Coase and Externalities


The concept of property rights is essential for preserving cooperation among people. And yet there are still many thinkers who deny this fundamental truth. Some believe that private property is the cause of all evil and that it should be abolished. Earth is considered to be a “common good” which is not anybody’s property. However, it is precisely the other way around. The record of history is crystal clear and confirms that when individuals’ private property rights were respected and society allowed its members to pursue their separate interests, the society flourished. On the other hand, when the societies departed from that, failure and decay were inevitable consequences.

In the past, economists and other social thinkers were always fascinated by their role in the development of countries and their prosperity. However, this has changed with the birth modern mathematical economics, i.e. thinking in terms of models and quantitative relations between social phenomena. But not all economists were so foolish to jettison the concept of property rights. The importance of private property rights has been acknowledged by the theorists writing in the tradition of the Austrian School and by their predecessors for several centuries. It was Carl Menger who famously described the crucial link between economics and the law: “Thus human economy and property have a joint economic origin since both have, as the ultimate reason for their existence, the fact that goods exist whose available quantities are smaller than the requirements of men. Property, therefore, like human economy, is not an arbitrary invention but rather the only practically possible solution of the problem that is, in the nature of things, imposed upon us by the disparity between requirements for, and available quantities of, all economic goods.“ In these days the word “private property” is considered a swear-word and is scratched out of almost all economics textbooks.

It is true that freedom and property rights may conflict. Economic thinking until the 1960s proceeded in a way that if a person violated someone else’s property, the invader should be “punished.” Imagine a factory, the smoke from which bothers the owner of an adjoining property.  What should be done about this situation? The standard, i.e. Pigouvian, approach would propose to tax the factory or it would simply forbid such an activity in that area. From a libertarian point of view, there is no need for taxes. What is needed is just a system of property rights.

It was Ronald Coase who pointed out in 1960 that the standard approach obfuscates the nature of the problem and the choice to be made. The Coasian approach to the problem of negative externalities, i.e. activities which have harmful effects on others, consists of two tiers. First, according to Coase, we have to realise that we are dealing with a problem of reciprocal nature. The problem is to avoid the more serious harm. Second, judicial activism has the potential to increase efficiency by reallocating property to higher valued uses when transactions costs are prohibitive.

There are several problems with this approach. A good example to illustrate the reciprocal nature is that of air or noise pollution around airports. Deirdre McCloskey says: “We usually think of airplanes as the cause. But wait. Suppose that there were no ears close to the airport. (Or that the ears were easily protected from the noise.) In that case the noise would be harmless and it would be silly to curb it. So the presence of the “ears” is as much a cause as the vibrations of the planes’ motors.” It wouldn’t be Walter Block if he didn’t reply to that. Block asserts: “I will tell you what, Professor McCloskey. I will box your ears with my fist, and then you can tell me that your ear is just as much a causal agent of this collision as my fist. This is dangerous nonsense.”

To put it bluntly, the reciprocal nature of harm is incompatible with the traditional teaching about the cause and effect. In a libertarian society, every person is responsible for its actions and the consequences stemming from it. If a person invades anyone else’s private property, the owner can seek an injunction from the court to prevent an activity he thinks breaches his property rights. However, according to Coase, the very fact that someone aggresses against private property does not mean that it should be prevented. Coase by this notion of reciprocal harm launched a frontal attack on private property rights.

The view that judges and politicians can achieve results which increase efficiency is also profoundly mistaken. Since costs are purely subjective they are not ascertainable by a judge and, therefore, they cannot be weighed. But, just for the sake of argument, suppose that it is possible to find out what the costs of a particular course of action are. It is still preposterous to talk about costs from a perspective of society as a whole since costs must be borne exclusively by individuals. Moreover, economic efficiency is a relative concept as it relates to the goals and ends that individuals pursue. The fundamental question that must be answered is therefore: Whose ends should rule? This is not an economic question, but an ethical one.

The Coasian approach to the externalities problem has immense social consequences. Gary North stridently illustrates this approach: “The initial reaction of anyone of the victims, if he knows that the civil law does not protect his ownership rights automatically, may be to blow up the factory or murder its owner. The multiplication of acts of violence would be assured under such a non-liability legal order. “Thus, social cooperation would be impossible under such a legal order.

Libertarianism on the other hand allows members of a society to pursue their goals. But these goals are sometimes in conflict. Therefore, there must be some objectively ascertainable rules which reduce the number of conflicts among individuals. Private property rights are precisely these kinds of rules. If one is allowed to violate some else’s property rights, the society is doomed to decay.