SPECIAL VIRTUAL ISSUE: ECONOMICS OF RISK ANALYSIS. by Michael R. Greenberg and Louis Anthony (Tony) Cox, Jr.

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1 SPECIAL VIRTUAL ISSUE: ECONOMICS OF RISK ANALYSIS by Michael R. Greenberg and Louis Anthony (Tony) Cox, Jr. Part 1. Economic Consequences of Hazard Events For much of the twentieth century, through wars, droughts, and other small and large disasters, the world has become more populated, industrialized, urbanized, globalized, and interdependent. Economists developed input-output analysis and econometric models to understand how supplies of resources, intermediate goods, finished goods, production technologies, and demands by the public and induced demands by businesses translate into transactions among businesses, feasible and sustainable consumption and growth paths, and flows of products and resources among sectors. They have used these models to forecast gross regional production, personal income, jobs, tax revenues, and other economic metrics. Input-output (I-O) models, in essence, are like massive spread sheets, showing how much of each commodity is used to produce one unit of each other commodity, based on government tabulations of transactions between businesses in the recent past. In the classic Leontief model, (1-3) the data are organized as a technical coefficient matrix that shows the volume or dollar value of products flow among major business sectors, and how flows of consumption, production, employment, income, and business purchases are affected by changes such as building new steel mills, chemical and other industrial facilities and by adding new infrastructure. Econometric time-series modeling provides a second standard approach to estimate economic impacts. (4-6) Using historical records that typically go back 20 to 30 years, analysts build an integrated set of equations (often several hundred) to estimate how an economic stimulus would likely be reflected in changes in jobs, regional production, personal income, unemployment, taxes and other metrics. Econometric models begin with national forecasts of employment, wages, and prices that drive state and local forecasts and project these for five to 20 years into the future. 1

2 Both of these standard modeling methods have limitations. Members of the SRA have responded with innovative designs that overcome some of them. Inoperability input-output models (IIM) (7-10) focus on interdependencies among businesses in order to understand the clustered segments of the economy most directly impacted by an event, that is, the suppliers and customers of the impacted business. For example, the 9/11 terrorist attacks in the US in 2001 directly impacted the airlines and, in turn, tourism, sports arenas and theaters, because some people were afraid to travel or congregate in densely populated places that might be targets. The IIM model design seeks to capture these direct and indirect economic impacts. Computable general equilibrium (CGE) models (11-14) typically are built from I-O models, but in order to capture the dynamic changes during and after an event, CGE models assume that, during an economic shock, businesses and consumers will make efficient decisions subject to resource, labor and capital constraints. So, for example, if the electric grid is disabled by a storm, people conserve energy, use generators, and reschedule activities. We have chosen five papers to highlight for I-O analysis. Understanding the economic costs and benefits of catastrophes and their aftermath (15) summarizes the need for economic models that guide strategic risk management decisions about land use and design, evacuation and relocation planning, and recovery and restoration for periods that range from a year to a generation, and for local, state, regional, national and international scales. The paper emphasizes the need for models that are sensitive to different geographical scales and time periods, and that can calculate the impacts of investments in mitigation and resiliency, and implications for disadvantaged populations. The authors evaluate established methods such as I-O (1-3) and econometric models, (4-6) and review some of the newer ideas such as IIM, (7-10) CGE, (11-14) HAZUS, (16) Regional Economic Modeling, Inc. (REMI) (6,15) dynamic stochastic general equilibrium (DSGE), (18) and several other options. The authors identify key data gaps in building economic impact models. The paper ends by suggesting a collaborative strategy among levels of 2

3 government to measure the costs and benefits. This is a good paper begin with if you are new to this subject. The second article, by Rosoff and von Winterfeldt (19), examines a possible terrorist attempt to detonate a radiological dispersal device (RDD) in the ports of Los Angeles-Long Beach. The authors take the reader through the six risk analysis stages described above. Their third step involves estimating the consequences, including fatalities and injuries, as well as longer term health effects and potential major economic impacts. The authors then discuss mitigation and resilience-increasing options, including preventing the purchase or theft of radiological material and checking all cargo and vehicles with radiation detection devices. To illustrate IIM, we chose a paper by Jung, Santos and Haimes (10) that not only reviews the model but adds an international trade component. The authors note that international trade in 2004 exceeded 12% of US gross domestic product and has been increasing. Los Angeles-Long Beach is among the busiest and most valuable port assets in the US. Disruption of the port activities would harm both the United States and is international partners. The article discusses the development of standard input-output models and IIM. Next, the authors describe their development of an international trade module and apply it to an event that impacts the port of Los Angeles for 10 days. The next economic impact paper, also centered on in Los Angeles, illustrates a CGE model. (14) Using a national survey as input data, it shows how the Los Angeles regional economy could be damaged by an RDD attack on the city associated with requests for higher wages from fearful workers, a request for higher return on investment from potential investors, and demands for price discounts from customers with other shopping options. In the past few years, several papers in this journal have used input-output models to explore the regional economic impacts over time of various types of natural disasters. In the final paper on this topic, Hallegatte (20) advances the state-of-the-art of such modeling by explicitly modeling the roles of inventories and distinguishing among storable inventories and essential 3

4 supplies that cannot easily be stockpiled and whose disruption immediately affects other economic activity (e.g., electricity). Using Hurricane Katrina as a case study, the paper identifies production bottlenecks during the first year after the hurricane that caused large losses in output. Use of an adaptive regional input-output economic model also gives insights into resilience and the time to recovery for different regional economic sectors following a disaster. Regional economic impact analysis of hazard events is a rapidly developing field that has been driven by an increasing number of major hazard events with high costs, and by advances in databases and computing capacity to build and use simulation models. REFERENCES 1. Leontief W. The Structure of the American Economy, : A Empirical Application of Equilibrium Analysis. Cambridge, MA: Harvard University Press, Leontief W. The dynamic inverse. In Carter A, Brody A, eds. Contributions to Input- Output Analysis, NY: North Holland, 1970, pp Miller R, Blair P.. Input-Output Analysis: Foundations and Extensions. Englewood Cliffs: Prentice-Hall, Guimaraes P, Hefner F, Woodward D.. Wealth and income effects of natural disasters: An econometric analysis of Hurricane Hugo. Review of Regional Studies, 23, 1993; Greenberg M, Mantell N, Lahr M, Felder N..Short and intermediate impact to New Jersey s economy of the loss of electric power in new Jersey s Urban industrial corridor. Energy Policy, 2007; 35: Treyz G.. Regional Economic Modeling; A Systematic Approach to Economic Forecasting and Policy Analysis. Boston, MA: Kluwer Academic Publishers, Santos J, Haimes Y.. Modeling the demand reduction input-output (I-0) inoperability due to terrorism. Risk Analysis, 2004; 24(6):

5 8. Haimes Y, Horwowitz B, Lambert J, Santos J, Lian C, Crowther K.. Inoperability inputoutput model for interdependent infrastructure sectors. 1: Theory and methodology. Journal of Infrastructure Systems, 2005; 11(2): Haimes Y, Horwowitz B, Lambert J, Santos J, Crowther K, Lian C. Inoperability inputoutput model for interdependent infrastructure sectors. 1: Case study. Journal of Infrastructure Systems, 2005; 11(2): Jung J, Santos J, Haimes Y. International trade inoperability input-output model (IT- IIM): Theory and Application. Risk Analysis, 2009; 29(1): Rose A, Liao S-Y. Modeling regional economic resilience to disasters: A computable general equilibrium analysis of water service disruptions. Journal of Regional Science, 2005; 45(1): Rose A, Lim D. Business interruption losses from natural hazards: Conceptual and methodological issues in the case of the Northridge earthquake. Environmental Hazards, 2002; 4: Rose A, Oladosu G, Liao S-Y. Business interruption impacts of a terrorist attack on the electric power system of Los Angles: Customer resilience to a total blackout. Risk Analysis, 2007; 27(3): Giesecke J, Burns W, Barrett A, Bayrak E, Rose A, Slovic P, Suher M. Assessment of the regional economic impacts of catastrophic events: CGE analysis of resource loss and behavioral effects of an RDD attack scenario. Risk Analysis, 2012; 32(4): Greenberg MR, Lahr M, Mantell N. Understanding the economic costs and benefits of catastrophes and their aftermath: a review and suggestions for the U.S. federal government. Risk Anal Feb;27(1): FEMA. HAZUS. Accessed April 2,

6 17. Greenberg M, Solitare L, Frisch M, Lowrie K. Economic impact of accelerated cleanup on regions surrounding the U.S. DOE s major nuclear weapons sites. Risk Analysis, 1999; 19(4): Smets F, Wouters R. Forecasting with a Bayesian DSGE Model: An Application to the EURO Area. Frankfurt am Main, Germany: European Central Bank, Accessed February 3, Rosoff H, von Winterfeldt D. A risk and economic analysis of dirty bomb attacks on the ports of Los Angeles and Long Beach. Risk Anal Jun;27(3): Hallegate S. Modeling the role of inventories and heterogeneity in the assessment of the economic costs of natural disasters. Risk Analysis, 2014; 34(1):