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Tuesday, September 28, 2010

 

Incentives

The fundamental axiom of Mancur Olson’s The Logic of Collective Action is that people act with a purpose. People will act when it is in their self-interest to become involved. Large groups that do not hold power through the application of government force have found that they can gain members by offering selective incentives. People respond to all sorts of incentives: both positive and negative. The government like any other large group can create incentives to motivate people to act. For example, I abide by the speed limit to avoid the price of being caught and fined. However, incorrect incentives can have unintended consequences.

BP and the Federal government are currently discussing to what extent BP should be held liable for its role in the recent oil spill. The debate is over whether BP should be considered negligent or not. It is in BP’s interest to avoid being considered grossly negligent because under the Clean Water Act alone the difference between a mistake and gross negligence is over 15 billion dollars. The various levels of government would like to see BP pay the higher fine in order dilute the cost of the clean up the government will have to bear. If BP and the involved members of government cannot reach a compromise the case will go to court. The main incentives on the two sides are at odds, but the government has an additional incentive: If the matter can be decided outside of court the repairs can be started sooner which would please constituents. Whether or not a decision is reached quickly will depend on how the government leaders involved value the two incentives. As Olson points out the minor players in any organization, in this case local government officials, have little actual power because those with the most to gain, the involved members of the Federal government, will look to their own interests first.

But can the government truly say that BP was negligent? After all if it seems that BP was negligent it is surely because the government provided incentives that led BP to act as it did. The limited liability policy BP was drilling under in the gulf meant that BP knew it would not be held accountable for the entire cost of any spill. It is therefore in the managers of BP’s interest to provide spill protection until the marginal cost of spill protection is equal to the marginal benefit. It would have been negligent of BP to spend less than where marginal cost equals marginal benefit, but the government has no certain way of determining whether or not BP did this. By creating a limited liability policy the government reduced the costs of an oil spill to BP and therefore made it more likely that BP would do less to prevent one. The government has brought the current dilemma on itself through its own policy decisions. The members of the government failed to recognize the consequences of the incentives they were offering. In a similar manner an organization without force that offers unappealing selective incentives will not survive, because people will not join the group solely for a collective benefit.

Reference:
“BP, Feds Talk Over Spill Fines.” The Washington Times. 28 September 2010.

Comments:
You might add at least one additional consideration. When Congress and the President created the statute that limited liability the politicians knew how this would change incentives and modify the behavior of businesses drilling in the gulf. So, the government also requires permits to do various production activities, and government regulates what the business can and cannot do when drilling in the gulf. The idea must have been that government bureaus would be able, through regulation and permits, prevent an accident from ever happening. So, it seems to me that BP may have followed regulations and had the proper permits and the accident still happened. In a sense, not only has government limited liability, but it has also taken on the responsibility of telling businesses that doing this and that is the way to drill for oil in the gulf. Perhaps that suggests to you that it is appropriate to limit liability when, after all, government has decided it can determine how best to drill.
 
Thank you for the comment. I had not thought of the issue that way so it helped a lot.
 
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