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  • Guest Editor collection: 26 Jun 2015 Kazuko Ishigaki
    Risk Knowledge Economist
    United Nations Office for Disaster Risk Reduction
    http://www.preventionweb.net/go/44972

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Kazuko IshigakiRisk Knowledge Economist United Nations Office for Disaster Risk Reduction (UNISDR)

Public investment planning and financing strategy for DRR

Economic loss due to disasters has been increasing in spite of substantial progress in Disaster Risk Reduction (DRR) policies promoted by the Hyogo Framework of Action (HFA). Disaster interrupts or slows down economic growth by damaging public and private infrastructures and negatively affecting people and economic activities. To reduce the impacts of disaster, governments need to invest in DRR. However, governments in most countries are suffering from tight budget constraints. The financial situations of low-income countries are especially tight when we consider the debt and interest payment of these countries. Public investment, especially in low and lower middle-income countries, is very volatile. On the other hand, in spite of these constraints, public investment is significant, recently representing 6 to 10 % of GDP in developing countries. Governments must protect the hard-won fruits of these valuable investments.

World Conference on DRR, Sendai, Japan, 2015.
Intergovernmental Segment, Ministerial Round Table ‘Public Investment Strategies for DRR’

Presentation

The Sendai Framework for Disaster Risk Reduction 2015-2030, adopted in March 2015 at Sendai, Japan refocuses the importance of risk sensitive public investment and financing. In the guiding principles, it clearly states that “addressing underlying disaster risk factors through disaster risk-informed public and private investments are more cost-effective than primary reliance on post-disaster response and recovery, and contribute to sustainable development”. Accordingly, “investing in disaster risk reduction for resilience” is defined as one of four priorities for action.

What are the gaps to be filled? During the HFA decade, risk assessment has shown significant progress. However, the widely recognized situation is that risk information has not translated well into DRR investment. It is important to focus here on the lack of linkages between natural science and social science, especially in economics. Risk information produced by natural science is not well connected to cost information examined by social science. Even when risk information exists, if it is not linked to cost information, it is difficult to promote DRR Investment. For example, Solomon Islands states “If policies based on risk information would lead to increased project costs, budget constraints may limit utilization of the risk information. Promoting cost benefit analysis is necessary in order to counteract this “ (HFA progress report 2013) .

Related to the lack of cost information is an opportunity cost issue. Ministries of Finance are not concerned only about disaster risk. They need to respond to other competing country priorities. In many countries DRR is not a high priority and policymakers tend to allocate limited financial resources to other urgent needs such as poverty reduction, education and public health. It is also difficult to explain why there is a sense of urgency surrounding DRR, a challenge that often leads to problems securing financial resources. A classic dilemma for policy makers is whether they can justify giving up investment in immediate growth opportunities and instead investing in DRR? In other words, risk needs to be examined through a socio-economic lens in each country.

In the DRM cycle, response, recovery and reconstruction also place pressure on the allocation of DRR budgets. Reconstruction and compensation for those affected is imminently needed in the majority of cases. In such situations, budget restructuring following a disaster often takes money away from DRR for use in reconstruction. To assure sufficient money for DRR investment, it is necessary to be able to justify the cost effectiveness of the DRR investment –as compared to expenditure in response and reconstruction.

The key questions that governments must tackle would be, "how much money should be allocated to DRM in total?” and “how to decide the most efficient and effective allocation of money between risk reduction and risk financing?”. Subsequently, more specific issues need to be examined: the design of risk sensitive investment mechanisms and risk financing mechanisms (i.e. appropriate combination of contingency funds, insurance and other tools).

To address these questions under HFA, in 2012, the United Nations Office for Disaster Risk Reduction (UNISDR) started a global project for around 30 countries: “Building Capacities for Increased Public Investment in Integrated Climate Change Adaptation and Disaster Risk Reduction: 2012-2015” financed by the European Union. The Southwest Indian Ocean Region was the first region to complete the full process. In cooperation with the Indian Ocean Commission, the project targeted four island countries as well as the Government of Zanzibar, Tanzania.

This programme was composed of three components: the establishment of reliable disaster loss databases (Component 1), risk evaluation and probabilistic risk assessment profiles (Component 2) and incorporation of disaster risk reduction into public investment planning through economic analysis and investment policy reviews(Component 3).

As a first step (Component1), a total of 3,235 data cards on disaster events and losses between 1980 and 2013 were registered in the national disaster loss database of these countries. Economic loss totalled USD 17.2 billion (2012 constant price), out of which, 96% was due to intensive and extensive cyclones. In the subsequent probabilistic risk analysis (Component2), Average Annual Loss (AAL) for tropical cyclonic wind and earthquake combined across the region was estimated at USD 161.43 million, with a Probable Maximum Loss (PML) of USD 1,466 million for a 50-year return period.

This loss and risk information pointed to the need to reduce tropical cyclone risk in the region. However, in itself it did not suggest policy guidance. Grounded in the loss and risk analysis, a thorough policy review and economic analysis were implemented (Component 3).

CATSIM analysis developed by IIASA identified that the fiscal resource gap year (i.e. the return period at which the government will face difficulty in raising sufficient funds for reconstruction) for tropical cyclone and earthquake hazards in each country. The gaps for the IOC islands were between 24 (Madagascar) and 329 (Seychelles) years. Drawing from the risk layer based approach, because of their high volume of extensive risk and their low fiscal gap years, it was judged to be more beneficial and effective for Madagascar and Comoros to focus on risk reduction efforts while Mauritius and Seychelles should also start to explore risk-financing mechanisms.

The following probabilistic cost benefit analysis (CBA) presents how CBA can support concrete and specific evidence-based decision making. A specific scenario and project was examined (i.e. housing retrofitting or water drainage) for each island using probabilistic (forward or backward looking) methods and a Net Present Value (NPV) for each was determined. Three of the five studied efforts were determined to be cost-effective. Key variables and updated damage and cost information were lacking to produce a more useful CBA especially in the cases that the NPV was negative.

Based on these findings, current Disaster Risk Reduction policy in the Indian Ocean region and especially public finance (including DRR investment and risk financing mechanisms) were examined. In spite of much progress in HFA implementation and disaster management systems, no definite and systematic DRR investment policy exists in the IOC countries. Several sectorial ministries in all five islands make risk sensitive investment implicitly. Cost benefit analysis, when required for large-scale projects, does not take disaster risk into consideration. Critical infrastructure is not sufficiently protected against disaster risk. Contingency financing mechanisms are also under-developed.

To explore the financial aspects of DRM policy, each country also estimated the current investment in disaster risk management by applying a DRM Marker method in an examination of national budgets, proposed for the OECD by the World Bank in partnership with UNISDR.

Results determined that between 2 and 16% of studied budgets is invested in DRM, implicitly or explicitly in any given year, corresponding to approximately USD 457 million. Overall, more than twice as much marked effort is categorized as “significant” (as opposed to “principle”), demonstrating that they are embedded in development projects --mainstreamed into development. The general trend points to greater investment in preventive /mitigation DRR action for Mauritius, Seychelles and Zanzibar; and investment in response for Madagascar and Comoros.

A comparison of annual investment in DRM to disaster risk (AAL) and observed historic loss determined that among the five islands, Madagascar suffers the greatest gap, pointing to the need for greater DRR investment. Most countries identified that for the budget review to be more meaningful, it needs to more carefully capture and track investment related to specific hazards.

During several meetings with representatives of the Ministries of Finance in the IOC region, it was established that a scattered approach to DRM is inefficient and there is need for stronger collaboration between the DRM agency, Ministry of Finance and other key sectoral ministries. Continuous capacity building on risk terminology and concepts, loss and risk information management and economic analysis was recommended by Ministries of Finance in the region.

The loss and risk information should be examined from the perspective of both DRM policy maker and financial planners. Given the importance of public investment in DRR, continuous refinement of loss and risk information should be promoted through regular dialogue with data users. In the process of economic analysis, Ministries of Finance understood and appreciated the importance of loss and risk information. On some cases, they identified several mistakes and inconsistencies in the records in disaster loss databases and the data were corrected. Such exchanges of information will improve the overall quality of knowledge management to support DRM decision making.

Government needs to develop investment and financing strategies to address both extensive (small scale but high frequency) and intensive (low frequency but high impact) risks. Climate change will increase risks in terms of frequency, geography and intensity. Understanding risk structures and the expected economic impact in the country is the critical first step to determine the optimum policy mix for each risk layer. In developing investment and financing strategies to address disaster risk, DRR investment and risk financing should not be considered separately. Depending on risk layers, the most appropriate policy mix changes and DRR investment and risk financing are not mutually exclusive. For example, DRR investment often decreases insurance premiums.

This packaged approach with a focus on financial planners in government will be standardized and replicated in Asia, Africa, Latin America and other regions in the coming years and the knowledge is planned to be archived and presented globally in a working paper series of UNISDR on “Public Investment and Financing Strategy for DRR”. The report summarizing activities in IOC region will thereby contribute to increasing the global knowledge base.

Your conclusion and your viewpoints

Although “risk as opportunity” has become an attractive political motto, on the ground, disaster risk simply represents costs for financial planners (both public and private) and society. While we often focus on disaster loss and impacts, the overall cost of disaster risk is a summation of a) ex-ante DRR investment and risk financing mechanisms, b) post-event response, recovery and reconstruction cost and c) disaster loss and impacts. The cost of disaster risk management distracts financial resources from other priorities regardless of ex-ante or post event efforts.

However, most countries do not have DRM labelling or dedicated budget lines for DRM in their public accounting system. So they don’t know how much they spend on DRR, response and reconstruction. Sectorial DRR is especially hard to label, as it is often embedded in larger projects. For example, earthquake proof school building is included under the larger category of school building so that the part of budget dedicated to strengthen the facility is not visible, making investment tracking almost impossible.

Not having a DRM budget monitoring system results in the inefficient use of resources and an insufficiency of funds. Without knowing their current budget status, countries cannot properly evaluate the current level of DRM and estimate how much funding is required for further promoting DRM activities. Nepal, which was severely hit by earthquake very recently, claimed “The budget allocated for disaster preparedness and mitigation is spread among different projects which render it ineffective. There is a need to develop and implement a financial tracking system to monitor all DRR related expenditures for mitigation, preparedness and emergency response” (Nepal HFA progress report 2013).

National governments assume primary responsibility to protect people and assets from disasters, and the risk preventive infrastructure represents public goods to remedy the problem due to market failure. In economics, public goods are characterized both as non-excludable and non-rivalrous in that individuals cannot be effectively excluded from use, and use by one individual does not reduce availability to others. Disaster risk reduction mechanisms are also public goods satisfying conditions of non-excludability and no-rivalry. Sea walls and early warning system protect many people and assets at once and do not exclude anyone. The problem of public goods is that no one wants to pay for the service and the goods are likely to be under-produced (i.e. free-rider problem).

The argument of public goods is closely related to market failure in economic theory. Market failure is a situation in which the allocation of goods and services by free market is not efficient. Market failures are scenarios in which the individual pursuit of pure self-interest leads to results that are not efficient – that can be improved upon from the societal point of view . The typical causes that lead to market failures include lack of information, externalities, or public goods. When private sector does not properly assess the disaster risk, it tends to over-invest. While it is important for all members of society to properly recognize disaster risk, risk assessment is often costly and beyond the capacity of small and medium enterprises.

Furthermore, the impact of disasters can be felt beyond private sector investment and spill over to society (e.g. damaged factory interrupts traffic and prevents response activity or interrupts production causing income decrease of the employee). In this case, portions of disaster costs are transferred to others in society. This phenomenon is called negative externality in economics. When externality exists, private sector does not have incentives to decrease investment in hazard prone areas even if they properly understand the risk. Government needs to commit to disaster risk reduction mechanisms precisely to provide sufficient risk information to society and thereby remedy the lack of information and externality problem.

Assuring sufficient disaster risk reduction mechanisms reduces exposed and/or vulnerable areas and facilitates private investment in such areas. In this sense, disaster risk reduction mechanisms constitute important infrastructure supporting economic development of society. That is also a reason why government needs to commit to integrating disaster risk in public investment planning.

In spite of decentralization trends, the role of national government does not diminish. Disaster risk reduction infrastructure, such as sea walls, are often very costly and beyond the financial ability of local governments. Given the positive externality of such infrastructure, national governments are justified to financially commit in the investment. Catastrophes such as Indian Ocean tsunami in 2004 (just before HFA adoption) and Great East Japan Earthquake in 2011 (whose experience influenced Sendai Framework for DRR) refocused the role of national government on their capability to prepare for and respond to intensive disaster risk. In the context of developing countries, accumulated impacts of low-to-mid scale disasters damage local level capacity and often need support from national governments.

In case of catastrophe, horizontal risk transfer mechanisms such as insurance may often not be sufficient. DRR investment is, unlike risk transfer mechanism, considered inter-generational risk sharing. Following the definition of sustainable development by the Brundtland Committee, only development that addresses the existing risks without compromising the ability of future generations to address them should be promoted. In summary, public investment in disaster risk reduction is theoretically sound and commitment of national level government is critical in spite of decentralization trends.

Links for further study: Working papers

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