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The hurricane on America’s eastern seaboardlast week (which I experienced in lower Manhattan) adds to a growing collectionof extreme weather events from which lessons should be drawn. Climate experts havelong argued that the frequency and magnitude ofsuch events are increasing, and evidence of this should certainly influence precautionary steps – and cause us to review suchmeasures regularly.
There are two distinct and crucial components of disaster preparedness.The one that understandably gets the most attention is the capacity to mount arapid and effective response. Such a capacity will always be necessary, and fewdoubt its importance. When it is absent or deficient, the loss of life andlivelihoods can be horrific – witness HurricaneKatrina, which ravaged Haiti and New Orleans in2005.
The second component comprises investments that minimize the expecteddamage to the economy. This aspect of preparedness typically receives far lessattention.
Indeed, in the United States, lessons from the Katrina experience appearto have strengthened response capacity, as shown by the rapid and effectiveintervention following Hurricane Sandy. But investments designed to control theextent of damage seem to be persistently neglected.
Redressing this imbalance requires a focus on key infrastructure. Ofcourse, one cannot at reasonable cost prevent all possible damage from calamities, which strike randomly and in locationsthat cannot always be predicted. But certain kinds of damage have large multiplier effects.
This includes damage to critical systems like the electricity grid and theinformation, communication, and transport networks that constitute the platformon which modern economies run. Relatively modest investments in the resilience, redundancy,and integrity of these systems pay highdividends, albeit at random intervals. Redundancy is the key.
The case of New York City is instructive. The southern part of Manhattanwas without power for almost a full workweek, apparently because a majorsubstation hub in the electrical grid, locatedbeside the East River, was knocked out in a fiery display when Hurricane Sandy and a tidal surge caused it to flood. There was no pre-built workaround todeliver power by an alternate route.
The cost of this power failure, though difficult to calculate, is surelyhuge. Unlike the economic boost that may occur from recovery spending torestore damaged physical assets, this is a deadweightloss. Local power outages may be unavoidable,but one can create grids that are less vulnerable – and less prone to bringinglarge parts of the economy to a halt – by building in redundancy.
Similar lessons were learned with respect to global supply chains,following the earthquake and tsunami that hit northeast Japan in 2011. Globalsupply chains are now becoming more resilient, owing to the duplication of singular bottlenecks that can bring much largersystems down.
Cyber security experts rightly worry about the possibility of bringing anentire economy to a halt by attacking and disabling the control systems in itselectrical, communication, and transportation networks. Admittedly, the impactof natural disasters is less systemic; but if a calamitytakes out key components of networks that lack redundancy and backup, theeffects are similar. Even rapid response is more effective if key networks and systems– particularly the electricity grid – are resilient.
Why do we tend to underinvest in the resilienceof our economies’ key systems?
One argument is that redundancy looks like waste in normal times, withcost-benefit calculations ruling out higher investment. That seems clearlywrong: Numerous expert estimates indicate that built-in redundancy pays off unless one assigns unrealistically lowprobabilities to disruptive events.
That leads to a second and more plausible explanation, which ispsychological and behavioral in character. We have a tendency to underestimateboth the probabilities and consequences of what in the investment world arecalled “left-tailed events.”
Compounding this pattern are poor incentives. Principals, be they investorsor voters, determine the incentives of agents, be they asset managers orelected officials and policymakers. If principals misunderstand systemic risk,their agents, even if they do understand it, may not be able to respond withoutlosing support, whether in the form of votes or assets under management.
Another line of reasoning is that businesses that depend heavily on continuity– for example, hospitals, outsourcing firms in India, and stock exchanges –will invest in their own backup systems. In fact, they do. But that ignores ahost of issues concerning the mobility, safety, and housing of employees. Abroad pattern of self-insurance caused by underinvestment in resilientinfrastructure is an inefficient and distinctly inferior option.
Underinvestment in infrastructure (including deferred maintenance) iswidespread where the consequences are uncertain and/or not immediate. Inreality, underinvestment and investment with debt financing are equivalent inone crucial respect: they both transfer costs to a future cohort. But even debt financing would be better thanno investment at all, given the deadweight losses.
Cities and countries that aspire to be hubs or critical components innational or global financial and economic systems need to be predictable,reliable, and resilient. That implies atransparent rule of law, and competent, conservative, and countercyclical macroeconomicmanagement. But it also includes physical resilience and the ability to withstand shocks.
Hubs that lack resilience create cascadesof collateral damage when they fail. Over time,they will be bypassed and replaced by moreresilient alternatives.
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