Insane at Any Speed

In 1997, an American family sued GM after a mild rear-end collision caused their car to catch fire, resulting in horrific burns. GM was forced under threat of contempt of court to produce an internal memorandum circulated in 1973. The document was written by GM engineer Edward Ivey at the request of company management. Its purpose was to mathematically analyze the cost potentially posed to the company by deaths involving cars GM manufactured posed to the company. The document was called “Value Analysis of Auto Fuel Fed Fire Related Fatalities,” and has since come to be called “the Ivey memo.”

The short document, easily viewed online, was prepared because of certain GM models’ tendency to have massive, fast-burning fires from very light rear-end collisions. The fuel tank on these models was positioned at the rear of the car, before the bumper, but without a strong reinforcing plate that would prevent minor read-enders from resulting in a serious fire. However, adding a protective shield or plate to the back of the vulnerable cars would be expensive, and so Ivey was commissioned to prepare a cost/benefit analysis for GM.

The calculation was chillingly simple. Based on the approximately 500 fatalities a year caused by fuel-fed fires in car collisions, and the fact that each fatality came with an average cost of $200,000 to the company in litigation, the product of these figures divided by the 41 million GM cars on the road resulted in a cost to GM of fuel fire fatalities of $2.40 per car. Next, Ivey estimated that if GM added protective plates to prevent such fires, it would result in a cost of $2.20 per car. On these grounds, the memo suggests that slightly re-engineering their cars for safety was not cost effective.

GM’s attorneys denied the existence of the Ivey memo, then denied it was circulated among management, and then insisted it was irrelevant to the case. The key to this revealing memo, and its relevance to how externalities disprove “market efficiency,” is the second piece of data fed into the first equation: “Each fatality has a value of $200,000.”

The point isn’t that GM’s employees are cold-blooded and don’t care about human beings; in fact, the memo says in its concluding paragraph that “it is really impossible to put a value on human life.” The point is that only the court-awarded average cost of $200,000 affected GM, and so this is the value used in the calculation.

While it may be “impossible” to put a value on a person’s life, it is possible to put a value on their life to General Motors. Indeed, the computation ends with “fatalities related to accidents with fuel fed fires are costing General Motors $2.40 per automobile in current operation.”

It’s not that deadly fuel fires pose no other costs, for example to society or to GM’s customers. But only the direct settlement costs are relevant to the company’s decision-making. GM pays two hundred grand and moves on. It’s the family that must grieve their dead loved ones and live with their disfiguring injuries. Similarly, making safety indicators standard on the 737 Max would have lowered the risks to the passengers and crew of Flight 302. But that was a risk to others Boeing accepted in order to create its lucrative add-ons market.

Crashes and Splashes

The same dynamic also contributed to the 2008 financial crisis. As the conservative Financial Times reported, there’s “a fundamental problem about banking…the social cost of a systemic disaster is greater than the private cost to the individual bank. In the end, it is the task of regulators, not investors, to address this externality.” A bank will view its assets as representing a certain risk to the company, and cannot afford to think of the broader “external” risk created for the system if it collapses from holding excessively risky assets. In other words, the stability of the system is someone else’s problem, and while investors may not want to see the system collapse, “their fiduciary obligations prevent them from taking a broader, systemic view.” The result is that risk is chronically underpriced in the financial markets. The Times elsewhere reported that “This inability to handle externalities” worsened the financial crisis at every stage, such as when hedge funds further weakened the banks and insurers by short-selling their stock.

But arguably the worst example is the Deepwater Horizon disaster of 2010, in which an offshore drill rig exploded and the attached well poured nearly five million gallons of crude oil into the Gulf of Mexico. Reporting in the business press and scientific journals documented a similarly consistent pattern of cost- and corner-cutting by BP. Like its corporate counterparts Boeing and GM, BP did not provision for the risks that didn’t directly affect them—such as the huge dangers to the Gulf’s already-battered ecology in the event of a major spill. These costs to the regional ecosystem, for which businesses typically are not held accountable, fall outside the firm and are therefore externalities from the point of view of market exchange.

The pattern is exemplified by BP’s admitted decision to ignore the results of a “negative pressure test” in the hours before the well exploded, despite the indication of a “very large abnormality.” This abnormality turned out to be a column of high-pressure natural gas erupting up the well. Other corners cut by BP include skipped cement quality tests, important for making sure the seal around the well’s pipe was airtight; and the unusual decision to run a single pipe from the sea floor to the oil reservoir, rather than the standard practice of two pipes nested one within the other, which “provides an extra level of protection, but also requires another long, expensive piece of pipe.”

The picture is pretty clear—an under-valuing of risk, which is to be expected in markets based on private exchange, with no regard to effects downstream. These early conclusions were later substantiated in a subsequent report by the US Coast Guard and federal regulators, who cited “poor risk management” as a crucial contributor to the disaster. The ultimate statement of this corporate undervaluation of risk through disregarding external costs came from a BP engineer, who wrote in an April report that the one-pipe option was “the best economic case.”

Planes flying without risk-lowering instruments considered costly “extras”; accepting the risks of death to others if their cost to the company isn’t too burdensome; skimping on essential drilling safety processes. It might be true that capitalism is the most efficient economic system in the world. But only as long as the risks to anyone and anything outside corporations are ignored.

Because as the Ivey memo’s math reveals, it’s not that there’s no value to the lives of Ethiopian pilots, midcentury GM drivers, or the environment of the Gulf of Mexico. It’s that they’re literally out of the equation.