For every $120 million seized by pirates operating off the coast of Somalia, the cost to the shipping industry and their customers is as high as $3.3 billion, according to research by Tim Besley, Thiemo Fetzer and Hannes Mueller, presented at the Royal Economic Society”s 2013 annual conference. This money is enough to employ well over a million Somalis for a whole year.
The study looks at the effect of pirate attacks on shipping costs, focusing on shipping routes whose shortest path takes them through regions where pirates are known to operate. It finds that the increase in attacks in 2008 led to an increase in shipping costs of around 8%. These extra costs are mostly due to the increased security measures that are needed to repel pirate attacks and risk premiums paid to crew and insurance.
The study develops a model to compare this cost to the shipping industry through pirate attacks to a tax on shipping that would finance the same transfer of funds to pirates. This allows the authors to calculate the ”welfare loss” caused by piracy. The main estimate suggests that for every $120 million extorted by pirates, the resource costs incurred by the industry are between $0.9 and $3.3 billion.
To put this in context, the research looks at how many Somalis could be hired for one year using the wasted resources. Using wage data from the Somali Food Security and Nutrition Analysis Unit, it estimates a yearly wage of around $900. This means that the extra spending due to piracy could finance one year of employment for well over one million workers at the going market rate. The authors are quick to note that this does not mean that such a transfer scheme would be realistic or that it would prevent piracy. But it does illustrate the scale of losses to the industry relative to the reality of the Somali economy.
Modern-day pirates are organised bandits that thrive in areas where law and order is weak, either because particular states provide safe havens or because of poor international cooperation to police them. The authors argue that beyond the costs inpeople”s lives, this may have repercussions for worldwide trade.
The issue of piracy has been brought into sharp relief by the upsurge of piracy in the Gulf of Aden between Somalia and Yemen. The waterway is part of the important Suez Canal shipping route between the Mediterranean Sea and the Arabian Sea in the Indian Ocean with 21,000 ships crossing the gulf each year, at one point it is only 20 miles wide. The gulf is earning the nickname ”Pirate Alley” due to the extent of pirate activity in the area. The authors note that this poses a threat to one of the world”s busiest shipping routes.
Max Weber defined a functioning state through the monopoly of the legitimate use of physical force within its territory. In the case of Somalia, the effective monopoly of power has not been with any form of state since 1991 as it has been topping the list of the failed states index for the past five consecutive years.
Based on this state failure, a thriving piracy business has spread from the Somali coast. Figure 1 visualises the geographical reach of this activity. Each red dot shows the location of one pirate attack. The risk of being attacked by Somali pirates has spread from the Gulf of Aden into the Indian Ocean.
In a study presented at the Royal Economic Society annual conference, the authors ask: what is the additional shipping cost that arises from the piracy risks? And how does this cost compare to a tax that could be imposed by a state with a monopoly of power?
Costs of $0.9 to $3.3 billion to generate $120 million pirate revenue
The analysis of the additional cost due to piracy comes from micro-data on individual shipping contracts. The researchers considers the direct link between the risk of piracy attacks and the cost of shipping by studying the impact on chartering rates on maritime routes that vary due to (i) weather conditions and (ii) the extent to which they are exposed to Somali piracy at different dates. Most of the trade between Asia and Europe has to pass through the Gulf of Aden and is thus, potentially affected by Somali piracy.
When piracy increased drastically in 2008, ship owners took several measures to protect against the increased risk of hijacking. The costs of these responses are passed on to those who charter ships. This impact on shipping rates is how the studyestimates the ”piracy tax”. It finds that piracy caused an increase in the shipping rates of between 8% and 12%.
Using these estimates, it is possible to provide some bounds on the overall cost of Somali piracy. The researchers find that $120 million in net revenues for pirates cost the shipping industry an additional $0.9 billion to $3.3 billion.
In other words, if the same revenue would have to be generated through a tax on shipping, the tax rate would have to be set at less than 1% (instead of 8-12%). A functioning state would probably be able to implement redistributive policies a lot more efficiently than the ”roving bandits”.
A particularly interesting feature of the piracy in Somalia is that it almost entirely disappears during the Monsoon season because it is difficult for pirates to operate in their small vessels. The piracy tax is absent before May 2008. It then increases drastically when pirates become active but fluctuates with the seasons. As a result, it is almost as expensive to ship during Monsoon post-2008 as it was before the increase in piracy.
Is there a solution to Somali piracy? One route is a private response that increases the number of private security guards. The researchers estimate the costs of this and argue that it should lower the overall costs if other costs (like the insurance premium) react accordingly. But coordination problems remain.
The alternative would be to seek cooperation between the governments of affected countries to internalise the externality through a cooperative defence effort. This is also being attempted.
Either way, the research shows that looking for ways to solve this does lead to the possibility of manifest welfare gains.
”One Kind of Lawlessness: Estimating the Welfare Cost of Somali Piracy” by Tim Besley, Thiemo Fetzer and Hannes Mueller (2012), Working Paper 626, Barcelona Graduate School of Economics.
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