Liability is a Liability

Posted by Don Fullerton on May 7, 2010

Filed Under (Environmental Policy, Finance, Other Topics, U.S. Fiscal Policy)

Who should pay for the cleanup and damages in the Gulf of Mexico?  The rig was owned by Transocean and leased to British Petroleum (BP), while some drilling services were provided by Halliburton.  Here is some information from today’s New York Times, before we do some analysis:

“BP and Transocean have been named by the Coast Guard as “responsible parties,” which means they must cover all cleanup costs, including those incurred by the Coast Guard and other government employees.

“They will also have to compensate people and businesses for things like property damage, lost business revenue and harm to ecosystems. BP’s liability bill is capped at $75 million and Transocean’s probably at $65 million, but those caps could be lifted if the companies were found to have acted with gross negligence or to have broken rules that led to the spills.

“Or the government could rule that the spill involves more than one incident, which would mean higher caps. And three senators have introduced legislation to raise the $75 million cap to $10 billion.”

Economists have long espoused the “Polluter Pays Principle”, which might make you think those companies should pay for the damages.  First of all, however, that principle involves two completely different concepts.  Discussions in the popular press are usually related to issues of fairness, while economists are usually interested in issues of incentives, behavior, and economic efficiency.  Economists would say that the polluters should have to pay, primarily to give them the proper incentives for precaution in the first place.  If the polluter faces all of the potential costs of their actions, and can adequately judge the probabilities of an accident, then the private cost-benefit analysis is the same as the social cost-benefit analysis: the whole project is only worthwhile to the extent that the benefits exceed the cost, maximizing economic efficiency.

By the way, if the polluter might go bankrupt or otherwise avoid paying the cost, then that is a possible justification for earlier government action, in the form of regulation to make sure they take the proper level of precaution in the first place.

The other issue is fairness, which is primarily a personal value judgment.  Economists don’t have any special expertise about what is “fair”, but they do have something to say about how market forces shift around the burden.  Those who actually pay can be quite different from those who write the check, and fairness ought to be about who actually pays!

This oil spill is a great example.  The moment the spill is discovered, we see immediate declines in the value of BP and other companies’ stock, and we see immediate declines in the value of local homes, fishing fleets, and other businesses that might be damaged.  Most likely, some of those homeowners or businesses will sell out now, either because of frustration or because they were already planning to retire and move somewhere else.  Others buy those homes or businesses for cheap.  Then those new owners are physically damaged when the oil hits the coastline and fishing areas.  I use the word “physically” here, because they are NOT damaged economically.  Yes, their home or business is negatively affected by the spill, but they already bought the property for cheap, which makes up for it.  Nonetheless, because of physical damages, they can sue BP and other polluters.

If they are successful, then they reap a net GAIN from the whole fiasco.  Those who really lost but sold out early may never be compensated.

Similarly, some BP stockholders now sell while the stock price is low.  Others buy the stock for cheap, and they may be forced legally to write the check to the “damaged” parties, but they don’t really bear any burden at all!  The fact that they bought the stock for cheap makes up for having to write the check.

Does this system collect from the “responsible parties”?  The owners at the time might be responsible, but if they sold out, then the new owners write the check even though they are not responsible for the spill.

Does this system prevent people from taking “benefits” from imposing pollution on others?  Not a bit!  The BP owners at the time of the spill may be “responsible”, but they may not be getting any benefits at all from having used sloppy and inexpensive precautionary measures.  Their purchase of BP stock just got them the same expected rate of return that they could have earned in any other investment.

Who did “benefit” from the pollution, or from using cheap and inadequate precaution against a spill?  And should those people be made to pay back their ill-gotten gains?  For better or worse, those who got the “benefit” of cheap oil production are you and me!  We’ve been buying cheap gasoline for quite a while now, produced in a way that does not cover the true social cost of production.  We are the culprits, not the oil companies.  Maybe we should be made to pay back our ill-gotten gains.  But again, it can’t happen, as we’ve already sold our 8-cylinder Pontiacs and bought new fuel-efficient hybrids.

These market responses combine to make proper compensation impossible.  You can’t collect from those who really took advantage of others, and you can’t find all the people who really lost from the spill.