That’s the classic question that Steven Shavell posed 25 years ago, and the debate over whether these two are potentially substitutes continues today.
The BP catastrophe has certainly brought more than its share of discussion on the issue. Paul Krugman weighs in on the side that the continuing spill is Exhibit A that liability is a failure the private sector needs a stern regulatory hand to guide it. Tyler Cowen frames the argument and takes Krugman to task on one point:
There is in fact an agency regulating off-shore drilling and in the case under question it totally failed.
Of course, not all regulation is as inept as the Minerals Management Service (MMS) seems to be in this case. One problem is that MMS is charged both with regulating environmental and safety concerns AND is responsible for approving leases to the provide sector.
And, which do they choose? According to the Washington Post:
Minerals Management Service officials, who can receive cash bonuses in the thousands of dollars based in large part on meeting federal deadlines for leasing offshore oil and gas exploration, frequently changed documents and bypassed legal requirements aimed at protecting the marine environment, the documents show.
Emphasis is mine, though the point sort of jumps out at you, doesn’t it? But, it’s not like the appearance of financial impropriety is a new thing with the MMS. On the heels of the spill, in fact, President Obama recommended bifurcating the agency to mitigate the clear incentive compatibility problem.