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Friday, May 14, 2010

Self-Regulation in the Corporate State: The BP Spill

Which system failed?

With modifications on May 18, 2010

With some 7,000 barrels of oil spilling into the Gulf of Mexico each day from BP’s exploded Deepwater Horizon well, offshore drilling and oil-industry regulation have returned to the front pages.

The familiar old trap is set: Do you want unfettered markets and oil spills or government regulation and safety?  The implied premise is that the oil industry operates in a free market. So, the argument goes, the only alternative is government regulation.

On first glance that story is plausible.

From USA Today:

The company that owns the offshore well spewing crude oil in the Gulf of Mexico and other major oil companies spearheaded a campaign to thwart a government plan to impose tighter regulations aimed at preventing similar disasters, according to government records. Tighter regulations would have required that drillers perform independent audits and hazard assessments designed to reduce accidents caused by human errors, but the federal Minerals Management Service (MMS) has so far not imposed the rules in the face of near unanimous opposition from oil companies. Oil executives — including BP, which leased the rig that exploded April 20 — argued that the industry had a solid environmental record and most companies had voluntarily adopted similar safeguards to protect against a major spill. They also said the new rules would have been too costly.

So: the MMS wanted to regulate, but the industry said it could regulate itself at lower cost, insisting it was a good steward of the environment. This is not to say that MMS was right and the companies wrong. For reasons provided below, government regulation is fatally flawed. Further, this is not just a simple matter of regulation. More fundamentally it’s a matter of ownership. The government has proclaimed itself the owner of the offshore positions where oil companies drill. In a free market those positions would be homesteaded and managed privately with full liability. In the absence of a free market and private property, built-in incentives that protect the public are diminished if not eliminated. Bureaucrats and “political capitalists” are not as reliable as companies facing bankruptcy in a fully freed market.

Observe: The New York Times reported, “Despite … repeated promises to reform, BP continues to lag other oil companies when it comes to safety, according to federal officials and industry analysts.” The Times said BP chief executive Tony Hayward “conceded that the company had problems when he took over three years ago. But he said he had instituted broad changes to improve safety….”

Why did BP have problems? The Times goes on: “Some analysts say the safety problems indicate that BP has not yet reined in the culture of risk that prevailed under Mr. Hayward’s predecessor, John Browne…. Mr. Browne set aggressive profit goals, and BP managers drastically cut costs to meet their quarterly targets. After the 2005 explosion in Texas City [killing 15 workers], investigators found that routine maintenance that might have averted the accident had been delayed because of pressure to reduce expenses.”

Another question can be asked: Has BP been too busy spending money to impress the government and the public with how “green” it is to look after safety adequately?

What we seem to have is a company that, in pursuit of short-term profits, was less than meticulous about safety (other people and their property, that is) while it and its industry effectively vetoed government safeguards that might have prevented the explosion that killed 11 workers and caused the damaging spill.

Some will defend BP in the name of the “free market” or minimize the event, protesting that the Obama administration’s remedial measures will “undermine our capitalist system.” Meanwhile, the “progressive” statists will declare that once again the free market has failed. The respective bases will be rallied.

Corporatist System

But BP’s defenders and statist critics both have it wrong. This is not the story of a well-meaning or negligent firm operating in the free market. Negligent or not, BP is a player in a corporatist system that for generations has featured a close relationship between government and major business firms. (It wouldn’t have surprised Adam Smith.) Prominent companies have always been influential at all levels of government — and no industry more so than oil, which has long been a top concern of the national policy elite, most particularly the foreign-policy establishment. When state and federal governments failed in the 1920s to put a lid on unruly competition and low prices through wellhead production quotas (prorationing), the oil companies turned to Franklin Roosevelt and the federal government, winning the cartelizing Petroleum Code, significant parts of which were revived after the National Recovery Administration was declared unconstitutional. In the 1950s, when cheap imports depressed prices, the national government imposed quotas on foreign oil. Venezuela was the chief target at the time. (In 1960 OPEC, a “cartel to confront a cartel,” was founded.) Republican or Democratic, energy policy is not made without oil industry input.

In this context there’s less to the contrast between government regulation and corporate self-regulation than meets the eye.  Self-regulation in a corporate state does not constitute the free market. When companies are sheltered in any substantial way from the competitive market’s disciplinary forces, incentives turn perverse. Moreover, “state capitalism” and the corporate form – with its agency problem – can produce the temptation to cut costs imprudently in order to make the next quarterly report look attractive to shareholders. “Putting profits before people” is a feature of state, or crony, capitalism not the free market.

Knowledge Problem

Those who see “tougher” government regulation as the answer are evading some formidable objections. First is the knowledge problem. Empowering regulators to prevent the next disaster tells us nothing about how they would know what to do without imposing costs that would dwarf any benefits.

Second is “regulatory capture.” Regulators and the industries they oversee develop mutually beneficial relationships that would appall those who idealize regulators as watchdogs. The rules that emerge from those relationships tend to foster more monopolistic industries.

It took the Deepwater Horizon tragedy to bring out the fact that a single federal agency, the Minerals Management Service, is “responsible for both policing the oil industry and acting as its partner in drilling activities,” writes the New York Times. “Decades of law and custom have joined government and the oil industry in the pursuit of petroleum and profit. The Minerals Management Service brings in an average of $13 billion a year. Under federal law, even in the case of a major accident, the company responsible for the oil well acts in concert with government in cleanup activities.”

The coziness between government and the oil industry is also apparent in the cap on liability for damages – a paltry $75 million — from offshore oil spills (not including cleanup costs). The interesting question is whether BP’s dubious conduct would have been different without the cap. Hayward, the Wall Street Journal reports, “admitted the U.K.-based oil giant had not had the technology available to stop the leak, and said in hindsight it was ‘probably true’ that BP should have done more to prepare for an emergency of this kind.” Transocean, owner and operator of the rig, is petitioning to limit its own liability to $26.7 million. (Moral hazard matters, but the story is complicated. Oil spills have been decreasing, and no energy development is without its risks.)

The free market will undoubtedly take the rap — but it’s an unjust rap. According to Reuters, “Like BP, both Transocean … and Halliburton, a contractor, also pumped money into the campaign war chests of senators who sit on the Energy and Natural Resources Committee and the Environment and Public Works Committee.”

I have a feeling the companies weren’t buying repeal of corporate favors.

  • Sheldon Richman is the former editor of The Freeman and a contributor to The Concise Encyclopedia of Economics. He is the author of Separating School and State: How to Liberate America's Families and thousands of articles.