Part of what I love about economics is to apply economic reasoning to unconventional situations (the whole Freakonomics trend). So today as I was reading yet another article on BBC News about Somali pirates hijacking yet more boats around the Horn of Africa and tried to come up with a simple economic (versus political) solution. My solution is as follows:Basically, my idea is that you assign a property right to Somalia for an area of ocean and they can create a taxable shipping lane that is protected by either Somalia, or by a group of countries that are willing to take on the task. According to the Law and Economics movement, privatizing allows for externalities (pirates) to be internalized through higher prices (fee of passage). Though this would be increasing the price, the expected price should be the same.
Economic Analysis
Assume a probablility of being hijacked, 0.1%, and a cost associated if hijacking occurs, $5 million (includes loss of life, cargo, and naval costs incurred by supporting hijacked crews). Assume if hijacked, the shipper makes no profit. Therefore, the expected benefits are profits, $1 million. Further, assume shipping companies are risk averse.
Expected Utility = 0.99ln(1m) - 0.01ln(10m) = $13.52
Now assume the shippers have a choice, they can pass with uncertainty (above) or pass with certainty and pay a fee. Assume the fee is $110,000.
Expected Utility = ln(890,000) = $13.70
So we see that 13.70>13.52 and therefore it would raise the shipping company's utility to pay a fee.
*I use a utility function of natural log simply because we know this is a concave function which implies risk aversion. *
Essentially this is Adam Smith at work: division of labour. To enter the lane you pay a fee and for that fee you are guaranteed safe passage.
Right now the US government is saying that it is the responsibility of the shipping companies to protect their boats. This results in the shipping company having to take extra precautions to ensure that their cargo is safe through that area of the ocean. Why not divide the labour? Let an organization worry about protection, and let the shippers ship their cargo. I have no doubt that this could be a great commercial venture for Somalia - I'm sure they could use the money.
Unfortunately, to construct something such as this requires a stable, working government; something Somalia has been lacking since the early 90's. But Somalia does not have to be the acting force here; as I said above, it could be established by a group of nations that value safe waters. The prices could be set a break even so that shippers are not being excessively burdened and the revenue would be used to fight off those pesky pirates: problem solved.
