Traditional economic analysis techniques, such as Cost-Benefit Analysis (CBA), form a critical input to decision-making when attempting to manage and invest in risk reduction alternatives. These techniques tend to be applied narrowly and uniformly across affected parties and contexts.
CBA is a systematic process which aims to evaluate the benefits of a decision against the costs associated with this decision. If the benefits of project exceed the costs associated with this project, the project qualifies on cost-benefit grounds. Although one of the main tenets of CBA is to improve social welfare, the disregard of the heterogeneous valuation of income across states of nature, individuals, and generations is still evident in most CBA protocols.
CBA is commonplace in Aotearoa New Zealand. Section 32 of the Resource Management Act requires that benefits and costs of a proposal should be clearly identified and estimated where possible, improving the understanding of the impact a proposal will have. The Treasury has developed the CBAx Tool, a spreadsheet model aimed to help agencies monetise impacts and undertake CBA. Nevertheless, limitations are present when using standard CBA approaches in a high impact, low probability context. Notably, most applications use a partial equilibrium approach, not accounting for the economy-wide impacts that are likely to be present in a high impact event.
Additionally, many applications fail to consider the distributional impacts of disasters or differing levels of vulnerability, in turn potentially deepening inequalities throughout society.
This study uses a high impact, low probability disruption to integrate one of the most essential concepts in economics, the one of a utility function representing well-being, and its more realistic treatment through the concept of a diminishing marginal utility, to improve the current implementation of CBAs. Specifically, it analyses the impact of fuel supply outage in New Zealand using a dynamic economy-wide model under alternative evaluation approaches.
The results show that when accounting for distributional considerations, both across income and time, the disaster mitigation strategy of expanding fuel storage becomes more justifiable.
Given this and the increasing need and complexity of the impact of extreme events. Standard economic evaluation assumptions need to be reconsidered and a new range of tools and processes need to be developed and popularized to better support decision-making around extreme events.
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