be hesitant to do so, lest DRM expenditures come out of their own budgets. Moral hazard also arises for large firms when their negligent actions are forgiven by governments who lack influence over them

# 4. Shortfalls in Private Sector Investment from the Standpoint of Society

# **4.1. Externalities**

The concept of _externalities_ has grown in prominence as community, regions, and the entire globe have become increasingly interdependent. An externality refers to the action by one individual or business that impacts another without being transmitted to the marketplace. Externalities can be either positive or negative, with the negative externality of pollution being the most widespread example (Weimer and Vining, 2005).

Those perpetrating a negative externality are able to do so until some legal or regulatory recourse comes about, which is increasingly the case not only in the industrialized but also the developing world. There is, however, yet another approach to dealing with externalities. Nobel laureate Ronald Coase (1960) pointed out that most externalities are due to a lack of property rights (the most poignant example being the global “commons”, where lack of ownership translates into lack of custodianship and hence abuse). He suggested the establishment and delineation of property rights can lead to entities engaging in bargaining, or trading, to alleviate the externality to the extent of the satisfaction of all parties (marketable pollution emission permits, now called cap and trade, are an outgrowth of what is known as the Coase Theorem).

Many externalities lead to or make society more vulnerable to disasters. These include the generation of greenhouse gases that cause climate change, wasting of water that exacerbates drought, or tilling practices that contribute to flood. Clearly, reducing negative externalities that make society more vulnerable to disasters should be a target of DRM. For example, if decision‐makers are convinced that climate change will cause drought and increased frequency and magnitude of hurricanes, they can consider mitigating the root cause (the emission of GHGs) rather than waiting and mitigating the disasters that climate change will spawn. Another reason to do so is to prevent the irreversible damages that even this subsequent mitigation cannot prevent.

Furthermore, some mitigation measures generate negative externalities, which are essentially “co‐ costs” or negative co‐benefits. For example, the Mexico case study (ODI, 2014) found that a major flood mitigation project in that country resulted in water being diverted, such that flooding was merely “transferred”. The case of DRM can be strengthened if these unintended consequences can be minimized cost‐effectively.

Contagion effects are a sub‐set of externalities that focus on cascading interdependencies between entities. Examples relate to the spread of fire among adjacent buildings or the spread of disease across the population. This means that a business that installs a sprinkler system or contains the drainage from its own property will benefit its neighbors. Unfortunately, it is an unable to reap the entire rewards of these actions, as will be discussed more thoroughly in the next sub‐section.

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