Tapping the Well of Freedom

Tapping the Well of Freedom

June 07, 2010
Originally published in The National Review Online

When the Deepwater Horizon first started gushing oil, many considered the incident an example of private enterprise having no regard for the environment. However, it is becoming clear that government was involved from the start, is in charge now (as President Obama himself tells us), and cannot do much about the problem. So is there any way to address this?

Yes. We need to move away from the crony corporatism that has characterized much of the nation’s energy sector during the last century or so. It would be foolish to promise that market-based reforms would prevent another disaster, but they would be more effective than yet more meaningless bureaucracy. There are several reasons for this.

First, the existing government regulations have been counterproductive. They pushed energy companies offshore — miles and miles offshore. America is a resource-rich country, and unlike other resource-rich countries, we have locked up most of our resources so we can’t use them. While the Gulf of Mexico holds about 44 billion barrels of oil in undiscovered reserves, according to Minerals Management Service (MMS) estimates, the continental U.S. has slightly more onshore. The difference is that we are allowed to explore and extract the offshore reserves, while it is extremely difficult to get permission to do the same on land. As a result, most exploration takes place offshore, where the consequences of a spill are so much greater.

Various restrictions also push the oil industry into deep waters, where it is so much more difficult to fix a blowout than in shallow coastal waters, where there is still plenty of oil. Allowing more onshore and shallow-water drilling would lessen the chances of an accident like this considerably.

Second, government and business corrupt each other. BP told the MMS that it could handle an event like this with ease with proven technology. The MMS took BP’s word for it. Now, as they attempt ad-hoc fixes, it is clear that both BP and the federal government were unprepared for such an event. Both are at fault.

As experience shows, when regulators and representatives from a regulated industry have day-to-day contact, they grow into a cozy relationship. This sort of state corporatism, where legislators, regulators, and industry become almost symbiotic, is hugely damaging to the polity and the economy.

The best way to end this relationship is for industry to no longer see government as a source of favors and privileges. The way to do this is by cutting back those rules that entice both entities into this relationship. For example, due to antitrust rules, companies seek to win favor with government regulators, rent-seeking industries get more income from government than from ordinary customers, companies divert important resources to support hortatory government policy (“Beyond Petroleum”), and so on. Dismantling the corporate state, so that corporate discipline comes from competition rather than from regulators’ largesse, is the best way to end this coziness. It will also lower barriers to entry and spur innovation. All of these effects will provide greater protections for consumers and the environment.

Third, those involved in potentially devastating activities must bear the costs of their failures. After the Exxon Valdez spill, legislators and industry got together and agreed to a cap on damages in exchange for an increase in tax payments. Generally, damage caps create what is known as “moral hazard,” lessening the consequences — and thus increasing the likelihood — of a potentially damaging act. There are good reasons for having shareholders limited in their liability, but there are few convincing reasons to shield corporations the same way. If ending that deal means lower tax revenues, so be it.

Finally, the Gulf has become a huge “tragedy of the commons.” No one stood ready to protect the sea — certainly not the federal government — because no one owned it. Yet there are many ways to invest the ocean with property rights. Individuals could own oceanic resources such as reefs and even shares in fish stocks. Not only would such property rights give owners a real incentive to ensure that these resources grow and develop, they give the owners an incentive to defend those rights. Thus, if a fishery or reef is threatened by a risky oil installation, the owner could take legal action to ensure that the risk is lessened. At the moment, that job is the government’s, and the government doesn’t do it. Having those most affected account for these risks would do much to internalize the external costs of oil drilling.

Some of these reforms might make oil drilling more expensive, while others would reduce its cost. But taken together, they would rebalance the oil industry’s priorities to make it more responsive to its neighbors and less invested in currying government favor.