Last week’s chemical spill that contaminated water supplies in West Virginia hammers home the fact that in a modern nation of about 315 million people, the economic activities of nearly anyone — no matter how beneficial overall — usually impose some economic harm on others.
This is not necessarily a result of any evil intent.
It is simply impossible to produce the goods and services needed to meet a population’s needs and wants without creating “external costs.” This is how economists describe situations in which either the production or the consumption of a good or a service harms a third party not involved in either the production or the use of the product.
External costs arise in every society and are managed in a variety of ways. But not all these methods are equally efficient in economic terms, and the fairness of these alternatives varies widely. However, societies that competently manage such externalities have a higher standard of living than those who do not.
The tragedy of contemporary U.S. politics is that, just as with tax reform, there are better ways to manage externalities than we do now, and these ought to be supported by both political parties. Economists across the political spectrum and across schools of thought within their disciplines agree on this. The hitch comes in everyday politics, with politicians in both parties trapped by demagogues on their own side of the aisle.
All that said, dealing with externalities isn’t easy in the real world. What we are throwing away right now is an achievable set of better outcomes — not perfect ones.
Consider the West Virginia spill. The reported quantity, some 7,500 gallons, or about the amount hauled by a semi-truck tanker, is not large compared with the quantities stored on the site. Although the spilled chemical, MCHM, is hazardous, it is not highly dangerous and is used in large quantities to wash coal.
“Command and control regulation” dominates U.S. policy at state and local levels. Producing, transporting, storing and using hazardous materials is regulated by the Environmental Protection Agency under the terms of the 1976 Toxic Substances Control Act and by state governments.
There are requirements for spill-containment measures at storage sites like this one and for prompt reporting of any spills that do occur. But there are about 85,000 kinds of industrial chemicals in use and possibly hundreds of thousands of sites where they are present in some quantity, large or small.
This particular site had not been inspected for more than two decades, and no one noted the inadequacy of its spill-containment structure. No one checked if spill-response plans were ready. And its managers probably had good reason to believe that ignoring the reporting requirement on a small spill would not result in severe punishment.
So the whole mess may be used as an example of the failures of existing regulations. In theory, there were measures in place to prevent what happened.
This is not necessarily due to any incompetence or sloth on the part of regulators. Regulatory budgets are limited at federal and state levels. Yes, outlays for the EPA and for state agencies may sound large in absolute terms, but they are small relative to the work that would have to be done to exhaustively oversee all facilities. Letting decades pass between inspections may represent an efficient use of available appropriated funds. There probably are bigger, or more dangerous, fish to fry.
Moreover, building containment structures and going through the bureaucratic toil of preparing response plans are precisely the sorts of things that business owners, large and small, see as unnecessary costs imposed by mismanaged bureaucracies.
Just as there is considerable opposition by many employers to zealous enforcement of immigration laws, there is considerable opposition by businesses to zealous enforcement of anti-pollution laws, particularly when it involves protecting against infrequent contingencies such spills rather than ongoing emission of some pollutant as a part of daily operations.
If you think writing regulations is the best way to deal with externalities, the response to this spill is to write even more detailed rules and hire more inspectors.
But there are alternatives.
Some with a libertarian bent follow Nobel laureate Ronald Coase’s admonition to define property rights strictly, then let violations be settled in civil court. In other words, sue the bastards.
People clearly have the right to use water that has not had a hazardous chemical dumped into it. And the company, Freedom Enterprises, clearly has a legal liability for damages it caused. It will be sued.
But with the damage this small spill caused extending to one-sixth of West Virginia’s population and hundreds of businesses, it is likely that the company’s insurance will be inadequate to cover all those claims.
The company probably will file for bankruptcy, just as the Montreal, Maine and Atlantic rail line did after one of its trains burned up much of Lac Megantic, Quebec, in July. Any net worth available from the bankruptcy will fall short of meeting claims.
So a system of externality controls based on liability suits also needs to require insurance coverage high enough to cover any eventual judgments. But what that will be is not easy to determine. And who is going to ensure that this is done? Government inspectors?
Yes, insurance companies have an incentive to hire their own inspectors to assess risk at businesses seeking coverage. And they can force their customers to take action to reduce risk as a condition of obtaining a policy or as a way to achieve lower premiums. That is how we got the National Electrical Code, originally promulgated by the National Fire Protection Association, a private group.
But the high administrative costs of inspecting small installations apply to private firms just as to regulatory agencies. It is expensive to send an inspector to evaluate the specific risks at every small chemical storage site that seeks insurance. So the insurer may offer flat rates for broad classes of businesses, with no incentive for safer facilities or operations by specific companies. The poorly managed ones get a free ride thanks to their competitors who do a better job of environmental protection and safety.
There is more to be said about controlling external costs. But that will have to wait for a subsequent column.