Evergreen Price Theory
Last week, the online world was enthralled by the ship Ever Given, which was stuck in the Suez Canal for six days. Not since my beloved Left Shark have there been so many wholesome memes around such a tragic figure. Everyone seemed to relate to the lone digger struggling at moving the giant ship.
With Ever Given back floating on the open waters, in this week’s newsletter, I want to lay out the questions that I asked about the whole debacle. None of this is meant to be expert testimony 🤣, just an illustration of how I approach a new puzzle with the help of economics. The questions are key.
How costly was the accident?
It’s clear that blocking the Suez canal was a big deal. But how much did it cost?
Let’s start with some facts from the appropriately titled “The cost of the Suez Canal blockage” from the BBC. They first say that “data from Lloyd's List showed the stranded ship was holding up an estimated $9.6bn of trade along the waterway each day.”
But that’s not the cost of the holdup. If my house gets delayed in being built, the “cost” is not the value of the house.
One way to start to estimate the value of the holdup is through standard discounting. If you expect $1,000,000 today, but instead it got delayed a year, at a 10% discount rate, that delivery is only worth $904,837 in present value terms. The delay makes you $95,163 poorer. That’s the cost.
Let’s bring this to the Suez canal. If the canal can run at double the rate it had been running (which I read somewhere), the backlog would be cleared in 7 days. So for the math, suppose 7 days of ships (roughly 350 ships) got delayed 7 days on average. The cost of a 7-day delay on $70 billion of goods and services would be around $19 million.
Each day of the delay costs around $2-3 million.
That is clearly a lower bound on the cost, since I didn’t take into account any other disturbances in the supply chain. I imagined that it was just dollars being delivered. I also assumed that there was no additional cost to running the canal at double speed for a week. That’s not a good assumption.
Another way to approximate cost is through the price that is charged to use the canal. The same BBC article reports that the canal lost around $14 million in revenue per day. It’s unclear how the Suez Canal Authority came up with that number and whether this is truly lost revenue or delayed revenue. If most ships end up going through the port, the revenue is simply delayed and not lost.
If Suez simply loses all the revenue, then that would be another way to estimate the cost: $14 million per day. Again, this would be a lower bound, since the value of using the canal must be weakly greater than the price.
These are well below the ultimate number that the BBC gives, based on initial reports from Allianz, which put the expected cost at $230 billion. I have no clue how they got to this number, but it now seems implausibly large for me, even though it made sense right away. That would be the economic cost of destroying 20 days of cargo, not just delaying it.
But for a theorist, that’s a pretty reasonable bound. Somewhere between $20 million and $230 billion. Okay, not so good. But I tried.
Do people have proper incentives to avoid getting stuck?
I’m then left wondering if the ship owners and captain have incentives to be sufficiently careful. Given most of the cost of getting stuck falls on other ships that were delayed and their supply chains, this may look like a classic externality. If it could have possibly been avoided (and not a pure accident), Ever Given’s captain’s actions hurt other people.
One way to solve this is to make firms liable for damages caused to other ships. This makes the ship internalize the externality. If the damages are too large, the owners will never be able to pay. This is a standard issue with liability.
But this isn’t the first accident in a canal, so they have processes in place to deal with things. The canal requires liability insurance. According to the WSJ, the ship had $3 billion of insurance for liability claims. Without knowing the cost of the damages, we don’t know if this is sufficient.
We still have a series of principle-agent problems (insurer to ship owners and ship owners to captains and crew) that create frictions relative to a benchmark where the captain would pay out of pocket. Still, policies have evolved to take account of the possibility of accidents.
Do people have proper incentives to get Ever Given unstuck in an efficient amount of time?
After the ship is stuck, the question is for how long? There is a marginal benefit for moving the ship sooner and a marginal cost to get that done. Why did it remain stuck for 7 days? Do people have proper incentives to get the ship unstuck, once it is stuck?
One possibility is that it may not have been technologically feasible to move any quicker. Hide tide from a full moon eventually helped break the ship loose and I’m not aware of any way to speed up the tides. It’s stuck, regardless of what people do.
But, as I explained in my last newsletter on Armen Alchian, it’s a standard idea within economics that projects can be sped up (on the margin) for an additional cost. If you accept that it’s technologically feasible to speed up the removal and the trade-off is an economic one of cost vs. benefits. If the costs per day are in the tens of billions (which I originally thought), then the canal authority should be spending in proportion, at least more than the rental rate of 1 digger.
Every overconfident guy on Twitter had a suggestion for how to get the ship unstuck. Surely, it could (and should) be done faster than by a single digger. Take one of them.
So why was there just one digger devoted? One could imagine another moral hazard problem here. If the canal spends tons of money getting all the stuck ships out in a hurry, that greats a moral hazard problem for the drivers of the ship, as Austan Goolsbee explained to me.
I’m a bit skeptical of this moral hazard, although there is obviously some truth to it. The insurance discussed above helps provide incentives for avoiding accidents.
Unfortunately, insurance also creates a different incentive problem. With the firm liable, the costs of delay will be paid by the insurance company but the solution to the delay is being paid by the canal authority. Even if the canal authority was a profit maximizing organization, it would not properly account for the cost that is paid by the liability insurance.
There’s also the issue that the canal is not a profit maximizing organization, but it is a government, and (from what I gather) not a benevolent one 🤔 It sets an average toll rate of around $320,000, while it’s marginal value relative to sailing around Africa is more like $450,000. If they are not receiving their marginal value on each voyage, they further do not have proper incentives to restore traffic quickly.
But why would the canal authority set price below marginal value? The standard theories of government under-pricing don’t seem to apply. I don’t have an answer yet. 🚢