Ron Paul Wants to Abolish the EPA

No surprise there. And he offers a conventional libertarian bromide as a substitute for the regulatory agency: "Polluters should answer directly to property owners in court for the damages they create...." For years, small minorities of economists and libertarians calling themselves "free-market environmentalists" (see, e.g., here and here) have argued that common-law property protections, by themselves, can and would supply efficient, even optimal, levels of environmental protection. They would certainly be right, if we lived in the mythical world of the "Coase theorem," in which information is complete and transacting is costless (see here). Indeed, if we lived in that world, we wouldn't even need property law or courts to resolve environmental disputes as parties in the free market would costlessly bargain to optimal allocations of pollution. But, as Coase himself acknowledged many times (see id.), the world we live in is not at all like the world of the "Coase theorem." In the real world, theories of free-market environmentalism are dangerously misguided because of transaction costs and the real limitations of common-law solutions to environmental problems.

Here's what Coase had to write about environmental protection in his 1959 article on "The Federal Communications Commission" (see here, p. 29):

[I]f many people are harmed and there are several sources of pollution, it is more difficult to reach a satisfactory solution through the market. When the transfer of rights has to come about as a result of market transactions carried out between large numbers of people or organizations acting jointly, the process of negotiation may be so difficult and time-consuming as to make such transfers a practical impossibility. Even the enforcement of rights through the courts may not be easy. It may be costly to discover who it is that is causing the trouble. And, when it is not in the interest of any single person or organization to bring suit, the problems involved in arranging joint actions represent a further obstacle. As a practical matter, the market may become too costly to operate.

In these circumstances, it may be preferable to impose special regulations (whether embodied in a statute or brought about as a result of the rulings of an administrative agency).

 Peter Grossman and I build on Coase's arguments in Chapter 15 of our book, Principles of Law and Economics (Aspen 2011), pp. 397-8:

The causation-proof problems Coase recognizes are especially important. Many pollutants travel long distances, and pollution-related diseases can have long latency periods. To prevail in court, plaintiffs must be able to trace their harm to a particular pollution source that might be located hundreds of miles away, and prove that their harm was proximately caused by exposure to a certain pollutant that may have occurred several decades ago. This evidentiary burden is often unbearable, and always very expensive. Moreover, common-law courts have traditionally restricted nuisance remedies to cases involving visible air pollution, such as smoke and dust; bad odors were usually not enough to state a claim. But, of course, many harmful pollutants - including some of the most toxic - are invisible. 

In addition to causation-proof problems, common-law remedies only protect environmental resources subject to property rights; they do not protect unowned, common-pool resources, regardless of social value.

The problems raised, respectively, by Coase and Cole and Grossman bear on Paul's belief that common-law causes of action provide sufficient remedies for environmental harms, but ultimately they are inapposite to his opposition to EPA and large-scale environmental regulation because Paul is not a welfare-consequentialist. As true-believing libertarian, Paul is more interested in maximizing individual liberty than overall social welfare (although he might believe that maximizing the former would maximize the later). Paul's strict libertarianism distinguishes him from his rivals for the Republican presidential nomination. While they mostly pander to anti-environmental interest groups, Paul's environmental position is principled. But, if implemented as policy, it would be disastrous for the health and welfare of the American people.

Tyler Cowen Pushes My Button Again

In this post, he suggests that the impeding settlement of the NBA strike puts the Coase theorem "back in the saddle." I can only shake my head in dismay that someone so erudite and sensible has failed to read Coase carefully enough to avoid this elementary (and all too common) error.

UPDATE: Looking at the comments, after my own, to Tyler's post at Marginal Revolution, I am astounded at the depth and breadth of misunderstanding that persists relating to Coase's theories of transaction costs and social costs.

Harold Demsetz Comes Down from the Fence

Harold Demsetz, an economist I have always greatly admired, has written a somewhat  baffling article (here)  in which he attacks Coase's correction of Pigou's treatment of externalities in social-welfare economics. Demsetz's disagreement with Coase is summed up in a single sentence, which suggests that Demsetz himself has finally descended from his perch between the Chicago School of neoclassical economics and the New Institutional Economics, landing firmly on the Chicago side:

"Coase has treated the legal system and its courts as if they are parts of the economic system, when they are not."

 In a footnote expanding on the point, Demsetz adds, "The neoclassical model ... assumes that all resources are privately owned and that ownership is fully respected; there is no place in its deductions for the courtroom drama imagined by Coase." That, of course, is precisely Coase's problem with the neoclassical model, and why he rejected it in favor of a "new institutional" approach. Interestingly, just one or two pages later Demsetz himself rejects the assumption of complete allocation of property rights, when he argues, in a way perfectly consistent with Coasean analysis, that "[t]here is an efficient degree of ownership that generally is smaller than '100 percent.'"

As usual, Demsetz's article is full of insightful points and witticisms, but his attack on Coase misses the mark. Coase has never focused myopically on market failure as a category; indeed, in a brief 1964 article, Coase pointedly argued that the category of government failure should be every bit as important in economic models. Moreover, Demsetz's assertion that the legal system is not part of the economic system is mind-boggling, especially coming from someone who has spent much of his career writing about property rights and other legal institutions as they affect economic activity.

Is Every Avoided Lawsuit a "Win for Coase"?

Over at Environmental Economics blog (here), Tim Haab tells a nice story about neighbors who almost came to litigation over trees on one property that blocked views from another. Fortunately, cooler heads prevailed, and the parties settled out of court.

Less fortunately, Professor Haab suggests that this case might  somehow constitute "a win for Coase." It's not entirely clear what he means by this allusion to Coase. But here are a couple possibilities: (1) the case provides evidence that the so-called "Coase theorem" sometimes functions in the real world - something Coase himself maintains is impossible; or (2) the case is an example of "Coasean bargaining," an ill-defined concept sometimes used to suggest that the "Coase theorem" can function in the real world and other times used to suggest that parties can overcome positive transaction costs, in at least some circumstances, to attain a socially efficient allocation of entitlements to resources.

The problem with the first understanding of "Coasean bargaining" is, of course, that it reflects a misguided belief that a world of zero transaction costs ever can actually exist. The problem with the second understanding is its implication that all contracts and other agreements in the real world must constitute "Coasean bargains," in which case "Coasean bargains" equal bargaining simpliciter. Just what does the qualifier "Coasean" add to the label "bargain"? Is any and every Pareto-improving (or potential Pareto-improving) exchange a "win for Coase"? It's far from obvious to me that Coase deserves, or would want, credit for observing that contracting parties sometimes overcome transaction costs to achieve mutually beneficial exchange.

One more point: a successful settlement is no more (or less) evidence that Coase was right than a failed settlement that results in litigation. In the first case, parties overcome positive transaction costs to bargain for an allocation of entitlements. In the second case, they fail to overcome positive transaction costs to bargain for an allocation of entitlements. Arguably, the second case better illustrates Coase's most important claim that the  market mechanism is costly to use.

More on Merrill and Smith's Attempted Resurrection of the In Rem/In Personam Distinction

In yesterday's post on Thomas Merrill and Henry Smith's new article on Coase's conception of property (see here), I noted my strong disagreement with their efforts to resurrect the in rem/in personam distinction the common law inherited from Roman law, but which fell into obsolescence during the first part of the twentieth century. However, I did not present many of my reasons for opposing a return to the in rem/in personam distinction because I wanted to keep the focus of that post on Merrill and Smith's analysis of Coase.

So, just in case anyone's interested, I am embedding below a brief essay I drafted a few years ago, but never completed or published, in response to a few earlier articles by Merrill and Smith complaining about how property is treated in Law & Economics (prominently including Coase's theories) and advocating a return to the old in rem/in personam distinction.

In Rem In Personam Distinction

Merrill and Smith on "Making Coasean Property More Coasean"

See the full paper here. The abstract:

In his pioneering work on transaction costs, Ronald Coase presupposed a picture of property as a bundle of government-prescribed use rights. This picture is not only not essential to what Coase was trying to do, but its limitations emerge when we apply Coase’s central insights to analyze the structure of property itself. This leads to what we term the Coase Corollary: in a world of zero transaction costs the nature of property does not matter to allocative efficiency. But as with the Coase Theorem itself, the real point is the implication for a positive transaction cost world: we need to subject the notion of property to a comparative institutional analysis. Because transaction costs are positive, it is no accident that property is defined in terms of things as a starting point, that uses are grouped under exclusion rights, and that in rem rights are widely employed: these features of property receive a transaction cost explanation. Simple lumpy packages of property rights motivated by transaction costs form an important baseline that furnishes presumptive answers to bilateral use conflicts. A more thoroughly Coasean approach points back to a picture of property more like the traditional one furnished by the law.

The gist of their argument is almost certainly correct: standardization of recognized property forms may well serve to economize of transaction costs (especially those relating to enforcement of title). It's easy to imagine Coase concurring with the "Coase Corollary;" it's already implicit in the "Coase theorem." If it doesn't matter which party has the property rights (in a counterfactual world of zero transaction costs), then the "nature," scope, or extent of those rights is hardly likely to matter either.

I continue to believe, however, that Merrill and Smith are (as they have been in previous articles) less than generous in attributing to Coase the claim that property rights are nothing more than "ad hoc bundles of government-prescribed use rights." It's certainly true that Coase does not share Merrill and Smith's deep (almost obsessive) appreciation of the in rem nature of property rights (that is, that property rights are good against "the entire world" -  a legal conceit if ever there was one); and perhaps he does not share their belief that the right to exclude  is the most important property right (I do not claim to know whether he does or not). There is, however, no particular reason to attribute to Coase the belief that property rights are anything other than what common-law courts say they are. Indeed, at one point in their article Merrill and Smith "seriously doubt that Coase entertained the notion that property rights are purely ad hoc assemblages of rights and privileges, like ingredients at a Mongolian barbecue restaurant." If so, then why do they keep attributing to him precisely the attitude they doubt he entertains? And if they don't believe he entertains it, then what attitude do they believe he actually holds about property? As it is, they seem to be attacking a straw man and calling him "Coase."

As in earlier articles, Merrill and Smith suggest that Coase was somehow infected by the Legal Realists' notion of property as a "bundle of rights," although once again they fail to identify the vector of contagion. Nor do they make a convincing argument that the "bundle of rights" view of property is either incorrect or pernicious. They complain that it "obscures," in various ways (all of which are debatable), the in rem nature of property, but then they concede that the "bundle of rights" conception of property is "not logically incompatible with the understanding that property rights are in rem." I believe that last statement is correct. Moreover, the main, positive contribution of their article - the argument that legal limitations of property ownership to a relatively few standardized forms may be efficient on a comparative transaction cost analysis - does not seem to depend on a conclusion that the "bundle or rights" view of property is erroneous or pernicious.

For many reasons (too many to go into here), I strongly disagree with Merrill and Smith's efforts to resurrect (from what is, in my opinion, a deserved obsolescence) the in rem/in personam distinction, and with their desire to elevate exclusion as the sine qua non of property (I just don't see why the right to exclude is necessarily more important or valuable to every owner than rights to alienate, possess, or use). But I will restrict myself here to just two objections that bear directly on their reception of Coase's work:

(1) Whether or not property rights are in rem has little or no bearing on the resolution of boundary disputes (among other types of property conflicts).

(2) Contrary to Merrill and Smith's assertion, recognizing the in rem nature of property does not render "utterly implausible" Coase's notion that land use conflicts invariably involve reciprocal harm (i.e., social costs).

Consider both objections in light of the famous case of Ampitheaters, Inc. v. Portland Meadows, 184 Or. 336 (1948). In that case, lights from a racetrack (used for evening racing) interfered with the operation of the neighboring drive-in movie theater. The racetrack had taken some steps to reduce the light emissions; the neighboring theater had done nothing to protect itself. The court ruled in favor of the racetrack, finding that it was not liable for a nuisance because the drive-in theater constituted an "abnormally sensitive" activity.

Both parties in that dispute were fee simple absolute owners of their respective lands. Even if we were to assume for the sake of argument that property rights were in rem, I don't see how that fact helps us. Does it avoid the problem before it arises, resolve the conflict (out of court) after it arises, or predetermine the outcome in court? Perhaps Merrill and Smith would argue that in rem would have resolved Portland Meadows (and similar cases), assuming that in rem rights entail the ad coelum maxim, which they mention in passing in their new paper. According to that maxim, property boundaries extend upwards to the heavens and down to the center of the earth. If that maxim were treated as a rule of property, stemming (however obscurely) from the in rem nature of property rights, the court in Portland Meadows might have been compelled to rule in favor of the drive-in theater because the light from the racetrack crossed the boundary between the two properties.

That solution would problematic in several respects. In the first place, no one to my knowledge, including Merrill and Smith, has argued that the ad coelum maxim is a necessary concomitant of in rem rights. Moreover, while often touted in dicta by common-law courts (far more in the US than the UK), the ad coelum maxim has never been consistently applied as a legal rule, let alone as a necessary concomitant of in rem rights. Finally, and most important for present purposes, the Supreme Court expressly disavowed the ad coelum rule in US v. Causby, 328 US 256 (1946) on grounds of - wait for it -  transaction costs (although the Court did not refer to them as such). The Court concluded that the ad coelum rule had "no place in the modern world" because it would have created insufferable (cost) barriers to civilian aviation. (On the problematic history of the ad coelem maxim, see my new paper on "Property Creation by Regulation" and Stuart Banner's marvelous 2008 book, Who Owns the Sky?).

Finally, returning to my second objection to Merrill and Smith's claims about the supposed in rem nature of property, in light of the outcome of Ampitheaters, Inc. v. Portland Meadows, it is clear that the owner of the drive-in theater was harmed by the court's decision. It had to either invest in high fences to block the light, pay the race track not to use its lights, move, or close down. Presumably, it chose the least expensive of those options, but every one of them entailed substantial costs. Now, consider if the court had come out the other way. In that case, the race track owner surely would have been harmed. It would have had to invest in better fencing to keep the light from crossing over the boundary, paid the drive-in theater to become an enclosed theater (or something like that), moved, or shut down. Simply put, the harm truly was reciprocal, and it's difficult to see how recognizing the in rem nature of property could possibly have changed that. Either way, one party or another is being prevented from doing what they want to do, and that is always costly, in the strict economic sense of that term, regardless of the ethics or legality of their wants.

We are left with the none-too-surprising conclusion that Coase was right! And just to end on the same positive note with which I began this post, Merrill and Smith are almost certainly right that the standardization of property rights, possibly even including the legal fiction of property rights good against the entire world, may serve to reduce transaction costs and maximize the social product across the run of foreseeable conflicts. I'm not sure that conclusion is "more Coasean," but it certainly is Coasean.

A New Interview with Ronald Coase

Here.

Hat tip: Marginal Revolution.

Happy 100th Birthday Ronald Coase

I've recently started noting historical events instead of celebrating birthdays, but I had to make an exception for Professor Coase, especially on his 100th birthday. His birthday is, in reality, an important historical event because of Coase's stature in both economics and legal studies. Two of his seminal articles - "The Nature of the Firm" (1937) and "The Problem of Social Cost" (1960) are among the most widely cited works in both fields. Unfortunately, the later article is too more often cited for the wrong reasons, as both economists and legal scholars continue to misunderstand not only Coase's intention but his analysis (do not read the Wikipedia entry about Coase, unless you want a complete misunderstanding of his work).

Coase was and remains the central figure in the modern Law & Economics movement because he explained why legal rules are such an important component of the economy. The law would not matter if it were costless to use the price system, that is, if transaction costs were zero, because individuals would simply bargain their way around all disputes over entitlements to resources. The reason the law does matter for  economic exchange is that transacting in the market is not costless. Transaction costs are always positive and often quite high. This central insight, while lost on many self-proclaimed "Coasians," who continually cite the "Coase theorem" (so named by George Stigler) and refer to "Coasian bargaining," was the most important combined legal and economic insight of the 20th century.

By the way, the 100-year-old Coase has a new book coming out (co-authored) by Ning Wang, entitled How China Became Capitalist. It will be published by Palgrave Macmillan in June 2011. I wonder how many centenarians have ever published new books?

The Economist on Coase's Theory of the Firm

The Economist, in recognition of Ronald Coase's 100th birthday on December 29th, has published a nice encomium of Coase's revelatory transaction-cost theory of the firm (here). That theory, which went largely unnoticed when Coase first published "The Nature of the Firm" in 1937, eventually gave rise to the modern Law & Economics movement and the development of a New Institutional Economics.