Coase theorem

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The Coase theorem is a method of dealing with externalities in an imaginary economy. As set forth by Chicago school economist Ronald Coase and his followers, the theorem states that if two or more parties are affected by an externality, when property is well-defined and transaction costs (time and money spent) are negligible or non-existent, then bargaining will always lead to the most efficient outcome regardless of the initial allocation of the property. Coase originally made this argument with regard to assigning radio frequencies in 1960, saying that it didn't matter who was assigned what frequency — the station with the best ratings would have more money and thus pay off other stations not to intrude on the former's frequency. However, Coase notes that when transaction costs are not zero, these costs must be factored into the decision of who is assigned the property.

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[edit] In imaginary economies

Say Farmer Brown has a bunch of cows. He lets them graze on an open field, which he doesn't own. The field is next to a nuclear reactor, Ten Mile Island, which decides to dump depleted plutonium into the open field before it's picked up for transport for safe disposal. Farmer Brown loses $100 on his next shipment of milk because some of it is contaminated. (On a side note, one radioactive carton does escape, causing the person who drinks it to become a superhero called The Milkman in a case of a positive externality, but that's beside the point.) Let's say a small temporary storage facility for the waste can be built for $50 (lead is on sale). To resolve this problem, we can assign property rights to either Farmer Brown or Ten Mile Island. If we give it to Farmer Brown, then Ten Mile Island must compensate him for every $100 worth of milk lost. However, it's easier just to pay the $50 once to build the storage facility. If we give the field to Ten Mile Island, then Farmer Brown suffers $100 worth of losses on every milk shipment. It's easier for him just to pay for the storage facility. And voila! The market, as always, leads to a perfectly efficient outcome!

[edit] Counter-hypothetical

Farmer Brown notices Ten Mile Island dumping plutonium into the field. He tries to bargain with the plant owners, but they buy out the field and use the entire thing to dump waste. The plutonium seeps over into his property. Farmer Brown attempts legal action, but Ten Mile Island has a team of high-paid lawyers and they settle out of court for a pittance. Next year, all of Farmer Brown's cows are dead. He loses his farm. The plutonium leaks into the nearby town's water supply. The people who drink the water, unfortunately, do not become superheroes.

[edit] Problem with even the ideal example

The Coase theorem is problematic from the very start in that it does not (and cannot, otherwise it becomes unnecessary in forming environmental law) prevent ecological damage done in the first frickin' place place. It's the difference between the law stopping someone from whacking your kid about the head with a baseball bat and the law allowing him to do so as long as you get sufficient weregild. This will only protect your child until someone with enough money decides that it's sufficiently fun or profitable to beat him or her up.

This is not exaggeration, by the way; it's an understatement if anything. For some odd reason Libertarians/Conservatives keep forgetting that pollution causes mental retardation, cripples people, and of course often causes people to die. To the tune of 24,000 premature deaths per year, just from friggin' diesel exhaust[1]. Why is the public at large already not rebelling at this appalling waste of life? Probably because it's not as visceral as a scary criminal with a gun screaming rap lyrics.

[edit] In real life

In reality, the situation tends to lie in the middle. Significant transaction costs often exist, and solving a conflict through governmental regulation is frequently the simplest and most efficient solution. So, for instance, having "free" parking is very popular, and parking meters are reviled, even though a basic understanding of economics shows that people are, on average, better off with parking meters; there's no use to having "free" parking if none of the spaces are available.

[edit] Libertarian arguments

Many libertarians argue that externalities like pollution can be dealt with by making public land private to solve the tragedy of the commons. This idea is, of course, to be implemented using Nobel-winning economist Robert Coase's theorem. This is often used to justify ideas like the privatization of wildlife.

[edit] External links

[edit] Footnotes

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