The economics of New Orleans and Cost-Benefit Analysis (CBA) for rebuilding
According to Hallegatte (2005), the probability of another Katrina-like hurricane occurring is 1/130 in. Besides, the levees that were built to protect New Orleans from other floods increases the probability of other areas flooding. Further, Hallegatte estimates that within a 100 year period, there is a 63% probability that a similar hurricane and flooding will hit the state. This is a low probability considering that many people live and work there and the state also houses a port and several industries (McGee, 2008).
To get the real value of the CBA for New Orleans the following data is provided:
Probability (p) of Hurricane Katrina = 1/130 = 0.0077
Probability of other floods > 1/130
Direct cost of Katrina = $81 billion (2005)
Cost of building new levees = $14 billion (2010)
Portion of land below sea level = 50% = 0.5
Probability (p) of flood occurring within 100 years = 63% or 0.63
In order to get the actual CBA value, it is necessary to get the monetary value of the benefits and cost of rebuilding New Orleans using the data provided by Hallegatte. These will include the cost and benefits of the projects for rebuilding the homes, industries, levees and other infrastructure destroyed by the hurricane. Other projects might include rebuilding roads, dams, highways, water and sewerage systems, as well as health systems that were destroyed during the floods.
Since probability of Hurricane Katrina is already given at 0.0077 and the probability of other floods occurring within 100 years is given at 0.63, the probability of other floods can be calculated as:
0.63 – 0.0077 = 0.6223
Now that we have the probabilities of both Katrina and other floods as well as the actual direct costs of Katrina at costs for building new levees, the expected value for rebuilding New Orleans in response to other floods in future can be calculated as follows:
Cost of building new levies (14 billion) / 0.0077 = 1,818.18 billion
Considering that the levees are already built, the total cost would be:
$1,818.18 billion – $14 billion = $1,804.18 billion
However, these are only estimates and the actual value might differ based on various factors including the cost of raw materials, the extent of damage by floods, inflation costs, costs of labor, and other economic factors.
The value of the CBA for each constituency
In regards to whether or not to rebuild New Orleans, these following constituencies are directly affected by the CBA: the federal government, residents of New Orleans, residents of the surrounding floodplains, and the mayor of New Orleans.
- Residents of New Orleans
These include residents who can relocate and those that cannot. The decision and the cost of moving or rebuilding the city will have different benefits and risks for this constituency. Suppose the city is rebuilt, the residents of New Orleans would expect that their homes would be rebuilt, infrastructure reconstructed, the levees that protect them from flooding rebuilt, their economic activity go back to how it used to be, and get compensation for their injuries. According to Hallegatte, 50% of this land is prone to flooding as it is either at or below the sea level (2005). This implies that if flooding occurs, then about half of the resident population will be affected by floods. However, the risk will be higher for the residents that cannot move. Abandoning the city would also be more costly for the permanent residents.
- Residents of the surrounding floodplains
These residents face similar risks as those living in New Orleans as the levees make the areas that they live prone to floods. Rebuilding New Orleans increases the risk of these residents losing their homes, being injured, killed or displaced. The main concern for the people living in the surrounding floodplains is whether they would be able to continue enjoying their economic and social lives if the levees are rebuilt. Abandoning their homes for the residents living in the areas surrounding the floodplains would be as costly as it would be for residents of New Orleans to leave their homes. This is because they will need to incur the expense of rebuilding their homes, economic activity and other social and economic costs. However, this group of constituents will get more benefits if the city is not rebuilt as they will no longer be at risk from the New Orleans levees.
- The Mayor of New Orleans
This is the local administrator of the city and for any mayor, the benefits of maintaining a city should always outweigh the cost. The decision to rebuilt New Orleans would be costly for the Mayor of New Orleans as the city will have to use its money and resources to reconstruct infrastructure and homes damaged by the floods. On the other hand, deciding not to rebuild would mean that the city would not be functional as it would not be receiving any revenues in terms of taxes from the city residents. Assuming that the probability of another Hurricane Katrina is 0.0077, this chance is low for a mayor who wants to see the city resume its social and economic activities. Rebuilding the city would therefore be more beneficial than abandoning.
- The federal government
This constituency is mainly made up of the taxpayers that is the people are contributing the money for rebuilding New Orleans and the Federal Emergency Management Agency (FEMA), which is tasked with rebuilding the city. For the tax payers, rebuilding the city would be costly as they will have to pay for the damages and incur additional costs of rebuilding levees and other infrastructure. The benefit of rebuilding is that New Orleans would become economically viable again as industries will reopen, people will get jobs and the residents will pay taxes. For FEMA, rebuilding the city will depend on the balance between the economic and social benefits and the initial costs of rebuilding.
The decision tree points out to different areas that would help in calculating the risk and the cost. Therefore, the probabilities provided would be critical in estimating the risk for every decision. For instance, at the top of the decision tree, it is evident that the land that is at or below sea level is at an increased risk of flooding. Hence, when a flood occurs, the rescue operations will be first directed to this area.
Next, it is necessary to identify the land that is possibly flooded and this can be calculated as:
0.50 x 0.63 = 0.315 or 31.5% of the land is flooded.
Hence the probability that the area is flooded is 0.315 or 31.5%.
Assuming the probabilities, rebuilding the city together with the levees will amount to $1.818 trillion in 100 years. Rebuilding the levees as of 2010 was $14 million; however, there is an additional cost of the residual risk of Katrina. This residual risk can be calculated as:
$14 / 0.6223 = $22.5 billion.
This implies that rebuilding the levees would amount to a total of $14 + $22. 5 = $36.5 billion.
Thus, with these estimates, the cost of rebuilding New Orleans for the federal government would be:
Cost of building new levies (14 billion) / 0.0077 = 1,818.18 billion
Overlapping, decision pitfalls and recommendations
The costs and benefits of building New Orleans could overlap and could be influenced by several internal dynamics. For instance, when it comes to availing the funds for rebuilding the city, the federal government, in this case the tax payers and the city of New Orleans will both provide the funds. In addition, while the government might be catering for the reconstruction of homes, the residents of New Orleans might be given these funds to do the constructions and renovations themselves. On the other hand, the City of New Orleans has to oversee the construction of homes as well as the construction of other infrastructure (Glaeser, 2005).
Considering that the federal government, specifically taxpayers and FEMA decide to pay for the city to be rebuilt, it will need to pay for the damages and the whole reconstruction of the city together with the levees. This implies that the federal government will need to pay the damages worth $81 billion and the reconstruction of the new levees at $14 billion. In case a similar flood hits the city and its surroundings in the future, the federal government would incur the following:
$81/0.0077 = $10 trillion
While most of this money will come from taxpayers, businesspeople and individuals, the mayor of New Orleans will also cover some costs of rebuilding the city. In addition, some of the New Orleans residents might decide to rebuild their homes and businesses themselves instead of waiting for the federal government.
While considering rebuilding New Orleans, a good question to ask is what the government would do with the money that it plans to use to rebuild the city if it was diverted to other projects. The best thing to do would be to build another city elsewhere or settling the people and businesses affected away from the city. Another option would be to give a cash settlement to every individual, family or business that suffered a loss and allow them to choose to rebuild in New Orleans or elsewhere. Suppose the federal government would spend $1.818 trillion to rebuild the city but instead gives a cash settlement to the city dwellers who are about $1.3 million people, each resident would get about $1.39 million that is more than enough to pay for a new home and business in a different town.
One pitfall for the federal government to rebuild the city is that spending that huge amount of money might not make sense if the residents do not want to stay. This would imply that the new city would become obsolete despite the billions spent to rebuild. To avert this risk, the government will need to assess whether the people want to stay and whether New Orleans needs a big city (Glaeser, 2005).
The estimated relevant expected utility
The probability (p) of a hurricane similar to Katrina is 1/130 or 0.0077
The frequency of other floods > 0.0077
Since the probability of such an event occurring in the next 100 years is 0.63
As calculated before, the total cost for rebuilding the city plus the levees would be $1,818.18 billion
The relevant expected utility of the four constituencies will be as follows:
- Residents of New Orleans
The expected utility of the decision to rebuild or not to rebuild the state will depend on the value of each outcome and the probability of each outcome.
The utility is the cost of rebuilding
Hence, since 50% or 0.5 of New Orleans is at or below sea level, the utility will be:
0.0077 x 0.5 x 0.63 = 0.0024
0.0077 x 0.5 x 0.63 x 1.818 = 0. 0044
Therefore, rebuilding would be more beneficial to New Orleans residents.
- Residents of the surrounding flood plains
For these residents, the expected utility will depend on the value of each outcome as well as the effectiveness of the levees. Hence:
EU = 0.0077 x 0.63 = 0.0049
EU = 0.0077 x 0.63 x 1.818 = 0.0057
Thus, rebuilding the city would yield more benefits for the people living in the surrounding floodplains
- The mayor of New Orleans
The utility for rebuilding the city will depend on the cost as well as the probability of another hurricane occurring.
EU = 0.0077 x 0.6223 = 0.00479
EU = 0.0077 x 0.6223 x 1.818 = 0.00871
Thus, rebuilding the city would be more beneficial for the mayor (Daniels, Kettl & Kunreuther, 2006).
- The federal government
Since the entire cost of rebuilding New Orleans will be incurred by the federal government, the expected utility for the federal government will depend the probability of each outcome, as well as its value. Hence:
EU = 0.0077 x 0.6223 x 0.63 = 0.003
EU = 0.007 x 0.6223 x 0.63 x 1.818 = 0.00549
Even though rebuilding would be costly for the government, it will have more benefits.
The first question to ask while considering rebuilding New Orleans is the extent of the damage in terms of cost of damage, the cost of rebuilding New Orleans and the probability of a similar hurricane occurring. It is evident that Hurricane Katrina caused extensive destruction in terms of direct damage to property and infrastructure as well as economic impact. This implies that the port was damaged, jobs were lost, homes were destroyed and the cost to rebuild would be even higher. According to Hallegatte (2005), the direct costs for Hurricane Katrina amounted to $81 billion as of 2005. Apart from the loss caused by damages, the levees that were built as a result of the hurricane would cost about 14 billion dollars. From the calculations in part A, the following is the estimated cost:
|The city plus the levees||The city only|
|Cost of rebuilding||$1,818. 18 billion||$1804. 18 billion|
Another point to consider is whether it makes economic sense to rebuild cities in a land that is already below sea level. According to Hallegate (2005), approximately half of all New Orleans is at or already below the sea level. This implies that no matter how many times the cities are rebuilt, a similar catastrophe would cause the same or more damage. Apart from the land being below the sea level, it is near Lake Pontchartrain and this further increases the potential harm in case another flooding occurs. This is because during Hurricane Katrina the levees that were already around the lake broke and this is what caused the flood waters to go to the streets and people’s homes. The expected utility is based on the following:
|Another Hurricane||Normal Flooding|
|Decision||Rebuild the city and levees||The city will be protected||The city will be protected|
|Do not rebuild the city||The city will be damaged||The city and surrounding plains will be damaged|
Rebuilding New Orleans would also mean that the levees would be built but at what cost? While Hallegate estimates the cost of building new levees to be 14 billion, all this will go under the drain if a similar hurricane hits. But then again, who would decide about how the money set aside for rebuilding New Orleans would be used? The key people to consider would be the residents of New Orleans and those living in the surrounding plains, the mayor of the city and the federal government. However, this decision should be made by the people contributing the money for rebuilding the city. These people include investors, home owners, businessmen and other taxpayers; if they decide to rebuild, the city should definitely be rebuilt. However, if they choose to invest the money elsewhere, then New Orleans should not be rebuilt.
The city of New Orleans should definitely be rebuilt. However, for any taxpayer, one ethical consideration of the decision to rebuild New Orleans is how best to spend tax payers and federal government money post Hurricane Katrina. While the government is tasked with spending funds wisely, the cost for rebuilding the city and compensating residents seems to be a lot. Spending an estimated $1.818 trillion is definitely questionable. Another thing to consider is whether it is fair for taxpayers and residents of other states like Michigan, California and Oregon to pay for the reconstruction of New Orleans. But since the federal government has no resources and it has to take the money in terms of taxes from someone, then the big burden lies on the taxpayers (McGee, 2008).
In future, the residents of New Orleans and the surrounding plains will need to reconsider some form of insurance to cushion them in case a similar flood occurs. If some residents want to live in a land that is at or below sea level and definitely a flood zone with no insurance, then they should not expect other taxpayers to help them rebuild their homes. Besides, the government is already overwhelmed with providing basic infrastructure like roads and hospitals. Still, it is important note that natural disasters like the hurricane will always happen and this increases the need for residents and the government to have some form of insurance to cover the damages when they occur.