A little while back I considered responding to this post on Economic Thought, which argued: "Had BP been liable for all the damages done, I am sure that they would do everything possible to avoid similar accidents in the future."
The thrust of the post was great - Jonathan Catalán argued that limiting the liability of oil companies makes them less careful than they would otherwise have been. It's a point that co-blogger Mattheus von Guttenberg made more recently as well. That is all well and good, and it's an insight that broad swaths of economists agree on. But is it accurate to say that "they would do everything possible to avoid similar accidents in the future"?
The thrust of the post was great - Jonathan Catalán argued that limiting the liability of oil companies makes them less careful than they would otherwise have been. It's a point that co-blogger Mattheus von Guttenberg made more recently as well. That is all well and good, and it's an insight that broad swaths of economists agree on. But is it accurate to say that "they would do everything possible to avoid similar accidents in the future"?
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I don't think so. One of the merits of markets is that they rarely converge on what economists call a "corner solution" - they never put all their eggs in one basket. Life is full of trade-offs, and a robust set of trade-offs usually means that the optimal choice involves a mix of different goods. BP's goal is to maximize profits. That is achieved by minimizing costs and maximizing revenue. You can't maximize profits without taking some risk that you're going to have another accident or spill, otherwise you'd be spending all your money on safety measures and none of it on exploration and production. Markets are great things but we can't ascribe things to them that they won't provide - and one thing they cannot provide is a single-minded pursuit of a particular end.
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Of course, the government can provide this single-minded pursuit (or at least can come closer to it than a private company). Usually this isn't such a good thing! We like the market because it's so good at arbitrating tradeoffs between millions of different options. We don't like corner solutions... usually. But to quote President Obama, sometimes you just need to "plug the damn hole". Catalán argues that the spill is costing BP dearly, that they have an interest in fixing it. Fine, but that interest is still going to be mediated through a cost-benefit analysis that is going to trade-off the very high costs of fixing the spill against the benefits of getting the spill fixed. There is no guarantee of what Catalán proposes - that BP "would do everything possible to avoid similar accidents in the future". In fact, based on what we know about the market, we can almost certainly expect that they will not do "everything possible". They will do less than what is possible because they will not find the corner solution of extreme caution to be profit-maximizing. This isn't an indictment of BP at all of course - it's just a statement of fact. There is no guarantee that the government will fix this problem or prevent future problems too, but the government has an incentive structure that frees it to express and act on sentiments like "plug the damn hole" in a way that an oil executive never could.
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As I said, usually corner solutions are not the ideal outcome. But on the occassions that they may be, we need to adjust the way we think about the state and the market, precisely because of how both are equipped to respond to corner solutions. More generally, whenever we think that a prioritarian ethics is appropriate or applicable, we have to question the implications of market outcomes. Even those who don't personally claim to be utilitarians have to recognize that the market operates on a utilitarian basis, where the utility of no agent is prioritized over another. All agents operate on the basis of their own subjective valuations. Usually this is fine, but when legitimate priorities do exist, the market is inevitably going to be limited in its response.
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UPDATE: The Onion says it better than I can: "BP Pledges to Continue Being Huge Profitable Corporation" - as well they should be, all jokes aside. Let's just not pretend they can pledge much beyond that. Profit maximizers maximize profits... that's all we should expect or ask of them.
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Thanks for the link! There aren't tons of comments on the ET post, but it's nice to hear people are reading and notice my work anyway haha.
ReplyDelete- Mattheus
No problem. I keep up with you guys. And I like to link to you, sort of as a "small econ blogger solidarity" thing :)
ReplyDeleteI think I probably have linked to more of Jonathan's posts in the past but I'm sure I'll link more in the future.
As per the meat of the post, I do agree that while Jonathan's phrase "everything possible" was hyperbole, he meant "everything possible that meets a cost-benefit analysis." And I agree with him. Clearly, if the only option left to BP to plug the hole (for whatever reason) was to declare bankruptcy and liquidate their shares, they would not do everything possible and they would not plug up the hole.
ReplyDeleteThe point being that as long as there are thousands of barrels of oil gushing out everyday, dozens of potential options still pass the cost-benefit analysis and so they will do "everything possible."
- Mattheus
Ya - if I remember I left positive responses except for that point on his post, and on an earlier post of his where he only mentioned the liability issue I left all positive responses.
ReplyDeleteMy point applies as much (perhaps more) to future accidents than the current case. Markets don't target corner solutions. They don't prioritize single goals. They only prioritize one thing - profits. That does a lot of good, but it has limits.
In our lauding of markets, I think we can forget this. You have to use the right tool for the right job, and markets solve only certain jobs.
The question is - is there truly such a thing as an "objective" goal that we all unanimously agree must be achieved at whatever detriment? That's the problem, I don't think there is. Government action necessarily implies objective value. Whatever it spends its money on (police, war on drugs, cleaning oil) must objectively be more valuable than anything private individuals could have spent their money on. I think that's wrong.
ReplyDeleteAnd if the clean up is truly valued by everyone to such a degree, in a free market, there would arise entrepreneurs to meet the demand of the people who want the oil cleaned. After all, government is only a handful of people with authority. If there truly were serious demand for the clean up, why could not free market firms take care of it?
- Mattheus
First, I think we need to think more critically about your points about (1.) unanimity, (2.) "at whatever detriment", and (3.) "more valuable than anything private individuals could have spent their money on". The first two are of dubious necessity, and the last point is questionable if the first is in fact unnecessary.
ReplyDeleteAs for the free market addressing it, I'm simply going to refer you to my post AND your post. In your own string of posts on ET you guys talk about how the lack of property rights to the Gulf and the lack of liability (this is tied to the property right question - it's NOT simply a statutory obstacle) prevents the free market from providing a solution.
The point is, if BP imposed upon the country by allowing the spill, why should the country have to pay to plug the whole? It's BP that's liable. But even if all the property rights to the Gulf were mapped out and there was no limit on torts, the country STILL wouldn't have the right to sue. So (1.) you've got it exactly backwards if you expect the people who are angry with BP to pay for it, and (2.) even if everything were set with the liability issue, they still couldn't make BP pay for it.
The first part of my post was directed to government spending in general. Spending, in general, assumes that whatever is being spent is most valued towards that project. And since government doesn't operate by profits and losses, it necessarily assumes objective value. That's all I said.
ReplyDeleteI agree that BP imposed upon the country, and it is BP that is liable for the clean-up. I wrote a whole post about it. It doesn't make sense, in this case, for BP to be responsible for an enormous spill, and have private citizens organize a clean up effort. I'm with you. The point I was making was generalized about government spending. If there is demand for a service (let's say nuclear waste clean up), private firms will cater to it. That doesn't mean that we can dump barrels of fissionable material in the Gulf and have minutemen firms clean it up.
- Mattheus
Could you explain "it necessarily assumes objective value" a little more? I understand why it doesn't use subjective valuation the same way a market uses subjective valuation... I don't see how it follows that it DOES use objective valuation.
ReplyDeleteUltimately, my impression is that government also uses subjective valuation, but it has electoral, political, and bureaucratic processes for making use of those subjective valuations. In most cases those processes are obviously inferior to the price mechanism's use of subjective valuations. In a few important cases, they have the prospect of being superior to the market.
ReplyDeleteSure, I'll explain.
ReplyDeleteIn the case of oranges, let's say - in your decision whether to purchase oranges or not, you have many things to consider. You have to consider the quality of the oranges, the type you like, the amount of trouble you must expend to acquire them, but most importantly the price (which includes opportunity cost of other goods.).
If, instead of buying oranges, you buy apples, then it follows that your purchase of apples was a product of different valuations you ascribe to apples and oranges. Clearly, for the factors described above, apples filled your "needs" better than oranges would. Perhaps another person has the exact opposite valuation and purchases the oranges even after weighing the options. The decision to purchase oranges or apples was a subjective choice based on information that only individual people have. No organization or third party could tell you that apples were more "want-fulfilling" than oranges because they don't have the information you do. This is expressed in the common dictum - "A fool can put on a coat better than a wise man can put it on for him."
Alternatively, if you were forced into buying oranges, even after weighing the incremental gain you achieve from buying apples, then the group that is using force is expressly declaring that "Your purchase of oranges meets some higher standard than your purchase of apples, thus my use of force is justified." This is what I mean by objective value. This group assumes that the purchase of oranges meets a higher, more enlightened (or more necessary, etc.) value because it is for whatever purpose they ascribe to it. No longer are you allowed to resort to the subjective decision making process that so well fulfilled you in the earlier episode. The coercive group arrives at the arbitrary (meaning not guided by profit and loss) decision to enforce the purchase of oranges on everybody. It assumes everyone values oranges higher than apples. They are declared objectively more valuable.
That process is what happens every time we fund a government project. As a libertarian minarchist, I have to concede that even my endorsement of a central government controlling the police force is an expression of the objective value fallacy because the taxation required to finance it could have been used more appropriately were I to use it subjectively.
- Mattheus
It strikes me that one could make such a crude argument for the same lack of subjective valuation in BP as well. And, conversely, one could make the same sort of argument that Daniel does for the presence of subjective valuation in government... indeed, that's what you're doing in citing market impulses.
ReplyDeleteIt's confusing to me why mystification and metaphysical appeals to objective valuation is the rule of thumb when explaining government, while reduction and subjective valuation is the rule of thumb when explaining non-government entities.
Mattheus - Your understanding of subjective valuation and the role of the price mechanism is the same as mine, except that I would add that these decisions are made on the margin (so, for example, an apple may actually be subjectively valued higher than an orange, but if the marginal apple is valued less than the marginal organge, you'll spend the marginal dollar on the orange... this doesn't contradict anything you said, it just refines it).
ReplyDeleteThat all is undertood and virtually universally agreed upon among economists. Again, though, I don't see how that necessitates the objective valuation by government. The difference with government, it seems to me, isn't that it doesn't use subjective valuation - it's that it doesn't use prices.
First, nobody in government ever claims that its projects are a higher priority for everyone. The claim is ludicrous on its face. The idea is that from a subjective social welfare perspective (which is simply the aggregation of the subjective private welfare perspective we both agreed on earlier), a project will maximize some utilitarian or prioritarian conception of the social welfare.
What the state lacks, of course, is the clarity of the price mechanism in maximizing social welfare. Which is why I said it uses electoral, political, and bureaucratic mechanisms (often imperfectly) in the same way that the market uses the price mechanism. But the main point is, both are applied to subjective valuations. There is no use of objective valuation to speak of, largely for the reason that you raise - objective valuation doesn't make much sense and nobody thinks in those terms. Value is subjective.
Evan,
ReplyDeleteBP does not suffer from a lack of subjective valuation. That doesn't really make sense. Subjective valuation is an explanation; its a theory of prices, production, and choices. Clearly, BP makes its decisions based on profit and the choices it chooses to make are made subjectively based on the information BP owns.
Government spending necessarily implies objective use value because the taxation required to finance its decisions tell the taxpayers "I don't care what you could have spend this money on, this is going to project X!" They assume that Project X is objectively a better use of the money than the millions of goods individuals would have bought otherwise.
Why is it confusing to you? We all make decisions on a cost-benefit analysis. According to my subjective process, responding to your comment was worth more than anything else I could have been doing with that time. Private individuals always make decisions subjectively.
As far as the subjective decisions made in government, the word you're looking for is arbitrary, not subjective. Government projects do not rely on profit and loss so they have no way to really KNOW which project is profitable and which isn't (which is just another way of saying they have no way to know what the consumers want). They always operate in the dark and so any decision they make is an arbitrary stab.
- Mattheus
Evan perhaps unknowningly touches on the work of recent Nobel laureate Oliver Williamson who, rather than highlight voluntary vs. involuntary action that we normally think of, focused on market action vs. hierarchy. Within corporations, resources are allocated hierarchically. We can think of this as a "voluntary hierarchy", whereas government is something of an "involuntary hierarchy". But I think he's right to note that the allocation decisions within BP and the allocation decisions by government are very similar: they both use non-market means to make use of subjective valuations. This is in contrast with the market, where the price mechanism is what utilizes information from subjective valuations.
ReplyDeleteThis is why I cringe every time someone cites Ostrom and Williamson to talk about why markets are so great. Yes, markets ARE great... but Ostrom and Williamson's work EXPLICITLY pulled away from markets and noted non-market allocation strategies.
"The difference with government, it seems to me, isn't that it doesn't use subjective valuation - it's that it doesn't use prices."
ReplyDeleteExactly. Without prices, how can they justify working on any project or building any infrastructure? How can they make any decision at all? Without prices (and profits), there is no way for a government to make an economical choice among trillions of alternatives. Instead, they are made according to the whim of bureaucrats.
Finally, the difference between private action and government action is that government action requires taxation. If I were to tell you that I set the tax rate for my neighborhood, and for all the years I've lived here, it's been 0% - that is, nobody has paid me any money. If I raise it to 5% to pay for a project I want to undergo, I am essentially telling the resident population that the money they could have spent on other things was diverted to my cause because my cause was worth it. I am implicitly telling them my project was valued higher than their project. That is an application of objective use value.
Henry Hazlitt does a wonderful job in explaining this, although he doesn't use the same terminology I do. Have you read Economics In One Lesson?
- Mattheus
"they both use non-market means to make use of subjective valuations."
ReplyDeleteThey do not. Decisions made by BP are made in light of pursuing profit. By what process are decisions made by government?
- Mattheus
RE: "Exactly. Without prices, how can they justify working on any project or building any infrastructure? How can they make any decision at all?"
ReplyDeleteHow do you allocate things within your own family? How do churches and community centers allocate resources? How do non-profits make decisions without prices?
We have allocated resources based on subjective valuation without prices for a long time - I wouldn't worry too much about it. The price mechanism has some absolutely incredible advantages - but it's not the only game in town.
RE: "Instead, they are made according to the whim of bureaucrats."
First, even when bureaucrats make decisions, it is not a "whim". Even then, this is hyperbolic, Mattheus. The most important decisions the government makes are not made by bureaucrats - bureaucrats usually just implement it. Implement it imperfectly? Yes. But not whimsically.
RE: "If I raise it to 5% to pay for a project I want to undergo, I am essentially telling the resident population that the money they could have spent on other things was diverted to my cause because my cause was worth it."
You're describing an autocracy which isn't really relevant to what we have in the United States.
RE: "Henry Hazlitt does a wonderful job in explaining this, although he doesn't use the same terminology I do. Have you read Economics In One Lesson?"
I have not.
RE: "Decisions made by BP are made in light of pursuing profit. By what process are decisions made by government?"
Yes, but now you're confusing the profit motive with the price mechanism. They are not the same thing, Mattheus.
I am no economist, and I imagine that my above comment was rather riddled with confusion (and any allusion to Williamson was indeed unknowing!)... but my point, I suppose, is the same as Daniel's w.r.t. electoral, political, and bureaucratic processes being the basis for valuation rather than prices. I don't (surely from my tender, ignorant stance as a non-economist, or at least as a non-libertarian) understand why such processes can't function in a way analogous to prices for the determination of value? Why is this arbitrary?
ReplyDeleteEvan and Mattheus - I have some clarifying thoughts I think I'll post on tomorrow morning.
ReplyDeleteHave a good night - see you all later.
"You're describing an autocracy which isn't really relevant to what we have in the United States."
ReplyDeleteThen substitute a democratic Congress. The form of government isn't relevant. What is relevant is that when decisions are made by any government, they are imposed upon the entire populace (or at least the tax paying populace) thus assuming the government project is more valuable than the individual projects the citizens would have other wise undergone.
But who says? The money that is taken from me to pay for Social Security could be utilized much more efficiently from my own perspective, but I'm not allowed to follow my judgment - I have to succumb to the notion that this government project is more valuable than my own, when it isn't.
See you tomorrow Daniel.
- Mattheus