The Gulf Oil Spill
The ongoing disaster in the gulf has spawned much debate about regulation versus tort liability as a way to prevent environmental diasters. Much of the discussion has not been that useful because it has been too broad brush. The question that needs to be addressed is what specific regulations, or what kind of liability system, would balance the benefits of increased oil extraction against the risk of environmental damage?
Here is one possibility: if the government grants a company like BP the right to drill in an area like the Gulf, where enormous damage to both private and public property is possible, it should also require BP to post a bond equal to something like the expected environmental damage.
Then if BP drills without incident, it gets the money back when it closes its wells. If damage occurs, BP loses some or all of the bond.
This approach gives BP an incentive to be careful. It also means that if an accident occurs, those harmed do not have to collect damages from a company that might already be bankrupt.
The reqirement to post a large bond might deter most drilling. That is appropriate, assuming the bond has been set at the right level, since this would indicate that the expected benefits of the oil extraction were less than the expected damages.
This approach is far from perfect. It requires reasonable estimates of the expected damages, and BP might litigate against any payouts from its posted bond. But the approach plausibly has better properties than a regulatory scheme that nobody enforces or a tort liability system that is difficult to enforce for large diasters.
Addendum: At forbes.com.
Categories: My Blog
Æternitatis
Generally, bonding is a good solution for many situations involving potentially large risks and judgment-proof offenders.
However, the example, while currently in the news, is ill chosen. BP’s current market capitalization (which long since factored in all the damages from the oil spill, probably accounting for a large share of the drop in its share price over the last three weeks) is *still* over $130 billion dollars.
That is a rather comfortable cushion against being judgment proof. The Valdez disaster, remember, only cost a few billion dollars.
In other words, requiring BP to post a bond for oil drilling would have accomplished little but create transaction costs.
Jimbino
Posting a bond will not stop the disaster. Posting a bond will amount to just another insurance racket. In any case, oil prices will rise, disasters won’t be eliminated.
Insurance always raises the cost of whatever it purports to cover. If it were otherwise, there would be no profit in insurance, and we know that waste and profit in insurance range from 98% of the premiums, in the case of title insurance, to some 35% in the case of federal flood insurance.
Æternitatis
@Jimbino
You are right insofar you suggest that posting a bond is akin to insurance and that, as insurance companies must cover administrative expenses and usually profits, insurance usually makes a product more expensive, rather than less–a fact that, as the recent health care debate demonstrates, was and remains incomprehensible to the vast majority of the population who carry the invincible conviction that insurance makes health care cheaper (or free!).
The rest … not so much.
First, a bond is unlike an insurance in that there are no ongoing expenses and constant cash cycling. That makes it likely much less expensive on average than the same amount of insurance.
Second, requiring a bond will reduce the number of disasters as the holder of the bond will have an incentive to monitor operations far keener than that of any federal bureaucrat. And it will ensure adequate compensation for victims.
Third, 98% of the premiums for title insurance are profit? Really? That seems to be a racket worth getting into. Why haven’t you?
Fourth, the general view of federal flood insurance is that it is vastly *under-priced*, inefficiently encouraging people to live in flood zones. Your claim that premiums cover not only payouts, but 35% “waste and profit” seems to the contrary. Evidence?
jivlick
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Jason
This sounds like a good way to clean up the oil spill and it kills two birds with one stone http://www.contributecontent.com/26051050/humor/stopping-oil-leak-filling-gulf-mexico
pipo
You don’t seem to be addressing the fact that republicans a few months ago blocked legislation that would raise the maximum penalty to be paid in such cases from 75m to 10bn. They said that such a raise was not necessary and that offshore drilling is safe. So technically, BP only has to pay 75m in damages, in addition to the clean up costs, which is of course peanuts compared to costs of the apparent ecological disaster.
Cliff Nelson
As others have pointed out, I don’t think the issue with BP is one that bonding would remedy. BP is enormously profitable and it has the money to pay. The problem is that the damages amount to a small fraction of its profits so it has no incentive to change.
You may remember back in 1996 the Supreme Court decided BMW v. Gore and held that the US Constitution limits the amount of punitive damages that a state court could award. At the time, many people believed that the holding would open the door to corporate irresponsibility. At common law (before BMW v. Gore) the relevant inquiry had been related to the amount necessary to change conduct. BMW v. Gore changed that and held that it must be related to compensatory damages. Since the purpose of punitive damages is to change conduct, I never could understand the rationale.
Anyway, now that corporations have blown up the economy and seem to be doing the same to the environment, it might be a good time to reflect on that holding.
Æternitatis
@Cliff Nelson
“The problem is that the damages amount to a small fraction of its profits so it has no incentive to change.”
This is a bizarrely moralistic argument. “BP must really hit ‘rock bottom’ before it looks deep into its own heart and change its fundamental values into ones of caring and sharing.”
Nonsense. BP is a heartless corporation in it for the profit (just like all the others). It will undertake conduct if the expected benefit exceeds expected cost (including legal). That is what ‘profit-maximizing’ means. And, as you see, the total level of BP’s profits (positive, negative, or zero) does not enter upon the incentives for any particular conduct.
“At common law (before BMW v. Gore) the relevant inquiry had been related to the amount necessary to change conduct.”
Really? That the relevant inquiry in the assessment of tort suits (and that is what we are talking about here) is the ‘amount necessary to change conduct’ will come as a surprise to the legal scholars of the subject.
So if you dent your neighbor’s car or your kid throws a baseball through his window, a court should not inquire about what damages this caused your neighbor (that would merely be that new-fangled ‘compensatory damages’ the Supreme Court allegedly invented in BMW v. Gore).
Rather, you say, at common law a court should ask how much it has to punish you so that you never drive again or your kid never plays ball again. If you are well-to-do, that might mean tens or hundreds of thousands of dollars of damages, even if the dent in your neighbor’s car could be fixed for a few hundred. If you are poor, you may stop your kid from ever playing ball again because of a $100 fine, so that is what the court should impose.
Of course, this is also nonsense. Compensatory damages–that is making the victim whole–without regard to the tortfeasor’s ability to pay or likelihood to change conduct has always been the proper, compensatory level of damages at common law for many centuries before BMW v. Gore.
What BMW v. Gore (and several cases since then) set a limit to were ‘punitive damages’–a rarely used form of damages which might have some justification before the invention of the class action, but now are an anachronism on the order of the stocks, debtor’s prison, or the death penalty for passing a forged note.
In fact, punitive damages merely serve to give juries previously- unlimited, now-limited discretion to reach into the pockets of wealthy out-of-towners to reward friends and family, with the opportunity to throw emotional hissyfits as collateral benefits. They are lawless and should be abolished entirely.
Cliff Nelson
“So if you dent your neighbor’s car or your kid throws a baseball through his window, a court should not inquire about what damages this caused your neighbor (that would merely be that new-fangled ‘compensatory damages’ the Supreme Court allegedly invented in BMW v. Gore)”
I agree that compensatory damages are very important and that the inquiry should be to ascertain the true extent of the actual damages caused by the conduct.
My post, however, was not addressing compensatory damages, but rather addressed whether the limits and caps on punitive damages opened a “gusher” from which corporate recklessness leaked.
As to your last point, let me turn it around, don’t the limits on punitive damages just give corporations the ability to go into local communities, act with total recklessness and destroy the people and their livelihoods?
Æternitatis
“Don’t the limits on punitive damages just give corporations the ability to go into local communities, act with total recklessness and destroy the people and their livelihoods?”
No, they don’t. As long as corporations (or you or I) are required to pay compensatory damages–calculated at the level of making the victims whole–nobody has a license or ability to interfere with anybody else’s legal interests.
You may say that Congress has limited compensatory common law damages by statute. Indeed, it has and it probably shouldn’t have.
But that Congress was able to do so with great ease and without judicial restraint owes much to the demise of the now nearly forgotten legal doctrine that statutes in abrogation of the common law should be construed as narrowly as possible. The abolition of that doctrine was one of the many great legal victories of the “progressives” in the 20th century. Now they (meaning both the progressives and Congress) get to lie in the bed they made.
Finally, let me suggest that your worry about “corporation[']s the ability to go into local communities” is revealing of the underlying psychological reasons why punitive damages were (and still are) so often abused: They give local juries free reign to exercise their xenophobic biases against outsiders/strangers/foreigners. As Bryan Caplan has noted, this is one of the most common economic biases. See http://en.wikipedia.org/wiki/The_Myth_of_the_Rational_Voter#Anti-foreign_bias .
Cliff Nelson
Hold on … but if the profit is greater than the compensatory damages why wouldn’t the corporation “go into local communities, act with total recklessness and destroy the people and their livelihoods?”
As for the point about mistreatment of foreigners, I guess that it works both ways, but as to the issue as to who should get a remedy, I would say it must go to the local communities because the corporations make the election to enter, and are the ones in control of the conduct.
Æternitatis
“Hold on … but if the profit is greater than the compensatory damages why wouldn’t the corporation ‘go into local communities, act with total recklessness and destroy the people and their livelihoods?’”
Yes, and that is how it supposed to work in a society governed by the rule of law and a free market.
If the local community (or rather, individuals in it) receive full compensation–again, defined as the level sufficient to make them whole–they should be fine with that.
It is an unavoidable, if not universally understood, fact of human existence that all conduct involves risk to innocent third parties. All large-scale human conduct (such as that engaged in by large organizations such as some corporations) involves the near certainty of damage to innocent third parties.
The purpose of the tort system is not to prevent all such conduct. To do so would for all practical purposes shut down society.
For example, UPS operates a large fleet of trucks. Given that number of drivers and their activity, it is completely unavoidable that they will cause accidents, likely on a daily basis. Indeed, it is a virtual certainty that UPS trucks will kill a certain number of innocent victims every year.
The only way to eliminate that risk (or indeed certainty) is to shutter UPS. And FedEx. And the USPS. And pretty much every single enterprise on earth. And pretty much everything you or I do every day with the possible exception of lying in our beds with sheets over our heads.
The purpose of the tort system is to make the victims whole and to make the tortfeasors pay the compensatory price. If the activity is still profitable, even paying that price, it should continue. And if not, it won’t.
Cliff Nelson
“The purpose of the tort system is to make the victims whole and to make the tortfeasors pay the compensatory price. If the activity is still profitable, even paying that price, it should continue. And if not, it won’t.”
Perhaps, but I think the tort system could also be better used to to preserve life and create a disincentive for knowingly and/or recklessly destructive conduct.
Contrary to your point, I think everyone will lie in bed with the sheets drawn if going “outside” involves the risk of getting run over by a UPS truck because UPS decided to mandate that its drivers make twice the deliveries in half the time.
Æternitatis
But compensatory damages already create such a disincentive.
The question which divides us is whether the legal system should increase this incentive so far beyond compensatory damages that all conduct which poses a risk (or even certainty of) injury or death to innocent third parties is suppressed.
I–along with probably a majority of economists and legal scholars who have thought about the issue seriously–think not. You think so.
So should UPS, as it is operating today, be shut down? Surely its management–being familiar with their own recent statistics–know perfectly well that continuing to operate UPS create a certainty of damage and death to third parties.
Nor is your “reckless” qualification going to do your argument any good. Employing tens of thousands of drivers, it is a certainty that some of them will at some point behave recklessly. And UPS, as their employer, will be held responsible.
So, as based on these undisputed facts and your reasoning, UPS should be shut down, right now, today. Do you accept that consequence of your reasoning? And, if not, why not?
And don’t evade the question by suggesting that UPS should just take more security precautions, such as training. Perhaps they should, perhaps they shouldn’t. But no matter what, no precaution, no training, no extra equipment, can completely avoid the certainty of injury and death to third parties. Hence, this would do nothing to avoid your conclusion that UPS (as well as pretty much everything else) ought to be shut down immediately.
Cliff Nelson
“The question which divides us is whether the legal system should increase this incentive so far beyond compensatory damages that all conduct which poses a risk (or even certainty of) injury or death to innocent third parties is suppressed.”
I think, and hope that we both can agree, that the legal system should act to remove all conduct which poses a risk of injury or death to innocent third parties which is unnecessary to the activities of business. Thus, since it is necessary for UPS to employ drivers and accident happen, I would (to answer your question) say UPS should not be shut down. However, if UPS had a policy of allowing its drivers to work without sleep and they absolutely refused to change that policy, I think they should be shut down.
Æternitatis
“[T]he legal system should act to remove all conduct which poses a risk of injury or death to innocent third parties which is unnecessary to the activities of business.”
Unfortunately, the new word “unnecessary” will not help your proposed legal rule any more than the words “knowing” or “reckless” did before.
That is because almost nothing is necessary. Almost everything is a question of cost and efficiency.
For example, it is entirely unnecessary for UPS to use trucks. They could just use their drivers as walkers to carry packages door to door. That would definitely avoid any of the predictable carnage that UPS’ trucks cause every day and year.
So by your standard, every time a UPS truck has an accident, courts should fine the company enough to force it to switch from the unnecessarily risky “driver” business model to the safer, not to mention eco-friendly, “walker” business model.
You may respond, but that would make UPS (and all the other delivery services) more expensive!
That’s true. But that is equally true of whatever you wanted BP (or anybody else on today’s menu for politicians) to do to avoid the spill. If a safety measure would not increase costs, any company would already have done it without needing any encouragement from the legal system.
That is why I–following many other smarter people–argue that the current legal system’s general practice of just making the tortfeasor pay compensatory damages and letting it decide, based on its bottom line, whether an activity is still worthwhile, even including compensation payments.
Your proposed legal rules demanding exorbitant punitive damages for any conduct which is “knowing” or “reckless” (as in your previous iteration) or “unnecessary” (in the current iteration), doubtless reflect popular sentiment.
But if your rules, rather than those developed in the common law system over the centuries, were applied logically and consistently, the result would be a near-instant shutdown of large parts of society and the economy.
Cliff Nelson
Well … even walking involves risk. Thus, it is a question of where to draw the line.
I think, and hope you agree, that people and firms (i.e. all of us) can and do act with a reckless disregard to the lives of others. We all also engage in harmful conduct that is not necessary, serves no purpose and is easily avoidable.
I also think, and hope you agree, that we all would be better off if we all didn’t.
Thus, the question is what to do? You think compensatory damages is enough. I think an award of punitive damages in amount minimally sufficient to stop us is necessary.
I do not and haven’t proposed that we all should do nothing. My use of the word “necessary” is to exempt certain conduct from the reach of punitive damages. Thus, if a corporation could show that the conduct was necessary (even if it involved risk) it could not be liable for punitive damages.
But lets not get distracted from the real issue,
Æternitatis
No, I don’t engage in harmful conduct that serves no purpose and could easily be avoided at no cost to me.
What in the world makes you think BP does or did? Would you be satisfied with BP escaping all punitive damages because if it could just show that avoiding this disaster would have cost it a few thousand dollars extra in precautions? if so, I’d be surprised.
You assume that there is some defined line somewhere between the “necessary” risks which are ok and the “unnecessary” risks. If there is a disaster like the recent spill, there must have been somebody somewhere who had evil in their heart and stepped across that line for no reason whatsoever.
But in the real world, there is no line. All there is are costs and benefits, risks and trade-offs.
Nobody in the world wanted this to happen, employees and management of BP least of all. That does not mean that BP must or should escape payment of compensation. But it does mean that trying to punish BP for deciding to spill all that oil is a fool’s errand.
Cliff Nelson
Look – I don’t think either of us knows what did or did not happened regarding the ongoing BP spill. I was talking more generally, but to the extent that you argue that it is a “fool’s errand” to attempt to deter certain conduct, I disagree. And I think – deep down – you do to.
Æternitatis
@pipo
There was an effort to raise a certain federal liability cap (for economic damages) from $75 million to $10 billion, but you misremember on every particular.
(1) The effort was not several months ago. It occurred *after* the BP oil spill.
(2) It was not blocked by Republicans. In fact, several gulf state Republicans were its leading sponsors.
(3) As it occurred after the spill, nobody made the argument that offshore oil drilling was invariably safe.
(4) Moreover, as it occurred after the spill, but was intended to cover the spill, it was–even if nobody in Congress so argued, our gentle host did, http://jeffreymiron.com/2010/05/who-will-pay-for-the-gulf-oil-spill/–an eminently lawless conduct on the part of Congress. In the heat of passion against BP, it violated one of the oldest, most basic principles of the rule of law: Nullum crimen, nulla poena sine praevia lege poenali. None can be punished for conduct except by the law in effect at the time of conduct.
WaitaHaptuh
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