TY - JOUR AU - Kousky,Carolyn AU - Luttmer,Erzo F.P. AU - Zeckhauser,Richard J. TI - Private Investment and Government Protection JF - National Bureau of Economic Research Working Paper Series VL - No. 12255 PY - 2006 Y2 - May 2006 UR - http://www.nber.org/papers/w12255 L1 - http://www.nber.org/papers/w12255.pdf N1 - Author contact info: Carolyn Kousky Resources for the Future E-Mail: kousky@rff.org Erzo F.P. Luttmer 6106 Rockefeller Center, Room 305 Department of Economics Dartmouth College Hanover, NH 03755 Tel: 603/646-6479 E-Mail: Erzo.FP.Luttmer@Dartmouth.Edu Richard J. Zeckhauser John F. Kennedy School of Government Harvard University 79 John F. Kennedy Street Cambridge, MA 02138 Tel: 617/495-1174 Fax: 617/384-9340 E-Mail: richard_zeckhauser@harvard.edu M2 - featured in NBER digest on 2006-05-29 AB - Hurricane Katrina did massive damage because New Orleans and the Gulf Coast were not appropriately protected. Wherever natural disasters threaten, the government -- in its traditional role as public goods provider -- must decide what level of protection to provide to an area. It does so by purchasing protective capital, such as levees for a low-lying city. We show that if private capital is more likely to locate in better-protected areas, then the marginal social value of protection will increase with the level of protection provided. That is, the benefit function is convex, contrary to the normal assumption of concavity. When the government protects and the private sector invests, due to the ill-behaved nature of the benefit function, there may be multiple Nash equilibria. Policy makers must compare them, rather than merely follow local optimality conditions, to find the equilibrium offering the highest social welfare. There is usually considerable uncertainty about the amount of investment that will accompany any level of protection, further complicating the government%u2019s choice problem. We show that when deciding on the current level of protection, the government must take account of the option value of increasing the level of protection in the future. ER -