Matthew E. Kahn

Right climate for incentives to cope with impact of climate change

Matthew Kahn is a professor of public policy at the Luskin School of Public Affairs as well as the Department of Economics and the Institute of the Environment. He is also research director at the Ziman Center for Real Estate at the UCLA Anderson School of Management.

While knowledge accumulates about the perils greenhouse gas emissions pose to the planet, there has been little attention on how neighborhoods and cities will be impacted by climate change.

In Southern California, that impact is becoming more real every day. The January 2013 wildfire in the parched Angeles National Forest showed that fire season is now practically year-round. Low-lying coastal communities such as Malibu face the challenge of a rising sea level that becomes dangerously obvious during storm surges. If climate change projections hold true, many L.A. communities will face significantly higher summer temperatures: My UCLA colleague Alex Hall predicts that Porter Ranch, for example, will experience a 22-day increase in the annual count of 95-plus degree days between now and the year 2050, while coastal areas such as Venice will see very little increase.

While Gov. Jerry Brown and the public sector grapple with government solutions to these crises, capitalism must also evolve to provide answers.

Consider the drought. Econ 101 teaches us that when demand is rising, prices for an increasingly scarce resource should also rise. L.A. residents pay roughly a half-cent a gallon for water and the governor is proposing rationing this scarce commodity rather than allowing market forces to work. If prices increased, some home owners would rip out their lawns and replace them with drought-tolerant native plants. Given that urbanites use half of their water outside, there are countless other ways to incentivize. My UCLA colleague Yoram Cohen is devising creative ways to augment our water supply. Such innovations are more likely to be adopted if water is no longer viewed as a “free resource.”

Future misery

Property owners in inland areas such as Porter Ranch might worry that land values will fall as temperatures rise. But the anticipation of future misery inspires entrepreneurs to devise high-performance air-conditioning systems and architectural designs so that indoor quality of life and productivity remain high. Mark Zuckerberg focused his attention on building Facebook. Future entrepreneurs will explore climate change adaptation.

For a final example, consider the challenges of coastal flooding due to sea-level rise and increased risk in fire zones such as Malibu. The insurance industry must be allowed by law to charge different premiums depending on emerging risk assessment. Increased risk to homeowners demands increased insurance pricing, with cheaper policies offered only if they have made investments (such as stilts) to reduce the risk of flooding. In fire zones, only homeowners who build using materials that are flame resistant or who invest in clearing brush should receive an insurance discount. This is how capitalism sends proper signals to real estate owners to invest in precautions. Yes, these are “small ball” investments, but they add up to a more resilient Southern California real estate stock.

Even our smartphones will help, giving us real-time updates on environmental adaptation. The government can text you that a Smog Alert is in effect and that you should spend more time inside. The electric utility can alert you that, due to dynamic pricing, electricity prices will be higher over the next three hours. This information will induce some people to cut back on consumption, helping to prevent power blackouts on even the hottest days. As California begins to mandate energy consumption disclosure laws for commercial real estate (Assembly Bill 1103), new apps will tell prospective real estate buyers what their electricity bills are likely to be in buildings they may rent or own. This information will nudge potential tenants to bid less for inefficient real estate and incentivize landlords to invest in energy efficiency.

Our real estate’s value hinges on strong fundamentals, and our quality of life is what attracts dynamic and desirable firms such as Facebook and Google to open offices here. Mayors seeking to preserve the property tax base have strong incentives to deliver quality of life in the face of climate change.