Assessing the Economic Damage of the BP Spill

Dr. Rick Harper of UWF’s Haas Center for Business Research and Economic Development, gives his studied opinion on the economic recovery from BP's disaster.

Business Speak Assessing the Economic Damage By Rick Harper, Ph.D. Originally published in the Oct/Nov 2010 issue of 850 Magazine

Individuals and businesses across the oil-affected region are preparing damage claims to be brought to Kenneth Feinberg and his team at the Gulf Coast Claims Facility. Local government entities are waiting to see if a similar facility will be established to review claims that they will bring representing the additional costs they have incurred and revenues lost since the spill began in late April.

While we don’t yet know what the lasting costs of the spill will be, it is reasonably certain that the short-term economic damage, in terms of cleanup response and lost net revenue to affected individuals, businesses and governments, will be greater than the amount currently available to the claims facility.

The simplest approach to measuring a business’s lost profits would be to compare its profit performance for the oil-affected months to the profits in preceding months. This is what questions 59 and 60 on the Gulf Coast Claims Facility’s claims form appear to ask for. Such an approach has the advantage of being quite tractable analytically. But for tourism-dependent businesses in Northwest Florida, June and July — and for spring break destinations, March — are the months in which net operating income is strongly positive and covers losses made in other months. Thus, the months immediately preceding the spill are not an appropriate basis for comparison for many businesses.

What about a look back to 2008 and 2009? If the 2008–2009 period were to be one of greater-than-normal profits, with 2010 representing a return to more normal levels, then injured parties on average would be overcompensated relative to their true loss. If, instead, the 2008–2009 period was one of less-than-normal profits, with 2010 representing a return to more normal levels, then injured Floridians would on average be undercompensated relative to their true loss.

The near- to medium-term profit outlook for 2010 is better than it was previously. Some of this improved profit performance is due to changes in the national business cycle as the economy slowly recovers from the Great Recession. Federal Reserve data on after-tax profits for U.S. nonfinancial corporate businesses show profits shrinking from the same quarter in the previous year for nine consecutive quarters beginning in July 2007. However, year-over-year profit growth rates for the last quarter of 2009 and the first quarter of 2010 were measured at 59 percent and 58 percent, respectively.

For Florida, somewhat of the same pattern holds true. For our state’s corporate income-tax revenues to return to their long-run trend levels, they would need to improve by 28 percent relative to recession-depressed 2009 levels. The Florida Revenue Estimating Conference projected on Aug. 12, 2010, that net corporate income-tax collections for fiscal year 2010–2011 would rise by 21.8 percent from fiscal year 2009–2010 levels. This, along with the projected $810 million, or 5 percent, increase in general revenue from sales tax, is a welcome change. Even as the economy recovers, slowly but hopefully surely, the Revenue Estimating Conference projects that it will be fiscal year 2012–2013 before the state returns to the sales tax revenue of fiscal year 2007–2008.

How can moderate increases in sales, such as 5 percent, be associated with large increases in corporate income, such as 21.8 percent? Most businesses have costs that they must incur regardless of how many customers they have and how much those customers spend. These might include the mortgage on their property, their property taxes, insurance, payroll for key staff, and other costs that don’t vary much with business volume. This means that profits, which can be measured as the difference between revenues and costs, are typically more volatile than overall consumer spending. The food costs that a Florida restaurant saves because it doesn’t have to purchase fish to prepare for diners who aren’t arriving due to oil-induced changes in vacation plans or fears about Gulf seafood might account for only 30 percent of the revenue earned from sale of a seafood meal. A modest change in revenue might then be the difference between profit and loss.

Other differences might reasonably be expected when comparing counterfactual baselines for different regions, different kinds of businesses and different types of revenue streams. But for economic performance to be evaluated against what would have occurred absent the spill, we have to look at where that claimant, whether an individual, a business or a local government, should have been economically in 2010, rather than where it was economically during the Great Recession.

Rick Harper, Ph.D.

Harper received his doctorate in Economics from Duke University in 1989 and is director of UWF’s Haas Center for Business Research and Economic Development. He served on Governor Jeb Bush’s Council of Economic Advisors from 2001–2006 and is now supporting the economic analysis work of the Florida Senate Select Committee on Florida’s Economy.