How the Failure to Account for Flexibility in the Economic Analysis of Flood Risk and Coastal Management Strategies Can Result in Maladaptive Decisions

Abstract

This paper uses two alternative economic analysis approaches, net present value (NPV) and real in options (RIO), to show how the failure to incorporate uncertainty and flexibility in the economic analysis of flood risk and coastal management strategies can result in maladaptive decisions. RIO offers a major development on the conventional NPV approach, because it integrates expected changes in future levels of uncertainty into economic analysis. This study applies RIO analysis to the semihypothetical case study of a coastal defense system to demonstrate its applicability for decision making on climate change adaptation. In the case study, two different adaptive strategies are analyzed, consisting of a hard and soft structural alternative. Soft strategies are often inherently more flexible than hard strategies. The results of the case study show that the NPV approach increases the relative cost of soft strategies for the two alternatives compared with hard strategies, because it does not account for the value of flexibility built into adaptive strategies. It is therefore recommended that RIO analysis be used for the choice between hard and soft strategies to avoid maladaptation. This is particularly significant in cases where there is both high climate uncertainty and high decision uncertainty concerning the best strategy.