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11) One of the other major mischaracterizations of the insights of Coase is the role that “transactions costs” play in promoting or preventing efficient outcomes. Does Coase ever argue that “transactions costs ARE zero?”

Coase never argues that transactions costs ARE zero. It would be an absurd argument. Rather the insight is to imagine what would have to happen to prevent efficient bargains from happening. The point of discussing transactions costs is that if there truly were ways to see value created, that WOULD happen if barriers to negotiation and exchange did not exist.

To quote Coase himself (something that is apparently too difficult for critics to do), “This is, of course, a very unrealistic assumption … these operations are often extremely costly … to prevent many transactions.


12) In the presence of prohibitive transactions costs, Coase argues that administrative solutions may be required (if they are possible). In this case, we “need” regulation to step in and take the place of the market in order to promote value enhancing propositions. Why does he invoke the theory of the firm as an analogy to think about here? When do firms emerge and what does this have to do with environmental regulation? What is one major difference between the administrative costs of a traditional firm and the new one that he calls a “super-firm?”

Because a corporation/firm is just a giant transactions cost reducing entity. That entity substitutes administrative rules for free-market negotiations among owners of factors of production that in many cases would be too hard to specify, negotiate and enforce (e.g. imagine every worker at the U of R, and every owner of every piece of equipment had to settle on the appropriate noise levels on campus, the appropriate levels of odors, etc.)

Firms tend to emerge to replace market transactions when the administrative costs of the firm are lower than the cost of the market transactions that it prevents from happening.

Coase then calls the government a sort of “super-firm” as distinguished from a regular firm. The difference of course is that regular firms face competition – which puts downward pressure on their contracting and administrative costs that governments do not face. The government has many other “attractive” features that firms do not (such as police forces).

Not only this, governments are of course subject to capture and special interest. So we have in essence an empirical “horse race” about whether relying on firms or governments to reduce transactions costs would be better. It’s not clear that direct government regulations would produce “better” outcomes and similarly there is no a priori reason to believe that government WON’T produce better outcomes either (e.g. just see the case of metropolitan air pollution regulations in Los Angeles as a great example)!

The MAJOR point is that all “solutions” have costs. And that observation (truism?) means that both government and market “fundamentalists” have little claim a priori on being correct in their preferences, at least when it comes to minimizing social costs.

It is perhaps ironic and sad that the major insights of Coase have come to be a bludgeon among free-market types (like me) to trump any and all government actions and a bludgeon among anti-market types about how absurd the theorem and insights themselves are. Read … the … paper.


13)Coase actually argues that courts DO tend to recognize (at least implicitly) the efficiency implications of their decisions. He invokes the term “common sense” several times to support this. Does this mean that courts’ decisions are not important?

In many cases it appears that judges seem to consider the economic consequences of their decisions, even as they do not seem to recognize the reciprocal nature of the social cost problems.  When deciding on liability courts clearly influence the distribution of income, but they are also going to have to be sure that when they are deciding on liability in cases of high transactions costs, they get the decision right. That’s much easier said than done.


14) On page 26 of the article, Coase addresses a particularly interesting claim. To what, does he blame, the source of many of the nuisances and complaints that make the news, hit the courts, and capture our imaginations? Can you think of examples in your local community that support this idea? Can you think of opposing general evidence? In any case, what is the major irony regarding these complaints and the folk-wisdom (of Pigou) about how to deal with them?

In many cases the source of the social cost conflict was the permission to operate and commit nuisances by the government itself. The following passage (and preceding pages) illustrates:

             It is the properf unctiono f the legislatived epartmento f governmentin the exercise of the police power to consider the problems and risks that arise from the use of new inventions and endeavor to adjust private rights and harmonize conflicting interests by comprehensives tatutes for the public welfare. … There are . . . analogiesw here the invasiono f the airspaceo ver underlyingla nd by noise, smoke, vibration,d ust and disagreeableo dors, having been authorizedb y the legislative departmento f governmenta nd not being in effect a condemnationo f the property althoughi n some measured epreciatingit s marketv alue, must be borneb y the landowner without compensation or remedy. Legislative sanction makes that lawful which otherwise might be a nuisance. Examples of this are damages to adjacent land arising from smoke, vibration and noise in the operation of a railroad . . . ; the noise of ringing factory bells … ; the abatement of nuisances … ; the erection of steam enginesa nd furnaces. .. ; unpleasanto dorsc onnectedw ith sewers,o il refining and storage of naphtha. … Most economists seem to be unaware of all this. When they are prevented from sleeping at night by the roar of jet planes overhead (publicly authorized and perhaps publicly operated), are unable to think (or rest) in the day because of the noise and vibration from passing trains (publicly authorized and perhaps publicly operated), find it difficult to breathe because of the odour from a local sewage farm (publicly authorized and perhaps publicly operated) and are unable to escape because their driveways are blocked by a road obstruction (without any doubt, publicly devised), their nerves frayed and mental balance disturbed, they proceed to declaim about the disadvantages of private enterprise and the need for Government regulation.

 The irony is that economists tend to look for governments to intervene to solve the very “problems” that it is itself responsible for creating.


15) Based on what you read in Coase’s paper, why should you not be surprised that the U.S. Military is perhaps the most “egregious” polluter in America and that the many green energy projects that we have discussed seemed to have their negative environmental impacts “swept under the rug” (e.g. the toxic chemicals that are used to make windmills, the hard to roads and air quality that windmill construction promotes, etc.). Or consider the awful environmental record of ethanol as a case study.

Coase recognizes that governments are inclined to look with a “benevolent” eye upon enterprises that they are promoting, and the military would be one dramatic example.

As it pertains to the environmental damage caused by green energy, rhetoric and perception matter a great deal. For example, it is much more likely to describe a nuisance created by a public project in pleasant terms as compared to a private project – those green investments are important “public goods” that will “move our nation forward …” and so on. We may end up protecting the very agents most responsible for doing environmental damage.

16)I have long argued that the default state of mind for students, faculty, policy-makers, citizens (i.e. almost everyone) is that if there is a problem out there, the default solution is to use government to solve it. I’ve found that striking given that if I asked folks about problems within their family and social lives I doubt the government would make the top 10 list of places they’d look for solutions. This is what we call, “The People’s Romance.”  And it is not without founding that we use the term. To what did Coase accuse Pigou of doing when Pigou set out to write his seminal article The Economics of Welfare? Provide one example to illustrate.

 He not only argued, but I think pretty clearly demonstrated that Pigou, like many others, was not out there trying to capture the corpus of options that are available to us to solve problems. Rather, he rather explicitly set out his research agenda to be:

 “How can government be used to solve this problem?”

This is not ipso facto a problem, insofar as similar studies are being done on other institutions with the goal of ultimately comparing them. But that of course was not being done.  Coase provides many examples, including the fact that Pigou’s canonical example for where government intervention could improve the outcome of railways’ sparks setting fire to crops could only have come about BECAUSE of a deliberate choice of the British legislature.

This is the “natural tendency” of the market which Pigou was criticizing.

This is not uncommon – we see this done in the “canonical” cases of light houses and bee-keeping as classic examples of market failures, which turn out not to be the case. Or the market for lemons – which turns out to be largely dealt with through market competition.


17) What is ironic about Pigou’s failure to recognize the reciprocal nature of externalities? This reciprocal nature was such an important understanding that Coase ended up being awarded the Nobel Prize in part because of it.

The irony is that earlier in his book, Pigou used an example that was reciprocal in nature to his preferred solution to negative externalities problems and never made the connection.

He argued that there were two major cases where social and private costs would diverge. One would be in the case when I do something “good” but for which I receive no compensation and the other is the case when I do something “bad” for which I do not have to pay compensation.

In the former case, he uses an example of a chimney owner who voluntarily puts a scrubber on his chimney as providing an unpaid for benefit. He recommends subsidizing the act.

Of course, merely framing the question as his failure to protect people from soot and smoke might imply that he could also be taxed for NOT doing it. Pigou never makes this point.


One Response to “The Problem of Social Cost, Part III”

  1. Harry says:

    I got a prompt from Comcast to see if I would qualify for a grant for tuition…click your age to see if you qualify!

    I was sickened, but then I thought that the Koch brothers might be giving out grants to friends of the Roberts family, Comcast customers who might wish to learn more.

    After several calls, I could find no one interested in Mr. Coase. Nor could I find any source to give me a free ride at the U of R for a semester with Doctor Wintercow. This is a social crime. Where’s my money?

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