Is there a satisfying answer to the problem of privatized gains and socialized losses?

By Valerie Scheer

The conclusion drawn from the New Orleans case has far-reaching consequences. Privatization of gains and socialization of losses encourages risk-taking. Citizens with houses in low-lying areas enjoy the benefits of living near a beach and in a familiar neighborhood, but all tax-payers shoulder the costs of rebuilding their houses after a flood.

Broadly speaking, the government has the following options to respond:

1.      Buy the land and prohibit further construction

2.      Require mandatory insurance coverage

3.      Do nothing and continue to pay for reconstruction whenever homes are damaged by natural disasters

None of these being ideal, I looked for potential guidance from similar situations where gains are privatized but costs socialized. Two analogies came to mind: the bank bailout during the financial crisis and the bailout of energy companies operating nuclear power plants, e.g. Tepco after the Fukushima disaster.

Nuclear power is sometimes criticized for being artificially cheap, because its price doesn’t account for several crucial factors: firstly, the costs of waste disposal and asset retirement, and secondly, the potential costs of nuclear accidents, since no insurance coverage is offered. Ultimately, this means when disaster strikes, all tax-payers are accountable.1

Neglecting these factors means energy companies can sell nuclear power at highly competitive rates and enjoy high profits, i.e. the gains are privatized (assuming most savings are kept by energy companies and not passed on to consumers). However, a share of the neglected costs gets shouldered by tax-payers, and in case of a catastrophic event, these costs can reach billions of dollars (see government stock purchase after Fukushima [1]). Most countries would support its companies in a crisis to secure a stable energy supply. Thus, losses get socialized.

Again, potential solutions boil down to the three options described above:

Sustainable Cities_Blog 2_table

Unfortunately, the biggest users of nuclear energy have no single agreed-upon plan of action. Germany announced after the Fukushima disaster that it will accelerate the phase out of nuclear energy production (option 1). Japan seemed to be leaning towards nationalization (option 2) but progress has stalled. Although Tepco was nationalized in 2012 and the former Minister of Trade and Industry Edano argued for nationalization of all nuclear power plants [2], in September 2012, Prime Minister Noda put this plan on hold, along with the proposed nuclear phase-out by 2040 [3]. Similarly, France, China and the US didn’t change their ‘do nothing’ approach and are only upgrading the safety standards for nuclear power plants (option 3).

There seems to be no single appropriate solution for such situations. With nuclear energy, different nations take different approaches based on their values, risk-assessments, and influence of stakeholders. While Chancellor Merkel said her views on nuclear safety changed after a new risk-assessment, indicating higher probabilities of accidents, many other leaders didn’t share her views. Similarly, no universal solution exists to high-risk zone housing. Freedom of choice with regards to location has to be balanced with the burden placed on tax-payers.

However, it is clear that governments should base their risk-assessments on recommendations made by scientists rather than powerful lobby groups. Japan’s change of policy should be worth critical examination. In cases like New Orleans, the government has to take into account every point of view, balancing the needs of tax payers, residents, and real estate developers in a fair manner.

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1 In the US for example each nuclear site is required to purchase $0.3 billion cover from private insurers. Additionally, a second insurance layer is jointly provided by all US reactor operators combined providing up to $10 billion. By comparison, costs from Fukushima amount to at least $137 bn [4]

[1] http://www.businessweek.com/news/2012-05-21/japan-may-own-76-percent-of-tepco-after-converting-non-voting-stock

[2] http://www.businessweek.com/news/2012-09-28/japan-minister-says-nationalization-needed-to-phase-out-nuclear

[3] http://online.wsj.com/article/SB10001424127887323981504578175113250636532.html

[4] http://www.bloomberg.com/news/2012-11-07/fukushima-137-billion-cost-has-tepco-seeking-more-aid.html

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4 thoughts on “Is there a satisfying answer to the problem of privatized gains and socialized losses?

  1. Thanks Valerie. The privitization of gains and the socialization of losses is certainly unpopular and problematic, for all the reasons you laid out. And I agree that government leaders should listen to scientists rather than powerful lobbyists, but that’s certainly not going to happen any time soon!

    For the sake of argument, I’d like to propose a 4th option, which is largely unpopular and rarely discussed. What if option 4 was to do nothing and then do nothing. What I mean by the second do nothing is to not help when a disaster strikes.

    Let me explain with an example. I live in Boston, adjacent to the HBS academic buildings. It snows here. But I don’t own snow boots. I don’t want to spend the money to buy them. Plus, I don’t need to. As soon as a drop of snow hits the ground, an amazing crew of Harvard operations staff descend on the streets to plow and salt the roads. So I can walk to class and get food without ever needing boots. In a scenario in which I didn’t expect Harvard to clean the roads and paths, I’d own boots in a second. Interestingly enough, I’m paying for “boots” through my tuition to Harvard, through the salaries of employees whose job it is to compensate by my refusal to buy boots. And my fellow students who own boots are “double taxed”, first since they paid for boots, and second since they also have to pay for the employees who remove the snow.

    Extrapolating this example to your post, when people know that their bad decisions (e.g., living in a flood plain) will be protected by support from the government in the event of a disaster, they make decisions that increase their personal risk. Then when an inevitable disaster strikes (e.g., flood, hurricane, tornado), the cost is socialized. Is that a good thing? Certain disasters are unexpected and should be paid for. We owe this to each other in a civilized society. But what about hurricanes in known hurricane areas? Or tornado damage in a known tornado area? I’d argue that the cost of bad personal decisions is socialized when we expect to be saved by the government.

    While unpopular, I think we should strongly consider whether socializing loses is the right thing. Does it make sense for this to be the default response? It may be painful in the short term to refuse aid, but does this then motivate people to make decisions that decrease risk in the future? To be truly sustainable, we should think about ways that decrease system wide risk, which may require us to reconsider where we live and how we each choose to protect ourselves when we choose to be exposed to risk.

    • By John Macomber

      This would kind of be a return to the old fashioned days of foresight and personal responsibility. If Laura Ingalls Wilder’s family in Little House on the Prairie were living miles from town and had their home flooded away, too bad. Even today, people like mountaineers and sailors are out there with no safety net, social or otherwise. You know they are thinking about avalanches and storms. One could riff about the days when a failed bank was a failed bank and the bailout was not socialized… I do see some differences however with respect to available choices of where to live. The adventure sailor and first-ascent mountaineers are out there by choice, as are presumably homeowners in Ipswich or Nahant or Chatham, MA, who are getting their homes eroded away. Two million people in low-lying slums in Mumbai are another story – they are steps away from desperate and there is no other choice of where to live.

      • I’m certainly sympathetic in situations where choice does not exist, as in your example about the low-lying slums in Mumbai. There is no other option there when disaster strikes. Either people suffer and die, or the government provides some level of aid. I’m fully supportive of providing aid in those situations.

        And FDIC insurance has been immensely helpful in decreasing the likelihood of a failed bank. The day’s of bank runs were terrible, largely due to a crisis of confidence that spread from the sick banks to the healthy ones, increasing the disease much more than was necessary. However, location based disasters don’t have the same “crisis of confidence” attributes of the banking sector. They are localized and isolated. If a banking crisis were localized to just the banks that were sick, government aid in the form of FDIC insurance and bailouts would probably be unnecessary.

        My comment was about those who do have choice, yet still continue to live in situations that are risky, or about governments that have choice, yet choose to develop where its risky. Why are we investing in parts of New Orleans that are below sea level? Aren’t we just setting ourselves up for a future disaster? Aren’t we encouraging people who we’d put in the “no choice” category to be exposed to life threatening future risk? I argue that we often default to the “but there’s no choice!” argument. In some cases that argument holds true. It often seems like we just don’t want to change our behavior, but we desperately need to! There’s more choice out there than we are willing to believe. If want to create a world that is sustainable, then we need to have these unpopular conversations and make unpopular decisions. I worry that these short term decisions increase system wide risk that we pay for economically, but more importantly with lives.

        • By John Macomber

          There is a lot of merit in several of these concepts. Probably the main one is that the longer we collectively put off hard decisions by “being nice” (or by “being greedy”) in the short run, the harsher is the long term adjustment. When it’s not your own home, it’s easy to see why other folks should not build in the line of peril.

          I think the FDIC example is a little misplaced: FDIC is basically private insurance where banks pay premiums for the coverage, the FDIC doesn’t cover you unless your books and credits are in order, and if you (the bank) go bust, the insurance pool pays out. It’s more like property-casualty or life insurance. On the other hand to have the TARP program or to have the US Treasury own Citigroup stock to keep a bank from cratering under it’s own mistakes, that is a socialized bailout.

          Anyway the core point about ducking unpopular decisions and increasing systemwide risk is for sure a big deal. We could pay with many thousands of lives – for location choices that could have been avoided.

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