A short review of Matthew Kahn’s An Introduction to Natural Disaster Economics.

When I first studied environmental and natural resource economics, I was struck by its focus on certain topics and comparative neglect of others which seemed equally important.  My MSc course, like many textbooks, gave prominence to environmental externalities such as pollution and policies to address them, to the valuation of environmental goods such as parks and other recreational sites, and to the management of natural resources such as water, minerals, fisheries and forests.  There was little place for environmental ‘bads’ such as  tropical storms, wildfires, earthquakes and volcanic eruptions which, by contrast, receive due attention in high school geography courses.

It was therefore with considerable interest that I approached Matthew Kahn’s An Introduction to Natural Disaster Economics, available as a free download from his website.  A work described as an introduction invites the question: introduction for whom?  Is it, for example, an introduction for those who have studied the sort of environmental and natural resource economics covered in my course and would like to address the gap identified above?  Or is it an introduction for those with a good background in economic principles but have never studied any sort of environmental economics?  Or is it an introduction for the lay person with no knowledge of economics beyond what they may have gathered from following current affairs or from its impact on their own lives?  In my opinion, the work is for the most part accessible to the lay person.  There are no formulae, just the occasional simple arithmetic explained within the text, few economic diagrams, and little economic jargon.  Occasionally the argument becomes more technical, as in mentions of the Coase Theorem and climate model RCP8.5, but that is the exception rather than the rule.

That is certainly not to say that the book would not be of interest to those who have studied environmental economics.  Contrary to some, I am of the view that text and mathematics both have their place in presenting economic ideas.  One reason is that sensible economic policy is often concerned with trade-offs between desirable but conflicting aims.  Maths is likely to be needed when trying to estimate the optimum trade-off, but all too often poor policy results from failure to recognize the need for a trade-off at all, in which case the best means of enlightenment will probably be a straightforward textual explanation.  Kahn’s work is a good example of the effective use of text to explain economic issues.  Text is well-suited to his topic because policies relating to natural disasters are almost invariably about other aims too, such as poverty relief, perceptions of fairness, and promotion of home ownership.  Having said that, it is fair to note that it has an air of being work in progress, with some typos and inadvertent repetitions, no list of contents and no index  (1).  It is also very US-centred, even to an extent  California-centred, and readers from elsewhere might find it challenging to relate some of the discussions to circumstances in their own countries.

The central focus of the book is on households and businesses making decisions relating to potential or actual natural disasters, having regard to the information available to them and the incentives created by a market economy, well-defined property rights, and government policies.  Kahn takes a broad view of the choices available to households.  Where a property is known to be at risk, say from wildfires, precautionary steps can be taken to reduce the physical risk, such as clearing surrounding undergrowth or fitting fire-proof materials, and also the financial risk, by purchasing appropriate insurance.  Should the property actually be damaged and perhaps rendered temporarily uninhabitable, then it will be important to have built up savings to pay for repairs and/or temporary accommodation, and also to draw appropriate lessons for the future.  Perhaps it is unwise, even if it can be afforded, to own a property in an area of risk.   It might be better to rent, or to live in a less risky area.

What about the choices available to businesses?  Just like households, businesses can make various kinds of decisions to address their own disaster risks.  However, the aspect on which Kahn lays emphasis is the role of profit-seeking businesses in offering products or services which can help households to address their risks.  That includes supplying and fitting products such as the aforementioned fire-proof materials, and providing insurance against natural disaster risks, but also much more.  He gives the example of a business buying a large stock of canned tuna in anticipation that, in the event of people evacuating their homes in a disaster, there would be a sudden large demand for a nutritious food product that can be consumed without the need for cooking equipment.  Businesses can also provide information to help householders make decisions, both on disaster risks and, during a disaster, real-time spatial data on matters such as air pollution levels from wildfire smoke.

A feature of Kahn’s argument which I found particularly interesting is his lack of enthusiasm for households to own their homes.  This is in strong contrast to opinion in the UK where almost everyone wants to ‘get on the property ladder’, and promoting home ownership is widely regarded as a proper aim of government policy.  His view is also at variance with policy in the US where, as he explains, the tax code effectively subsidizes home ownership.  Nevertheless, he makes three arguments, all of which have force.  One is that single-family homeowners generally lack the knowledge and skills to manage the risks to property from natural disasters.  They are amateurs performing a role that calls for appropriate professional input.  This point is only partly weakened by the fact that homeowners can choose to buy in professional input; they may not know what sort of input would be most beneficial.  It would be better, Kahn suggests, for homes to be owned, wholly or in partnership, by investors holding a portfolio of property investments with the scale to provide professional management and the capital to afford works when needed.  The profit motive would ensure that they took the necessary steps to preserve and increase the value of their portfolio. 

A second argument starts from the observation that to own a home is to own an asset, the value of which is often a high proportion of a household’s total assets.  In any other context most people would see the importance of reducing risk by not putting ‘too many eggs in one basket’.  Such thinking, however, is rarely uppermost in people’s minds when their main asset is a home (perhaps they think that in the event of a disaster they can rely on insurance or on the government).  Kahn suggests that, rather than owning a home in a risky area, ”betting … on a single point of the map” as he puts it, a household might rent a home while investing in safe assets the money that they would have used to buy a home.  Alternatively, it might obtain 50% ownership of its home with the other 50% owned by a private equity partner, so reducing its risk.

The third argument concerns the political economy of housing policy. Communities with many single-family homeowners often experience the phenomenon of NIMBYism: homeowners collectively lobbying for restrictions on the building of new homes.  Kahn observes that if more residents were renters, they would be more likely to support policies to increase housing availability.  Extending his argument a little, the incentives of owners and renters in this respect are quite different.  Owners will want to limit housing supply so as to maintain their property values, while renters may be happy for supply to be increased since it may lead to lower rents.  Kahn’s conclusion is to suggest that policy should encourage more individuals to become renters.

The last two arguments also illustrate a further theme of the book: government policies leading households or businesses to make sub-optimal decisions in respect of natural disasters, and the political economy of such policies.  Although Kahn does not use the terms, he is concerned very much with government failure and not a lot with market failure. That partly reflects the book’s subject: unlike, say, a serious pollution incident from an industrial source, the occurrence itself of a genuinely natural disaster does not imply any sort of market failure.  Nevertheless I feel he could have given more attention to the role of various kinds of market failure in making the consequences of natural disasters more serious than they might have been.  

Control of a wildfire, for example, could be made more difficult by a natural monopoly of water supply within a local area, with managers of firefighting operations having to negotiate with the single supplier just when time is of the essence.   The harm done by flood water could be aggravated by the discharge of agricultural or industrial pollutants into the water. Most importantly, protective measures against natural disasters, such as the building of levees to lessen flood risks and fire-fighting to restrict the spread of a wildfire, often have the characteristics of public goods.  Residents in affected areas cannot be prevented from benefiting whether they are willing to pay or not, and so such services tend to be under-provided by the market.  

Kahn does in fact discuss at length the case of building levees.  He rightly points out how difficult it can be to assess the net benefit of such projects, not least because making an area more resilient to flood risk may lead more people to live there, with the consequence that if the better-protected area should in exceptional circumstances still be flooded, more people than otherwise might die.  He also states that such local public goods should be funded by local, not national, government so as to promote accountability and focus on the part of local politicians and voters.  From this discussion one may infer that Kahn recognises that there is, at least in some cases, a justification for government provision of public goods to protect against natural disasters.  In a work claiming to be an introduction, this fundamental point should surely be stated explicitly?

One very important example of such a public good, with the extra complication of being an international public good, is climate stability, the mitigation of climate change by limiting emissions of greenhouse gases.  I found Kahn’s discussion of climate change less interesting than other parts of the book, partly because some of his points have been often rehearsed elsewhere.  Broadly, he is not opposed to decarbonization measures but concerned at their opportunity cost, is inclined to the view that the US should shift its balance somewhat from mitigation to adaptation, and is rather optimistic about the potential for adaptation should household and business decisions not be distorted by inappropriate government policies.

To return to government failure, among the policies Kahn criticizes are: government support for mortgage lenders; land use regulations favouring single-family housing; price controls on insurance; and restrictions on the sale of water. A large part of the book is devoted to explaining the unsatisfactory consequences of these and many other policies.  I will try to present the essence of Kahn’s explanations in a way which abstracts from their US context. 

In a free market, mortgage lenders would exercise due diligence and would tend to avoid lending on properties in risky areas, because the rate of default by borrowers in such areas is high.  Suppose however that lenders can reduce their risk from default by selling on loans at above-market prices to government-supported institutions.  They will then be less diligent about their risk assessment and more willing to lend on homes in risky areas.  That in turn will encourage the building of homes in risky areas, since developers there will know that buyers will be able to obtain mortgages.

The effect of reserving a certain zone for single-family housing is to prevent the development of taller, multi-family housing and so limit the population it can accommodate.  If the zone is in a desirable location, then families who would have liked to live there will have no choice but to live in what may be a less desirable location.  Desirability depends on a whole range of factors, of which low risk from natural disasters is just one, but in this way land use regulation can contribute to the spatial distribution of housing being sub-optimal in respect of disaster resilience. 

Insurance, as we have seen, can be a means by which homeowners can reduce their financial risk in respect of natural disasters.  In a free market, insurers will set the price of cover on the basis of their assessment of levels of risk, including risks from natural disasters.  That will tend to mean higher prices for homes in risky areas.  If government policy sets limits on the price of cover, a likely consequence is that insurers will cease to offer cover in areas where their assessment of risk implies that they can do so only at a loss.  Hence homeowners in risky areas may find themselves unable to obtain cover. 

A reliable supply of water is essential for dealing effectively with wildfires. Rainfall, however, can be highly variable spatially and seasonally.  Given a system of property rights in water and a free market, water will be sold to wherever it has a high value, and the protection of homes from wildfires is likely to be among its highest value uses.  Policies to restrict the sale of water can therefore reduce resilience to wildfires. 

Kahn also points out that the consequences of many of these various forms of government failure will tend to become more serious to the extent that climate change increases risks from natural disasters.  The converse is that a freeing of markets could in various ways facilitate adaption to climate change.

Overall, and despite my criticisms of certain points, there is much in the book from which anyone with an interest in or concern with policy towards natural disasters can learn.  It is to be hoped that a more finished version will be made available soon. 

Notes and References

1. My comments are based on the book as I downloaded it in May 2025.  I have not provided chapter or page references as Kahn’s website states that the book will be updated frequently.