Arnold Kling  

Nuclear Power Regulation

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Randall Parker recently sent an email to a few economics bloggers about nuclear power plant regulation. In particular, he asked whether we think that the Price-Anderson Act, which limits the liability of nuclear power plants for accidents, represents an excess subsidy for power plants.

I responded that I thought that the question was whether power plant safety was based on a proper balance of private and social costs. I remarked that I thought that a regulatory agency probably could create this balance more effectively than the tort system. Lynne Kiesling disagrees, and let me quote from her email.

I think Price-Anderson does distort energy markets (plural). I have skepticism about the ability of a central authority operating under both political and economic pressures to be able to assess relative risks better than decentralized agents who have financial incentives to get the assessments as close as possible. Political processes also tend to result in too much insurance at too high a price (note, for example, the recent FDA activities and the standard zero-tolerance stance that emanates from many regulatory institutions).

I also think the negatives of the moral hazard created by such implicit subsidies are pretty large. Neither tort systems nor regulatory institutions are well suited to relative risk assessment and risk management. But if we rely solely on rigid, static regulatory institutions implementing politically-motivated, rigid regulations, how are we going to discover/create other institutions that are better suited?

In fact, I become increasingly convinced that the development of the re-insurance industry reduces the argument for regulatory treatment of such discrete, large risk issues as nuclear. If SwissRe and their ilk could integrate nuclear into their reinsurance portfolios, that might give them some very interesting dimensions for risk spreading ...


At this point, let me bring the debate into the blog space. First of all, her case for the dynamism of markets vs. the rigidity of political institutions is exactly the one that I make in Learning Economics, so I can hardly disagree.

My comeback to Lynne would be that I like reinsurance, and I agree with all of her criticisms of regulation. I believe--or at least I am willing to stipulate--that if the task were estimating the true cost of a nuclear accident and providing the appropriate incentives for power plant owners to prevent such an accident, then the private sector might do it best.

However, the problem that the insurance companies have to solve is not estimating the true cost of a nuclear accident. The challenge is to estimate the cost that the tort system will assign to a nuclear accident.

The biggest risk within the context of the tort system may be that a small event or a non-event is used by trial lawyers as an excuse for a billion-dollar lawsuit. They find a few plaintiffs living near a nuke plant with horrible illnesse and parade them in front of a jury. The jury looks at these miserable people and at the deep pockets of the plant owners and the insurance companies. The result is a huge award. The fact that the illnesses have nothing to do with the nuclear power plant makes no difference.

I trust regulators less than markets. However, I trust jurors in class-actions suits less than regulators.

Watch this space for updates. I'm hoping Lynne will follow up.


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TRACKBACKS (3 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/238
The author at Knowledge Problem in a related article titled A QUICK NUCLEAR RISK FOLLOW UP TO ARNOLD writes:
    Lynne Kiesling On Friday Arnold Kling went public with a little email chat that he, Randall Parker and I were having about strategies for managing nuclear power plant risks. The Price-Anderson Act is a controversial piece of law that limits... [Tracked on April 18, 2005 9:21 AM]
COMMENTS (19 to date)
Jim Erlandson writes:

I look forward to Warren Buffett's response, speaking for the insurance industry. Perhaps John Edwards can do double duty representing both regulators and trial lawyers.

Bernard Yomtov writes:

I think you should review your co-blogger's post on the FDA. He cited a number of quotes from economists, and more than a few suggested that the tort system would serve as an effective constraint on misbehavior by the drug companies.

I take it you disagree.

Jon writes:

Arnold,
Isn't there an inconsistency here-- when they are in the market place people are rational optimizers; when they are in the jury room they are emotional putty who will put aside their self interest (lower electricity rates, lower insurance costs) in favor of sympathy for some unknown person?

It is also possible the tort system will assign too low a cost to a nuclear accident. Just as there are people get undeserved tort awards; there are people who deserve damages get less from a jury or settlement then they deserve.

Randy writes:

Nuclear power may be an industry that the government has inadvertantly nationalized via regulation.

No private energy producer with any sense will try to build a nuclear plant. But unless there is some major engineering breakthrough, or the discovery of a major new oil supply, we are going to need nuclear power in the next couple of decades.

Lawrance George Lux writes:

Arnold,
Your actual argument in not freeing nuclear power from liability by regulation, but need for Tort Reform. I agree to this element. I have long argued Liability Awards should be awarded in multiples of the Victims' annual income before the Incident, with a legal limition of the multiple factor Courts and Juries can use. Damage Awards must cover actual costs of correction.

The trouble with the argument of all Conservatives, and most Economists, lay in their desire to protect the Profits of Business. I will state a heresy here: In a Venture-Capitalist system, Investors must stand ready to lose their Investment Capital upon creation of Conditions which lead to the injury of Others. lgl

Randy writes:

Lawrance,

Re; "...desire to protect the Profits of Business"

Against rightful damage claims - no.
Against jealous thieves looking for deep pockets - yes.

asg writes:

Isn't there an inconsistency here-- when they are in the market place people are rational optimizers; when they are in the jury room they are emotional putty who will put aside their self interest (lower electricity rates, lower insurance costs) in favor of sympathy for some unknown person?

No inconsistency at all, primarily under the concentrated benefits/diffuse costs theory. Any psychic benefits from feeling nice (or avoiding feeling bad) about an injured plaintiff, regardless of responsibility for the injury, are pure benefits since the cost of enjoying them is entirely paid by someone else (the defendant). The individual costs in higher premiums etc. faced by jurors are likely to be small, or distant, or difficult to calculate, or perceived to be inappropriate considerations. Conversely, market costs are incurred in full by consumers.

Bernard Yomtov writes:

Going a step further than LGL, I would say you are advocating not tort reform, but abolition of the jury system. It is not only tort cases, after all, that deal with matters where jurors may reach emotional rather than purely rational decisions.

Of course, someone has to decide these things. Maybe Spock can help us recruit some Vulcans as unemotional jurors.

Rick Stewart writes:

'the argument of all Conservatives, and most Economists, lay in their desire to protect the Profits of Business.'

Huh?

As for improving jurors, how about requiring that the 'minimum' IQ for a juror be 100? I suspect the 'average' juror IQ at present is actually less than 100, and for that reason we get bogus results/rewards.

But, are the billion dollar verdicts really just outliers - cancelled out by far more negotiated out-of-court settlements and reasonable rewards, including false negatives (innocents)?

Does anyone have an 'actual' example of an industry 'ruined' or 'decimated' by excessive jury awards?

Arnold Kling writes:

It's true that I hate the jury system. I think that the average person is ignorant, and I have little confidence in juries.

But it is also true that I do not trust experts and officials. The jury system may be comparable to what Churchill said about democracy--the second worst solution to its problem, with all the others tied for worst.

Because I trust neither the masses nor the elites, I prefer limited government to the extent possible.

For nuclear power plants, I see a need for government, because of the huge externality. And this is a rare instance in which the concentration of risk is so high, and the assessment of the risk so technical, that I would rather put all of my eggs in a regulatory agency's basket than go with a decentralized approach.

dsquared writes:

Should the hypothesis not be at least considered that this is the market's way of telling us that we shouldn't be building nuclear power stations? You've got an industry here that doesn't generate electricity cheaply enough to pay for the cost of cleaning up plants, and one which creates risks that have to be socialised (and socialised in the worst way possible, to the victims via limited liability) because no private insurer will touch them at an economic premium.

Doesn't this rather suggest that, at current electricity prices, nuclear power plants are not a good use of resources and should not be built?

I also find the following statement curious:

The fact that the illnesses have nothing to do with the nuclear power plant makes no difference.

Are you suggesting that nuclear power plants don't make people ill?

Jon writes:

asg wrote that

Any psychic benefits from feeling nice (or avoiding feeling bad) about an injured plaintiff, regardless of responsibility for the injury, are pure benefits since the cost of enjoying them is entirely paid by someone else (the defendant).

If we are going declare pursuit "psychic benefits" as rational utility seeking behavior, then much of economic theory becomes the meaningless tautology such as "In a free market all players act to maximize their utility... the maximum utility is defined as the choice that people make absent of constraints".

I agree the cost to the individual is small, but it is greater than the measurable cost of ruling against the defendant.

Bob Knaus writes:

Many years ago I worked as a contractor at the Turkey Point nuclear plant in south Florida. There were 4 units at the site, 2 nuclear units and 2 oil-burning ("fossil") units. Each of them produced 600MW of power.

Visually, it seemed easy to tell which untis were environmentally damaging. The fossil ones cast a pall of smoke over Biscayne National Park. The nukes had a closed system of cooling canals where the endangered American Crocodile had better breeding success than in the nearby national sanctuary.

Which units made people ill? Numbers with references are hard to find, but you might try this one from Canada.

The operational economics of the units were interesting. Nuke fuel is very cheap compared to fossil. Nuke units are slow and complicated to startup and shutdown, whereas fossil units can respond quickly to changes in demand. In a competitive electric market, an operator would run the nukes as much as possible, reserving the fossil units for peak demand.

But of course, electricity is not a competitive market, it's regulated on a cost-plus basis. One obvious result of that was overstaffing on the nuke side of the plant. The fossil units had a workforce of about 75. The nukes had 400 permanent, which would swell to about 1200 over a planned outage. So far as I could tell, many of the staff on the nuke side were white-collar drones producing and reviewing paperwork. Basically, the gap between nuke and fossil fuel prices made these staff positions possible within the cost basis. They happened because they could.

A few years ago, FP&L mothballed the nukes. With partial deregulation looming, it was a lot easier to get paid for shutting them down (you get to include that in your cost basis!) rather than find ways of operating them more economically.

Now there is a lot more smoke in the air over Biscayne Bay :-(

I'll bet there is a similar explanation for the huge regulatory costs of nuclear power. It's tied to the big difference in nuke fuel cost versus fossil. It happens because it can.

Maybe the economists here have a name for this?

Bernard Yomtov writes:

Should the hypothesis not be at least considered that this is the market's way of telling us that we shouldn't be building nuclear power stations?

It should be considered. But when considering it we ought to bear in mind that alternative power sources - notably coal - may also socialize some of their costs in the same way.

Marco Parillo writes:
Does anyone have an 'actual' example of an industry 'ruined' or 'decimated' by excessive jury awards?
How about private airplane manufacturing for hobbyists? I understand that in the 1950s, Cessna, Piper et al. used to manufacture for the general public. Gentle corrections welcome.
Robert Schwartz writes:

"In particular, he asked whether we think that the Price-Anderson Act, which limits the liability of nuclear power plants for accidents, represents an excess subsidy for power plants."

The answer to this question is actually fairly simple. In the 21st century, when power plants may be owned and operated by so-called merchant producers (MPs), I assume that a MP will separately incorporate and finance each power plant. In that event the financial liability of the MP will be limited to its investment in the plant. The equity owners do not need insurance because they can limit their risk by diversifying their investments. If insurance cannot be had at a reasonable price, they will demand a higher return to cover the additional risk, but, given that there have been very few nuclear accidents world-wide over the last 50 years, I doubt that it would exceed the premia demanded by investors in riskier business like pharmaceuticals.

Operating from the assumption that a nuclear plant will cost about $1.5/Watt, a 2 Gigawatt Nuclear plant (think Indian point in New York) would cost about $3 billion. Since the equity would probably be about 10% of the total investment, the rest being bonds, the total equity investment would be about $300 million. Since these numbers are less than the P-A cap, it is not relevant, because the entire investment could be wiped out fairly easily. These numbers are not out of scale with other private equity investments and such a project should be doable, if, and its a very big if, the regulatory climate is temperate and the spent fuel problem can be solved. But these are political, not economic, questions.

I should note that the original intention of P-A was not to subsidize the nuclear power industry, but to limit the risk to the rate paying public and hold down their rates. In the 1950s power plants were only owned by regulated utilities. Because of this, the people at financial risk from a nuclear mishap were the customers of the utilities who could have been forced to pay higher rates if there were an accident. The limit was set when dollars were a lot bigger than they are now and juries were less generous, it was a prudential trade off between potential accident victims and rate payers both of whom could be considered innocent segments of the general public.

"The biggest risk within the context of the tort system may be that a small event or a non-event is used by trial lawyers as an excuse for a billion-dollar lawsuit. They find a few plaintiffs living near a nuke plant with horrible illnesses and parade them in front of a jury. The jury looks at these miserable people and at the deep pockets of the plant owners and the insurance companies. The result is a huge award. The fact that the illnesses have nothing to do with the nuclear power plant makes no difference."

Sort of like breast implants. This is a generic problem in the American system and needs to be fixed, but it is not limited to the power business. The fixes are myriad small changes to procedural and substantive legal rules. Jury trials would be better if there were no peremptory challenges of jurors, jurors were paid a more reasonable sum than the customary $15/day and lawyers were prevented from using theatrics in court. A more rigorous system for qualifying and hiring expert witnesses would help. Legal rules on damages could be better specified. And so on and so forth.

Dylan writes:

"In the 21st century, when power plants may be owned and operated by so-called merchant producers (MPs), I assume that a MP will separately incorporate and finance each power plant. In that event the financial liability of the MP will be limited to its investment in the plant. The equity owners do not need insurance because they can limit their risk by diversifying their investments."

This is probably false. The legal doctrine of "piercing the corporate veil" permits plaintiffs to go after the personal assets of stockholders in certain circumstances. One of those is undercapitalization, and "proper" capitalization must take into account potential legal liability.

The empircal evidence suggest the application of the doctrine is rather arbitrary, and in cases where not much is at risk, like single taxi cabs owned by a single corporation involved in $30k fender bender, it may not be cost effective to litigate the issue even when you can when. But it sure as hell will be cost effective when billions are at stake from a nuclear accident, and if NO equity provision is made or insurance coverage taken out for accidents, it's a sure thing the court will permit them to seek the investor's personal assets. The question then becomes what amount of insurance/equity provision is "reasonable" and whether that will stand up after an accident. I doubt many investors want to take the risk of underinsuring and losing their home.

Mark Bahner writes:

"Does anyone have an 'actual' example of an industry 'ruined' or 'decimated' by excessive jury awards?

How about private airplane manufacturing for hobbyists? I understand that in the 1950s, Cessna, Piper et al. used to manufacture for the general public. Gentle corrections welcome."

My old company, Babcock and Wilcox, went bankrupt due to asbestos. They didn't manufacture asbestos, they just used it in building boilers.

I went to a ladder manufacturing facility about 15 years ago. I think they told me something like 50% of the cost of a ladder is due to legal battles.

Robert Schwartz writes:

It never fails. You write a comment about an economic issue and some lawyer brings up an obscure equitable doctrine to quibble about.

Corporate veil piercing is a doctrine designed to prevent the misuse of the corporate form to perpetrate a fraud or illegal act. I have a lot of trouble believing that a court would hold it applicable to a situation where $300 million of equity capital supported a $3 billion project. But as a lawyer, I was very bad a frightening clients with far fetched scenarios like that.

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