Disaster Avoidance, Disaster Relief, and Policy Coordination in a Federation

This paper presents a general equilibrium analysis of disaster policy in a federation. The national government is postulated to offer optimal disaster relief, a policy that creates moral hazards for subnational government and private sector decisionmakers. In equilibrium, subnational governments, which compete for mobile productive resources, choose inefficiently low amounts of costly disaster avoidance expenditures. This is true even when the national government subsidizes these expenditures through conditional matching grants, implying that national government mandates or direct control over local policy may be required to achieve efficient disaster avoidance. †This paper has been prepared for presentation at a SITE conference on “Federalism and Decentralized Governance”, Stanford University, July 21-22, 2008. An earlier version was written for a conference on “Fiscal Relations and Fiscal Conditions” at Georgia State University, April 20-21, 2006.