How Economics Affect the Oil Spill Blame Game

BY Paul Solman  June 1, 2010 at 1:00 PM EDT

The underwater gusher in the Gulf has critics pointing fingers every which way. British Petroleum is the obvious first choice, but Obama administration officials are another easy target: It happened on their watch. Or you can blame the predecessor Bush team and its devotion to deregulation, not to mention the “Drill, Baby, Drill” movement. And at a benefit concert the other day, I heard comedian Lewis Black add Halliburton for its role in “cementing” the well just before it blew.

As with so many disasters, there’s surely blame enough to feed multitudes; a cast of would-be culprits worthy of the Orient Express. Yet larger laws of economics are also at work.

You might call one of them the Mastitis Principle. It seems that when you milk a herd of dairy cows, if a certain percentage of them don’t develop mastitis, you’re not maximizing your yield. You push the envelope, that is, to squeeze out the maximum profit, even after taking the cost of teat inflammation into account.

I once heard the same principle put differently by economist Roger Brinner: If you never miss a plane, you’re getting to the airport too early; if you never get a speeding ticket, you’re driving too slow.

Economic decision-making is to weigh costs against benefits, as best you can ascertain either. A competitive system forces its participants to shave those costs to the minimum. Indeed, that’s the justification for a competitive system.

But there’s always the possibility of error. Risks are forever being taken. The completely safe, never-fails-no-matter-what airplane would not be economically viable. Speed limits of 25 mph would cut auto accidents drastically. And so on.

There is another relevant principle of economics: “diminishing returns,” which means getting less out of the next unit than out of the last one. The fifth Kit-Kat bar is a lot less appealing than the first, no matter how much you like chocolate. In the context of fossil fuels, we’ve drilled the easy-to-find oil long ago. So we go deeper, migrate off-shore, plunge into murkier and murkier waters.

Combine diminishing returns with the strivings of a competitive system, throw in the indeterminacy of all human systems (especially as the world becomes more complex*), and a Gulf oil spill shouldn’t come as much of a shock. Not even one that, in retrospect, seems so easily avoidable.

* The esteemed blogger, investor and Marcel Proust buff Michael Lewitt has a fascinating disquisition on the increasing complexity of modern life in his latest online newsletter. I hope he won’t mind if I quote one paragraph in full:

“In 2000, Thomas Homer-Dixon, a professor at the University of Toronto, published a truly original and brilliant book entitled The Ingenuity Gap, in which he argued that “the complexity, unpredictability, and pace of events in our world, and the severity of global environmental stress, are soaring.” Professor Homer-Dixon went on to argue that “[i]f our societies are to manage their affairs and improve their well-being they will need more ingenuity – that is, more ideas for solving their technical and social problems. But societies, whether rich or poor, can’t always supply the ingenuity they need at the right time and places. As a result, some face an ingenuity gap: a shortfall between their rapidly rising need for ingenuity and their inadequate supply.”3 Drilling for oil more than 5,000 feet below sea-level is a perfect example of our reach exceeding our grasp. Doing so without taking steps to address the worst-case scenario that is now washing up on the beaches of the Gulf Coast is not only tragic but inexcusable.”

P.S.: Lewitt has a new book out which I haven’t read, but certainly intend to: The Death of Capital.

This post is cross-posted from Paul Solman’s Making Sen$e page.