The Problem of Social Cost Coase 1960 Journal

The Problem of Social Cost Coase. 1960. Journal of Law and Economics. BADM 545 Fall 2019 Presented by: Hyunsun Kim-Hahm

Research Question • What is the appropriate social arrangement to solve the problem of harmful actions (negative externalities)? Types of social arrangements discussed: • • Market Firm Government Doing nothing 1

Quick Summary Prior approach of Pigou(1920) in The Economics of Welfare has to be revised as followed: • The question should be asked differently, taking account the reciprocal nature of the problem • Social net products has to be considered, in addition to private products • “Factors of production” as rights (to do something which has a harmful effect) 2

Examples of harmful actions • Prior approach (Pigou, 1920) A harms B B harms A Noise machineries of a confectioner Doctor renders reduced supply of confectionery products Straying cattle destroys crops Crop supply renders reduced supply of meats Dirt and noise from a demolition harms the business of a nearby hotel Hotel business renders the reduced benefits of new construction in the demolition site Noise from the nearby railway/airport disturbed an otherwise quiet house in the neighborhood Keeping the area quiet will be at the expense of the benefits of having railway/airport 3

Examples of harmful actions • Suggested: reciprocal nature of the problem A harms B B harms A Noise machineries of a confectioner Doctor renders reduced supply of confectionery products Straying cattle destroys crops Crop supply renders reduced supply of meats Dirt and noise from a demolition harms the business of a nearby hotel Hotel business renders the reduced benefits of new construction in the demolition site Noise from the nearby railway/airport disturbed an otherwise quite house in the neighbor Keeping the area quiet will be at the expense of the benefits of having railway/airport 4

Solution based on market • When there is no cost for using the market (e. g. , identifying actors, bargaining, contracting, monitoring), • The resource allocation will be identical, regardless of whether the harming party is liable or not • Resource allocation will be optimal, as the value of the additional production will be weighed against the costs for both parties, and the reduction in the value of production elsewhere will also be taken into account 5

When the cost of market transactions are present • Although it is not going to be satisfactory, it helps to consider costs and benefits of alternative arrangements, such as: the firm, government, do nothing • The firm: resource allocation (rearrangement of production) through an administrative decision • Problem: it might be too costly to bring diverse activities within the control of a single organization • Government regulation: a “super-firm”, using power and obedience, can completely avoid the market • Problem: unlike some prior beliefs, governmental administration can be extremely costly or inefficient. Subject to political pressures and without “competitive check. ” • Doing nothing • Given the costs of all the other options, is doing nothing a better option? 6

Legal determinants of rights and the economic problem • When market transactions are costly • It is often difficult to change the arrangement of rights established by the law. • In such cases, the court should understand the economic consequences of alternative decisions • Judges in common law countries (British and American cases) tend to be cognizant about the economic implications, comparing utility and harm. • Some directly compares gains and losses • Some indirectly recognizes as discussing “reasonable” or “common or ordinary use” • Decisions should be based on the detailed investigation of actual results • Decisions about whether a case is a “nuisance” (harm, such as smoke, dust, noise that are illegal) or not depend on the circumstances (e. g. , character of the neighborhood) 7

What does government do? • (As many economist tend to believe) government indeed extends the scope of ”nuisance” and regulate harms produced • However, there are many governmental projects that create those harms • Also, governments are responsible for a “long list of legalized nuisances. ” • Government might have a role, but there is a danger for the extensive intervention by the government • In this sense, there is an irony in Pigou (1920)’s example of a railway’s rendering harm, because in real world, such case can only exist as a result of deliberate choice of the legislature. 8

Suggestions for a change of approach • Analysis in term of divergencies between private and social products are necessary • The opportunity cost approach might not be enough • All spheres of life should be taken into account • Comparison should be between the original situation in reality and the new situation that would be possible • Rather than comparing a state of laissez faire and an ideal world • Factor of productions should be thought as rights to perform certain actions • Rather than as a physical entity which the businessman acquires and uses 9

Discussion • This paper emphasizes concepts such as social products, actual world, and all spheres of life. How are these ideas reflected in our thinking of organizations? • What difference does it make, if we consider factors as rights rather than physical entities? 10