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13 February 2014

Borrowing is the best way to pay for flood protection

As flood defences provide protection for many years to come, it is wholly appropriate to pay for them gradually with long-term borrowing.

By julian Morgan

Economics is not called the dismal science for nothing. As we watch the shocking images of filthy water pouring into homes and distressed residents leaving in rubber dinghies, economists are already debating what this means for the next GDP figures. This highlights the shortcomings of GDP as a measure of economic progress, but looking at the wider economic impacts can help us deal with the challenges posed by the floods.

Let us start with GDP and the surprising fact that natural disasters can be good for GDP, at least in months that follow. In the case of the floods, there will need to be a lot of extra spending by households, businesses, insurance companies and the government to clean-up and restore damaged property and infrastructure. Some things will work in the other direction, for instance if a lot of people are unable to work due to the floods, but it will be no big surprise if GDP is pushed up for a while.

But as ever in economics, there is no free lunch and someone will have to pick up the tab. If households are not fully insured, it will be them. If they have cover, it will be the insurance companies and, in turn, the owners of these companies, which may include our pension funds. The government will also need to stump up for the cost of repairing public infrastructure. For some households and the government it may mean taking on more debt, while for others it may mean running down savings. In economic terms, the cost of making good the damage caused by the floods will be to lower the UK’s net wealth.

As the crisis is still unfolding, we don’t yet know how big a dent it will make in UK wealth. Some reports have suggested that it may cost insurers up to £1bn but there will also be uninsured losses for some households and substantial damage to public infrastructure. Of course, none of these losses take any account of the human cost of having one’s home flooded.

If climate change leads to more winters like this one, we are going to experience more frequent hits to the country’s wealth. Taking a longer perspective, we need to play our part in decarbonising the world economy to try to keep climate change within reasonable limits. More immediately, we need to prepare for the problems that even moderate levels of climate change may bring, such as increased winter rainfall. 

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While the Environment Agency has a long term investment strategy to protect us against flooding and coastal erosion, not enough is being spent to prevent increasing numbers of households being at risk of serious flooding. The Committee on Climate Change estimate that we should have spent over £0.5bn more on flood defences between 2011-15 and that this under-spending could lead to avoidable flood damages of around £3bn in the coming years.

Naturally, there is a need for a rigorous economic appraisal to ensure that each flood defence scheme makes sense, but we should not set the bar too high. These schemes are now expected to show an incredibly high average of £8 of damage avoided for every £1 spent by the government. Compare this with HS2, where most estimates suggest benefits of around £2 for every £1 spent. 

The sums of money that we need to spend on flood defences are not even that large in comparison with overall government spending. For instance, if we were to spend an extra £250m a year over the next five years to make up for the past shortfall and return spending to the Environment Agency’s plan, this would raise annual government spending by less than 0.04 per cent. While this could be covered by lower spending elsewhere or higher taxation, we could also simply accept slightly more government borrowing. Given the small sums involved, it need not derail plans to balance the budget in the next parliament.

Indeed, as flood defences provide protection for many years to come, it seems wholly appropriate to pay for them gradually with long-term borrowing by issuing 30 or even 50 year gilts, especially when the cost of financing is so low. This would mean that the burden would not only fall on the current generation of taxpayers, but would be spread across the current and future beneficiaries of the flood defences.  

The shocking flooding across large parts of our country must focus minds on the urgent need to improve our defences. The economic and human costs of flooding are real and cannot be masked by any short-term rise in GDP. We need to be prepared to make sensible investments to protect the country’s wealth from its increasingly dismal winter weather.

Julian Morgan is chief economist of Green Alliance