$8 billion – this is the likely cost of the BP oil leak, which spilled 206 million gallons of oil into the Gulf of Mexico. Whilst the oil leak has been stopped for some time, there were ongoing concerns that the leak would re-appear due to the underwater pressure. The cost of stopping the leak has been substantial, but BP will face further costs, as the company begins to pay out compensation.
$20 billion is the compensation that residents of the Gulf of Mexico will receive. Further to this, BP has said that it will invest more money in promoting the tourism industry there, which has suffered from the oil spill. However, what about the fishing industry? Although compensation will be paid for the losses incurred, will this continue in the long term? The oil may cause a loss in productivity in certain populations of sea-life. How will this impact us? If certain fish became scarcer, then their price will rise accordingly, whether you purchase the fish at a shop or have it as a meal in a restaurant. To make matters worse, the hurricane season has arrived in the affected areas, which will make the clean-up effort even harder.
As BP’s share price has fallen, individuals have suffered from lower dividends. Jupiter Income Trust had almost 10% of their portfolio invested in BP, which largely explains the 9 per cent drop in their payout.
Articles
BP oil well ‘poses no further risk’, says Allen BBC News (5/9/10)
BP oil spill fallout hits Jupiter dividend Mail Online, Richard Dyson (4/9/10)
Gulf Oil leak: biggest ever, but how bad? BBC News, Richard Black (3/8/10)
BP oil spill didn’t hit tourism too hard Jabber Lounge, Gloria Rand (5/9/10)
BP oil victims face strings on $20 billion oil fund Telegraph, Rowena Mason (20/8/10)
BP share price data
BP historical share prices Yahoo Finance
BP share price chart Interactive Investor
Questions
- Which industries have been affected by the oil leak? Don’t think too close to home – look at the wider picture.
- Is the oil spill an example of a negative externality? Can it be illustrated on a diagram and, if so, how?
- What has happened to BP’s share price since the beginning of the oil spill? Put this on to a graph to trace the trend. Try to explain the changes in the share price using a demand and supply diagram.
- How would BP have calculated the compensation to be paid to residents of the Gulf of Mexico? Would cost–benefit analysis have been involved?
Skin cancer is on the increase in the UK. Calls are thus being made by both retailers and cancer charities for a cut in VAT on sun cream.
At present the VAT rate on sun cream in the UK is the standard rate of 17.5%, which is due to increase to 20% in January 2011. But would cutting the rate to 5%, as is being proposed, be effective in cutting skin cancer rates? What information would you, as an economist, need to assess this claim?
Articles
Government urged to cut VAT on sun cream amid skin cancer fears Guardian, Rebecca Smithers (27/7/10)
Brits Get Burned By Vat Rise On Suncream PRLog (7/7/10)
Why we still think bronzing is tan-tastic Irish Independent, Susan Daly (27/7/10)
Evidence on sun creams
Sunscreen Wikipedia
Sun creams Cancer Research UK
Questions
- What would determine the incidence of a cut in VAT on sun creams between consumers and retailiers?
- If there were a 50:50 incidence of a VAT cut between consumers and retailers and the VAT was cut from 17.5% to 5%, what percentage fall in the retail price would you expect?
- Assume that the price elasticity of demand for sun cream is –1 and price elasticity of supply is +1, how much would sales of sun cream rise if the VAT rate fell from 17.5% to 5%? Are these realistic values for the price elasticity of demand and supply?
- Under what circumstances may promoting the use of sun creams encourage the development of skin cancer?
- Are people being rational if they choose to expose themselves to the sun for long periods in order to receive a ‘fashionable’ tan? How are time preference rates (personal discount rates) relevant here?
- What market failures are involved in the tanning industry? If the use of sunbeds contributes towards skin cancer, should they be banned?
Whenever a sporting event comes around, there is mad frenzy from countries across the world to enter a bid – this was entirely evident with the 2018 World Cup bids! And it’s not really surprising with the attention that the World Cup and the Olympics receive. Hundreds of thousands of spectators, billions of pounds worth of investment in infrastructure, thousands of jobs created and television deals in every country of the world.
However, why is it that every sporting event of this magnitude fails to come in on budget? The costs are always underestimated. The Athens Olympics was supposed to cost £1.5 billion, but ended up costing over 10 times as much. It is also suggested that it may have played a part in the current Greek financial crisis. The 2002 Japanese World Cup had little effect on the struggling Japanese economy. The London 2012 Olympics was estimated to cost £2.35 billion, but suggestions say it will now cost taxpayers some £20 billion, although budget cuts are inevitable. What about South Africa? Costs of $300 million were estimated for stadiums and infrastructure, with a boost to GDP of $2.9 billion. However, $300 million was not even sufficient to renovate Soccer City (where the first and final game will be held). Add on to this over $1 billion to rebuild the rest of the stadiums and then take into account rising inflation, which has caused inevitable cost over-runs.
On top of this, every country says ‘look at the benefits’ when they enter their bid. However, economists have suggested that there are actually minimal employment benefits in the long term. Obviously there is substantial investment in infrastructure leading up to the World Cup, which will benefit locals, but the overall boost to GDP is not expected to be significant. A similar thing can be seen with the London Olympics. In the study by PriceWaterhouseCoopers in 2005, there were estimates of a direct gain to London’s GDP of £5900 million between 2005 and 2016. However, UK GDP would only rise by £1936 million. Some of the costly stadiums that were built for the Portuguese European Championships were simply knocked down after the event.
So, what can we expect from South Africa? There have been many criticisms of poor ticket sales and that this World Cup is only for the rich. Street sellers have been booted out of their normal selling ground, as they do not have the necessary permits to sell and cannot afford to buy the permits anyway. Whilst transport has been improved, there are still concerns about the distance that has to be travelled between stadiums and this has put off many potential spectators. However, the Super 14 Southern Hemisphere Rugby tournament was staged in South Africa, with the final at the end of May and the event was successful. Transport worked perfectly, spectators arrived by the thousand and it is hoped that this is a positive omen for the fast approaching World Cup!
Articles
Saved by the Ball Times Online (5/6/10)
South Africa World Cup just for the rich BBC News (10/5/10)
Footing South Africa’s World Cup bill BBC News (4/6/10)
Will South Africa reap rewards from hosting the tournament? Peace FM Online (5/6/10)
Did 2004 Olympics spark Greek financial crisis The Associated Press (4/6/10)
Cost of 2012 Olympic pool triples BBC News (8/4/08)
Watchdog attcks ‘astonishing’ £5bn rise in cost of 2012 games Times Online (22/4/08)
South Africa World Cup costs above budget Reuters (13/8/08)
Reports and papers
Olympic game impact Study PriceWaterhouseCoopers December 2005
A Cost-Benefit Analysis of an Olympic Games Queen’s Economics Department Working Paper No. 1097, Darren McHugh, Queen’s University (Canada) (August 2006)
Questions
- Why do costs tend to be under-estimated and benefits over-estimated?
- What technique could be used to determine whether a sporting event, such as the World Cup, should go ahead? Can you apply this to the London 2012 Olympics?
- How is the multiplier effect relevant to a sporting event, such as the World Cup or the 2012 Olympics?
- To what extent do you think the Athens Olympics contributed to the Greek Financial Crisis? Could the same thing happen with London?
- What might happen to the South African exchange rate during the South African World cup and the sterling exchange rate during the London 2012 Olympics?
- How has inflation affected the budget of South Africa?
As the news from the Gulf of Mexico goes from very bad to even worse, so BP is increasingly coming under the international spotlight for its approach to risk management and safety. Was it sufficiently cautious? Could the accident on April 20 that killed 11 men and has been gushing some 800,000 gallons per day of crude oil into the sea have been averted? When the consequences of a pipe rupture are so catastrophic, is ‘catastrophic risk’ appropriately priced? As Tony Hayward, BP’s Chief Executive, told the Financial Times (see links below): “It was ‘an entirely fair criticism’ to say the company had not been fully prepared for a deep-water oil leak.”
One insight into BP’s approach to risk has come to light with the leaking of a 2002 memo from BP on how human life ought to be valued in any cost–benefit analysis of a project. As the Chicagoist summarises the memo:
A two page document prepared by risk managers in 2002 titled “Cost benefit analysis of three little pigs” shows the type of thinking BP put into risk assessment. The memo shows, in cartoonish fashion, that blast resistant trailers for BP’s workers weren’t necessary, because the cost was too high. In 2005, a refinery caught fire, killing 15 and injuring 170 people.
So how should catastrophic risk be taken into account? What does a company do when the probability of a disaster is extremely low and yet the costs of such a disaster, were it to occur, are extremely high?
BP’s Shocking Memo The Daily Beast, Rick Outzen (25/5/10)
Old BP document calculates worth of human life with “Three Little Pigs” diagram Yahoo News, Brett Michael Dykes (25/5/10)
Industry can cut accident risks, says BP chief Financial Times, Ed Crooks and Edward Luce (2/6/10)
BP ‘not prepared’ for deep-water spill Financial Times, Ed Crooks (2/6/10)
The BP Oil Spill’s Lessons for Regulation Project Syndicate, Kenneth Rogoff (1/6/10)
US oil firms ‘unprepared’ for major offshore disaster BBC News (15/6/10)
Questions
- What is meant by catastrophic risk?
- Why is it difficult to put an accurate valuation on outcomes with a very low probability of occurrence?
- Explain the table entitled “Cost benefit analysis of three little pigs” in the Rick Outzen blog.
- How should human life be valued?
- What value should be put on a serious injury (of a particular type)?
- Should BP (or any other company, for that matter) ever conduct operations that risk human life? Explain your answer.
- On what basis should BP have decided whether or not to install a $500,000 acoustic trigger that could have shut off the well when the blowout protector failed?
- How is the existence of environmental externalities relevant to BP’s decisions on safety?
Labour’s Chancellor, Alistair Darling, delivered his last budget on the 24th March 2010. However, with the new Coalition government planning to make more substantial cuts and with George Osborne and other ministers claiming to find ‘black holes’ in the budgets left by Labour, an emergency budget will take place on the 22nd June 2010. The Coalition government has agreed to make £6 billion of spending cuts in the current year in a bid to reduce the UK’s substantial budget deficit, which stands at nearly 12% of GDP. Vince Cable told the Times:
I fear that a lot of bad news about the public finances has been hidden and stored up for the new government. The skeletons are starting to fall out of the cupboard.
There are plans to reform capital gains tax, possibly increase VAT to 20% and remove tax credits from some middle-income families. In Alistair Darling’s budget, it was middle-income families who were among the ‘losers’, with tax rises of around £19 billion, and it looks as though middle-income families may be hit again. Throughout the election all parties pledged to continue to help the poorest families, but there appears to be a lot of uncertainty ahead for middle-income families. They are likely to face reduced benefits and higher taxes as the Coalition government tackles the £163 billion deficit.
Despite critics of spending cuts arguing that it could cause a double-dip recession, the government is confident that cutting spending now is the right thing to do. As Osborne told GMTV:
I am pretty clear that the advice from the Governor of the Bank of England was that [cutting spending now] was a sensible thing to do, and if there is waste in Government that people at home are paying for with their taxes, let’s start tackling that now.
Chancellor launches audit of government spending Independent, Andrew Woodcock (17/5/10)
Osborne to give details of £6bn spending cuts next week (including video) BBC News (17/5/10)
Savings cuts to ‘hit middle class families’ BBC News (15/5/10)
Osborne to deliver emergency budget on June 22nd Times Online, Susan Thompson (17/5/10)
David Cameron declares war on public sector pay Telegraph, Rosa Prince (16/5/10)
All eyes on the emergency Budget Financial Times, Matthew Vincent (14/5/10)
Tax rises likely under Coaliation government, says Institute of Fiscal Studies Telegraph, Edmund Conway (13/5/10)
Questions
- What will be the likely impact on middle-income families if proposed spending cuts go ahead? How might this affect the recovery?
- What are the arguments for a) cutting spending now and b) cutting spending later?
- In the future, the Coalition government plans to limit bonus payments. How might this policy affect jobs and recruitment?
- What is the likely impact of the future increase in personal tax allowance? Who will it benefit the most?
- How are the proposals for corporation tax and capital gains tax likely to affect the economic recovery?
- Is a rise in VAT a good policy? Who will it affect the most? Will it reduce consumption and hence aggregate demand or is it likely simply to raise tax revenue? (Hint: Think about the type of tax that VAT is.)