The Coase Theorem and Its Relevance to the Control of Environmental Externalities - Coursework Example

Explain what is meant by the ‘Coase theorem’ and explain its relevance to the control of environmental externalities I. Introduction In order to identify the causes of specific social, political, financial and environmental phenomena, scientists around the world has developed through the years a series of theoretical frameworks that can help towards the achievement of the above target. In this context, Coase theorem has been traditionally considered as an important theory that can be applied equally in many sectors of modern society. Coase theorem has been stated by Coase Ronald in his article ‘The Problem of Social Cost’ (1960). In the above article Coase proved that ‘a decentralized negotiation between the producers and the victims of damage enables them to spontaneously achieve a situation corresponding to an efficient allocation of the resources (efficiency thesis of the Coase theorem), provided that there are zero transaction costs and that the property rights are unambiguously defined’ (Boisvert et al., 2002, 154). It should be noticed that the application of Coase theorem is followed by specific requirements. More specifically, it is suggested by Barrett (1999, 133) that ‘the desirable outcome promised by the Coase Theorem requires more than a full specification of property rights; it also requires enforcement by a third party; even if the former requirement were satisfied, the latter cannot be, because third party enforcement of contracts (treaties) is not countenanced by the international system’. In other words, the application of Coase Theorem can be fully achieved primarily within a particular state. When having to deal with situations referring with the international community, appropriate preparation should be made in order for Coase Theorem to be applicable. Current paper focuses on the use of Coase theorem for the control of environmental externalities. As already stated above, Coase theorem can be used in many ‘sectors’ of modern society. Environment is one of these sectors. However, it should be noticed – as already mentioned above – that Coase theorem cannot be applied without the appropriate preparation. In fact, it would be necessary to identify primarily all phenomena (social, political, financial and environmental) that should be examined using this theorem trying to use the closest arguments (included in the theorem) for the explanation of each one of them. II. Coase theorem – definition and characteristics In order to understand the role of Coase theorem in the control of environmental externalities, we should examine primarily the general framework in which this theorem was formulated. In this context, it is noticed by Vira (1997, 769) that ‘the Coase theorem was developed in the context of producer-producer interdependence and that its extension to other types of interaction, even within the economic sphere, is questionable’ (Vira, 1997, 769). However, the above assumption is just the personal view of the particular researcher. In fact, Coase theorem could be interpreted using a variety of theoretical views, mostly because by its nature is a theory applicable in many social sectors (including environment). At a next level, it has been found that Coase theorem can offer a series of advantages if compared with other theoretical frameworks applicable in the same cases. Coase Theorem has been also described by Richards (2000) who stated that ‘the Coase Theorem states that if all parties have full information about their costs and benefits, if there are zero transaction costs, and if property rights are fully assigned and understood, then parties will bargain to allocatively efficient outcomes’ (Richards, 2000, 221). On the other hand, the study of Ayres et al. (1995) – referring especially to the use of Coase theorem in the explanation of the parties’ responsibilities regarding a specific transaction – showed that ‘even when liability rule damages are not sufficient to deter nonconsensual takings, the Coase theorem predicts that the parties may still have incentives to engage in consensual transactions’ (Ayres et al., 1995, 1031). However, the application of Coase theorem in the above case is an issue depending on the willingness of the parties involved. This is of particular importance mostly because the non-application of Coase theorem can lead to different assumptions regarding the obligations and the rights involved in the above transaction. On the other hand Coase theorem can be also used in the political ‘sector’ appropriately formulated in order to respond to the needs and the characteristics of this sector. The application of Coase theorem in politics (known also as political Coase theorem) has been explored by Vira (1997, 768) who found that ‘given an initial distribution of political entitlements, such as voting rights, lobbying rights, etc., within a given constitutional framework, the optimal institutional outcome will be achieved if there are no political transaction costs, and this outcome does not depend on the initial allocation of political entitlements’. Other researchers have explored the potential ‘division’ of Coase theorem in parts – independent one from another – that will be applicable in different social sectors. In this context, the First Coase theorem is related with the assumption that ‘transaction costs are zero’ (Felder, 2001, 257). The first Coase theorem should be considered as not applicable in the real world where costs always involved in transactions. However, the Second Coase theorem could be possibly applied. In accordance with this theorem: in the presence of transaction costs, the initial allocation of salable rights affects the final allocation of rights and it may also affect the overall amount of social welfare’ (Felder, 2001, 258). The above ‘version’ of Coase theorem could be possibly combined with its third version – the third Coase theorem which suggests that ‘in the presence of transaction costs, improvements over and above those attainable through trade are possible through a judicious assignment of delimited rights; this assumes that the government can approximate and compare the welfare effects of alternative delimitations of rights at relatively low cost’ (Felder, 2001, 258). However, in this case also (involvement of government in the application of Coase theorem) the application of Coase theorem should be regarded as problematic because of the following two facts: a) the involvement of government in the application of Coase theorem cannot be ensured (internal and external turbulences may be an obstacle towards the theoretical interpretation of certain social, political, financial and environmental issues), b) there may be also other theoretical frameworks applicable on a specific social, political, financial or environmental ‘conflict’. In this case the application of Coase theorem should be decided only if this theorem would be the most appropriate theory in accordance with the conditions of the particular case, the willingness of the parties involved and the right of government to intervene. III. Coase theorem and environmental externalities In order to understand the role of Coase Theorem in the control of environmental externalities, we should also refer to the development of environmental regulation around the world. Towards this direction it is noticed by Lotspeich (1998, 85) that ‘environmental regulation is formulated in a political process, and public attitudes depend on how private wealth will be affected and on citizens ethical points of view on the environment; the fundamental social problem of pollution control policy is resolving the associated conflict, and market approaches are not always the most effective mechanism of conflict resolution’. Moreover, the involvement of Coase with environmental externalities could be understood through a report of the Chicago School of Economics referring especially to the characteristics of Coase theorem and its applicability in environment – related issues. In accordance with the above report ‘Coases argument begins by addressing a well-known problem of markets: externalities, otherwise known as the Spillover Effect; this occurs when someone other than the buyer must share the benefits or costs of a product; the classic example is pollution; factories can either treat pollution -- which costs money -- or dump it into the air or water for free; sometimes the spillover effect is both positive and negative’ (Chicago School of economics, [1]). It is through the above framework that Coase theorem can be applied in environmental externalities (as described above) around the world. When using the Coase theorem in order to control environmental externalities, a series of specific reactions are expected to be observed. More specifically, in accordance with the study of Wiener (1999, 688) ‘instead of regulating conduct or prices, a global environmental regulator might regulate the quantity of access to the shared global resource, or restated, the quantity of entitlements to cause external harm to the global environment; the regulator could partition the property rights to what had formerly been treated as an open access resource, either via geographically defined property boundaries (e.g., fishing zones), or via property entitlements to use the resource or cause harm’. After following the above methodology, environmental regulator could proceed to the description of the relations between the source and the victim in accordance with the terms of the particular assignment (referring to entitlement ‘to cause harm, or to be free from harm’ (Wiener, 1999, 688)). On the other hand, there are a few issues that should be considered before applying Coase theorem. In this context the intervention of government in the resolution of a series of ‘externalities’ should be considered as significant. However, the application of Coase theorem in this case could lead to the following two assumptions: ‘(i) the "victim" owns the "right" to be free of this pollutant, so the firm must buy those rights, or that (ii) the "polluter" owns the rights to pollute, so the victim must pay the firm; the surprising result of the Coase theorem is that efficiency is achieved either way’ (Fullerton, 2001, 224). It is in this case, that there is no need for particular taxation related with the protection from the pollution of environment. However, when the above theoretical ‘sequence’ is not followed, then it is necessary for the government to intervene and impose taxes towards the protection of the environment. Appropriate legal rules could be also implemented in order for the environment to be protected; however financial support for the realization of projects related with the protection of the environment would be required in any case that Coase theorem fail to regulate the relationship between the ‘source’ and the ‘victim’. Regarding this issue, it has been supported by Coase that ‘an amount of compensatory payment or dissuasive premium can be determined through a direct bilateral negotiation between the producer and the victim of the damage; this negotiated amount can be considered as the terms of exchange of property rights to resource uses’ (Boisvert et al., 2002, 154). However, even if appropriately compensated citizens continue to claim their right for a ‘healthy’ environment (in terms of air and water used by them on a daily basis). In other words, the right to ‘health’ (as also derived by the right to life) cannot be ‘sold’ – such a transaction would be with no applicability. On the other hand, the compensation of victims could be a sample of the firm’s (polluter) intentions to handle its waste. If this behaviour (pollution of environment) insists, the government should intervene by prohibiting the firm to operate until all appropriate measures are taken for the protection of the environment. In these terms, Coase theorem could be used in the control of environmental externalities, but just temporarily. It could not produce permanent effects because in that case fundamental rights (such as life and health) could be severely violated (which is against any local and international law). IV. Conclusion Traditionally, law and economics cooperate in order to resolve specific social and political issues. In the case of environment, the role of both the above sciences in the resolution of a series of issues has been significant. On the other hand, the cooperation of these sciences has been based on many theoretical works but just two of them have been considered to be most important. The first is the work of Coase and the second is that of Calabresi and Melamed. In accordance with the first researcher (Ayres et al., 1995, 1093) ‘when transacting is costless, the choice between property and liability rules does not affect the attainment of efficiency’ while the two others suggested that ‘when transaction costs make consensual transfer prohibitively expensive, liability rules, which allow for nonnegotiated transfer, are likely to dominate property rules’ (Ayres et al., 1995, 1093). In any case, it should be noticed that Coase theorem is mainly based on transaction costs. However, this could also have a negative aspect. The parts of Coase theorem that requires no transaction costs cannot be applicable in real terms. In other words, Coase theorem could be applied in order to control environmental externalities but only under the term that transaction costs – if deployed in the relevant hypothesis – they should have a specific price, i.e. they should exist. However, the opposite view has been also suggested. More specifically, in accordance with Wiener (1999) Coase theorem could be applied even in cases that transaction costs are zero. In this case it is suggested that ‘with zero transaction costs, the parties can costlessly reallocate entitlements to internalize externalities, regardless of the initial assignment of entitlements among them; in this case, the liability rule and the property rule are equivalent because the parties will contract around either one; if these transaction costs are high, such Coasean deals may be frustrated and externalities may persist’. In other words, even with zero transaction costs Coase theorem could be applied but its application will not be free of problems. In fact in this case the control of environmental externalities can be proved too difficult to be achieved. From another point of view, it is noticed by Arora et al. (1999, 694) that ‘in a world without transaction costs, the Coase theorem suggests that releases will increase in neighbourhoods in which the releases will do the least damage; according to this hypothesis, releases will be greater in neighbourhoods with lower rent’. The above view refers especially to the case of environmental externalities related with a particular neighbourhood. In the above case, Coase theorem could be applied also in order to regulate the relationships among the members of the specific community always regarding the natural environment of the particular region. The application of the Coase Theorem in the control of environmental externalities seems to be limited under the influence of the following theoretical scheme: ‘two broad ethical viewpoints on environmental policy can be distinguished: instrumentalists, who see the environment as a tool for improving human welfare, and environmentalists, such as the "deep ecology" movement, who see preservation of the environment as an end in itself; an effluent charge, representing a price payable for the right to pollute the environment, is acceptable in principle to instrumentalists’ (Lotspeich, 1998, 85). In accordance with the above Coase Theorem could be used for the control of environmental externalities but such a choice should be followed by the view that the pollution of environment could be compensated (even at a high price) – a view that is difficult to be accepted and it can be used only if referring to a temporary situation (pollution) due to circumstances that cannot be controlled. It could not refer to a permanent situation; it could not be used either for the provision of rights over the natural environment because such a decision would be opposite with the public interest. References Arora, S., Cason, T. (1999) Do Community Characteristics Influence Environmental Outcomes? Evidence Fro the Toxics Release Inventory. Southern Economic Journal, 65(4): 691-2004 Ayres, I., Talley, E. (1995) Solomonic Bargaining: Dividing a Legal Entitlement to Facilitate Coasean Trade. Yale Law Journal, 104(5): 1027-1117 Barrett, S. (1999) International Cooperation and the International Commons. Duke Environmental Law & Policy, 10(1): 131-140 Boisvert, V., Caron, A. (2002) The Convention on Biological Diversity: An Institutionalist Perspective of the Debates. Journal of Economic Issues, 36(1): 151-163 Chicago School of Economics. Ronald Coase and the Coase theorem [Online], available at http://www.aliveness.com/kangaroo/L-chicoase.htm [1] Coase, R. (1960). The problem of social cost. Journal of Law and Economics 3:1-44. Felder, J. (2001) Coase Theorems 1-2-3. American Economist, 45(1): 54-61 Fullerton, D. (2001) A Framework to Compare Environmental Policies. Southern Economic Journal, 68(2): 224-245 Lotspeich, R. (1998) Comparative Environmental Policy: Market-Type Instruments in Industrialized Capitalist Countries. Policy Studies Journal, 26(1): 85-107 Richards, K. (2000) Framing Environmental Policy Instrument Choice. Duke Environmental Law & Policy Forum, 10(2): 221-264 Vira, B. (1997) The Political Coase Theorem: Identifying Differences between Neoclassical and Critical Institutionalism. Journal of Economic Issues, 31(3): 761-775 Wiener, J. (1999) Global Environmental Regulation: Instrument Choice in Legal Context. Yale Law Journal, 108(4): 677-766 Read More