The Fiscal Implications of Hurricane Strikes in the Caribbean

By Bazoumana Ouattara, University of Manchester; Eric Strobl, École Polytechnique; Jan Vermeiren, Kinetic Analysis Corporation and Stacia Yearwood, Caribbean Catastrophe Risk Insurance Facility.

Worryingly losses associated with tropical storms have risen considerably over the last few decades and are currently estimated to be about $US 26 billion a year. Moreover, some predict that the intensity of these phenomena may increase with climate change. In this regard, arguably the small disaster prone island economies in the Caribbean are particularly vulnerable, as their limited budgetary capacity prevents them from establishing sufficient financial reserves to absorb such potentially large negative shocks.

Added to this, their high level of debt restricts their ability to access credit in the aftermath of a natural disaster, while high transaction costs associated with the relatively small market restricts access to private catastrophe insurance covering potential losses. International aid also does not provide a solution since, when it comes, it is often too little and too late.

A demonstrative example of the consequences of such financial shortfalls in the Caribbean was the case of Hurricane Ivan, which struck Grenada in 2004 causing losses twice the size of the island’s GDP. In the immediate aftermath the country was no longer able to finance its public service bill, but had had no budget contingency in place or access to the private insurance given the relatively small market. It was thus was forced to introduce a number of revenue enhancing measures and delay efforts of recovery and reconstruction in order to address the fiscal shortfall, thus likely further amplifying the long term effects of the hurricane.

In fact it is in response to such fiscal vulnerability to natural disasters that in 2007 a number of Caribbean economies established the Caribbean Catastrophe Risk Insurance Facility (CCRIF), a multi-country risk pooling scheme that can provide members with almost immediate fiscal relief when a natural disaster occurs. As a matter of fact, since its inception the CCRIF has issued over US$ 23 million as a consequence of 4 tropical storm events alone.

Payouts to participating members under the CCRIF as a consequence of a tropical storm are made according to the storm’s physical characteristics, predicted losses, a country’s risk profile, and a country’s loss coverage, the latter being the only choice parameter of a country.

Ultimately the country’s chosen coverage will, however, depend on its expectations with respect to the impact of a tropical storm event on its fiscal sector. In this regard, there are only a handful of statistically based studies which can provide quantitative indication as to the actual short-term fiscal shortfalls in response to a natural disaster event, and these provide mixed evidence of an impact on the fiscal gap of countries.

However, all existing studies only look at the impact of natural disasters events in terms of annual data. One suspects in this regard that much of the true short-term fiscal reaction is likely `netted out’ in annual terms, and thus can only provide limited insight into how severe such fiscal shortages in reality are likely to be.

In a recent study we address the limitations of the current literature by explicitly examining higher frequency, i.e., monthly, fiscal reactions to natural disaster events. Additionally, and unlike previous studies, we also provide estimates of return periods of fiscal shortages in an extreme value theory framework. To these ends, we compile a data set of monthly potential hurricane losses and fiscal expenditure and revenue over the 2000-2012 period for a set of Caribbean countries. We combine these data with destruction estimates derived from actual hurricane tracks and a detailed spatial distribution of assets. Our econometric analysis on this data shows that government revenue drops immediately after a shock, while there is no discerning significant effect on total public expenditure.

More specifically, an average hurricane reduces revenue by 17.6%, while the largest observed event reduced it by more than 200%. Examining the main components of expenditure, however, we discover that current expenditure increases temporarily two months following the shock. More specifically, an average event caused a 16.8% rise in current expenditure.

Overall, we find that there is an immediate and sizable impact on Caribbean economies’ monthly budget deficit, namely 20.3% for the mean hurricane strike. Using our estimates and extreme value modelling we show that return periods of significant fiscal impacts may be considerable for many of the island economies in the Caribbean. For instance, a 100% debt increase is likely to occur within the next 57 to 174 years, depending which island one considers.

First published as a policy brief by Fondation pour les études et recherches sur le développement international 



Socrates, a pig and progressive taxation: A Mirrleesian morality tale

By Cathy Wilcock, Doctoral Researcher, Global Development Institute


Socrates and a pig walk into a bar. Socrates orders a fine bottle of claret and argues for hours with the bartender about Romantic poetry. Being infuriated by the bartender’s base reading of Ozymandias, Socrates attempts to stab the bartender in the heart with his pocketknife. He is so drunk on claret that he misses completely. In the meantime, the pig has ordered several pints of mud and poured them over himself. The bartender slips over in the mud, lands on the pig’s pocketknife and is stabbed in the heart. Who is morally better – Socrates or the pig? And please show your working.

For Utilitarians like Bentham and Mill, the answer lies in the felicitus calculus: the sum total of the happiness produced in the consequences of any given action or inaction. In Socrates’ encounter with the bartender, the sum total of happiness was far greater than in the bartender’s encounter with the pig. In spite of Socrates’ nefarious intentions, he is more morally virtuous in this situation than the pig. For utilitarians, only the consequences matter. Variations of this calculation can, and often are, applied to pressing social, economic and political questions. For example, as in the subject of this seminar, how much should we tax the rich?

For Utilitarians like Nobel prize winning economist James Mirrlees – and his former PhD student Ravi Kanbur, our esteemed speaker – the ‘right’ answer is that which produces the greatest happiness for the greatest number. Mirrlees developed a calculation for working out what tax rate would maximise the sum of utilities or, in ordinary language, which would make the most people most happy. He concluded that a progressive rate of taxation – where the rich are taxed proportionally more than the poor – would produce the greatest happiness for the greatest number. Therefore, utilitarian calculations can provide evidence for arguments for progressive taxation.

It sounds strange to think that the ‘right’ way to tax people is based on the total amount of happiness produced by taxation. What about justice? Shouldn’t taxation be about evening the playing field which has, through accident of birth, allowed some people to make more money than others? Isn’t ‘happiness’ a crude and naïve way to measure what is best for complex human beings? Can it also be used to justify some types of inequality? For example, if the ‘sum’ of happiness is the most desirable outcome, we are committed to preferring a society where 40% are desperately unhappy and 60% are deliriously happy over a society where 100% are quite happy. All of these are critiques launched at utilitarian approaches by egalitarians who, in this context, we can take to mean creatures who would like to find ways of reducing inequality.

What Kanbur is saying is that these egalitarians, while some of their critiques of utilitarianism hold water, shouldn’t be so sneering at utilitarianism. Why? For two key reasons. First, the Mirrleesian formula provides egalitarians with key evidence to support progressive taxation. In the face of those arguing ‘We shouldn’t tax the rich because if we do, we incentivise them to work less hard and our economy will become inefficient’, egalitarians have a ready-made response in Mirrlees’ calculus. By using Mirrlees they can show exactly how much you can tax the rich before they will reduce their labour supply. Mirrlees’ formula clearly demonstrates that efficiency is not compromised by a progressive tax rate. Utilitarianism therefore, according to Kanbur, gives egalitarians an anchor to argue for progressive taxation.

Secondly, Kanbur builds his case for a utilitarian approach to taxation by arguing that non-consequentialist approaches to taxation proposed by egalitarians as alternatives to utilitarianism, can actually support regressive taxation. For example, an approach based on equality of opportunity, as opposed to outcome/consequence, can paradoxically lead us down a non-egalitarian route towards a regressive tax rate. In an approach which attempts to level the playing field by adjusting for equality of opportunity, we have to demarcate between inequalities that are due to circumstance and inequalities that are due to lack of effort. In following the logic inherent within a framework such as this, Kanbur says, we would end up arguing for a regressive rate of tax. Kanbur argues, in abandoning our calculation of consequences and focusing instead on non-consequentialist approaches to taxation, egalitarians are driving themselves down a non-egalitarian cul-de-sac. This is the last thing that they want!

Therefore, Kabur is arguing that people who are interested in reducing inequality should stop sneering at utilitarianism and actually make use of it in their arguments for progressive taxation. He says, despite their apparent incompatibility, utilitarianism isn’t all that bad a doctrine for egalitarians!

I would like to ask two questions about this argument. The first is – is utilitarianism useful to egalitarians or is it really only Mirrlees who is useful?  On the one hand, utilitarianism positions the ‘right’ action as the one which produces the greatest happiness for the greatest number. On the other hand, the ‘right’ action for egalitarians is that which produces the greatest decrease in the gap between rich and poor. Mirrlees set out with a utilitarian aim of creating a taxation system which maximises the sum of happiness – it just so happened accidentally that the utilitarian outcome was a progressive rate of tax. Utilitarians would accept a regressive tax if that was proven to be the one which maximises happiness, but egalitarians would never accept this. While Mirrlees’ position on progressive tax converges with the ideal outcome for egalitarians on this occasion, it is only really an accidental quirk of Mirrlees’ findings. If another calculation were applied or if circumstances changed, the greatest happiness for the greatest number might be a taxation system which increases inequality. In this sense therefore, egalitarians are perfectly sensible to reject utilitarian frameworks. Sure, Mirrlees’ framework happens to help them out on this occasion but does utilitarianism in and of itself really do them any favours?

Secondly, do egalitarians really need the help of utilitarian approaches? Can they argue for progressive taxation without resting on a utilitarian crutch? The equality of opportunity approach is only one alternative to utilitarian consequentialism which, admittedly leads to regressive arguments. As Kanbur himself pointed out in his talk, alternatives to consequentialism ‘may, but not always, lead to non-egalitarian arguments’. Other alternatives to consequentialism – such as Rawlsian theories of justice and other deontological approaches – don’t lead to arguments for regressive taxation. So my final question is – why should egalitarians cautiously use consequentialist utilitarianism when they can confidently use non-consequentialist egalitarian arguments?

Thanks to Chris Lyon whose comments on the seminar really helped me with this blog.

A new economic geography of trade and development? 

By Dr Rory Horner

In a new article published via Territory, Politics, Governance, Rory Horner reviews emerging evidence of the growth of South-South trade and argues for the need to move beyond win-win notions from development cooperation to highlight the commercial realities and very uneven geographies and development outcomes associated with this new economic landscape. Rory has synthesised the article for us below.

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