Thursday, February 25, 2010

Economics of the Somali Pirate Business Model

. Thursday, February 25, 2010

This semester, I'm teaching four recitation sections of POLI 150: Intro to International Relations here at UNC (which is being taught by Dr. Oatley with Sarah and Will as fellow TA's). In each recitation I always like to spend the first five to ten minutes of class talking about current news and events in international politics and try to connect the theories and frameworks that we are teaching our students to the real world so they see that what they're learning actually does have value and provides explanatory power over topics outside of the classroom.

For my Wednesday afternoon recitation, after whatever pressing new events (this week it was the coup in Niger, the Winter Olympics, Greek sovereign default, and the Dalai Lama meeting) that they bring up have been explored, somehow the conversation always turns to pirates, how Somali piracy works, how and why countries respond to pirate attacks, etc. It's a great topic to discuss anarchy, collective action problems, bargaining, state vs. non-state actors and informal networks and markets. It seems like my obsession with pirates is starting to rub off on my students as each week they're bringing up new interesting questions and finding really awesome articles like the one I'm linking to below.

I was going to go into detail about this article, but instead I'm just going to completely outsource this post to Wired Magazine who provide an absolutely fantastic analysis of the incentives, costs and benefits facing not only Somali pirates but "shippers, insurers, private security contractors and numerous national navies" operating off the coast of Somalia. This is just an absolute must-read. Here is the opening:
The rough fishermen of the so-called Somali coast guard are unrepentant criminals, yes, but they're more than that. They're innovators. Where earlier sea bandits were satisfied to make off with a dinghy full of booty, pirates who prowl northeast Africa's Gulf of Aden hold captured ships for ransom. This strategy has been fabulously successful: The typical payoff today is 100 times what it was in 2005, and the number of attacks has skyrocketed.
Like any business, Somali piracy can be explained in purely economic terms. It flourishes by exploiting the incentives that drive international maritime trade. The other parties involved — shippers, insurers, private security contractors, and numerous national navies — stand to gain more (or at least lose less) by tolerating it than by putting up a serious fight. As for the pirates, their escalating demands are a method of price discovery, a way of gauging how much the market will bear.
The risk-and-reward calculations for the various players arise at key points of tension: at the outset of a shipment, when a vessel comes under attack, during ransom negotiations, and when a deal is struck. As long as national navies don't roll in with guns blazing, the region's peculiar economics ensure that most everyone gets a cut.
All of which makes daring rescues, like the liberation in April of the Maersk Alabama's captain, the exception rather than the rule. Such derring-do may become more frequent as public pressure builds to deep-six the brigands. However, the story of the Stolt Valor, captured on September 15, 2008, is more typical. Here's how it played out, along with the cold, hard numbers that have put the Somali pirate business model at the center of a growth industry.
Some very interesting tidbits:
An ordinary Somali earns about $600 a year, but even the lowliest freebooter can make nearly 17 times that — $10,000 — in a single hijacking. Never mind the risk; it's less dangerous than living in war-torn Mogadishu.
The insurance business is a gamble. Insurers know that some ships will be hijacked, forcing the companies to dispense multimillion-dollar settlements. However, they know the chance of this happening is minuscule, which by the calculations of their industry makes it worth issuing policies. In 2008, only 0.2 percent of ships sailing Somali waters were successfully hijacked.
(The hat tip goes to Paula, one of my students in class who found and emailed me the article).


Economics of the Somali Pirate Business Model
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