Disaster Capitalism: what it is, why it’s a problem

The fires in Hawai’i and reports of predatory behavior on the part of investors has triggered a discussion in some circles of a phenomena sometimes called “Disaster Capitalism.” Before the tragedy in Lahaina and the recent hurricane landfalls disappear from the headlines, I think it is important to discuss this phenomena, which has been a misunderstood but vital factor in understanding how post-disaster response in the US reshapes our economy, society, and vulnerability to disasters.

Although the phenomena has been around for a long time and gone by different names, the term Disaster Capitalism was apparently coined by the Canadian activist Naomi Klein, and aspects of it described in her book “Shock Doctrine.” The Oxford Dictionary defines it as “the practice of taking financial advantage of natural or man-made disasters and unstable social, political, or economic situations” and has it tagged as a derogatory term. Certainly it is inflammatory to imply that some profit from other’s misfortune, and I’m not sure I like the term. As the old proverb goes, it is an ill wind that blows no good. The question is if such actions are illegal, unethical, or if facilitated by a system that is biased or broken in some way. Let’s take a look. Please note in the discussion below the loss of life aspect is largely left out – that’s not being hard-hearted, we should never lose sight of that, but this discussion is just looking at the economics of disasters.

The reality in a large developed economy is that natural disasters reshuffle the economic deck and force economic activity to be redirected, but despite physical damage rarely result in much net loss. That’s why I usually don’t talk about “losses” – that’s an insurance industry term since they have to write you a check so they see it as a “loss” to their bottom line, but for you, in theory, it is a “offset” that has reduced or, if you had replacement cost policy, mostly eliminated your “loss” other than a nominal deductible. In fact, if the insurance company wasn’t too greedy and managed their assets, investments, and exposures properly, and existed in a rational regulatory environment, it isn’t really a “loss” to them either, it is simply the cost of doing business much like inventory is for a grocery store – and nobody calls it a “loss” when a grocery store buys inventory from the wholesaler!

The net impact to the economy of a disaster therefore should be minimal since you’re going to spend that check on fixing things, a construction company got work, monetary velocity increases, it may even be a slight plus overall in certain economic terms, although I disagree with the concept of a “disaster stimulus” because that doesn’t factor in opportunity costs. Properly managed, insurance reserves themselves are an important source of capital for the economy, further indirectly offsetting the impact of disasters. In theory, while it may not exactly be win-win, nobody should really lose in a big way (again, in purely economic terms). Put another way, in a developed well managed economy, disasters redirect the flow of money and resources temporarily but things should balance out for the most part.

However, if some individuals or classes are selectively harmed while others benefit due to practices or systemic design, that’s a problem, both ethically and since systemic distortions are ultimately counterproductive in terms of stability of the socioeconomic system. Put more bluntly, a system that cheats people will ultimately fall apart.

Take the insurance example above. Not always being terribly altruistic, insurers sometimes engage in practices such as offering people immediate settlements lower than what they could or should have offered, knowing that their clients need money now and can’t drag out the process. A well-to-do client, with the resources to contest a low offer, will usually not be low-balled in this way. It’s unethical, potentially illegal, probably not as common as it used to be, often hard to prove, but regulators do try to keep this kind of thing to a minimum.

A far bigger problem is systemic. In the urge to maximize shareholder profit, companies don’t always invest wisely or keep those investments available for payouts, not to mention a convoluted, 50 state regulatory framework that makes the insurance industry an illogical mashup of laws and pressures (such as authorized rates not being based on actual risk) that are incompatible with good actuarial practice. Regulators push myopic regulations that benefit their state at the expense of the system as a whole. The insurance lobby pushes regulators to allow practices that are not necessary from an actuarial standpoint, but maximize profit again at the expense of the client. One egregious example of that are higher deductibles for “named storms” – an arbitrary process that protects investors at the expense of the public. When insurance companies don’t have enough reserves for major disasters, they collapse. They distributed profit for years, but when it comes time to pay out, they can’t, so either government has to step in, or once again their clients take the hit. Combine that with tax advantages and a complex, layered system of reinsurance and the capital markets, it is designed to privatize profit while socializing risk.

Another major problem in disasters like hurricanes, or the Lahaina fire, is that regulatory changes intended to prevent or reduce future disasters often drive existing owners of desirable property off their land. Here I can give you a personal example: our family inherited a small beach cottage on a barrier island. If it were damaged more than 50% or destroyed, we could not rebuild it as is because the flood zone regulations are such it would cost perhaps ten times the replacement value. That, and the value of the land itself resulting in higher property taxes, ensures that if the worst happens it will likely have to be sold. I have seen this happen time after time all over the east coast, where small, expendable beach cottages have been replaced by condos or huge expensive homes after a storm.

Now, consider this: what happens when ten 80 thousand dollar cottages (total structure value $800,000) are replaced by a $5 million dollar condominium. That same storm that wiped out the cottages would cause “only” 33% damage to the condo – but 33% of $5 Million is $1.65 million, DOUBLE the expense of the “expendable” cottages. Thus, the net effect is that the regulations designed to reduce the impact of hurricanes in fact increased their overall economic impact by forcing (and, via insurance, subsidizing via socialized risk) denser, higher cost developments into the hazard zone!

But the dollar numbers are not the whole story. In the 1960’s a middle to upper middle class family, if they were frugal, could afford to have a beach cottage as well as a home in town, or live in a nicer (yet still relatively inexpensive) coastal home. Today that is impossible given the much higher property values that are disproportionate to incomes, accounting for inflation, in part due to regulatory and other factors. The change in demographics of ownership due to regulations and reconstruction costs has ripple effects across society. Properties that have been in families for generations are forced to change hands and wealth is concentrated in the hands of high-end property owners, typically corporations. The former owner may have gotten some money out of the deal, but it may not have fully been their choice, their quality of life and overall financial situation has probably suffered.

In short, given the structure of society and the nature of government and economics as it is practiced in the US, those who can least afford it are often the losers in disasters, and those already in the upper reaches of the economic strata often benefit. In other words, the pain and profit isn’t evenly distributed.

We are seeing this play out in Hawai’i, where heartfelt stories have appeared about the pain and stress caused by realtors and investors who are swooping in to take advantage of the situation. Some will argue that this is just free market capitalism at work and it benefits both the seller and buyer. However, this argument misses some of the of aspects as noted above: most importantly, that it is not really a free market, these are forced sales that are at least in part a result of government and insurance policies that are regulated by government, and have been put in place after having been written by advocacy groups of various leanings. This is at best an unintended consequence of regulations designed to create more resilient communities, or at worst crony capitalism. Either way, it has had a corrosive impact and created a less resilient, less egalitarian society.

The Hawai’i situation is further complicated by the fact that some of the properties are owned by native Hawaiians. The governor has proposed blocking or limiting property sales, but that is likely to meet with legal challenges as well as potentially create a whole new set of problems.

How do we fix this? It’s complicated. You could argue from a libertarian standpoint and say the problem is government, so get government out of it and really let the free markets work. That certainly has some appeal, but so does a more interventionist model some would call socialist. What doesn’t work is the existing system that is what can only be called crony capitalism.

What do I think, based on 30 years studying the economics of natural disasters and governments? We need to take a serious look at the overall vulnerabilities of our society and how we address them, balancing insurance, regulation, personal responsibility, and government relief programs. It has to be national level – the present system is way too fragmented with state level fiefdoms and contradictory regulations. Someone from the Pacific Northwest might say “I’m not vulnerable to Hurricanes and don’t want to pay for that” just as a Floridian might say “who cares about Earthquakes or volcanoes.” Yet both care about wildfires, and in fact both would benefit from a system that did not distinguish by peril and evaluated rates based on overall risk, and contributed to a common pool in a transparent way. No matter where you live, nature has it in for you somehow :P. It makes no sense to do this by state or even regionally, and ultimately a mix of public and private aspects in a coherent system would probably work best. A comprehensive approach can benefit everyone, as was demonstrated in an award winning research paper published in 2014 (insert CDT Standardized Expression 3V, “Modest Awareness of Virtue” here).

This is a complex topic – it’s not as simple as “insurers are evil”, “developers are exploitative and cruel,” “regulations are oppressive,” “politicians are corrupt,” or “consumers are stupid”, although each of this statements has truth in them. Solutions can be created across the range of economic philosophies from Marx to Smith – but it has to be comprehensive and well structured. Unfortunately, legislators usually only care about this topic right after a major disaster, when there is a rush to “do something,” which means patching an already deeply flawed system rather than taking the time for comprehensive reform.

We deserve better.