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Notes: McCloskey - 1998 - the So-called Coase Theorem
- George Stigler’s version of the Coase Theorem, in the 1960s
- It doesn’t matter where you place the liability for, say, smoke pollution, because in a world of zero transaction costs, the right to pollute will end up in the hands that value it the most.
- In a textbook of Shughart, Chappell, and Cottle: “In the absence of transaction costs, the allocation of resources is independent of the initial assignment of property rights.”
- Stigler’s theorem is actually Adam Smith’s theorem (1776). It is wholly explicit in Edgeworth (1881, 30ff, 114); and with all the bells and whistles in Arrow and Debreu (1954).
- Smith, Edgeworth, Arrow, Debreu, with many others, noted that an item gravitates by exchange into the hands of the person who values it the most, if transaction cost (such as transportation) are not too high.
- Coase’s actual point was to note what happens in the many important cases in which transactions costs cannot be neglected. If the situation does have high transactions costs, then it does matter where the liability for pollution is placed. In consequence, the economist’s preference for a simple, blackboard solution, taxing the party that “causes” the pollution (as Pigou and Samuelson suggest), is no longer defensible.
- McCloskey 1993, footnote 2
- Coase’s article was not meant to show that we live already in the best of all possible worlds (as Stigler was inclined to assume in this and other cases) but on the contrary that if we did there would of course be no need for policy; and that in fact, as Coase argued also in the 1937 article, transaction costs push our world unpredictably far from the blackboard optimum [thus second best].
- Email conversation between McCloskey and Weisskopf
- McCloskey: In the presence of transaction costs, one cannot in general efficiently internalize an externality by taxing/subsidizing whoever is generating the negative/positive externalities, because it would generally not result in the right to the resource affected going to the person who values it the most.
- McCloskey: In other words, whoever is generating the negative/positive externalities is not a meaningful notion.
- In the railway/farmers example: who “causes” the burnt of fields of corn, the railway which makes the sparks, or the farmers who plant imprudently close to the line?
- In the noise pollution around airports example: are the airplanes the “cause” of the pollution, or the ears that near the airports? The presence of ears is just as much a “cause” as the vibrations in the planes’ motors. Where then should the Pigou/Samuelson tax be placed?
- Weisskopf: Is it true that Coase implies not that state should get out of the business of dealing with externalities, but implies that states should try to get the entitlements right rather than getting the prices right?
- McCloskey: Yes. But Coase also claims, with considerable empirical evidence, that in many cases, government trying to get the entitlements right is worse than laissez faire (FCC or the lighthouses or the law of liability). In most cases, because of lack of knowledge.
- McCloskey: In other words, Coase claims that laissez faire is desirable not because it’s the First Best (transaction costs are low, things will come into places), but because it is the Second Best (the transaction costs are so high that entitlements matters, and transaction costs are so high that it is hard for the government to get the entitlements right).
- McCloskey: It is this claim, that lead people to confuse Coase as yet another laissez faire economist.
- In a wider context, Pigou, Samuelson, and Stiger are “modernists”. Modernism has had some good moments, such as the Ronchamp Chapel by Le Corbusier or The Foundations of Economic Analysis by Paul Samuelson. It was worth a try, though on the whole it did not work very well. Have a look at economic policy; or, if that doesn’t appall you, then look at the average academic article in economics, pure theoretical modernism, blackboard economics gone loco.
- I commend Coase for his old-fashioned ways. The old-fashioned ways have become the latest fashion, actually. You read it here: Ronald Coase is a postmodern economist. And his theorem, a post-modern one, is about the difficulty of knowing what is to be done.