Commentary

The Gulf Spill and Compensation for Disaster Victims

When man-made or natural disasters strike, do the victims deserve compensation? Most people assume the answer is yes, but the case for compensation is not always clear.

In many instances, the threat of disaster is widely understood, so property values in these areas are lower by the amount of expected damages. Crop land in flood plains, for example, is cheaper than similar land elsewhere, as is beachfront property at risk from offshore drilling. So property owners in at-risk areas get a financial bonus — cheap land — in years when disasters do not occur.

Compensation for victims when disasters do happen, therefore, is double-payment. Owners of these properties do suffer the uncertainty associated with disaster risk, but those who wish to avoid this risk can buy private insurance.

Thus, fairness does not necessarily dictate compensation; in fact, it argues against it. In addition, compensation can reduce private incentives to avoid disaster. While no part of the country is entirely immune from these risks, some places — flood plains, and coastal areas, in particular — are far riskier than others. If property owners expect an outside party to mitigate their losses, they will live or locate their businesses too often in these areas.

In some instances, of course, no one can reasonably forecast disasters, and in those instances compensation makes sense. The Gulf spill is plausibly one such instance. Many people realized that spills could happen, but few appear to have recognized that a disaster of the current magnitude was possible. In addition, the federal government gave British Petroleum permission to drill and claimed to have insured safety with appropriate regulation. So, the case for compensating the victims is reasonable.

Assuming the Gulf victims do receive compensation, who should pay? British Petroleum, as much as possible. This makes sense from the perspective of fairness, since BP’s actions caused the damage. And, holding BP liable is one way to reduce the frequency of future incidents. Liability does not prevent all accidents, as the current situation illustrates, but it plausibly does better than regulation. Other oil companies are watching BP’s stock price plummet, which should make them more cautious about their own operations, and regulations are difficult to enforce (again, as the current situation illustrates).

If BP’s net worth is not sufficient to compensate all victims, should taxpayers chip in? That is a more difficult question. But just as government contributed to the magnitude of the Katrina disaster by encouraging people to build homes below sea level in an area with frequent hurricanes, the federal government bears some responsibility for the Gulf spill because of its failure to regulate properly. So a taxpayer contribution, if BP becomes bankrupt, is defensible.

Jeffrey Miron is Senior Lecturer in Economics and Director of Undergraduate Studies at Harvard University, and a Senior Fellow at the Cato Institute.