Optimal adaptation in cities

Abstract

Due to their vulnerability and their special role as being a center of economic activities cities are particularly important in the context of adaptation to adverse events derogating land quality, e.g. resulting from long-term climate change. This paper analyzes economic efficiency of public investments in adaptation within a spatial general equilibrium framework that focuses on the level of cities. We provide a theoretical analysis that highlights the fundamental forces determining efficient public investment in urban adaptation. We further extend the approach to a spatial computable general equilibrium model thereby identifying optimal urban adaptation investment strategies. Our analyses suggest that full adaptation can be an inefficient strategy even in urban areas due to a wide range of direct and indirect spatial general equilibrium effects. Setting investments optimally only reduces a small fraction of the welfare loss of non-adaptation. The findings are robust with respect to assumptions on the marginal returns of adaptation, the degree of possible relocation as a response to an adverse event (intra-urban relocation and inter-urban migration), and the funding scheme applied to finance adaptation (land tax vs. labor tax). Interestingly, adverse urban effects of adaptation could make non-adaptation more efficient than full adaptation. However, if adaptation measures like building dikes or even relocating cities are available and sufficiently productive, full adaptation could become an efficient policy option being able to offset a large fraction of the potential welfare loss of extreme events. Distributional effects of urban adaptation investment (absentee landowners vs. urban renters) as well as a misleading orientation of policymakers to maximize urban GDP rather than social welfare can result in overinvestment in urban adaptation.