[ Table of contents ]   [ List of papers ] [ PDF Version ]     Three Preliminary Papers on the Economics of Occupational Safety and Health by Peter Dorman Geneva, April 2000 Chapter 1 The Cost of Accidents and Diseases

In any assessment of the overall burden of occupational injury and disease the main emphasis must be on the human cost--the pain and suffering, loss of function, diminished quality of life, and premature death. Nevertheless, in recent years there has been an upsurge of interest in the economic cost of poor working conditions. There are several reasons for this. First, the economic costs are important in their own right. Damage to workers has a large collateral impact on enterprises and even whole economies, and recognizing this adds impetus to the demand for improvements in safety and health. Second, the key decision-makers in this field are firms and their managers, and their primary motivation is economic. By analyzing the structure of economic costs we can better understand the behavior of these firms, and we can also craft policies that intervene effectively in management decision-making. Finally, while governments are called upon to respond to the ethical imperatives of safety, global competition has fixed their attention on the economics of safety as well. In this chapter we will take up the problem of identifying the economic cost of occupational injury and disease: not only the overall scale of these costs but also their structure, for, as will become apparent, different types of cost have important implications for safety and health at work. Logically, the types of cost identified in this chapter should be seen as additions, not alternatives, to the human costs we are already aware of.

The modern study of accident costs begins with the work of Heinrich in the U.S. during the 1920s. He surveyed thousands of cases and came to the conclusion that management grossly underestimates the real cost of injuries on the job. Throughout his long career he campaigned for greater attention to these costs, and for greater management commitment to safety and health in general. Unfortunately, many of his claims were exaggerated, and the cost categories he used were not very clearly defined. In recent decades a variety of alternative cost accounting systems have been proposed--controllable/uncontrollable, fixed/variable, insured/uninsured--and the classification methodology can often vary widely from one study to the next. Moreover, the relationship between costs at the company and national levels is seldom made clear. In the future, we will need greater clarity and standardization in cost analysis.

The place to begin is with a clear understanding of the concepts involved. In this chapter we will categorize costs as economic or noneconomic, fixed or variable, direct or indirect, and internal or external. Each of these distinctions has important consequences for our analysis.

Economic Costs and the Incentive to Improve Safety and Health

The most important costs of accidents and diseases are noneconomic. These include the direct physical cost to the victim, the emotional cost to the victim's family and community, and damage to social values like justice and solidarity. Attempts have been made to place monetary values on some of these (and such attempts are unavoidable in the awarding of damages by the courts), but in the end no number can capture the losses which money cannot recompense. (Dorman, 1996) By definition, however, economic costs are those that can be calculated, at least in principle. They encompass the loss of goods or services that either have a price in the market or that could be assigned an approximate price by an informed observer. These include financial costs to the worker, the loss of household services that have or can be given a market value, losses incurred by the firm, and lost productive capacity available to society. In computing these costs it is important to avoid double-counting: if, for instance, an insurance company pays for the medical costs of injured workers but the employer pays insurance premiums, the cost must be charged to only one payer--generally the ultimate payer, in this case the firm. On the other hand, it is not quite correct to say that all economic costs ultimately represent lost production. This is because there is generally slack both at the level of the firm (what economists call "x-inefficiency") and at the level of the whole economy (unemployed resources). But slack can hardly absorb most of the costs of injuries and illnesses, nor can the demands of replacing incapacitated workers be credited with any significant diminution of slack, so most of the costs to members of society will eventually show up in the form of reduced output.

Within the realm of economic cost there is an important distinction to be made between costs that are essentially constant whatever the level of injury or disease, and those that vary with incidence. The overhead of insurance and regulatory systems, for example, are relatively fixed costs to society, and much or all of a firm's insurance premium may be equally independent of the number of injuries or illnesses that actually occur. (The role of workers' compensation insurance will be examined in the next chapter.) While the costs of specific accidents or health problems can be allocated to fixed costs by an accounting procedure, there is no corresponding financial incentive for decision-makers to reduce occupational risks. Only the variable cost component, such as the costs of writing up individual accidents or paying higher insurance rates because of an increase in claims, provides this motivation.

Direct and Indirect Costs

Related to the fixed/variable distinction but also somewhat different is the distinction between direct and indirect costs. In the literature on cost analysis there is a tendency for each author to draw this distinction somewhat differently. A typical approach is to simply list the costs that will qualify as direct, and assign all the rest to indirect. Since each industry is unique in terms of the kinds of costs it generates and the channels through which they are paid, it is not surprising that no two lists are the same. Our approach will be more general, and is based on the attempt to answer this question: will the decision-maker--generally a high-level manager in a private company--identify the cost and attribute it to the firm's OSH experience in the absence of an extra expenditure of time and resources to calculate and allocate it? Or, equivalently, do the amount of the cost and its cause automatically show up in the firm's routine accounting system? If yes, it will be called direct; if no, indirect. The motivation behind asking this question is to determine how likely it is the cost will be perceived and properly understood in the first place.

Although not exactly the same, the lists of direct and indirect costs resulting from this approach will be similar to those found in most of the literature. Insurance premiums, legal settlements, and direct payment to physicians will usually be examples of direct costs at the company level. Indirect costs are just as real, but they must be inferred from close observation and calculation. Thus, if a machine has a shorter lifespan because it was involved in an industrial accident, this is a "hard" economic cost, but it may be one that goes unnoticed unless someone takes the extra time to measure and allocate the damage. A list of possible indirect costs at the company level appears in Table 1. In using a list like this it is important to remember that, in specific situations, a cost item may switch categories depending on the details of the payment mechanisms and accounting system.

Table 1

Potential Indirect Costs of Occupational Accidents at the Company Level

The failure to identify and take into consideration these costs can have a profound impact on a company's willingness to invest in workplace safety and health. Estimates of indirect costs as a proportion of direct costs have ranged from less than 1:1 to more than 20:1, depending on the specific industry and methodology of the researcher. In general, however, a firm that fails to tally the full cost it pays for poor working conditions operates under the misleading perception that it has less incentive to remedy them. Without realizing it, the firm may be undermining its economic as well as physical health. Box 1 offers an example of "full cost accounting" applied to safety and health and demonstrates the disparity between direct and full actual cost.

Why don't most firms calculate indirect costs? Reasons vary, but common factors include:

• measurement problems: Measuring these costs can be difficult and expensive. Under the best of circumstances it may take considerable time to sort out the ripple effects, assign prices to them, etc. In addition, the firm may not have the trained staff this task requires.
• management overload: Managers have only a limited ability to absorb new information--a problem decision theorists call "bounded rationality". Their attention is often fully taken up by existing proposals and reports, leaving little surplus attention to devote to the complex issue of indirect safety and health costs.
• biases in accounting methods: Standard accounting procedures are less able to accommodate measures of investment in, or depletion of, human resources than traditional assets of brick and steel. (Blair, 1995) This bias toward "hard" rather than "soft" asset valuation is a problem for many programs to enhance the workforce, including safety and health programs. Even when managers appreciate the importance of these efforts, outside parties, like investors and creditors, may be more difficult to persuade. This points to the need for new accounting standards that better reflect the capacities of workers, and not just the materials they work with.
• allocation problems: At its heart, accounting has a simple purpose: to reveal the financial consequences of past decisions and aid in estimating the consequences of future decisions. For this purpose to be served in the field of occupational safety and health it is essential that the costs of working conditions be correctly allocated to the units responsible for them. One complication that often arises is that the unit generating the cost is often not the one that pays for it, so that the cause-effect linkage needs to be tracked down and made clear in the records. Worse, many firms make little attempt to allocate OSH costs to individual units; for instance, it is common for firms to allocate the cost of workers' compensation premiums across units by payroll size rather than by their actual claims experience. (Hopkins, 1995) In this way the costs of failing to make work safer remain invisible.
• low status for OSH departments: The job of calculating and allocating OSH costs generally falls on the firm's OSH department. Their ability to do the job thoroughly and bring the results to the attention of top management depends in part on where their unit stands in the firm's overall hierarchy. Too often OSH has a low status with little claim on resources or input into the strategic level of management. An essential aspect of an effective "safety culture" is the upgrading of OSH personnel within the organization.
• "don't ask, don't tell": In some firms there is a conspiracy of silence surrounding working conditions. Managers may fear that simply recording the true financial impact of injuries and illnesses may stir up the workforce and lead to more demands from unions or similar groups. Their strategy is to avoid the topic altogether and discourage their safety and health personnel from taking their job too seriously. (Frick, 1996)

These are the obstacles that must be overcome at the enterprise level if worker safety and health are to gain the attention they deserve. Note that many of these will be particularly acute in small and medium enterprises--precisely the firms that tend to have the most pressing safety problems and the greatest need to address them.

Internal and External Costs

As important as the fixed/variable and direct/indirect distinctions are at the company level, from a social standpoint the most important difference is between internal and external costs. An example should make this clear. Suppose a company experiences a certain number of occupational illnesses each year due to a particular compound used for painting, and that the potential remedy consists in buying a safer but more expensive compound instead. To make matters simple, assume that all of the costs stemming from these illnesses are variable. Without undertaking any study, managers can see that they pay an extra $1 million in medical and indemnity costs--costs they could avoid by switching paint formulas. This might provide enough incentive to make the change, or it might not. If the firm cares only about profits and feels no ethical obligation to safeguard its workers' health, its decision will depend on whether the extra cost of the new paint is more or less than $1 million. But now imagine that the company hires a team of safety investigators, and after scrutinizing the elements in Table 1 they are able to determine that there is an indirect but real cost to these illnesses of another $2 million. It is quite possible that this new information (which is well within the range of estimates for calculations of this type) will tip the balance: the investment that was unprofitable when only $1 million could be saved is profitable when $3 million are in the balance. But, again, perhaps not. It may be that it costs $4 million to switch paints. In that case it will never be in the company's immediate financial interest to solve their exposure problem. Yet most of the economic costs of injuries and illnesses do not fall on employers; they are paid by workers, their families, and their communities--this in addition to the noneconomic costs which, by definition, cannot show up on the firms' books. Let us suppose that these extra costs amount to another $3 million, effectively doubling the total social cost. A $4 million investment to save $6 million is a good bargain for society, but not for the firm itself, since its losses are lower. In this example, the direct internal cost is $1 million, the indirect internal cost is $2 million, and the external cost is $3 million.

Economic theory tells us that the existence of external costs drives a wedge between the incentives of individual decision-makers, such as enterprises, and the interests of the wider community. Environmental pollution is often given as an example, but the costs of injuries and illnesses suffered on the job could serve just as well. When careful attention is given to these costs, it becomes clear that by far the largest part of them falls not on the employer but on the worker and society as a whole. A partial list of the components of external cost appears in Table 2. Recall that these are elements of economic cost only, and do not include the human costs that resist monetization.

Table 2

Typical Components of the External Cost of Occupational Accidents and Diseases

The next-to-last of these, environmental contamination, deserves special consideration, since there is a tendency to overlook the connection between the workplace and wider ecosystem. Hazardous substances do not read signs proclaiming "private property" and "do not enter"; they migrate readily by air and water between production sites and residential areas. The risk is compounded by the usual pattern in which neighborhoods spring up around factories, mines and other places of employment. This is particularly common in developing countries, where industrialization and urbanization are part of the same phenomenon. The result can be a horrendous disaster, as in Bhopal, India; literally thousands died from an accident in a fertilizer plant. But the routine emission of pollutants can also create an insidious problem, undermining the health of workers in their own homes. (See the discussion of the Ulsan/Onsan complex in the Republic of Korea in WHO, 1992.) The implication for cost analysis is this: depending on the production methods and control processes involved, the same factors that generate risks of injury and illness on the job generate risks off the job, and with few exceptions these wider ecological costs will be externalized. The "polluter pays" principle is more honored in the breach, and even when massive attention causes a company to pay some of the direct costs of an environmental disaster, as occurred after the Bhopal episode, these payments cover only a fraction of the full cost. Even with the best of intentions, however, it is often difficult to trace specific environmental health outcomes to individual enterprises or production methods. These costs, increasingly recognized as serious, will be paid mostly by families and communities, not businesses.

For most workers the main impact of cost externalization is on their own family budget. It is not uncommon for the combination of lost income, uncompensated medical expenses, and diminished future job prospects to consign a sick or injured worker's family to poverty. This is virtually the rule rather than the exception in the developing world, where workers' compensation is seldom provided and there is little other employer support to take up the slack--and where working families are not far removed, if at all, from poverty circumstances to start with. But even in the welfare states of the industrialized world a substantial portion of the most direct financial costs of accidents and disease falls on the victim and his or her family. We will see this to be the case in our look at the U.S. evidence (Box 3), but it also emerged in a study of injured Danish workers. (Lings et al., 1984) There, depending on the way ambiguities in the survey data are resolved, between 44-89% of the financial cost was externalized, with approximately 20% falling on the worker directly.

Nevertheless, while cost externalization is a problem everywhere, it is more pronounced in some situations than others. Some of the factors which can increase the extent to which it is society and not the employer who pays are:

• degree of market competition: In highly competitive markets individual firms are more likely to try to avoid bearing safety and health costs. This principle applies to whole countries, specific industries, and particular sectors of industries. Thus externalization is likely to be greater in open economies than closed ones, competitive industries than concentrated ones, and small and medium enterprises than large firms. (See Box 2 below.)
• unemployment: When unemployment rates are high firms are more able to shed costs on their workers. Cost externalization will therefore tend to be greater during business cycle downturns, in depressed regions, and in countries with large reserves of un- and underemployed labor.
• transfer and social insurance programs: Countries with highly developed public welfare programs are more vulnerable to cost externalization, since these programs either pool risks (dissipating the risk to the enterprise) or transfer a portion of the burden to taxpayers. An example would be publicly funded health care systems, which absorb much of the cost of occupational accidents and diseases.

All of these are and will continue to be aspects of everyday life. There is no reason to expect the distortions caused by external costs to diminish over time.

The magnitude of the external costs sketched in Table 2 indicates that in a wide range of situations it will be in economic interest of society to mitigate hazards on the job even when it is not in the economic interest of the individual enterprise. Since it is the enterprise which, in general, plays the primary role in creating and controlling these risks, the resulting rates of injury and illness will greatly exceed levels that can be justified by economics. What can be done? First, measures can be adopted to close the gap between internal and total cost, by placing more of the financial burden on employers. This was a common response of reformers during the early years of the industrial revolution, and it is making a comeback in many national OSH systems. Second, society can establish a system of regulation that impels firms to improve working conditions beyond the limits of their own financial interest. While neither approach alone is sufficient, together they can go a long way toward meeting the safety and health needs of the workforce. In the following chapter we will examine the strategy of "internalizing the externality"; for now it is enough to say that it is our position that both economic incentives and improved regulation are necessary components of an effective worker protection strategy. In coming years we will see a major strengthening of national systems on both fronts, as well as increased efforts to harmonize them on a global level.

The magnitude of the external costs sketched in Table 2 indicates that in a wide range of situations it will be in economic interest of society to mitigate hazards on the job even when it is not in the economic interest of the individual enterprise. Since it is the enterprise which, in general, plays the primary role in creating and controlling these risks, the resulting rates of injury and illness will greatly exceed levels that can be justified by economics. What can be done? First, measures can be adopted to close the gap between internal and total cost, by placing more of the financial burden on employers. This was a common response of reformers during the early years of the industrial revolution, and it is making a comeback in many national OSH systems. Second, society can establish a system of regulation that impels firms to improve working conditions beyond the limits of their own financial interest. While neither approach alone is sufficient, together they can go a long way toward meeting the safety and health needs of the workforce. In the following chapter we will examine the strategy of "internalizing the externality"; for now it is enough to say that it is our position that both economic incentives and improved regulation are necessary components of an effective worker protection strategy. In coming years we will see a major strengthening of national systems on both fronts, as well as increased efforts to harmonize them on a global level.

Table 3 summarizes the various cost categories discussed to this point and their economic implications. Its overall message is that simply tallying costs, although it is a start, is not enough; attention must be paid to what kinds of costs are involved and what implications these hold for the public interest.

Table 3

Distinctions in the Cost of Occupational Accidents and Diseases

Quantifying the Economic Costs of Occupational Injuries and Diseases

We have already seen how the fixed/variable and direct/indirect distinctions appear in a case study of OSH costs at the company level. Box 3 describes an extremely elaborate attempt to estimate the total economic cost of occupational illness and injury in the United States for the year 1992. To place this information in context, consider that 3% of GDP is sufficient to provide every worker with 1 1/2 weeks of paid vacation, or to finance a third of all capital (nonresidential fixed) investment in the U.S. economy during 1992. Note, in addition to the large overall amount, the striking degree to which these costs are passed on to workers and consumers. If even remotely accurate, this breakdown indicates that, even with the best possible systems of cost accounting, firms will not find an economic motive to address most of the safety and health risks at work.

Conclusion

As important as these estimates are, they are backward-looking. They give us an indication of the costs of injuries and illnesses in the past, but what about the future? Do we expect the economic burden to rise or fall? In part, this is a function of our expectations of the safety and health data themselves. Here we would like to pause to consider likely future trends in the economic aspect--the degree to which future safety and health impairments will also give rise to economic loss. Most predictions of the future are risky, but one that is almost certain is that, for any given accident or disease, the perceived economic cost will increase on a global basis. There are several reasons for this:

• better measurement: As we have seen, most economic costs are indirect and/or external. This means that, unless they are carefully quantified, they will not be properly attributed. The art of measuring and allocating these costs is still in its infancy; in the future this job will be done more often and more accurately. An important lesson from the past is that, in general, as we improve our ability to measure safety and health costs, the totals go up. In addition, developing countries will play a greater role in identifying the economic burden, and so less of their own costs will remain hidden from view.

• increased human role in production: As technology develops there is a tendency for more of the routine work, both manual and intellectual, to be performed by machines, while the tasks that require greater judgment, sensitivity, and skill remain with the worker. In different ways, emerging management styles recognize this and put greater reliance on workers to solve problems and determine the details of the work process. The greater this reliance, the greater the cost to the enterprise and society when the worker is suddenly removed from production by injury or debilitated by disease. An extreme example is provided by just-in-time production methods. In this system inventory is kept to a minimum, and each work station is directly dependent on the quality and flow of work from the station just upstream. The goal is not only, or even primarily, to reduce the carrying costs of inventory, but to increase the pressure to maintain high performance levels at every stage of the process by taking away the safety net. In such a system, an accident can ripple through the entire production system, bringing it all to a standstill. The consequences of the temporary or permanent loss of a worker who deploys substantial skill and experience on a regular basis may be less dramatic but even more costly in the long run.

• diminished slack: At the beginning of this chapter it was pointed out that the existence of slack at both the company and societal levels cushions somewhat the economic impact of occupational injury and disease. Over time this slack will almost certainly fall. It will fall at the company level as management systems become more sophisticated, whether "lean" or "socio-technical" models ultimately prevail. (Appelbaum and Batt, 1994) Macroeconomic unemployment will also decline, whether because of the application of policy, as in the developed countries, or because of the gradual spread of the formal sector in the developing world. It is doubtful that the current level of human waste will be tolerated for much longer.

• rising medical costs: Although the dramatic upward trajectory of medical costs in the industrialized countries appears to be tapering off, future advances in technology will still tend to consume money rather than save it. But the big story is in the developing world, where access to the latest--and most expensive--medical techniques will continue to widen. In the future, the typical injured worker in Jakarta or Lima will receive medical attention comparable to that received today in Osaka or Frankfurt.

As we speculate on the future costs of injury and disease, it is important once again to remember that they pale beside the primary costs of poor working conditions--the human costs to workers and their families. Yet the current and future magnitudes of the economic costs convey additional messages: that the material aspirations of the world's people are also at risk, and that, in the deepest sense, economic development may not simply be compatible with occupational safety and health but may even require it.

We expect that, as economic factors play a greater role in government policy, and as the data on the economic costs of poor working conditions become more widely known, a consensus will emerge that safety and health are not expendable, nor can they be deferred. Excuses predicated on "economics" will not be seen as acceptable.

References

Appelbaum, Eileen and Rosemary Batt. 1994. The New American Workplace: Transforming Work Systems in the United States. Cornell (NY): ILR Press.