Thursday, 16 April 2009

Modern day pirates

In an article on the BBC website, the BBC News website's world affairs correspondent Paul Reynolds asks Could 19th-Century plan stop piracy? At one point in the article Reynolds notes,
And the UN Monitoring Group on Somalia issued a damning report last December in which it castigated ship owners for paying ransom.

"Exorbitant ransom payments have fuelled the growth of [pirate] groups," it stated.
And there is a logic to the UN group's report. Supply curves slope upwards, the more you pay for something the more you get supplied. As far as pirates are concerned, the more money they can make, the more pirate "firms" will enter the market. So if companies pay large ransoms they could be making the piracy problem worse.

Clearly companies want their ships and crews back and are willing to pay to get them back. But while paying up will get a given ship back it could also increase the likelihood of more ships being taken in the future. Basically paying a ransom, while rational for a single company, conveys a negative externality on all other ship owners since it increases the chance of other ships being taken in the future.


matt b said...

Is there any reason an economist would not say that the negative externality should be corrected by a ransom tax? I suspect the optimum tax, ignoring noncompliance, would be 100%.

The externality can be internalised by an insurance scheme that compensates owners for total loss and shares none of the proceeds with pirates. If members of the scheme can publicly and credibly signal their participation in the scheme prior to an attack then it should deter pirates.

However, if pirates seek the ship's cargo rather than ransom, on the other hand, then this will not work. Rigging the ship with dynamite would solve that, but convincing the crew to press the button might be a problem.

matt b said...

Actually there's a second insurance market here, one in which the insurer pays ransom to the pirate on your behalf.

You get your ship back, leaving you in the same position as under the other insurance, but you pay only a fraction of the premium, at least initially. Once this insurance has destroyed world trade nobody will need it any more. :-)

Paul Walker said...

Matt: I think the cargo is a problem for your scheme. Even if the prates don't get a ransom they can still sell the cargo and make at least some money. More than they would make in their next best alternative.

Also do you want to compensates owners for the total loss as this could cause moral hazard problems. If pirates filled waters are the quickest way to get from A to B I may go that way if I'm insured where I wouldn't do so if I'm not insured.

matt b said...

The moral hazzard problem is easily managed, either because it is more costly to hire crewmen willing to sail in risky waters, or, more importantly, because insurers will carve out coverage in those risky places where moral hazzard is an issue, much as French insurers do for drivers at Arc de Triumphe.

The cargo problem is harder.

Paul Walker said...

How does the insurer verify to a court exactly where the ship went?