Coase’s paper “The Problem of Social Cost” appeared in the October 1960 volume of the Journal of Law and Economics. This brings us, for reasons that we will explain, to the television show Have Gun – Will Travel, which aired from 1957 to 1963. A particular 1958 episode, called “Bitter Wine,”1 is likely the most Coasean episode of television ever made. Every element of the “Problem of Social Cost” makes an appearance in the episode: the reciprocal nature of externalities, how the initial allocation of property rights matters in a world with transaction costs, and how the legal system can overcome transaction costs to allow for an efficient allocation of rights.
This is from Jon Murphy and John Schuler, “Have Coase – Will Travel,” the Econlib Feature Article for May. I highly recommend it, especially for economics professors who want to give their students a short, readable article that helps concretize the much-longer Coase classic.
READER COMMENTS
Thaomas
May 6 2019 at 5:05pm
If I understand the story properly, the oil well was generating zero economic rents but did produce a negative externality. If Donatello’s property right to unpolluted air and water were recognized from the beginning, the oil well would not be drilled (no loss to anyone) and no conflict would have arisen. The cost of negotiation does not enter the optimal solution.
If initial property rights are such that Donatello has no right to unpolluted air and water, then negotiations could ensue about how much Donatello would pay to have the oil well install the mitigating equipment to achieve the optimal level (not necessarily zero) of pollution and this will achieve an optimal result, given the investment in the oil well, but this leaves the oil well investment no better off and Donatello worse off. The investment was not Pareto optimal and negotiations could not achieve a Pareto optimal result.
Thaomas
May 6 2019 at 5:12pm
If I understand the story properly, the oil well was generating zero economic rents but did produce a negative externality. If Donatello’s property right to unpolluted air and water were recognized from the beginning, the oil well would not be drilled (no loss to anyone) and no conflict would have arisen. The cost of negotiation does not enter the optimal solution.
If initial property rights are such that Donatello has no right to unpolluted air and water, then negotiations could ensue about how much Donatello would pay to have the oil well install the mitigating equipment to achieve the optimal level (not necessarily zero) of pollution and this will achieve an optimal result, given the investment in the oil well, but this leaves the oil well investment no better off and Donatello worse off. The investment was not Pareto optimal and negotiations could not achieve a Pareto optimal result.
The chief theoretical advantage stemming form the Coase Theorem should be to persuade Libertarian economists that it sometimes makes sense to impose Pigouvian taxes or subsidies (or even regulation) to optimally encourage/discourage exteralities. In practice it seem to have failed in this regard.
Jon Murphy
May 7 2019 at 6:23am
Why do you say it was generating zero economic rents? Gorman was not turning a major accounting profit, yes, but he was at least operating at the point where the benefits of operating the rig exceeded his total costs (including his opportunity cost).
It’s also not clear to me your contention that, if the property rights were well-defined at first that no oil well would have been built. A point of Coase is that it doesn’t matter where the initial property rights are allocated; the result is the same. And obviously Gorman still benefits from drilling and operating the rig post-negotiation because he continues to do so profitably.
Obviously not. The pollution was harming his grapes. They went from prize-winning to soot. Reducing the pollution does make Donatello better off and Gorman is no worse off; we have a Pareto Improvement.
The Problem of Social Cost was written for the opposite purpose. Coase was pushing back on the Pigouvian approach that constantly called for taxes and whatnot. Coase pointed out the problems with that approach.
Of course, it is theoritical possible that a tax can fix externalities. But there’s a number of issues with that once you figure in public choice issues, subjective probabilities and preferences (see Carl Dahlman’s paper The Problem of Externality) and the big point: “efficiency” is a pretty vague concept
Thaomas
May 7 2019 at 5:10pm
The story said Gorman claim to be barely breaking even of something like that. If there is enough rent between the two firms then there exists an investment in the oil well and optimal level of pollution mitigating equipment. The initial definition of the right to unpolluted air and water will not affect the investment chosen — that’s the Coase Theroem, right? — but it surely seems that it will affect the distribution of the rents from the two firms.
Jon Murphy
May 8 2019 at 9:30am
Right. That refers to accounting profit. We do not have enough information to determine Gorman’s economic profit (we are not told his opportunity cost).
Possibly, yes. But that is irrelevant here. At least one party is made better off (Donatello) and the other party is not made worse off (Gorman). We have a Pareto-improvement.
robc
May 7 2019 at 9:04am
You are so stuck on the concept of Pigovian taxes that you just became the first person in history to argue that Coase’s work supports them.
Jon covered it already, but that is as wrong as it is possible to be.
Thaomas
May 7 2019 at 6:06pm
Maybe not. Murphy DID admit to the theoretical possibility of Pigouvian taxes working, 🙂 so that means it down to empirical estimations in any given case. I’m just not convinced that there is a feasible negotiation outcome to achieve an optimal level of atmospheric CO2.
Mark Z
May 7 2019 at 10:49pm
I think you’re setting up anasymmetric comparison between Coasean and Pigovian solutions: Coase needs to be ‘feasible’, but Pigou only needs to be ‘theoretically possible?’
How exactly would a Pigovian tax achieve an optimal level of atmospheric CO2? How would one determine the optimal tax rate?
Thaomas
May 8 2019 at 7:48am
Well you might start by setting up an international commission to review scientific findings on the relationship between CO2 and climate change and to estimates the damage that the change causes. Then you detect get some economists like Nordhaus to model the costs of different levels of CO2 taxation, its effects on CO2 emissions and the harm mitigation achieved. Then you try to get people who understand economics to start charging a tax on net CO2 emissions. All are pretty difficult, but less so than trying to get a muti-generation international negotiation to achieve the same end.
Thaomas
May 8 2019 at 7:58am
I think you have the asymmetry going the wrong way. The policy implication of the Coasean insight is to definitely to do nothing about an externality. The Pigovian insight is that it might be possible to do something in circumstances in which the Coasean solution has not worked. If CO2 is too scientifically controversial, how does Coase work in the case of particulate emission from coal-fired power generation.
Jon Murphy
May 8 2019 at 9:36am
No. He explicitly says otherwise. Indeed, this is a point raised in my article. One of the things that can be done is to clarify property rights. Another is to reduce transaction costs. What Coase points out, contra Pigou and Samuelson, is that an externality necessarily requires a tax or some other intervention to correct.
Again, not necessarily. Coase was pushing against this claim in his article (and he subsequently wrote two long essays pushing back on this interpretation of his work).
Jon Murphy
May 8 2019 at 9:31am
Then there is not a feasible negotiation outcome for a Pigouvian tax. You need the market to set the price.
Thaomas
May 8 2019 at 2:39pm
Excuse my inexactitude. I mean that I doubt the feasibility of achieving a negotiation among all those who are emitters of CO2 and are harmed by CO2 emissions. Now maybe getting the US Congress and other governments to pass CO2 taxes is pretty infeasible too, but that seems at least to have some sort of chance.
Thaomas
May 8 2019 at 3:01pm
Again, I guess I did not express my self well. I was not speculating about Coase’s intentions in writing the article. I was referring to practical implications. I’m not aware of a policy proposal of a way of reducing negotiating costs in dealing with any of the typical externality problems of air and water pollution as an alternative to taxation or regulation.
Maniel
May 6 2019 at 11:29pm
Prof Henderson,
Nice post. I was always a fan of Richard Boone and HGWT; now I know why.
Mr. Boone was a great actor, and never better than in this clip from Hombre starring Paul Newman. I think one point of the scene is to decide who has the edge; you might even call it the “comparative advantage,” but such edges can be fleeting.
Mark Bahner
May 7 2019 at 1:49pm
I hope Econlog will allow my usual not-directly-related-to-the-bottom-line (but hopefully-somewhat-amusing) comments:
We should probably also count a loss for the families of the two men killed. To paraphrase Paul Newman’s classic line in the classic movie, “Absence of Malice”:
But…with that soot comes…CO2! Global warming! Global warming! Oh, the humanity!
And as any good environmental engineer knows, soot contains black carbon, which means…even more global warming! “Thanks for poisoning the planet, Gorman”!***
Soot…not a benign as you think! 😉
P.S. ***Simpsons fans will recognize the word that belongs in place of “Gorman”, from the classic episode, “The Seduction of Homer.” If you don’t know what the word is that “Gorman” is replacing…well… 🙂
Jon Murphy
May 7 2019 at 3:30pm
Well…watch the episode 🙂
You are absolutely right. In a fully just world, those families would get some form of compensation (however inadequate it would be). John and I didn’t include that in the article as it would have distracted from the main point
robc
May 7 2019 at 4:03pm
When you hire out as a mercenary, that is one of the risks you face.
Jon Murphy
May 8 2019 at 9:38am
True, but that’s one thing I recently noticed in another re-watching of that episode. They’re not mercenaries, but employees of Donatello; they’re winemakers. He calls on previous acts of loyalty to rally them.
Mark Bahner
May 8 2019 at 9:58am
I must admit that I didn’t read the wording very carefully. Here’s what the precise wording was:
I guess the wording strongly implies they were Donatello’s men, but my thought when I wrote my comments was that “two men were killed” probably meant one man on each side. I thought that in part because it seemed strange that a surprise attack would lead to both deaths being on the attackers’ side.
I was going to add the theoretical twist that “suppose their were just winemaker neighbors of Donatello”…I’m glad the show’s writers did add that twist.
Another possible twist would be that the pollution isn’t simply ruining Donatello’s grapes, but is actually making members of his family sick. The family members could be shown in bed coughing and moaning. What neighbor wouldn’t try to help in that situation? (Of course, a possibility in that situation would be indoor air filters. They could do an anachronism, and buy a HEPA filter from the General Store.)
Mark Bahner
May 7 2019 at 9:26pm
Hi Jon,
Yes, “The Seduction of Homer” episode was an absolute classic from the Simpsons’ good ol’ days.
Yes, my apologies. I’m not good at staying on point. BUT…I have a lot of stories from my career as an environmental engineer that are absolutely on point.
For example, I did support of EPA regulations for primary copper smelters. Two “high arsenic” copper smelters were the former ASARCO copper smelters in Tacoma, WA, and El Paso, TX. In the 1930s-1960s, those smelter emitted a lot of arsenic. I think the Tacoma smelter was emitting more than 1000 tons per year of arsenic…that’s into the air alone. Both smelters had tremendously tall smoke stacks…but all a stack does is disperse the solution. (“Dilution is the solution to pollution,” as they used to say.)
I’m not as familiar with the location of the Tacoma smelter and know less about Tacoma, but the El Paso smelter was right in the middle of downtown El Paso. So there were a tremendous number of people involved. Even consider that El Paso is on the border, so some amount of arsenic was being dumped into Ciudad Juarez, Mexico. Two gigantic Coasean situations. With evolving knowledge about the dangers of arsenic and other heavy metals (not to mention the hundreds of thousands of tons of sulfur dioxide being emitted every years).
Another interesting situation (on a much smaller scale) was a quarry in a Middle Eastern country. (Don’t want to reveal more.) The neighbors were complaining that the blasting operations were loud, dusty, and cracking their house foundations. The quarry pointed out that: 1) virtually all the neighbors moved in right next to the quarry long after the quarry commenced operations, and 2) the quarry was doing almost all it possibly could to minimize the problems from blasting. I thought the quarry had an extremely strong case…though I tried to think of some other things they could do that would be relatively inexpensive. I wish I’d known about viewing situations like that in Coasean terms back then (this was probably at least a decade ago, and if Coase was covered in my undergraduate economics classes in the late 70s, I’d long since forgotten).
Mark Bahner
May 8 2019 at 9:26am
Hi,
I thought last night I published some comments about what I thought were interesting Coasean situations with copper smelters in the U.S. and a quarry in the Middle East. But this morning the comments seem to be gone…? It’s possible I never hit the “submit comment” button…? Or maybe I had the wrong Econlog posting open…?
I’d hate to have to regenerate them, but I thought they were particularly interesting because they actually describe significant real world problems that parallel the TV show, but add additional complications (many more people involved, even multiple countries involved). Did anyone see my comments?
David Seltzer
May 8 2019 at 3:45pm
David, Yale told the story of how Coase convinced Stigler, Friedman and Aaron Director of the problems of social cost. Yale, ever the imp, said it was at a dinner party hosted by Director, Milton’s brother-in-law where, he was sure, alcohol was involved. Richard Sandor, a CBOT futures trader and economist, was profoundly influenced by Coase. Sandor founded The Chicago Climate Exchange in 2003 and began trading greenhouse gas futures. Coase provided the intellectual framework for reducing pollution by trading carbon credits instead of enforcing anti-pollution laws . Unfortunately, the CCX ceased trading in 2010 as liquidity dried up. It seems, the problems of greenhouse externalities remain
Thaomas
May 8 2019 at 10:43pm
Correct me if I am wrong, but it seems to me that the assignment of rights to pollute or no to be polluted upon does and should affect the investment decision to drill the oil well next to the vineyard. If Gorman does not expect to have to mitigate the pollution and the investment he will make the investment even it generates marginal rent. Gorman cannot invest in mitigation; Donatello can if his investment is not marginal,too, but it is possible that Donatello would just cease production. The return on the investment in the oil well will be negative for the two firms as a group, a movement that makes one party worse off and the other unchanged. If on the other hand Gorman does not expect to have the right to pollute, he will not make the investment leaving Donatello un harmed and Gorman only marginally worse off.
It seems to me that the assignment of rights does make a difference in the economic outcome in addition to the effects on the change in income distribution. The Pareto improvement from negotiation occurs only when the oil well has already been drilled.
Jon Murphy
May 9 2019 at 1:04pm
The activity will only cease if there is not a mutually beneficial outcome. In this particular case, there is. To take your hypothetical: if Gorman cannot pollute and he knows it, he can still access the oil and be profitable if he comes to the same negotiated outcome as in the show: Donatello (or someone) lends him $3k to build the necessary items. Capital markets exist, after all.
Thaomas
May 10 2019 at 12:53pm
The “negotiated solutions occurs in the know “no right to pollute” case only if the activity generates a sufficient margin to invest in the mitigation. In the know “right to pollute case” the negotiated solution does not occur.
BTW what does any if this have to do with typical cases in which there are multiple pollution sources and even more numerous people who are harmed maybe each one by a small expected value extent? EPA does not get involved in apple orchard/bee keeper problems.
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