Environmental Economics

oilspillWhen big companies (like, say, British Petroleum) wreak great havoc (like, say, by spilling millions of gallons of oil into the Gulf of Mexico), it can be good policy to make them compensate their victims (like, say, with a $20 billion claim fund). It can also be bad policy.

A.C. Pigou taught us that we get better outcomes when decisionmakers bear the costs of their actions. Ronald Coase taught us that Pigou’s lesson cuts two ways. The shrimp boats that are sitting idle today are sitting idle partly because BP decided to drill in the gulf, but also partly because the shrimpers chose to operate in the vicinity of an oil rig. In this case, making BP feel the costs of its own decisions entails insulating the shrimpers from the costs of theirs.

In this particular case, I’m inclined to believe that it’s a good thing for BP to pony up. But contrary to what I’ve been reading around the web, there’s absolutely nothing in economic theory to dictate that conclusion; instead the conclusion depends on the particulars of the case. Is it cheaper to deal with the problem of spills by encouraging oil companies to be more responsible, or by encouraging others to stay out of their way? That’s an empirical question. Theory can’t answer it.

The various commentators who think they can justify holding BP liable by crying the word “externality”—and stopping there—exhibit a commendable grasp of environmental economics circa 1930. But this is 2010.

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24 Responses to “Environmental Economics”


  1. 1 1 Doctor Memory

    Speaking of the seen and the unseen: please do let me know when you’ve figured out how to convince the shrimp and plankton to move their base of operations further away from any active oil rigs.

  2. 2 2 JLA

    But why were the oil rig and shrimp boats operating in the same vicinity in the first place?

    This entire ordeal could likely have been avoided if oil drilling was allowed in the Arctic.

  3. 3 3 sconzey

    Oh, Stephen. Firstly, BP hasn’t been “British Petroleum” since it’s acquisition of Amoco in 1998.

    Secondly, you do not want BP to go bust, once they file for bankruptcy it’s game over player one. Which do you think is more likely to make them go bust? A sudden seizure of $20bn of assets, or $20bn paid out in compensation over a number of years?

    Thirdly BP has already said they’d be happy to compensate those affected by the spillage. Their public image, and thus their ability to win further contracts abroad has been seriously damaged. It’s strongly in their interests for justice to be seen to be done; they’re going to make sure that fair compensation goes to those who need it.

    On the other hand, this “escrow fund” is only being argued for so that politicians can have a greater say in who gets the compensation, and redirect it based on political expediency, rather than need.

  4. 4 4 Harold

    In “more sex is safer sex”, you use the example of a rabbit farmer next to a cornfield. It may be economically best to solve the problem for next year by growing beans (which these rabbits don’t like) in that field, and the corn at the other end of the farm. This may be a cheaper alternative than shutting down or moving the rabbit farm, but bears the cost? This seems a different issue than finding the lowest cost solution. If the rabbit man came along second, does he have to pay the corn farmer the expense of changing fields? What if the rabbits were there first?

    In the BP case, it seems clear that BP pays whatever the costs are. It seems to me that the economic descision is whether they pay to restore the shrimp fisheries, and cover lost income until then, or pay for the shrimp fishers to do something else, or do it somewhere else.

  5. 5 5 Ryan Dean

    Why do American commentators insist on calling BP, BRITISH Petroleum. I know we all need scape goats and so I’m not surprised that the government should be looking to point a xenophobic finger in the direction of Britain. I am, however, surprised that you’ve been caught up in this Steven as I tend to view your blog as internationally neutral.

    I need not remind you and everyone else that a sizable chunk of BPs shares are owned by the largest consumer of oil in the world, Americans.

  6. 6 6 Ken B

    One point I think you have overlooked. Bad govt policy — limiting liability to 75M — contributed to BP’s choices here, and to the shrimpers’. The pain of that needs to be felt — by politicians and hence by voters. So too much from BP and not enough from shrimpers provides too much insulation and cover for the policy makers.

  7. 7 7 Mike

    Following up on what KenB said, and I don’t remember if this was in a book or from that video lecture you have posted, but you have stated that there is almost certainly too much pollution in the world simply based on the fact that polluters don’t feel the full force of the negative externalities of their actions.

    I understand that it’s difficult to quantify the amount of damage caused to anyone in the gulf (perhaps we could start to try by comparing the opportunity cost of shrimping in the south to perhaps Texas or Mexico). I agree that simply using the term “externality” as a medium for shrimpers to get money is probably a stretch, however providing a disincentive to spill massive amounts of oil is probably a good thing… The only real argument is should the money go to shrimpers or someone else (and I don’t know the answer to that question).

  8. 8 8 Rocky Humbert

    An analysis that allocate costs between only BP and the shrimpers seems incomplete. I don’t live anywhere near the Gulf, yet I am a victim too.

    For example, I expect that the price of the All-You-Can-Eat Shrimpfest at my local Red Lobster Restaurant to increase substantially in the months ahead. Should I make a claim on BP? Or on the Shrimpers?

  9. 9 9 Alan Wexelblat

    Are you talking about the NY Times piece? That seemed to be mostly a primer on the concept of externalities as applied to this situation and my read of it was that it was rather wide-ranging in scope. In particular I recall that the author noted we couldn’t really state, let alone compute the costs of, all the externalities. For example, what is the cost to you and me of the distortions introduced into our foreign policy vis a vis Saudia Arabia, given how much oil we get from them?

  10. 10 10 Sean

    “Why do American commentators insist on calling BP, BRITISH Petroleum. I know we all need scape goats and so I’m not surprised that the government should be looking to point a xenophobic finger in the direction of Britain. I am, however, surprised that you’ve been caught up in this Steven as I tend to view your blog as internationally neutral.”

    I agree, but am not surprised at the petty dig:

    “I need not remind you and everyone else that a sizable chunk of BPs shares are owned by the largest consumer of oil in the world, Americans.”

    Then why did you remind us?

    I’ve been living in Europe for fifteen years and I’m convinced that if a multinational company formerly called American Petroleum spilled this much oil off the shore of any European country, there would be rioting in the streets and not a single McDonald’s in Western Europe would have an intact pane of glass.

    I agree that BP is a multinational corporation and it is incorrect to call it British Petroleum or point fingers at the Brits but were the tables turned I have no doubt that every newspaper in Europe would be baying for American blood.

  11. 11 11 val

    I came over to say just about what DrMemory said: the shrimpers are shrimping where the shrimp are, which was the case long before the oil rigs showed up.

    Moreover, spaces well over 50 miles from said oil rig have already been affected.

  12. 12 12 DividedLine

    In his Nobel lecture, Coase acknowledged that the theorem named after him applied only when transaction costs were negligible (e.g. neighboring farmers, law of treaspass in place, agreement on the amount of damage etc.): “I tend to regard the Coase Theorem as a stepping stone on the way to an analysis of an economy with positive transaction costs,” he said. And he went on: “It does not imply, when transaction costs are positive, that government action…could not produce a better result than relying on negotiations between individuals in the market.”

    The transaction costs of BP negotiating with every individual shrimper, or of BP acquireing property rights to the entirety of the sea and not just what is underneath it, is clearly non negligible. The transaction cost of every shrimper moving to other grounds, or of similarly holding exclusive rights to the sea, is also clearly non negligible. Coase himself told us his theorem was not adequate when there were transaction costs of this magnitude, nor did he tell us the market would do a better job than governments in a situation like this.

    BP clogged the water with oil, the shrimpers did not clog the wells with shrimp. The cry of externalities might be so 1930, but it also happens to be the last word economists have had on a case with transaction costs such as this.

  13. 13 13 Steve Landsburg

    DividedLine: In the absence of transactions costs, it wouldn’t matter who was liable for the damage. In the presence of transactions costs, which is certainly the case in this instance, it *does* matter who is liable, and no assignment of liability can get all the incentives right. It’s therefore an empirical question which is the right policy.

    The problem here is caused by having oil rigs and shrimpers in the same place. As Coase forcefully observed, that’s a symmetric problem. There’s no *a priori* reason to make either party more liable than the other.

    Incidentally, moving shrimpers from one location to another is not a transactions cost.

  14. 14 14 Steve Landsburg

    Val: the shrimpers are shrimping where the shrimp are, which was the case long before the oil rigs showed up.

    Yes, and one of the great lessons Coase taught us is that “who was there first” is quite irrelevant to the question of determining the efficient solution.

  15. 15 15 Mike

    Sean said:

    “I’ve been living in Europe for fifteen years and I’m convinced that if a multinational company formerly called American Petroleum spilled this much oil off the shore of any European country, there would be rioting in the streets and not a single McDonald’s in Western Europe would have an intact pane of glass.

    I agree that BP is a multinational corporation and it is incorrect to call it British Petroleum or point fingers at the Brits but were the tables turned I have no doubt that every newspaper in Europe would be baying for American blood.”

    My wife is a Brit, and I spend every summer in the UK. What Sean says is UNQUESTIONABLY true. Bitching about the U.S. is the main pastime of the British media and most British citizens, even in the best of times. If an Exxon/Mobil well were spewing oil into the North Sea at the same rate as the BP well, there wouldn’t be enough storage capacity in the world to hold all of the venom and bile.

  16. 16 16 Bill

    Is it not also the case that were it not for U.S. policy limiting shrimp imports, U.S. shrimp prices would be much lower, the Gulf shrimp industry would be much smaller (non-existent?) and the financial damage suffered by shrimpers due to the spill would be much smaller (non-existent?)?

  17. 17 17 dWj

    I read this post this morning, and thought of it this afternoon, when I saw a car that seemed to be designed to suffer expensive damage if rear-ended.

    My understanding is that New Jersey caps medical liability for injuring (in a car accident) a passenger who isn’t wearing his or her seat belt. I suppose that gets the expected marginal cost to careless drivers wrong, but people seem to dislike assigning liability that adds up to more than the total cost, and it seems better than placing none of the risk on the person deciding whether to buckle up.

  18. 18 18 dave

    ‘…the question of determining the efficient solution.’

    well first things first, gotta stop the spill.
    i would put bp’s squad of their finest up against pretty much anybody elses when it boils down to deadliest warrior of oil extraction technology.
    i seem to recall them saying at the beginning the only way they had to ‘guarantee’ to kill the well is drill the relief wells and kill it that way. in a way, the problem has already been solved.

  19. 19 19 Robert Wiblin

    So give the shrimpers the right to determine who drills for oil, and let them sell off the rights for a price they choose?

    Lots of actors amongst the shrimpers would make that hard. Also adds to any tragedy of the anticommons present in getting drilling set up.

  20. 20 20 Robert Wiblin

    What external costs do the shrimpers actually impose? Imagine even that they sold all their rights to seek compensation if BP inhibits their shrimping. So BP acts as if they suffer no costs (and so there are more spills).

    But even under those conditions, the optimal amount of shrimping might well be greater than zero. It’s not the shrimping that is costly per se – it’s only keeping the water pure for shrimpers all the time which is costly.

  21. 21 21 Steve Landsburg

    Robert Wiblin: What external costs do the shrimpers actually impose? The external cost imposed by the shrimpers is that they make it costlier for BP to drill for oil, because, following a spill, they are going to come looking to BP for compensation.

  22. 22 22 dave

    is it of any interest that the shrimpers require bp’s product to operate, yet bp workers could just eat rice?

  23. 23 23 jpd

    really? no shrimping there before oil wells?
    didn’t know that.

    if i grew up in coastal louisiana, i am not sure how much
    of a choice i have as to where i shrimp.

  24. 24 24 The Elephant's Child

    I have read (but cannot verify) that BP was rapidly paying claims for damages before the Obama administration created the escrow account to be managed by another “Czar” — in this case the “Pay Czar.” I have not heard of any instance in which BP is trying to avoid responsibility. I would be willing to guess that payment to those, like the shrimpers, now without a livelihood, will arrive much more slowly as it filters through the government bureaucracy.

    Hauling BP before a Congressional inquisition (when many answers are not yet available) so Congressmen can pose and preen, forcing BP into an illegal or extra-legal $20 billion escrow fund has unintended consequences. Overseas businessmen are rethinking any interest in investing or doing business in the U.S.

    And on shrimping and Louisiana — Have you ever seen a display of Oregon shrimp in your fish market? It would be a rare giant that reached one inch in length. Perhaps there’s more reason for shrimping in the Gulf than growing up there?

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