Below is the uncorrected machine-read text of this chapter, intended to provide our own search engines and external engines with highly rich, chapter-representative searchable text of each book. Because it is UNCORRECTED material, please consider the following text as a useful but insufficient proxy for the authoritative book pages.
HAZARD COMPENSATION AND INCENTIVE SYSTEMS: AN ECONOMIC 146 PERSPECTIVE original typesetting files. Page breaks are true to the original; line lengths, word breaks, heading styles, and other typesetting-specific formatting, however, cannot be About this PDF file: This new digital representation of the original work has been recomposed from XML files created from the original paper book, not from the retained, and some typographic errors may have been accidentally inserted. Please use the print version of this publication as the authoritative version for attribution. PROBLEM CHARACTERISTICS Low-probability, high-consequence events have special features that are important in designing alternative compensation and incentive mechanisms for dealing with them. This section discusses five such features: (1) the nature of risk, (2) the existence of externalities, (3) the need to reconcile conflicting preferences, (4) ex ante actions and ex post outcomes, and (5) conflicts between efficiency and equity in designing compensation and incentive programs. By explicitly considering these characteristics, we may be able to recognize the opportunities and limitations of proposing certain courses of action. The first consideration is the nature of the risk. The phenomena that cause catastrophic accidents are often ''rare'' events for which it is difficult to produce scientifically credible estimates of risk (Weinberg, in this volume). Catastrophic accidents emanating from an LNG plant or environmental pollution from a hazardous waste facility are not sufficiently well understood to permit estimates of their probability with any degree of accuracy. The health and environmental consequences of an accident may not emerge for years. This latency period between the occurrence of an event and its first noticeable effects makes it extremely difficult to assign causality to a particular technological facility (Baram, 1982). For these reasons there are frequently disagreements among the experts on both the chances and consequences of a particular accident, and there are limited statistical data to settle these differences. The ambiguities associated with specifying probabilities and outcomes therefore raise a series of analytical as well as practical challenges. Even when extensive historical data are used to determine the nature of a risk, such as the frequency and severity of motor vehicle accidents, individual perceptions of risk may differ from the objective data. Experts and laypersons alike use heuristics, or rules of thumb, in estimating the probabilities of certain outcomes, and these rules may lead to large and systematic biases (Slovic et al., 1979). A second feature of societal problems involving low-probability, high- consequence events is that they create externalitiesâsituations in which the actions of one individual affect the welfare of others either positively or negatively. If a community is willing to accept a hazardous waste facility "in its backyard," this creates beneficial effects for an entire region. When a person suffers a severe automobile injury because he or she did not wear a seat belt, there are negative externalities to the general taxpayer because health costs are partially subsidized by the government. These externalities make it difficult to use normal market mechanisms for dealing with risks. For example, unless there is some type of compensation
HAZARD COMPENSATION AND INCENTIVE SYSTEMS: AN ECONOMIC 147 PERSPECTIVE original typesetting files. Page breaks are true to the original; line lengths, word breaks, heading styles, and other typesetting-specific formatting, however, cannot be About this PDF file: This new digital representation of the original work has been recomposed from XML files created from the original paper book, not from the retained, and some typographic errors may have been accidentally inserted. Please use the print version of this publication as the authoritative version for attribution. mechanism associated with the siting of a new technological facility, it is unlikely that any community will agree to host it. Similarly, if people know that as victims of a natural disaster they will have their property made whole by liberal government relief, then there is little incentive for them to protect themselves with insurance. A third feature of these societal problems is the many interested parties who have a stake in the final outcome and want to participate in the decision process. Each of these stakeholders has goals and objectives that affect his or her preferences. The nature of the risks and the types of externalities associated with these problems make it difficult for standard market mechanisms to reconcile conflicting preferences. Consider, for example, the proposal by a consortium of gas distribution utilities in 1974 to site a liquefied natural gas facility in one of three locations in California. Over the next three years, a number of interested parties at the federal, state, and local levels debated the desirability of each of these sites. By 1977 it became clear that none of them would be approved under existing procedures. This impasse led the utility companies and business interests to lobby successfully for a new state siting act. It simplified the licensing process for LNG facilities and stipulated population-density limits that would be acceptable to environmental and public interest groups. To help resolve the safety question, several risk studies were commissioned independently by some of the interested parties. The various studies' estimates of the risk to population differed enough to cause considerable conflict about whether a proposed facility was "safe enough." Citizen groups sprang up at the proposed sites and used these studies to voice their concerns about having a local LNG terminal. Final approval of Point Conception, a site in an unpopulated area, came at the end of 1982, at which time the utilities decided to defer construction of the terminal until an unspecified date (Kunreuther et al., 1983). A fourth feature of societal problems involving low-probability, high- consequence events is the ex ante-ex post connection. By ex ante is meant actions that are taken in anticipation of a disaster and whose purpose is to mitigate the consequences of a disaster should it occur. For example, a community might demand some type of payment or compensation for agreeing to host a new technological facility. This could be in the form of taxes paid by the developer or in-kind compensation such as a reduction in residents' electricity rates. Or, ex ante protective actions might be taken by industryâfor example, designing a facility to reduce the risk of an accident to an acceptable level. (Buckling one's seat belt is another example of an ex ante action: it reduces the potential consequences of an automobile accident.) By ex post consequences is meant the impact of a disaster or accident on
