Charles Wheelan, Ph.D. The Naked Economist

Hurricane Katrina has prompted us all to do some soul-searching, but it's also given the usual partisans new ammunition for the same stale arguments. Yes, Bill O'Reilly did declare "the government can't protect you, and you better have enough assets to protect yourself."

Meanwhile -- and this is a real shocker -- Michael Moore released an open letter blaming the "manmade annihilation of New Orleans" on the Bush administration. Who would have expected that?

I suppose they both raise some interesting points. That does not make their approach to public policy any less irksome. They remind me of an elementary school student who shouts "seven" every time the teacher writes a problem on the board. The fact that he will make sense every once in a while does not validate the approach to solving problems.

I've called out O'Reilly and Moore here only because they said the most conveniently outrageous things post-Katrina; many other ideologues have the same basic approach -- find an answer and then repeat it no matter what problem happens to come along: Tax cuts are good, corporate America is bad, guns are good, guns are bad, and so on.

All of which is a roundabout introduction to this column. To my mind, economics is essentially the opposite. It is a process of inquiry that uses our knowledge of how individuals and firms behave to explain the world, and perhaps make it better. That leaves plenty of room for philosophical disagreement; for example, reasonable people can disagree over what a "better" world might look like.

But for anyone who really cares about public policy, economics is the best tool you're going to find. So let's circle back to Hurricane Katrina. If we can get past the finger-pointing and the political posturing, I think Katrina has the potential to teach some lessons about the proper role of government -- not just when a major city is swamped by floods, but in general.

Before we go there, let's start with a quick survey on your attitudes toward government. Choose the answer that best corresponds to your views.

Traffic lights:

1. Are just one more example of big government trampling on our individual rights.
2. Are a simple but powerful example of how government enables millions of complete strangers to work together to create a more orderly and prosperous society.
3. Should be reconfigured to give right-of-way to anyone driving a Toyota Prius.

Hunting down the terrorists who have vowed to destroy our society:

1. Is best accomplished by the private sector.
2. Is a shared social objective and therefore an important responsibility of government.
3. Impinges on suicide bombers' important right to self-expression.

Property rights, rule of law, a sound currency, and dependable infrastructure:

1. Are all overrated, which is why Haiti and Iraq are current business hot spots.
2. Are things that an effective government provides, thereby lowering the cost of transacting business and enabling markets to work more efficiently.
3. Are mere opiates for the people, delaying the inevitable proletarian revolution.

This is the point where I'm supposed to tell you that there are no "right" answers. Well, that's not really true, at least if you believe in capitalism. The right answer in each case is number two. Here's why: If society's goal is to maximize total wealth and well-being (agnostic for now on how it is distributed), then basic economics tells us that there are certain things that government must do. And there are certain things that government should not do.

It turns out that in New Orleans, we got some of both wrong.

What Government Should Do

Markets work best when government provides public goods. These are not, as the name wrongly suggests, anything purchased with public money. Instead, public goods have two salient characteristics: 1) They can be provided just as cheaply for thousands or even millions of people as they can for a single individual and 2) It's difficult or impossible to prevent people who haven't paid for such goods from enjoying their benefits.

For example, the levees protecting New Orleans.

Levees are expensive to build and maintain -- but it's no more expensive to protect 500,000 people from floodwaters than just one. It's a fixed cost. And if contributions for the levees were voluntary, the deadbeats would be protected just like those who paid; it's impossible to protect some houses from flooding and not others, depending on who has mailed in their check.

So follow the logic: The levees clearly make individuals better off. Yet no individual can afford to build a levee by himself. The private sector won't solve the problem either, as any firm that builds levees will find it difficult to make a profit when all people benefit from their service whether they pay for it or not. So government builds them -- and that's a good thing.

In the case of public goods, government enables us to do things that make us better off but that we literally cannot do on our own. There is nothing inherently liberal about that idea. The same analysis can be used to support research on a missile defense system. Indeed, national defense is the quintessential public good.

The Economist magazine pointed out one of the less obvious sources of shame related to Katrina: Spending on the New Orleans levees has fallen by nearly half over the past four years, even as Congress passed a transportation bill with "$24 billion-worth of pure pork."

That is a lesson from economics lost on too many talking heads and politicians: The debate over "big" government or "small" government is essentially vacuous. If we need a bumper sticker, it should be "sensible government" because some big, expensive things make perfect sense (e.g. counterterrorism) and other small programs are totally worthless, or even counterproductive (e.g. tax loopholes for tackle box producers -- yes, that was really in the 2004 corporate tax bill).

And What It Shouldn't

Okay, but I also hinted that government made the damage from Katrina worse. How so? Again, it's a basic lesson from economics: Government should not subsidize reckless behavior. Flood insurance, which is available only through the federal government, does just that.

Government provides flood insurance because the private sector will not (other than policies that offer coverage above and beyond what the government offers). Flood risk -- unlike fire -- is not randomly distributed. Insurance companies cannot offset the costs of providing insurance to flood-prone properties by selling policies to safer risks. People who live on high ground don't buy flood insurance. The market is not likely to be profitable.

At first glance, government is making things better by stepping in to fill that insurance void. But it also means that more properties get built in harm's way -- things that would not have been built without an implicit government subsidy. And that makes the damage from a disaster like Katrina worse. As does using government money to rebuild properties in areas particularly prone to natural disaster.

After the Mississippi floods of 1993, FEMA (which administers the flood insurance program) literally paid some flood-ravaged towns to pick up and move to higher ground. The entire town of Valmeyer, Illinois, is now a mile and a half east of its former location -- and 400 feet higher. It doesn't flood anymore.

Shouldn't we think about that as we look to spend billions of public dollars rebuilding New Orleans?

Welcome to "The Naked Economist." It's not Michael Moore or Bill O'Reilly. I hope in the long run that will make all the difference.