Abstract
Flooding events can affect businesses close to rivers, lakes or coasts. This paper provides an economic partial equilibrium model, which helps to understand the optimal location choice for a firm in flood risk areas and its investment strategies. How often, when and how much are firms willing to invest in flood risk protection measures? We apply Impulse Control Theory and develop a continuation algorithm to solve the model numerically. We find that, the higher the flood risk and the more the firm values the future, i.e. the more sustainable the firm plans, the more the firm will invest in flood defense. Investments in productive capital follow a similar path. Hence, planning in a sustainable way leads to economic growth. Sociohydrological feedbacks are crucial for the location choice of the firm, whereas different economic settings have an impact on investment strategies. If flood defense is already present, e.g. built up by the government, firms move closer to the water and invest less in flood defense, which allows firms to generate higher expected profits. Firms with a large initial productive capital surprisingly try not to keep their market advantage, but rather reduce flood risk by reducing exposed productive capital.
Highlights
Climate change puts increasing environmental pressure on coastal zones (Turner et al 1996) and on areas around lakes and rivers Vrösmarty et al (2000)
How often, when and how much are firms willing to invest in flood risk protection measures? We apply Impulse Control Theory and develop a continuation algorithm to solve the model numerically
A representative firm can have multiple choices: First, it can choose the optimal location for its production plant, second the optimal investment in capital used for production and third, the optimal investment in flood risk reduction measures
Summary
Climate change puts increasing environmental pressure on coastal zones (Turner et al 1996) and on areas around lakes and rivers Vrösmarty et al (2000). A representative firm can have multiple choices: First, it can choose the optimal location for its production plant, second the optimal investment in capital used for production and third, the optimal investment in flood risk reduction measures To implement this diverse decision framework our paper rests on three building stones. Subject to a water level that increases over time, the decision maker has to decide about the optimal timing and size of the increase of the dike height in order to find an optimal balance between the costs associated with dike height increases and the improved flood protection that results from a dike height increase This strand of literature abstracts from (firm) investments so that the economic value of the protected land develops exogenously.
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