Can externalities be corrected without government intervention?
Ronald Coase famously argued that negative externalities can be eliminated through a process of ‘private bargaining’, in which all affected parties, who have various conflicting interests, can negotiate over how to distribute the costs of a plausible and mutually-acceptable solution to the dispute (see Bowles et al., chapter 4)—without ever turning to government. In other words, Coase claims that when faced with negative externalities, our options need not be to either accept these market inefficiencies/failures or to accept the need for government intervention to prevent or correct for these failings. Consider the illustrative example of how American Electric Power and residents of Cheshire, OH reached such a negotiation, as reported by New York Times: 13 May 2002.
Are thinkers like Coase correct: can these sorts of externalities be internalized without government intervention? In answering this question, you can discuss other relevant examples (your focus need not be on the Cheshire case), but you do need to address possible problems with the private bargaining process, and to explain whether these problems can be overcome. For instance, with regard to the Cheshire example, did the decision of residents to sell their properties to AEP and move away solve the externality problem?
Critical Deliberation 
Coasian bargaining is affected by pre-existing conditions
Coase’s argument that externalities can be corrected without government intervention is optimistic, but is based only on competition. The other dimensions of economic life, command and change (Bowles 2005: 52), are overlooked, leading to an unrealistic view. I will focus on change, the time dimension.
The endowment effect refers to the under-weighting of opportunity costs and thus over-weighting of loss aversion (Thaler 1980: 39). What this means is that a gain and a loss of equal objective value will subjectively feel unequal. An example he gives is greater acceptance of spending $10 on a movie ticket after losing $10 than after losing an already bought movie ticket.
A similar effect can be seen in placing less value in a windfall. Psychologist Hal Arkes recounted a story of employees of a firm being given a $50 bonus at an annual meeting at a hotel/casino. Almost without fail the employees blew the $50 at the casino, but did not spend their ‘own money’ (Arkes 1994: 331-332). These examples show the importance of pre-existing conditions. Dan Ariely talks about these forces in terms of setting the default choice, and shows how the existence of a default choice has a strong influence on decision making (Ariely 2008: 10:58).
In Coase’s railroads/farmers example (Bowles 2005: 86) it is implied that a choice exists between two costs: the damages to the fields or redesigning the train engines to not emit sparks. Assuming the farmer’s produce is a commodity, this suggests a simple price comparison can show which cost is higher. Though the costs are applied to different actors, by bargaining they can choose the lower cost and then work out some ratio of payment to satisfy each actor, reaping the benefit of an efficiently lower cost. The argument rests on the assumptions of private property law enforcement and zero transaction costs.
Assuming the farmers owned the land first and then allowed the railways to build tracks, I would argue that the farmers would be less likely to pay the “fair” medium value proposed by Coase than a farmer who knowingly bought land next to railroad tracks. These subjective values will make an objective bargain hard to hash out between the two actors. This will drive up transaction costs, and the issue (fields catching on fire) will persist as long as negotiations are maintained. This puts added pressure on the farmers, as they are (by default) the ones incurring costs, thus they are more likely to settle on a price that is unfair to them.
The idea of an external arbiter (like a government) would eliminate subjective biases between the actors, leading to a balanced and efficient distribution of resources and costs. This, however, would come with the price of more transaction costs: information gathering, negotiating with each actor, and enforcing the decision for example. Each of these takes time, which costs money for someone to do. Both solutions will inevitably involve transaction costs–the question is which has fewer.
Ariely, Dan. “Are we in control of our own decisions?” TED Talks. December 2008. Web. 26 Jan. 2015
Arkes, Hal R., Cynthia A. Joyner, Mark V. Pezzo, Jane Gradwohl Nash, Karen Siegel-Jacobs, and Eric Stone. “The Psychology of Windfall Gains.” Organizational Behavior and Human Decision Processes 59 (1994): 341-347. Web. 26 Jan. 2015.
Bowles, Samuel, Richard Edwards, and Frank Roosevelt. Understanding Capitalism: Competition, Command, and Change. New York: Oxford University Press, 2005. Print.
Lehrer, Jonah. “The Curse of Mental Accounting.” Wired Science. Wired. 14 February, 2011. Web. 26 Jan. 2015.
Thaler, Richard. “Toward a positive theory of consumer choice.” Journal of Economic Behavior and Organization (1980): 39-60. Web. 26 Jan. 2015.
Private Bargaining Does Not Really Lead to Happier People
Negative externalities cannot be eliminated through “private bargaining”. With the American Electric Power (AEP) example, private bargaining was seemingly beneficial to both parties. AEP was able to potentially avoid more of a money loss by just paying the home owners in Cheshire, OH. The residents avoided the effort of suing and gained more money than they could from just selling. Given these facts, it would seem that the agreement was beneficial to both parties involved. However, just giving people money did not completely solve the problem. Ultimately, AEP still caused problems for the residents and the pollution didn’t go away.
Having the residents leave is still a major inconvenience for them and the health effects are not known today. Although the residents may have money now, their health may be permanently affected. The town employees were not included in the deal and thus they were hurt by the deal. The schools also were not helped by the deal.
According to Sheeran and Hahnel, “Coasian negotiations can only be seen as one-on-one negotiations between two parties” (Sheeran and Hahnel 2009, 220). Because the negotiations were not an individual dealing, they do not go exactly how Coase would argue. The home owners of Cheshire, have multiple desires and wishes that one private deal can’t satisfy. The book example, with the farmer and railroad owner, works because they are both individuals who are able to satisfy each other’s needs. With the AEP example however, the elders of the town did the deciding and did not take into account everyone’s needs in the town.
Power is a factor that plays heavily into making private negotiations unfair. For example, the Cheshire residents would not be able to sell their house in a polluted area and if they went to court with the issue, they may have to remain in the town for many years. AEP had the advantage in the negotiation, which may be why some residents of the town felt that they gave in too easily. According to Jones and Richard, “in general, transaction costs restrict the ability of groups to organize and, as a result may limit the group’s bargaining powers and result in non-optimal levels of pollution control” (Jones and Richard 1984, 307). This statement shows how non-optimal results can often be achieved through private negotiations.
The pollution externality also did not go away. If the government was involved, they may have enforced proper pollution control. The problems of private bargaining can be solved if the negotiations are just one to one. The overall problem must also be taken care of. With the book example, the problem is solved because the field is not set on fire anymore. In the AEP example however, the pollution is still a problem, and the plant can now monitor its own emissions. Because of the problems of private bargaining, I do not think these sorts of externalities can be internalized without government intervention.
Hahnel, Robin, and Kristen A. Sheeran. “Misinterpreting the Coase Theorem.” Journal of Economic Issues (2009): 215-38. Print.
Seelye, Katharine. “Utility Buys Town It Choked, Lock, Stock and Blue Plume.” The New York Times. 12 May 2002. Web. 28 Jan. 2015.
Sproule-Jones, Mark, and Patricia L. Richards. “Toward a Theory of the Regulated Environment.” 305-15. Print.
Response to Emily B.
I agree that negative externalities cannot be eliminated through “private bargaining” but this does not imply that they cannot be solved in theory. Coase’s Theorem dealt with a theoretical world without any transaction costs or at least sufficiently minimal transaction costs. In such a world, Coase believed that two parties could come to a mutually beneficial agreement in order to resolve externalities without the use or need for government intervention. In this, Coase is correct. In any given situation, without any transaction costs, it seems plausible that two parties could come to such an agreement. As noted though, the world is hypothetical. Coase never intended to imply that the real world was without transaction costs. On the contrary, “Coase’s goal in describing a transaction-cost-free world was to focus attention on the importance of transaction costs in economic policy.” (Lee 2013)
Sometimes, Coase noted that transaction costs are sometimes high enough that government intervention is justified. “There is no reason why, on occasion…governmental administrative regulation should not lead to an improvement in economic efficiency.” (Lee 2013) This does not negate the fact that private bargaining can, at least sometimes, accomplish an agreement that deals with negative externalities. Concurrently, government intervention is necessarily ripe with high transaction costs. It involves paying a number of people (inspectors, lawyers, etc), a large time cost, the ripple effects of needing government agencies, and so on. Also, when an externality is solved through government intervention, the action creates more negative externalities by definition. Government has no money of its own and has to tax other citizens, who were not originally involved in the initial externality, to pay for the process. Therefore, the question is not only whether or not private bargaining can deal with externalities, its whether or not its cheaper and more efficient than having the government intervene.
In the example with American Electric Power, the two sides came to a mutually beneficial agreement. The transgressed individuals received a more than fair sum of money, while the transgressor (AEP) paid and made efforts to rectify their behavior. Clearly, the result is not ideal for every person involved. Most likely, there are citizens that did not wish to move, or had the decision “forced” on to them by either the council or the circumstances. Regardless, the process of private bargaining probably came to a mutually beneficial result much faster than government intervention could have produced. This possibly prevented gross physical harm for the citizens and years of potential litigation that may have produced a far worse result than receiving three times the value of their houses. That said, if the transaction costs of government intervention or regulation are less than the transaction costs of private bargaining, government regulation and intervention would be a smarter route. Sometimes, when collective action problems are too difficult to solve through private bargaining, intervention is not only smart, but vital.
Coase, Ronald H. “The Problem of Social Cost” The Journal of Law and Economics. Volume 3, October 1960.
Lee, Timothy B. “The Coase Theorem is Widely Cited in Economics. Ronald Coase hated it.” The Washington Post.
Environmental Externalities Pay, but Not in the Right Way.
In an ideal world conflicts between private sectors would be solved behind closer doors with private, non-government intervention in the form of private bargaining. Such bargaining would be done in a way that ensured that both parties held equal weight and lead to an outcome that was mutually beneficial. Unfortunately this is not the case, and doesn’t seem like it ever will be this clear cut. Government is instrumental in making sure that private deals go smoothly and are managed fairly in addition to ensuring that negative externalities don’t expand. In situation like that of Cheshire, Ohio the large corporation has an almost insurmountable advantage in bargaining. The externalities imposed on the small town had already taken its toll and the citizens were left with little choice but to sell their houses and move.
This example simply sharpens one of the larger issues when it comes to private bargaining – that large private entities are able to buy their way out of situations. This highlights the large unequal power dynamic that often exists in private bargaining scenarios. Unequal power leads to situations were the forefront focus is no longer the externalities that are being introduced but how much either side is willing tolerate for a pay-off. This is seen in instances like The American Electrical Power buying the town of Cheshire, Ohio (Seeley 2002: 1-2) instead of dealing with the blue smog descending on the city and Enbridge Energy buying out 154 residential properties in Marshall, Michigan after an oil pipeline broke in 2010 (Frosch 2013:1). In both cases citizens were affected by the externalities of large private corporations. These private businesses were willing to pay hush money and in addition asked those effected to sign agreements not to sue if other externalities were to revels themselves in the forms of further property damage or health issues. This provides clear evidence that government intervention would help protect and allow for greater transparency between different private sector actors.
Government intervention in cases of large externalities will be helpful in preventing such externalities from having such massive effects. In California the aggressive environmental regulations have actually redirected jobs from oil and gas companies to high-tech industries that focus on solar and other clean energy. These regulations have not only reduced the negative externalities that were damaging the environment and population but cause positive externalities like employment growth and technological innovation (Weber 2010: 1). Such government policies and sanction can not only prevent negative externalities from existing but can also help create a roadmap for companies to follow in the cases were externalities could not be foreseen.
Frosch, Dan. “Amid Pipeline Debate, Two Costly Cleanups Forever Change Towns.”
The New York Times. 10 Aug. 2013. Web. 27 Jan. 2015.
Weber, Jonathan. “The State’s Green Ways Are Under Attack.” The New York Times. 26 June 2010. Web. 27 Jan. 2015.
All Is Fair In Love And War, But Not Bargaining
Response to AJ D.
I support AJ’s approach and argument about private bargaining. As he says, in an ideal world all conflicts between private firms would be settled privately, efficiently, and fairly. However in light of the political economy theory that is presented and discussed in the textbook, there are contextual factors such as power dynamics that are inseparable from private bargaining and negative externalities. In the Cheshire example, the conflict between the citizens and the energy company is settled but not necessarily in a fair way. We discussed last class about capitalism being based on ‘voluntary’ exchanges and in this Cheshire example the purchase of the town and everybody having to move out didn’t seem exactly voluntary. Granted, there were surely people who were happy to take the $150,000 dollars for their home and leave the polluted area, but in theory this is an example of power and capital winning out in the negotiation and thus dictating the solution. As AJ alludes to, if all the citizens in the town were to come together and say they wanted the power plant to leave the town instead of themselves having to leave, I doubt this would have made any headway. Instead the big, rich, powerful firm was able to calculate the cheapest solution to solving the complaints and execute it. In this particular example it did not work out too badly for the citizens on the losing end of the negotiation, but it sheds light on the tendency the system to favor the richer, more powerful actor in a private bargaining situation.
I agree with AJ that big corporations in capitalism are at a unfair advantage over other economic actors they may face in a conflict over negative externalities. The issue at hand is a moral one, and in economics it is very easy to turn a blind eye to morals and just go with what makes the most financial sense. However in situations of negative externalities people’s lives and well-beings are on the line. We can’t trust or expect corporations to act with the good of the people in mind, instead the government must be actively involved in settling disputes between private entities to ensure fairness. The example of California’s regulations is a very interesting point AJ brings up because it shows the successful intervention of government to settle present and prevent future conflict.
A counterargument to this standpoint is that government intervention is inefficient and thus unnecessary. In many examples to date government intervention has been quite inefficient but that is because there is so much resistance to it. Our free market ideology in America refuses to grant merit to the idea that the government can play a beneficial role in the private sector. This argument is presented by the people on the more powerful side of the coin, but the government is necessary in making sure these more powerful economic actors don’t abuse their power, which they likely would otherwise.
Government intervention not essential in solving negative externalities
Although the United States Government serves as a means to create and enforce laws to ensure prosperity for all, it is unnecessary to develop solutions to problems that arise due to negative externalities. Externalities are present in all types of economic systems. However, with a Capitalist economic system the parties involved are able to assess and defuse situations without the hand of big brother being involved. To clearly analyze whether government intervention is extraneous, one must assess transaction costs, property rights, and impediments that might hinder bargaining involved.
Ronald Coase developed the idea of transaction costs also known as “costs of carrying out exchanges” (Bowles 2005: 85-86). Communication and bargaining in order to combat negative externalities also can have transaction costs. Coase argues that “in the absence of transaction costs, the spillover problem can be solved in many situations without government regulation.” (Bowles 2005: 85-86). Realistically, transaction costs will always be present in any situation involving negative externalities. Even in Coase’s railroad example, transaction costs are present. Both the railroad and the farmers involved still have to take time to assess and develop possible solutions to the fields catching on fire. However, transaction costs would still be very present in a government regulated situation, such as lawyers and of course, time. That being said, in order for government regulation to be deemed unnecessary, transaction costs must be lower in a situation without government involvement.
Property rights are an essential part of solving issues without intervention by the government. “Both parties must have clearly established property rights” (Bowles 2005: 86) in order to properly identify a sole firm or the multiple groups involved. A situation without clearly identified rights to property must involve the government. For example, “Secondhand tobacco smoke is… a negative externality. Like other forms of air pollution… it’s a byproduct of activity that inflicts costs on others.” (Pollock 2015). In order to assess the toxins of second hand smoke, laws must be written in order to designate public space as smoking or non-smoking. Based on these points, Coase’s argument that the existence of property rights is essential to individual regulated situations is sound.
Bargaining mightn’t always be easily facilitated. That is, those affected by these negative externalities might not always be able to easily make contact with those that are the source of these externalities. For example, “there are all sorts of costs associated with driving that the actual driver doesn’t pay.” (Dubner 2008) Why is this? No one can hold any one driver accountable for the emissions of his/her vehicle. This is yet another situation where the government is needed, as they have the power to pass emission standards for cars. A person could argue that laws are the only incentive for firms to bargain. Based on this idea, the government could be seen as regulating all bargains made.
Despite the idea of government law being the driving force behind bargains, one would likely assume that firms might make right the negative externalities based on moral obligations.
Bowles, Samuel, Richard Edwards, and Frank Roosevelt. Understanding Capitalism: Competition, Command, and Change. 3rd ed. New York: Oxford UP, 2005. Print.
POLLOCK, ROBERT. “It’s Time: Snuff out Public Smoking.” NY Daily News. N.p., n.d. Web. 27 Jan. 2015.
Dubner, Stephen J., and Steven. “Not-So-Free Ride.” The New York Times. The New York Times, 19 Apr. 2008. Web. 27 Jan. 2015.
Evidence Shows We Need Government Intervention
Response to Nick C.
In the blog post “Government intervention not essential in solving negative externalities,” the main thesis contends that “although the United States Government serves as a means to create and enforce laws to ensure prosperity for all, it is unnecessary to develop solutions to problems that arise due to negative externalities.” In a capitalist economic system, “parties involved are able to assess and defuse situations” by assessing transaction costs, property rights and “impediments that might hinder bargaining involved.” Overall the author has offered a clear summarization and elucidation of Ronald Coase’s argument on the carrying out of exchanges. Coase argued that if an externality exists, bargaining will lead to an efficient outcome if there are no transaction costs and property rights are involved; although in economic reality, situations that meet these criteria are rare.
You argue that transaction costs will be present in bargaining, whether that bargaining takes place between private parties or with government intervention. As a result, Coase’s theorem should be modified to stipulate that government intervention is only necessary in situations where transaction costs are higher without government intervention. Additionally, you endorse Coase’s argument that clear property rights are necessary for situations where bargaining takes place between individual entities or multiple groups– noting that it must be easy to identify the party or parties responsible for the negative externalities. In cases which the responsible parties are not easily identifiable– government intervention is necessary.
The first few points seem to make sense, taken as a modification of Coase, however I would argue that the final point does not strengthen the overall argument. The final contention states: “Despite the idea of government law being the driving force behind bargains, one would likely assume that firms might make right the negative externalities based on moral obligations.”
In the article “The Limits of Bargaining,” Adam Ozimek argues that when negative externalities exist, social norms are limited in attempts to resolve those externalities via bargaining, because people forgo those social norms for private benefit. Offering profit in exchange for an externality only encourages that behavior. He writes that in the case of negative externalities, “Coasean bargaining would have us advertise to the world that we are willing to instead pay for this behavior… people who are willing to violate some social norms because they enjoy the externality producing behavior are likely to… violate other social norms for profit” (Ozimek 2013). Thus I would argue that clear government involvement would lead to more efficient outcomes. In the example of a negative externality such as pollution, it seems that moral obligations have done little to trump profit making incentives. James Surowiecki argues in “Climate Trades” that developing countries have no incentive to reduce pollution, in favor of economic growth, and “the people who pay to stop it will be those who reap the biggest benefit from stopping it” (Surowiecki 2014). However, firms in developing countries clearly do not feel morally obligated to reduce pollution, and the United States has done little to reduce international pollution levels.
As a result of the ambiguities in clearly assessing transaction costs, defining property rights and the opportunity costs, or impediments to bargaining, paired with the tendency for individuals to be on the losing side of bargains involving firms and negative externalities, I would argue that preferable results arise when the government is involved in regulating negative externalities.
Ozimek, Adam. “The Limits Of Bargaining.” Forbes. Forbes Magazine, 4 Sept. 2013. .
Surowiecki, James. “Climate Trades.” The New Yorker. Conde Nast Digital, 13 Oct. 2013.
Externalities such as those caused by American Electric Power in Cheshire, Ohio more often than not require government intervention to solve. In the case of Cheshire, Ohio the American Electric Power company was polluting to such an extent that residents began experiencing discomfort and medical issues. American Electric Power ended up buying every home in the town at above market value in order to continue operating. Although the homeowners may have been alright with this outcome it failed to solve the externality that was created by the power plant. In the case of Cheshire, Ohio the externality was a decrease in the quality of air which can be considered a public good. According to Thomas Helbling an advisor for the International Monetary Fund “households and firms do not place enough value on these public goods, and efficient market outcomes through bargaining typically are not feasible” (Helbling 2010). Hebling argues that since public goods such as air are non-rival and non-excludable that they are often undervalued by society. In the case of the American Electric Power company the residents were willing to accept above market value for their homes in exchange for the American Electric Power company to keep polluting. In doing this the residents failed to properly value clean air and did not realize the effects pollution may have. The continued pollution by American Electric Power could have future negative effects that spread beyond Cheshire, Ohio such as acid rain, harm to plants and animals and therefore the ecosystem, and adding to the problem of global warning. For this reason the private resolution failed to deal adequately with all of the externalities. Some such as Ronald Coase and Bryce Caplan an economics professor at George Mason University argue that “If transactions costs are reasonably low, then the affected parties negotiate tolerably efficient solutions without government intervention” (Caplan 2008). In reality though transactions costs are rarely low. In the case of American Electric Power the transaction costs were 5.6 million dollars for just the residents lawyers. These transaction costs are not likely to become lower and negatively affect the ability to negotiate efficient outcomes. Lastly companies such as American Electric power often have much greater resources than those such as the residents of Cheshire, Ohio putting the company in a much better position to negotiate and gain preferable outcomes than their opposition.
Helbling, Thomas. “What Are Externalities?” FINANCE and DEVELOPMENT 47, no. 4 (2010).
Caplan, Bryce. “Externalities.” The Concise Encyclopedia of Economics. January 1, 2008. http://www.econlib.org/library/Enc/Externalities.html.
Government Intervention Unnecessary but Legal Arbitration is the Career to Have
Response to Preston A.
First things first, am I the only one who suddenly wants to become an arbitration lawyer? Out of the $20 million dished out by AEP, $5.2 million went to the 3 lawyers hired by the town. The average homeowner in the town got $150 thousand for their home. This is on average 3 times the worth of the houses. Comparatively, the average lawyer got $1.7 million in the deal, with all probability that none of the 3 were homeowners in the town. This seems like a gigantic transaction cost. The people of the town chose these lawyers, however. My question to Preston would be “what would involvement by the government change, that would improve the situation of the homeowners in the AEP story?” Would you recommend a cap on lawyer fees? Force the electric company to somehow get net zero emissions? Assuming we had the tech to even do that, the only fair way to make AEP adhere to it would be to make it a blanket regulation. That would mean power plants all over the country would have to retrofit, itself an externality causing the nation’s power costs to go up as the companies pass these costs to the consumer. The Energy Information Administration says that “In 2013, the United States generated about 4,058 billion kilowatt-hours of electricity. About 67% of the electricity generated was from fossil fuel”…”with 39% attributed to coal.” So, at least half of the electricity consumers in the US would be affected by any regulation against coal companies. Certainly, in enacting such regulations, the government may have saved the town of Cheshire, Ohio, but at what cost? I would also argue that the people of Cheshire were much better off moving away from the uncertain health risks living under a power plant created. “’It’s just not healthy here,’ said Carolyn Little, 55, a longtime resident who plans to rent a trailer a few miles away. She glanced at the thick brown puffs overhead. ‘You can’t live under this all day, every day.’” (Seelye) The potential for externalities in the form of health problems later on is greater than the cost of the inconvenience of being moved from your own home, being paid 3 times its value in the process. Both the utility company and the residents benefited from this deal. The fact that one party had greater benefit is of much less concern to me than if one party benefited while another suffered a loss.
Seelye, Katharine. “Utility Buys Town It Choked, Lock, Stock and Blue Plume.” The New York Times. 12 May 2002. Web. 28 Jan. 2015.
“What is US electricity generation by energy source?” U.S Energy Information Administration. 13 June 2014. Web. 30 Jan. 2015.
Response to Preston A.
I agree with you that externalities, such as the American Electric Power example, often need government intervention to solve. However, I believe that Ronald Coase’s statement that externalities can be eliminated through private bargaining without government intervention is not something so black and white. In other words, private bargaining can be successful in specific circumstances, such as Coases railroad and field fire example – there is an externality only when the damage they imposed on farmers was greater than the cost to the railroad (Bowles et al. 2005; 86) But government intervention can also fail, such as in the AEP example, because it continued to create negative externalities and impose large transaction costs on the residents when government intervention was not involved.
Another example of government intervention failing, or causing market inefficiencies is the court case of Poletown v. Detroit (Poletown vs. City of Detroit; 1981; 1). A major company, General Motors, has bases in Detroit and provides jobs to the residents. In 1981 the company got approval from the government to use condemnation on the city of Poletown in order to build a new plant. It was stated that the new plant would bring 6,000 new jobs to the city. 465 acres of land were cleared in 8 months, and 4,200 residents of Poletown, despite their best effort, were evicted from their home. 1,500 homes, two schools, and a church were demolished to make room for the plant. The cost to the city total was $300 million. The residents fought for the homes by refusing to leave and attempting a failed court case against a large monopoly. In the end, GM only brought 3,000 new jobs to the plant, and in late years, the plant shut down. The city suffered and grew to become a ghost town. The externalities in this case were mainly brought on because of government intervention and an imbalance of power. Government intervention can be successful on a small scale (field fire), however it continues to fail and causes more externalities on a larger scale. Therefore, Coase’s argument is not valid and absolute for all cases involving government intervention and private bargaining.
Bowles, Samuel, Richard Edwards, and Frank Roosevelt. Understanding Capitalism: Competition, Command, and Change. 3rd ed. New York: Oxford UP, 2005. Print.
Supreme Court of Michigan. “Poletown v. City of Detroit.” 13, March 1981. Web. 30, January 2014.
Response to Preston
I agree with the arguments you presented in your blog post. Money completely correlates to power. The more capital a corporation has, the more influence that corporation has in society. And this concept is fundamentally destructive since if profit is the only source of power, corporations have no incentive to do anything that will not give them a profit. With the case of Cheshire, Ohio in mind. American Electric Power solved the issue by paying the resistants living costs three times above market price on the condition that the residents don’t sue the company for health, and pollution problems affecting the town. The company essentially didn’t solve the environmental issue at all but used their wealth and power to appease the residents of Cheshire. In hindsight, paying off the residents is a less costly solution to the issue then for AEP to actually invest and implement more economically friendly methods of producing electricity. American Electric Power will continue to pollute and wont face repercussions because the companies total profits are so high than they have the power to buy out those effected by the negative externalities they produce. This case shows that Coase’s idea of private bargaining doesn’t work to its best effectiveness.
The people of Cheshire who decided to stay in the town, are most likely forced to stay because they are not economically powerful enough to move to a town with cleaner air. Their lack of wealth and power forces them to accept the environmental conditions they live in and AEP can continue to pollute in the area.
The Cheshire example shows that businesses on their own are too economically self interested to deal with negative externalities in an effective way. If government were to impose environmental sanctions on the company, perhaps the externality will be solved and over time the air in the local area will be cleaner. But sanctions imposed by the government is bad for business and AEP’s power and influence will be greatly decreased.
The government needs to intervene to help solve for these negative externalities. Powerful corporations who only pursue their own interests do not work on a moral basis of doing whats right for society but rather what is right for them. Government intervention would help keep these corporations in control so that they do not continue to produce generally undesirable outcomes in society.
Seelvye, Katharine Q. “Utility Buys Town It Choked, Lock, Stock and Blue Plume.” New York Times. N.p., 13 May 2002. Web.
Power, Pollution and Fish: A critique of Coasian Bargaining
Post-industrial revolution societies and their leaders from around the world have gravitated towards what they see as the potential of capitalism. Originally a western experiment, capitalism brought huge productivity, a higher standard of living and influence over the rest of the world stage and were all attributed to the successes of the free market. Following WWII, other countries looked to the U.S, a beckon of liberty and military might with democracy at it’s heart, but capitalism in it’s soul.
However, as countries such as China, India and Russia all espoused (to varying degrees) capitalism’s economic potential from trade and domestic production/consumption, they have also realized the risks at play as smog and other environmental factors are attributed to these “super-productive” states. Often (as of late) we hear about the theoretical liabilities and possible chaos that the financial world could bring to certain regions: defaulting on debt, raising interest rates, bonds and hyperinflation keep our leaders and businessmen on edge as they each compete for their share in the world market.
The competitive nature of capitalist economies have allowed many within the financial or political sector to fail to recognize how their means of production can negatively affect surrounding or even distant environments. People, businesses and entire ecosystems can all be directly threatened from capitalism’s once unimaginable yields of products/goods.
Ronald Coase had categorized the issue of “unintended social costs” for others as “negative externalities”. Coase based his theory solving these externalities on a free market that has achieved a level of efficiency that no public/government entity could rival. Coase assumed that correcting these externalities would therefore be best confined to the private sector. Assuming that all parties would reach the quickest and most desirable outcome through the process of private bargaining.
However, is this method truly the answer to externalities that Coase envisioned? In the example Coase gives on the “railroad and the farmer”, several criticisms on his theory immediately emerged. One being the power differences between parties that Coase himself recognizes in his critique of neoclassical economics (Bowles Ch. 6). Powerful economic actors in the “political economy” possess a great deal of legal and finical assets that rival even the collective actions of many and would likely drown out the economic grievances of the few. A second criticism of Coase’s theorem is the idea that private bargaining is ideally absent of transaction costs. As Dr. Greenwood of law matters describes, such a condition is “extremely unlikely” or even impossible. Greenwood highlights that as parties utilize their time and resources in striking a deal with one another, they are bound to incur costs. This additionally leads us to the competitive nature that capitalists also posses. When the sole goal of a market agent is to increase profit, there is little incentive for that agent to adequately absorb the social costs of the externality created from production. Lastly, as Timothy Lee writes in his article for the Washington Post, there is the problem of the “missing market”.
As described by Lee, a missing market is when two parties would like to transact with each other, (in this case to absorb a social cost) but simply do not have a platform to do so. Such occurrences often happen from widespread pollution from production. For example, when fisheries along the gulf coast experience a smaller catch presumably from fertilizer pollution that drains into the Mississippi, fishermen would like to negotiate a deal that benefits both farmers and fishermen. However, the fisherman cannot hold one farmer directly accountable and does not have a platform for all fishermen and farmers to directly negotiate. This situation highlights how difficult it can be to point your finger at an economic agent as the source of a social cost as seen in the “farmer and railroad” example. Often pollution is widespread and crosses state and even national boarders making it difficult to even attempt to hold one source accountable.
http://www.washingtonpost.com/blogs/wonkblog/wp/2013/09/04/the-coase-theorem-is-widely-cited-in-economics-ronald-coase-hated-it/
http://people.hofstra.edu/daniel_j_greenwood/Courses/Torts/Coase.htm
Coasean Bargaining, or Bullying?
Negative externalities can absolutely be internalized without government intervention. My problem with such a broad argument would have to be the generalization of the situations actors may find themselves in. Sure, for the most part, parties should be able to eliminate negative externalities through ‘private bargaining’ and find a mutually beneficial solution to their problem, but what happens when they don’t?
An article written by Thomas Helbling, an advisor for the International Monetary Fund, criticizes the notion that all problems can be solved through ‘private bargaining’ as Ronald Coase advocated for, and sheds light on the faults in Coase’s argument. He writes, “High transaction costs and problems related to uncertainty are other obstacles that prevent parties involved in technical externalities from internalizing costs and benefits through bargaining solutions” which eludes to the uncertainty of various aspects of bargaining (Thomas Helbling 2012: March 28). In the case of American Electric Power buying out a town and it’s residents in Cheshire, Ohio, the stakes were high and the negative externalities for both parties were overwhelming. The New York Times reported the unique deal and American Electric Power “is believed to be the first by a company to dissolve an entire town” which is a small step for Ohio and a big step for Coasian bargaining (or vice versa). Thomas Helbling really focusses on property rights being hard to define in all cases which leads to the uncertainty in successful bargaining. In the case of Cheshire, OH, the town and residents selling out did not solve the externality problem as a whole, the plant is still polluting and making the town inhabitable. In their case, government intervention could have been very beneficial for the residents rather than mostly beneficial (although costly in terms of monetary value) for the American Electric Power company. It would have taken an absurd amount of time for the residents to have won any kind of court battle and AEP knew that, so, they were bought out. Even though the deal was seemingly mutually beneficial for the two parties involved, the power company having more influence financially was virtually able to manipulate the town however they wanted. Helbling tied property rights to environmental issues and private bargaining, and when clean air as a public good is concerned and not properly taken into account, he says, “As a result, households and firms do not place enough value on these public goods, and efficient market outcomes through bargaining typically are not feasible. In other words, environmental issues often face a collective action problem” (Thomas Helbling 2012: March 28). Some, negative externalities can be internalized without government intervention, but not all. I believe that it is on a case by case basis what can be solved through private bargaining and what needs to be overseen by a third party.
Helbling, Thomas. “Externalities: Prices Do Not Capture All Costs.” International Monetary Fund. N.p., 28 Mar. 2012. Web. 28 Jan. 2015.
Seelye, Katharine Q. “Utility Buys Town It Choked, Lock, Stock and Blue Plume.” The New York Times. N.p., 13 May 2002. Web. 27 Jan. 2015. <http://www.nytimes.com/2002/05/13/us/utility-buys-town-it-choked-lock-stock-and-blue-plume.html?pagewanted=1