What is the Theory of Coase - Essay Example

Environmental Economic, What is the theory of Coase and has it any bearing on policies for the control of environmental pollution There existed a fewtheories of externality before Coase's. In general the goods are produced if the value of the goods are more than their manufacturing cost, but if their value is less than the goods are not manufactured. Here the cost of the manufacturing includes the direct costs like raw material, labor, electricity etc (The Swedes Get it Right, 1) Let us consider the example of a steel manufacturer around which there are residences. Its costs include, iron ore, coal, electricity etc. and also uses the clean air and discharges polluted air consisting suphur di oxide. In this case the pollution will cause the health hazards worth say $100. Now when the steel manufacturer makes his balance sheet he won't include these external costs into profit and loss statement for he pays nothing for that. The solution in this case may be that the government tells the company how much it can pollute air or it may impose the taxes depending upon the amount of the pollution it causes, called Pigovian taxes. This was the general theory followed before Coase came up with his theory (The Swedes Get it Right, 1). Coase approach: Coase begins by giving the example of straying cattle, which destroys the crops in the neighborhood land. In this case we get more cattle i.e. the meat at the expense of the crops. Thus we can get either the crops or the meat. The answer lies simply in deciding the value of what we obtain at the expense of value of what is sacrificed. Thus Coase gives prime importance to the value of the product (1). In this example Coase considers various options. Suppose if the value of the meat is more than the value of the crops in that case the cattle raiser may give some compensation to the farmer by mutual understanding. If the value of the crops on the other hand is more than the value of the meat in that case the farmer may build the fencing to protect its crops from the cattle and demand some compensation for doing so. In other case, if the farmer is not using some part of land he may allow the cattle bearer to use that land at some fixed costs agreed upon by both. There is also the possibility that if the cattle bearer finds that by increasing the number of the cattle he can get much more profits and he could easily pay the farmer all the cost of the crop in that case he may just compensate the farmer for completely stopping the growth of the crops. There is one more angle to these discussions. If the farmer had the initial rights to use the land for the crops, then the cattle bearer bargains with the farmer to allow the cattle rising in his vicinity. While if the cattle raiser has the initial rights to raise the cattle in his vicinity then farmer has to bargain with the cattle bearer so that his cattle create least damage to his crops (Coase, 2). In either way, what is important to come up with the solution is the value of the product that is be obtained and of the product that is sacrificed. The greatest thing is that the problem is solved by the mutual discussions and the contract is raised among the concerned parties, which benefits all. Here there is no involvement of the government, no regulations and no political or the beurauracratic proceedings. However, one of the most important things to understand is the fixing of the property rights which plays the dominant role in the success of the Coase method (Swedes Get it Right, 1). In the example considered by Coase the property rights belong to only the two persons, the cattle raiser and the farmer. Here it is quite easy for the two parties to get involved in the discussions and come out with some contract. In case of the example of steel plant if the plant owners have the initial rights to production and create pollution then the residents will bargain with the manufacturer to create the least possible pollution. In this case the residents may make some payments to them to either use some methods to stop the pollution completely or to purchase the coal of good quality so as to reduce the pollution. The solution will depend upon the costs of both the methods and the compensation that the residents are willing to pay to the manufacturer. If on the other hand the residents have the initial rights to the pollution free air then the manufacturer will bargain with the residents to allow him to pollute the air. In this case he may install the pollution abatement equipments or he may use the coal of better quality or may pay some monetary compensation to the residents and pollute the air. The solution depends considering various cost factors. Thus again the solution is found by the mutual discussions among the various parties considering the value of various products. These discussions can be explained with the help of a graph: B,C C' M - Manufacturer V- Victim W X B' Y Z J S The graph shows Benefits and costs of the polluting activity. The function B'(x) shows M's marginal benefits, the function C(x) describes V's marginal damages which are the nuisance costs resulting from M's activity. The optimum level of activity in this case can be where x = J which is where B(x) = C(x). Marginal cost equal marginal benefits associated with optimum level of pollution. (Neoclassical Analysis of Pollution Costs, 2) Case I: If the Manufacturer (M) has the unhindered right to production without the concerns of the residents he will resort to maximum production at x = S. Case II: On the other hand if the victim (V) is totally intolerant of the M's activities he will allow zero production at X = 0. However between the two parties the mutual compromise can be struck at x = J where M will pay the V compensation of Y at least to compensate for its pollution activities. M's benefit in this case was W+Y (Neoclassical Analysis of Pollution Costs, 2) On the other hand if V was to bargain with M to produce less production again the compromise will be struck at x = J, where the V will pay M amount Z at least which the manufacturer forgoes by reducing it production from x = S to x = J. In turn V will prevent it self from the damages which could have cost him X+Z. This solution is as per the Coase theorem mutually benefits all the concerned parties. The Problem of free riding: when the victim V is the diffuse collection of the agents the problem can arise called free riding. Some individuals will try to benefit from the negotiations without actually participating in the process. They may work in two ways if the V is suppose to pay to M then they may be disinclined to pay the contributions. On the other hand if they are suppose to get the money then they make undue demands. This may lead to the failure of the negotiations. (Neoclassical Analysis of Pollution Costs, 4). Advantages of Coase theorem: 1) Instead of speaking of the market failure this analysis looks to the market for the solutions. (Yandle, 1) 2) Where transaction costs are low and the property rights are clearly assigned optimum solution can be obtained. (Yandle, 1). 3) The parties involved themselves collect information and use it in reaching the contract, and change in due course of time. They don't have to wait for the election results and the national statuettes. (Yandle, 1) Limitations of Coase theorem: 1) If the number of parties is lesser then negotiations may be successful. But in actual practice large number of parties are involved, like many residents discussing with many industries in the locality, then the transaction cost are very high which leads to the failure of the negotiations. (Yandle, 1) 2) Suppose in the multiple parties the deal is struck. But the problem will be: for the particular type of industry say, steel, the contract in different parts of the country will not be same. It will depend upon the property rights, number of parties involved and local conditions. Due to this the overall manufacturing cost of the product will vary in different parts of the country. The site where the M company gives more compensation, the manufacturing costs will be high. This will lead to some non-uniform conditions and act as a strong barrier in competition. If the transaction costs are high the company won't be able to face the competitors, it will not be a perfect competition. 3) Again the property rights play crucial role in Coase's method. Its very difficult to decide about the property rights. (Swedes Get it Right, 1) 4) At the time of Coase the transaction costs were lower. Now these are very high and dependent upon many factors, like market, political etc. thus affecting the bargaining (Yandle, 1). Pigou's method of taxes: This approach considers that the pollution causing industries are using the natural resources of the earth and hence they should be taxed. This analysis has nothing to do with the concern of the society but everything to do on competing demands for use of an asset (Yandle, 1). The taxes are to be collected from various industries causing the pollution and at the same time the rates of the taxes vary depending upon the production of the company i.e. the quantity of pollutants discharged and the number of residence around the industries being affected by the pollution i.e. the extent of damage caused by the pollutants. As per Pigou more taxes are to be collected for more production, as that will cause more pollution. Pigou's method is difficult to apply practically as Yandle says, "Information is costly to assemble. It is impossible to determine the optimal amount of discharge for thousands of industrial dischargers located along hundreds of rivers and streams, a difficulty Pigou recognized late in his career." (1) Kyoto Protocol To The United Nations Framework Convention On Climate Change: As per the Article 2 one of the point of protocol is, "(v) Progressive reduction or phasing out of market imperfections, fiscal incentives, tax and duty exemptions and subsidies in all greenhouse gas emitting sectors that run counter to the objective of the Convention and application of market instruments" (1). As per the Kyoto protocol the governments of countries should take initiatives to reduce the pollution. This will not only protect the environment but also lead to uniform cost throughout the world. Conclusion: We live in the world where there is tension between rule of law and politics. The best solution is to solve problems with the mutual understanding and compromise. The Coase theorem helps to reduce the pollution by coming to understanding on the reasonable limits of pollution. The Coassian approach can help the government in fixing the property rights issue and also setting the directives regarding the terms of negotiations between the parties involved. If the government does implements these directions the chances of final solution can increase which will ultimately lead to the reduction in pollution. Works Cited Coase, Ronald. H. "The Problem of Social Cost." 29 March 2006. Yandle, Bruce. "Coase, Pigou, and Environmental Rights." Acton Institute for The Study of Religion and Liberty. 29 March 2006. "Kyoto Protocol To The United Nations Framework Convention On Climate Change." 30 March 2006. < http://unfccc.int/resource/docs/convkp/kpeng.html> "Neoclassical Analysis of Pollution Costs." Lecture 8. D.S.G. Pollock : Environmental Economics. "The Swedes Get It Right." 30 March 2006. Read More