Earthquakes As Economic Phenomena

~Frederic Sautet~

A violent earthquake (magnitude 7.1) struck the city of Christchurch, New Zealand on Saturday morning at 4:31am local time. According to the NZ Herald, there is extensive damage throughout the city. Here are the main stats:

 500+ Buildings damaged;

90+ CBD buildings damaged;

Estimated cost of damage: NZ$2 billion (US$1.5b);

58 Aftershocks;

245 Residents housed in welfare centers;

15 per cent of Christchurch homes still without water;

3,500 homes still without power;

300,000 liters of water transported to Christchurch by rail yesterday;

Distance of epicenter from Christchurch central: 40km.

Some people have been injured but, to my knowledge, no one died directly because of the earthquake. Specialists say that more aftershocks are to be expected and some may be violent. There are still risks: buildings could collapse on people in the coming days. But overall, the tragedy in Christchurch is mostly material. Human life was, by and large, protected. Compare this to the loss of life in Haiti last January. 

Problems in Haiti came from bad building construction, but also and mostly from what happened before and after the earthquake. As Pete Boettke has mentioned many times in this blog, John Stuart Mill pointed out that countries can bounce back quickly from natural disasters provided the free flow of people and capital is permitted. A corollary to this statement is that countries can be well prepared against natural disasters provided trade, accumulation of capital, and insurance contracts are free, and property rights are well defined and enforced.

Clearly the impact of earthquakes is mostly an economic issue. What happened in Kobe many years ago or in Christchurch last weekend doesn’t compare with what happened in Haiti. And the difference is economics. NZ has a building code and by and large buildings are built according to the code in place—it is enforced. But it is not the building code that ultimately saved people's lives; it is capitalism. Indeed, compare this to Haiti. Haiti probably had a poorly enforced building code. But it is not because building inspectors in Haiti are corrupt that buildings are poorly built. Rather it is because of the lack of surplus in the economy. It is the surplus created in a free economy that enables people to dedicate more resources to earthquake protection thereby making code enforcement easy. As long as Haitians will be poor, building codes will not be enforced because people have more urgent things to do with the small amount of resources they have.

It will be interesting to see the response of government officials in Christchurch. Official policy response can either slowdown recovery (as it happened in New Orleans in 2005) or it can foster it. Cases of fast recoveries abound in the past: Chicago after the great fire in 1871 is one of the most studied cases. The rebuilding of the city was mostly done by the private sector with a bit of help from the Federal government. Within three years, Chicago was back in business. The general point is that the government should do what it does in normal times: enforce the law. The government can provide emergency relief, shelter, and things like that, but it shouldn’t do much beyond this. While governments can be good at specific rescue operations (as Steve Horwitz argues here), they are not good at large-scale coordination of resources and should leave this to those who have the incentives to do so.

Those who live in Christchurch were saved by capitalism and the accumulation of capital it has enabled over the years. Natural disasters are economic phenomena. Governments, including in the West, often ignore this truth to the detriment of the victims who suffer twice—once from the earthquake itself, and a second time from the consequences of poor government policies.

Addendum: For a rigorous treatment of the subject, Chris Coyne just wrote a paper on the constitutional political economy of responses to crisis. This is for the conference on James Buchanan's contributions to political economy at GMU next week.

Comments

[Bill Stepp]

The San Francisco earthquake of 1906 is another case study. Malcolm E. Barker compiled a series of memoirs and eye-witness observations to this event in the book Three Fateful Days: San Francisco Memoirs of the 1906 Earthquake and Fire (1998). Two essays are especially noteworthy, Frank Hittell, "Holding Back the Volunteers," (pp. 247-49), and James B. Stetson, "The Defiant Mr. Stetson" (pp. 251-54). Frank Hittell was an attorney whose account was originally published in 1927 in The Argonaut. He stated that federal troops prevented townspeople, including himself, from aiding firefighters by providing them food and water, etc. He was struck with the barrel of a gun by one of the soldiers. James Stetson, whose memoir was published in 1906, was forced from his home, but he was able to sneak back and save his neighbor's home and the whole block from burning. He was president of the private California Street Railway Company, which had the cars running in five months.

[Per Bylund]

3,500 homes demolished and nobody died? Wow, that's got to be a population of all-alert individuals. Somebody should tell Israel Kirzner. ;-)

[Dave Prychitko]

Hayek's a fan of building codes in the Constitution of Liberty.

[Jerry O'Driscoll]

A very good post on an important issue. A similar argument can be made about famines. Crop failures may be natural events, but famine is an economic event.

The aid that got to New Orleans was largely from private sources, both nonprofits and for profits (e.g., Walmart). The residents of the French Quarter armed themselves.

There is a private-sector story to the rescue efforts after 9/11/2001 at the Pentagon. Costco organized the delivery of drinking water to the rescue workers. The store had pallets of water for sale. If a customer purchased one, Costco arranged for dleivery. The company gave the names of all the patrons purchasing the water to the Pentagon, who invited them to the memorial service.

Chile has presented an interesting case study with first its earthquake and now the mine disaster.

[Jerry O'Driscoll]

The origin of building codes were insurance company codes. They became enacted in statutes with all the costs and benefits associated with government's taking over enforcement of private practices.

[Frederic Sautet]

On the subject of insurance, there is also another interesting issue in NZ. To my knowledge, the Earthquake Commission (EQC: http://www.eqc.govt.nz/) offers insurance compensation to everyone in NZ up to a certain limit. Beyond that limit, one has to be privately insured.

I am not familiar with the origin of the EQC but according to its website, it was born during the war and after the great 1931 earthquake in Napier, which killed a lot of people and left many without a home. Private insurance was deemed insufficient at the time. I don't know of studies on the subject, but I suspect that it was more a public choice story: those who didn't have/want insurance forced it on everyone else through taxation, a classic case of spreading the costs.

As Jerry says, insurance companies have otherwise an interest in making sure buildings are insurable and thus built according to certain engineering specifications. Of course, insurance companies could suffer some form of adverse selection if only a portion of the buildings in a given town are insured (those uninsured can become hazards for those insured). But this may still be an insurable risk, just as in the case where one has to be insured against those who don't have car insurance. It is simply reflected in the premiums. Insurance companies have an incentive for selling as much earthquake insurance as possible, which makes me doubt of the usefulness of a government entity such as EQC.

[Bill Stepp]

Re: adverse selection in these insurance contracts, wouldn't an uninsured property owner be liable under tort law for damage to an insured property owner's structure(s) caused by his own property? This would seem to distinguish this sort of insurance from health insurance, where the only effect experienced by an insured person is a higher premium than would be the case if more uninsured took out coverage.

[Bill Stepp]

From Chris's paper:

In general, entrepreneurs will have the incentive to anticipate and respond to crises when
property rights are well-defined and enforced and when the price mechanism is allowed to
operate.

But what about situations where property rights are not well-defined and enforced? My understanding of Katrina is that much of the damage was caused or made worse by what the Army Corps of Engineers did in constructing the levees, and that this has been the case in other disasters too.
As for a crisis enabling the State to wipe the slate clean, I'm skeptical.
Coincidentally, as a member of the Better Late than Never club, I'm just finishing Hernando De Soto's book The Mystery of Capital (2000), which is about prpperty rights and the formation of capital. He doesn't discuss disasters, which would have been a fascinating chapter I'm sure, but he does mention informal ("extralegal") property rights documentation in Haiti, among many other places.

[Dave Prychitko]

@Jerry Interesting.

[FC]

If GMU or Mercatus can afford it, they should send some scholars to Christchurch to study the aftermath. It would be a valuable counterpart to studies of New Orleans and Haiti.

It would also help offset the deluge of statist propaganda that inevitably follows disasters. I predict a Labour landslide in the next NZ elections.

[Mark Hubbard]

As I've just posted on a New Zealand Blog, having just come through the Christchurch earthquake - and being knocked off my feet in a 7.1 quake is not something I desire doing again -the comparison with the quake of equal size in Haiti is stunning.

In that earthquake something over 250,000 people were killed, in Christchurch on Saturday morning, not one person died. They are calling it a miracle, which it is, but a very man made one. New Zealand is not called the Shaky Isles for nothing: we have a building industry geared around constructing buildings that are earthquake proof - good old modern technology born of capitalism, as this article suggests. This is particularly since the Napier earthquake.

To continue the comparison with Haiti, and acknowledging that our CBD is currently shut down, some small businesses will suffer greatly, and many houses in some specific subdivisions will be uninhabitable, just three days after a major earthquake, I was working, as normal, from the office in my home, with water, sewage, power and Internet. Indeed, we had all these things where we are since mid-afternoon on the day of the quake (the quake was at 4.35am, we had all services back by 3.00pm).

Note the Earthquake Commission is government run, and pays out the first $100,000 only of all claims in an event such as this, then private insurance companies pay the amounts over this.

The buildings that are damaged, many beyond repair, are the historic buildings built at the end of the 1800's that obviously weren't built to withstand earthquakes. The houses that have sustained the most damage, and many thousands look to be uninhabitable possibly,in some instances, for good, are new subdivisions on the flat land that have been built on what once was swamp, and so the land under them has suffered serious liquifaction: no matter how sound the house, I guess it's hard to build against sinking. At least the way these houses, some of them sawn in half, were built, with their flexible wooden framing, etc, saved the people inside them.

Thank goodness for capitalism, though as with all the West, New Zealand unfortunately has now come down to the stage where we are closer to a planned economy (thus planned society) than to a laissez faire one. And so the Keynesian roosters are coming home to roost here also, though we have not implemented the huge stimulunacy programs that Obama and the northern hemisphere economies have.

A good New Zealand blog to read on the Chch earthquake is this one, Notpc blog:

http://pc.blogspot.com/

(Hey, see, you've got Kiwi fans :) )

[Mark Hubbard]

Addendum: due to the private insurers working 'on top of' the Earthquake Commission, the market will solve the problem of the houses being built on reclaimed land (assuming that cannot be dealt with via technology), as I would assume the private insurers will not insure houses in those areas again.

[Jim Rose]

Frederic,

The earthquake commission insurance cover is only for those who have private home and contents cover. The first NZ$100,000 plus GST of damage to private homes is covered. After that, private insurers are liable for the remaining earthquake damage.

The earthquake commission insurance cover does not extend to commercial and public assets.

The earthquake commission is funded by a levy on households that choose to be insured and the commission has NZ$15 billion in investments as reserves. My earthquake commission premium is about NZ$120 per year.

The first NZ$100,000 plus GST of damage cover has not changed since I came to NZ in 1998. Back in 1998, that would have covered the majority of damage, especially for smaller towns and smaller claims.

The earthquake commission insurance is no more and no less than a publically owned specific purpose insurance company.

Private insurers would take an interest in earthquake resistance of the building they insurer, as you say

The earthquake insurance commission cover mixed up these incentives to prepare for earthquakes. Only in a small number of cases will private insurance companies have to pay out. A publically owned insurer has less reason to engage in risk rating and reward earthquake strengthening with lower premiums.

The option of earthquake insurance commission cover saves the majority of home owners from the risk of having to strengthen their homes to get private home and contents insurance.

Cheers

[Jim Rose]

Building codes should be considered in their totality, including lulling effects.

the rebuilding after the NZ quake will cost NZ$2 billion plus, much of it is insured.

PricewaterhouseCoopers found the NZ leaky-home disaster would cost between NZ$11.3 billion and NZ$24 billion.

During the 1990s many houses were built using methods that haven't withstood the weather conditions in New Zealand. Because of the problems involving design, and installation of materials, these houses leak when it rains.

an inquiry found that about 70% of weather tightness problems were due to the Government-run association recommending poor quality products to the building industry. the rest was due to builder error.

Much of the legal liablity is with local government because of poor certifications.

the government has proposed a NZ$6.3 billion settlement that splits the repair bill 50:25:25 between the homeowner, the Government and local councils. this covers 23,500 leaky houses. another 13,000 are not covered.