Workshop on Sharing Experience in the Training of Engineers in Risk Management

1. OECD Workshop on Sharing Experience in theTraining of Engineers in Risk ManagementMontréal, Canada21-24 October 2003The Economics of Engineering Risk Management: A Primer Nathalie de Marcellis-Warin Bernard Sinclair-Desgagné and Carel Vachon

2. Outline of the presentation • Introduction: What do we mean by major technological risks? • Risk assessment and representation • Risk sharing • Risk control • Dealing with uncertainty • Conclusion

3. 1. Introduction Major technological risks are: - Catastrophic risks (small probabilities of large, collective and irreversible losses) - Man-made risks (endogenous to human activity, unlike natural disasters) - Linked to the production of goods and services (unlike bank runs, war and riots)

4. 2. Risk assessment and representation • Current engineering practice (HAXOP, FMEA, Monte-Carlo simulation, …). • Expertise and subjectivity - qualitative probabilities - rules for subjective quantitative probabilities (ex: coherence) - heuristics and biases (availability, control, …) • The acceptable level of risk (communication/framing, trust, …)

5. 3. Risk sharing • The pros and cons of civil liability - strict liability vs. negligence - burdens of proof - litigation costs - limited liability - extended liability • Insurance - adverse selectionor “hidden knowledge” - moral hazard or “hidden action” - ambiguity aversion

6. 5. Dealing with scientific uncertainty • Aversion to ambiguity - the Ellsberg (1961) paradox: Urn A contains 50 red balls and 50 black balls Urn B contains 100 red or black balls “You win $100 if a ball drawn from the urn you pick is red.” Which urn do you pick? Most people pick urn A.

7. 5.1 Some background on the Precautionary Principle • Zoroaster: “When in doubt, abstain.” • Removal of the handle of the Broad Street water pump in London in 1854, an action that then stopped an epidemic of cholera (see, e.g., Charles E. Rosenberg, 1962). This measure followed documented (but unconfirmed) suspicions by John Snow, a physician and much revered early epidemiologist, that the cause of the disease originated in the pump. (Afterwards, a detailed investigation determined that, more than 20 feet underground, a sewer pipe passed within a few feet of the well.) • Vorsorgeprinzip – the “forecaring” principle – introduced into German environmental law in the 1970s.

8. The U.S-Canada Great Lakes Water Quality Agreement: “Such a strategy [a phase out of all toxic persistent substance] should recognize that all persistent toxic substances are dangerous to the environment, deleterious to the human condition, and can no longer be tolerated in the ecosystem, whether or not unassailable scientific proof of acute or chronic damage is universally accepted.” • Science-based regulation (the National Environmental Policy Act, the Clean Water Act, the Occupational Safety and Health Act, the Federal Food, Drug, and Cosmetic Act, …) • The U.S. Food Safety System stipulates that “conservative” risk management decisions be implemented when safety information on a hazard in a food is “substantial but incomplete.”

9. Despite this widespread use, however, the Precautionary Principle remains controversial and is often the object of acrimonious debates. • Advocates argue that it provides potential victims a safeguard against sloppiness or manipulation in science-based regulation. • But critics say that it gives undue veto powers to “environmental extremists” to block technological progress and opens the door to lobby groups to foster trade protectionism. • The potentially high stakes involved would make a clarification of its meaning and use quite timely.

10. 5.2 Economic contributions The PP as a “Real Option” • Arrow and Fisher (1974), Henry (1974): Uncertainty + learning => reversibility (or flexibility) has a positive value • Pindyck, Dixit and others develop the framework of real options as an extension of that of financial options. • Gollier, Jullien and Treich (1999) Precautionary measures are preferred when the decision maker exhibits the “right” amount ofprudence.

11. 0 1/2 1 1/2 2 1/2 1/2 1/2 1/2 1/2 2 3 1/2 «Left» is a prudent choice. 4

12. The paradox of precaution [Bernard Sinclair-Desgagné and Pauline Barrieu, 2003] • All statements of the PP involve three key items: a) scientific uncertainty giving way to a range of undismissable scenarios; b) collective preferences that identify at least one of these scenarios as a plausible “bad”; c) a feasible (i.e. morally acceptable, technologically doable, and affordable) precautionary strategy that, if implemented, would reinforce the status quo. Theorem: The statement that the occurrence of (a) and (b) entails (c) is logically inconsistent.

13. 6. Conclusion We believe that economics can offer, still partial, but quite valuable answers to the following questions. • What are the respective roles of governments, professional organizations, risk generators and insurers in promoting risk management for engineers? • Are there particular competencies that engineers lack through their education and training that need to be improved? • Is there a need to have particular licensing requirements for engineers who carry out risk management functions? • How can a more permanent awareness of risk and its consequences be obtained from people who work in the field of risk management?

14. THANK YOU