the lunch, but you do have a strong incentive to get your money’s worth.
Category IV refers to your spending someone else’s money on still another person. You are paying for someone else’s lunch out of an expense account. You have little incentive either to economize or to try to get your guest the lunch that he will value most highly. However, if you are having lunch with him, so that the lunch is a mixture of Category III and Category IV, you do have a strong incentive to satisfy your own tastes at the sacrifice of his, if necessary.
[Many government] . . . programs fall into either Category III – for example, Social Security, which involves cash payments that the recipient is free to spend as he may wish; or Category IV – for example, public housing; except that even Category IV programs share one feature of Category III, namely, that the bureaucrats administering the program partake of the lunch; and all Category III programs have bureaucrats among their recipients.
. . . Legislators vote to spend someone else’s money. The voters who elect the legislators are in one sense voting to spend their own money on themselves, but not in the direct sense of Category I spending. The connection between the taxes any individual pays and the spending he votes for is exceedingly loose. In practice, voters, like legislators, are inclined to regard someone else as paying for the programs the legislator votes for directly and the voter votes for indirectly. Bureaucrats who administer the programs are also spending someone else’s money. Little wonder that the amount spent explodes.
The bureaucrats spend someone else’s money on someone else. Only human kindness, not the much stronger and more dependable spur of self-interest, assures that they will spend the money in the way most beneficial to the recipients. Hence the wastefulness and ineffectiveness of the spending.
But that is not all. The lure of getting someone else’s money is strong. Many, including the bureaucrats administering the programs, will try to get it for themselves rather than have it go to someone else. The temptation to engage in corruption, to cheat, is strong and will not always be resisted or frustrated. People who resist the temptation to cheat will use legitimate means to direct the money to themselves. They will lobby for legislation favorable to themselves, for rules from which they can benefit. The bureaucrats administering the programs will press for better pay and perquisites for themselves – an outcome that larger programs will facilitate.
The attempt by people to divert government expenditures to themselves has two consequences that may not be obvious. First, it explains why so many programs tend to benefit middle- and upper-income groups rather than the poor for who they are supposedly intended. The poor tend to lack not only the skills valued in the market, but also the skills required to be successful in the political scramble for funds. Indeed, their disadvantage in the political market is likely to be greater than in the economic. Once well-meaning reformers who may have helped to get the welfare measure enacted have gone on to their next reform, the poor are left to fend for themselves and they will almost always be overpowered by the groups that have already demonstrated a greater capacity to take advantage of available opportunities.
The second consequence is that the net gain to the recipients of the transfer will be less than the total amount transferred. If $100 of somebody else’s money is up for grabs, it pays to spend up to $100 of your own money to get it. The costs incurred to lobby legislators and regulatory authorities, for contributions to political campaigns, and for myriad other items are a pure waste – harming the taxpayer who pays and benefiting no one. They must be subtracted from the gross transfer to get the net gain – and may, of course, at times exceed the gross transfer, leaving a new loss, not gain.
These consequences of subsidy seeking also help to explain the pressure for more and more spending, more and more programs. The initial measures fail to achieve the objectives of the well-meaning reformers who sponsored them. They conclude that no enough has been done and seek additional programs. They gain as allies both people who envision careers as bureaucrats administering the programs and people who believe that they can tap the money to be spent.
Category IV spending tends also to corrupt the people involved. All such programs put some people in a position to decide what is good for other people. The effect is to instill in the one group a feeling of almost God-like power; in the other, a feeling of childlike dependence. The capacity of the beneficiaries for independence, for making their own decision, atrophies through disuse. In addition to the waste of money, in addition to the failure to achieve the intended objectives, the end result is to rot the moral fabric that holds a decent society together.
Milton and Rose Friedman. Free to Choose. New York: Avon Books, 1979. pp. 116-119.
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