Hazards: Technology and Fairness (1986)

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HAZARD COMPENSATION AND INCENTIVE SYSTEMS: AN ECONOMIC 161 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. • How do individuals perceive the nature of the risk and the benefit? • Who is liable for and should therefore bear the cost of an accident? • What is the default option if a proposed alternative is not adopted? • What is the perceived role of the public and private sectors in dealing with accident losses? • What other policy options could either be combined with or replace compensation (for example, regulations and standards)? These questions pose challenges to both the analyst and the policymaker in educating experts and nonexperts alike. By designing programs that recognize the importance of institutional constraints and individuals' decision processes, society may be better able to manage low-probability, high-consequence risks. NOTES 1. A decision tree is a descriptive model of a problem involving a sequence of decisions ( , or decision nodes) and chance events ( , or chance nodes). The ultimate outcomes or payoffs for each possible combination of choice and chance are shown at the tips of the branches. When outcomes cannot all be expressed in monetary units, the analyst attempts to quantify the utility (welfare, well-being, or satisfaction) of each outcome. The expected value of an alternative is a long-run average calculated by multiplying the value of each possible outcome at a chance node by its probability and then summing these products. The optimal decision is the one that yields the highest expected value. 2. The same type of analysis could be undertaken by the operator of a technological facility, who can be viewed as a potential victim (from a financial point of view) should there be an accident. A decision about whether to increase the safety of a plant by instituting a specific risk- reduction measure will be determined by comparing the cost (C) with the reduction in loss (L- L') if an accident with probability P occurs. 3. For a detailed discussion of incentive-compatible mechanisms for this problem, see Raiffa, 1982, Ch. 22. 4. There is a large body of recent work designed to elicit willingness to pay and willingness to accept values for public and private goods (see Brookshire et al., 1985, for a summary). Recently, Kerry Smith and coworkers (1985) conducted a survey to determine how individuals evaluate the expected reduction of risks due to hazardous materials. On the basis of a field survey in the Boston area, the authors tentatively concluded that one may be able to elicit households' benefits for reduction of risks due to hazardous materials. If this preliminary finding is substantiated, then one may be able to compare these estimates with those obtained by other procedures. 5. The fraction that communities would have to pay could be lower than 1/(n-1) if industry or the state were partially compensating the community. To prevent overbidding, however, it is necessary to impose a tax on communities benefiting from the facility. References Akerlof, G., and W. T. Dickens. 1982. The economic consequences of cognitive dissonance. Quarterly Journal of Economics 84:488–500. 

HAZARD COMPENSATION AND INCENTIVE SYSTEMS: AN ECONOMIC 162 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. Arnould, R., and H. Grabowski. 1981. Auto safety regulation: An analysis of market failure. Bell Journal of Economics 12:27–48. Arrow, K. 1983. Behavior Under Uncertainty and Its Implications for Policy. Institute for Mathematical Studies in the Social Sciences. Stanford University, Stanford, Calif. Baram, M. 1982. Alternatives to Regulation. Lexington, Mass.: D. C. Heath. Brookshire, D. S., D. L. Coursey, and W. D. Schulze. 1985. Experiments in the solicitation of private and public values: An overview. Paper prepared for the Public Choice Society Meetings, New Orleans, La. Calabresi, G. and P. Bobbitt. 1978. Tragic Choices. New York: Norton. Festinger, L. A. 1957. A Theory of Cognitive Dissonance. Stanford: Stanford University Press. Graham, J., and M. Henrion. 1984. A probabilistic analysis of the passive-restraint question. Risk Analysis 4(1):25–40. Hogarth, R., and H. Kunreuther. 1985. Ambiguity and insurance decisions. American Economic Review: Papers and Proceedings 95:386–390. Kahneman, D., and A. Tversky. 1984. Choices, values, and frames. American Psychologist 4:341– 350. Kahneman, D., Slovic, and A. Tversky. 1984. Judgment Under Uncertainty, Heuristics, and Biases. Cambridge, England: Cambridge University Press. Katzman, M. T. 1985. Chemical Catastrophes: Regulating Environmental Risk Through Pollution Liability Insurance. Homewood, Ill.: Richard D. Irwin, Inc. Kunreuther, H., J. Linnerooth, J. Lathrop, H. Atz, S. Macgill, C. Mandl, M. Schwarz, and M. Thompson. 1983. Risk Analysis and Decision Processes: The Siting of Liquefied Energy Gas Facilities in Four Countries. London: Springer-Verlag. Kunreuther, H., P. Kleindorfer, P. Knez, and R. Yaksick. 1985. The Role of Compensation for Siting Hazardous Facilities: Theory and Experimental Design. Working Paper #85-04-03, Department of Decision Sciences, University of Pennsylvania, Philadelphia. Lave, L., and T. Romer. 1983. Specifying risk goals: Inherent problems with democratic institutions. Risk Analysis 3:217–227. Nordhaus, W. 1984. Supplementing notice of proposed rulemaking on federal motor vehicle safety standards. Occupant Crash Protection, Docket #74-14, Notice 35, June 13, Reference 10. O'Hare, M., L. Bacow, and R. Sanderson. 1983. Facility Siting and Public Opposition. New York: Van Nostrand-Reinhold. Popper, E 1983. LP/HC and LULU's: The political uses of risk analysis in land use planning." Risk Analysis 3:255–263. Raiffa, H. 1982. The Art and Science of Negotiation. Cambridge, Mass.: Belknap Press. Sanderson, D. 1984. Compensation and negotiation primer. Mimeo. Slovic, P., B. Fischhoff, S. Lichtenstein, B. Corrigan, and B. Combs. 1977. Preference for insuring against probable small loss: Implications for the theory and practice of insurance. Journal of Risk and Insurance 44:237–258. Slovic, P., B. Fischhoff, and S. Lichtenstein. 1978. Accident probabilities and seat belt usage: A psychological perspective. Accident Analysis and Prevention 10:281–285. Slovic, P., B. Fischhoff, and S. Lichtenstein. 1979. Rating the risk. Environment 21:14–38. Slovic, P., B. Fischhoff, and S. Lichtenstein. 1980. Facts vs. Fears: Understanding Perceived Risk in Societal Risk Assessment: How Safe Is Safe Enough? R. Schwing and W. Albers, eds. New York: Plenum. Smith, K., W. H. Desvousges, A. M. Freeman, III. 1985. Valuing Changes in Hazardous Waste Risks: A Contingent Valuation Analysis. Draft Interim Report (2 vols.), prepared for U.S. Environmental Protection Agency. 

HAZARD COMPENSATION AND INCENTIVE SYSTEMS: AN ECONOMIC 163 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. Svenson, O. 1981. Are we all less risky and more skillful than our fellow drivers are? Acta Psychologica 47:143–148. Thaler, R. 1983. Using mental accounting in theory of consumer behavior. Cornell University Working Paper. Trauberman, J. 1981. Compensating victims of toxic substance pollution: An analysis of existing federal statutes. Harvard Environmental Law Review 5:1–19. von Winterfeldt, D., and W. Edwards. 1984. Patterns of conflict about risky technologies. Risk Analysis 4(1):55–68. 

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 original typesetting files. Page breaks are true to the original; line lengths, word breaks, heading styles, and other typesetting-specific formatting, however, cannot be retained, and some typographic errors may have been accidentally inserted. Please use the print version of this publication as the authoritative version for attribution.PERSPECTIVE HAZARD COMPENSATION AND INCENTIVE SYSTEMS: AN ECONOMIC 164