Oil Spills and Social Cost

We have all benefited from advantages of cheap oil, so should BP have been allowed unlimited liability? A look at the social impact of the Deepwater horizon oil disaster. First Published on The Graduate Times.

Image courtesy of Garry Tanner

In an excellent chapter in More Sex is Safer Sex, Steven E. Landsburg tells us how Ronald Coase solved a centuries-old problem in his paper The Problem of Social Cost (1960). In 1597 there was a legal battle between two farmers that became known as Boulston’s case. One farmer grew corn, while his neighbour raised corn-eating rabbits, which more than occasionally ate from the other farmer’s corn. The court ruled that because the rabbit farmer didn’t actually own the rabbits (he merely dug burrows to lure them for trapping) he could not be held accountable for their behaviour. Even though the judge’s logic here seems a little messy to say the least, this ruling was affirmed by subsequent courts well into the 20th century.

An alternative (opposite) view was held by the great economist A.C. Pigou, who looked at the rabbit issue and correctly declared that ownership is not the issue. Subsequently, however, he made a grave mistake by declaring that “fault” is the issue and that the rabbit farmer should be held responsible.

Pigou’s reasoning is wrong too, and it took a lawyer and economist by the name of Ronald Coase to get it right.  His solution follows: first of all we should not lose sight of the problem: 1) rabbits eat corn. Secondly we should remember the cause: 2) The rabbits eats corn because they are near corn. Thirdly we should not lose sight of the symmetry: 3) The corn is close to the rabbits in the same way the rabbits are close to the corn. Therefore we may conclude that both parties are at “fault”. Remove the rabbits and you solve the problem, or remove the corn and you also solve the problem.

This problem can be configured to fit many other cases, even the common and contemporary problem of neighbours making noise. When my neighbour plays loud music, he imposes a cost on me. But when I call the police instead of wearing ear plugs I impose a cost on him.

Often simply removing one of the agents is neither possible nor optimal. A property right solution is proposed following the Coase Theorem. Here one of the Agents (the polluter or sufferer) has the right to silence or the right to play music. If the sufferer has the right to silence, the polluter will be willing to pay a certain amount to play loud music for a certain period. But if the polluter has the property right the sufferer will be willing to pay a certain amount for the polluter to reduce the noise level, or be silent for a period of time. The efficient amount of noise will then be produced as soon as parties are able to bargain and property rights are efficiently enforced so that all (external) costs are internalized.

BP’s case
Now in 2010 more than 400 years after Boulston’s case, we have a case which fits the same three-way logic of Ronald Coase.

1) The problem: Drilling for oil may cause pollution to the Environment.
2) Cause: Oil is found in the environment
3) Symmetry: The oil is close to the environment in the same way as the environment is close to the oil.

BP drilling oil therefore imposes a cost on society as it may damage the environment. Yet stopping or making it prohibitively expensive to drill in the environment also imposes a cost on society: more expensive oil. The solution is to make sure that both parties take these costs into account. BP takes possible environmental costs into account, and society takes the benefits of having cheap oil into account.

In this case the property rights were effectively given to the (sufferer) US government as owner, who auctioned the oil field for a particular price, with a limited liability in the event of an oil spill. If the US government valued the environment more it would have raised the price of drilling and thereby made it less attractive to drill in the Gulf of Mexico; with less drilling there would be less chance of an oil spill. However the apparent preference for oil is reflected in a lower price for the oil fields, more oil drilling, and a higher probability of an oil spill.  Therefore, the right balance between the desire for cheap oil and a clean environment was struck when the fields were auctioned off.

We have all benefited from cheap oil and it would be wrong to not stick to the other side of the deal and submit BP to unlimited liability. It would be like receiving money from your neighbour to be silent, and having received the money, play loud music after all!