May 3, 2010

Spillover Effect

As millions of gallons of oil choke the waters, wildlife and livelihoods of Louisiana, Mississippi, Alabama and Florida, armchair economists wade through the muck of deceit that parties involved share with the news media, in order to gauge the "true" costs of this ecological nightmare. As Austrian economists, we immediately wonder who pays which costs.

Environmental catastrophes, such as the exploratory oil rig spill in the Gulf of Mexico, present an opportunity for neoclassical economists to discuss the "negative externalities" inherent to fossil fuel consumption. Generally speaking, externalities represent the costs to those who were not contracting parties to an exchange - the costs to society which are not reflected in the price of the good or service consumed. In the case of Transocean's Deepwater Horizon exploratory rig, the negative externalities of oily water and air pollution associated with the spill and cleanup result in closed shipping lanes, lost tourism and grounded commercial fishing fleets to name just a few costs. There are those who look to our Uncle Sam to stem the flow of crude from reaching America's fragile coastline, and with good reason. Thanks to public mandate and finances, the U.S. Coast Guard is the most capable emergency responder in this instance. So who pays?

In order to "internalize" the externality - to create a neoclassically efficient outcome - a price must be put on the extraction of crude oil to offset the harmful consequences that such spills can cause. Yet government regulations, created by women and men in tidy offices in a faraway city who entertain the advocates of the petroleum industry, never solve the "problem," that is, unwanted spillover of oil into ocean water, without creating a new unintended consequence - most likely in the form of mandated controls and redundant safety equipment which consumers will fund through their gasoline purchases.

Perhaps a less forceful, more sensible approach to the remedy for this disaster has already begun. As a primary party to the accident, British Petroleum will spend over $100 million for the resultant cleanup. The degree to which BP and Transocean are at fault for causing damage to fishing, tourism and commercial shipping should be determined by courts of law. Parties hurt by the spill can seek damages in a well-functioning civil court system. The question of who pays and how much revolves around the issue of who has the property right to what, an issue most effectively settled by the judicial system. Ship owners, shrimpers, even beach combers all have a potential claim against the offending parties. As a result, the oil rig owner and the petroleum refiner may incur enormous costs to satisfy the plaintiffs. As it should be. Only limited liability and government protection stand in the way of justice being served.

One possible extension of the application of property rights to help determine how cleanup costs shall be determined is government claiming domain over the coastal waters, if citizens mandate that government regulate what may not be put into coastal waters. Regardless of whether The Force or individual parties have rights to unspoiled ocean water, I hope that the bill for damages presented to BP and Transocean is thorough and memorable.

1 comment:

Larry Eubanks said...

I think you are correct that the conceptual approach to this oil spill taken by most neoclassical economists would be to consider this a negative externality. However, from the point of view of neoclassical economics, I would suggest that this would be an illustration of what I call "externality abuse."

Generally, the neoclassical analysis of a negative externality involves a situation in which property rights are not well defined. In addition, it is typically the case that the negative externality is like air pollution from a coal-fired power plant where pollution is routinely and more or less continuously released into the airshed. The profit maximizing choice in this case is to respond to ill-defined property rights to the air shed by seeing the incentive offered by a zero price for release.

But, the oil spill is different. It is an ACCIDENT. It is not routine. In contrast to the coal fired power plant, the business owner does not choose to release the oil. The oil is a good to him. The owner of the power plant sees the particulate emissions as a bad and releases them (if they were a good to him he would collect them and sell them). I do not consider, from the neoclassical conceptual view, accidents to be appropriately characterized as negative externalities.

From the neoclassical viewpoint I think the appropriate discussion is whether or not the producer takes an efficient amount of precaution against an accident from occurring. In this actual spill, because government statute limits the liability of the oil producer, my guess is that because of government failure the producer has not taken an efficient precaution (again, seeing things from the neoclassical view).

Thinking about property rights is a very sound conceptual approach, both from the neoclassical externality point of view, as well as the Austrian point of view specifically suggested by Cordato. But, consider that I think it is best to see government as the owner of the ocean through which the pipe is plunged. Government is the owner of the sea bed through which the hole is punched. Government is the initial owner of the mineral (oil and natural gas) below the ocean floor. Government is the owner of the ocean surface upon which the drilling rig sits. Government is also really the owner of many of the natural resources that will likely be harmed by the oil, including shrimp, fish, and sand along the coast line. I a sense, it seems to me best to see that government's choices and actions in leasing the various things needed by the oil producer with respect to this rig has led to the government harming itself. In other words, for much of the potential damage, government's contract with the oil producer should already have internalized the potential risk in the production of the oil. As such, from the neoclassical perspective, once again, there can be no externality here. If there is inefficiency involved in this production accident, it is due to government failure.

More to Cordato's emphasis, we should make the same observation about government acting and the result being harm to it's own resources. The property owner to be compensated because of the production accident associated with government resources would have to be the same government, or to a large extent the same government. There are other property owners, private property owners, with beach sand that may be harmed. But, much of the sand is probably owned by state and/or federal government.

By the way, I don't think a shrimper has a property right that can be harmed by the oil killing shrimp. A shrimper does not own the shrimp until they are harvested. The shrimp are owned by government. Government does allocate access to harvest shrimp, but such access is not the same has having conveyed a property right. If this is correct, then payments by government to shrimpers who find far less shrimp to harvest after the spill would seem properly characterized as something akin to welfare don't you think?