Miami: Doomed by Climate Change?

+ Matthew Kahn

This will be a blog post about durable capital, expected present discounted value calculations, endogenous depreciation, and the efficient markets hypothesis. My point is that only real nerds will want to read this. But, I will be talking about $60 Trillion Dollars. This article offers an interesting teachable moment about the economics of climate change:

And what of Miami? It contributed $263 billion to gross domestic product in 2010, according to the Bureau of Economic Advisors. Caught between rising seas to the east and the Everglades to the west, the city is doomed to drown.Abandoning Miami means not only moving or abandoning the businesses who create its gross domestic product, but walking away from its pricey real estate, its roads, hospitals, schools and infrastructure. The cost of relocating its people needs to be calculated both in dollars and in heartbreak. But if you ask people to estimate the cost of abandoning Miami, you get blank stares. It’s as if the language to ask the question hasn’t been invented yet.“It is not difficult to envision much larger costs, [i.e. $60 trillion] given the potential larger and more abrupt warming [the more abrupt the warming, the more costly it is to try to adapt] that the authors calculate,” says Mann. And it’s not difficult to imagine that there are costs we haven’t even begun to imagine. And when you multiply those costs, city after city after city, suddenly $60 trillion becomes a very realistic and frightening number."

A recent "big think" paper in Science posited melting of the Arctic Icecap will cost us at least $60 trillion in damage. To make this salient, climate activists such as Mann are saying that we will lose Miami and this will have horrible impacts on our economy. This makes no sense. The economic activity that currently locates in Miami will move to higher ground. Nobody claims that Miami is so inherently productive place that the $263 billion dollars in economic activity it generates could only be generated there. Miami will reform in another piece of the U.S.

The following questions can help to frame the economics analysis of Miami in the face of climate change:

What is the probability that Miami vanishes within the next 75 years? The smaller this number, the lower is the expected present discounted value of damage.
How many years into the future is this event likely to take place? We discount future benefits and costs using the real market rate of interest. The further in the future this damage is likely to take place, the lower the costs.
Isn't all urban capital infrastructure depreciating over time? Our buildings, roads, hospitals—nothing in cities lasts forever. The usual life of a building is 60 years. If we anticipate that Miami is going to flood in the year 2060, then in the year 2025 we stop maintaining Miami buildings and we don't build new buildings or other placed-based infrastructure. Instead, we build new infrastructure on higher ground and the firms and people in Miami engage in an organized retreat. This rebuilding activity stimulates the economy (think of Europe rebuilding after World War II).
Who loses from the retreat from Miami? The land owners who owned the land just as the "new news" that Miami will be doomed in the year 2060 was announced and digested. These land owners "overpaid" for the Miami land because the price when they paid reflected the present discounted value of the rental stream they would earn out into the infinite future. But if Miami will be flooded after the year 2060, then there is no such rental stream. Home prices today will reflect this expectation and will drop as the "new news" is incorporated into current asset prices (this is the efficient market hypothesis under rational expectations). As home prices drop, lower income households may move in, taking advantage of access to cheap short run land.

Assets such as the Miami Dolphins will move to another city. The University of Miami will let its campus go and find a new place in Florida to do business. This is adaptation. Those geographic areas that have a competitive advantage in the face of climate change (i.e they are on higher ground) will command a price premium and land prices and economic activity will rise there as a new Miami will take root.

So, the doom and gloomers would only be correct if the capital stock lives forever. In this case, valuable assets that will always be valuable would have been built in the wrong place (Miami) and cannot be dragged to higher ground. In the real world, all assets fall apart over time. As Miami's assets depreciate, rational investors will not invest in improving them because they will recognize the short investment horizon.

With all of this said, is Miami doomed in the face of climate change? I would say no. The engineers and urban planners and land owners in the city need to take a sober look at identifying which parts of their city are the most likely to be resilient in the face of climate shocks. The city should encourage densification there. The insurance industry should price future premium to encourage economic activity to relocate there. If the people of Miami choose not to retreat, then the housing stock and electricity grid and storm sewers will need to be upgraded to make it more resilient in the face of shocks.

Cross-posted with modifications from Environmental and Urban Economics.

Tile image by Ed Costello.

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Thank you!