[WARNING: As mentioned in the comments below, this post’s discussion of the “Coase theorem” contains several errors—most notably, that Coase himself did not present his arguments mathematically. In fact, according to a number of sources, there really is no single “Coase theorem”—instead, there are several different and somewhat conflicting notions that followers and interpreters of Coase have presented as theorems. For more, please read the comments, below.]
Those inclined to be uncharitable might see the phrase “free-market environmentalism” as somewhere between oxymoronic and greenwashing. But I’m a charitable sort: I believe that people can be sincerely committed to caring for the planet—and also firmly committed to the idea that free-market principles offer the best hope of doing so.
And sometimes, markets really can be great tools for advancing sustainability. Consider the problem of overfishing: some great successes in fisheries management have come from giving individual fishers a “property right” to a share of each year’s harvest. Once those rights are established and firmly enforced, fishers have incentives to boost future years’ harvests—because an abundant fishery increases the value of their “property”—and also to keep an eye on their neighbors to ensure that they’re not taking too much of a shared resource. As it turns out, giving individuals the incentive to act both as stewards and enforcers can be a pretty effective combination. (This National Research Council report has more details—but I should be careful to note that the study found that transferable fish quotas are no panacea.)
As for fisheries, so for air and water? Free-market environmentalists would say yes: the best way to guarantee clean air and fresh water, they’d argue, is to establish clear property rights for pollution, and let the market sort things out. Many even argue that a property-rights based system could lead to major reductions in pollution, since governments sometimes allow more pollution than people actually want.
But unfortunately, free-market sincerity only goes so far: it’s possible to be perfectly sincere and also deeply misguided. And, in fact, that’s the conclusion that this article in the Journal of Economic Issues reaches. The authors, Robin Hahnel and Portland-based Kristen Sheeran, have constructed a convincing case that the key intellectual pillar of free-market environmentalism—a bit of theoretical economics known as the Coase theorem—has almost no relevance to how pollution markets would play out in the real world.
So what’s this Coase theorem thing all about?
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In a nutshell, Nobel-winning economist Ronald Coase proved mathematically that, with a system of guaranteed pollution property rights and under ideal “free-market” conditions, society as a whole would get exactly the amount of pollution that its members want—no more and no less.
For example, if individuals were granted a “property right” to be pollution-free, then some would be willing to accept cash payments in exchange for allowing a little bit of pollution; and ultimately, after lots of pollution trading, “the market” would decide on how much pollution society as a whole could tolerate. Conversely, if polluters are given the “right” to pollute, then people who wanted to be pollution-free would pay the companies not to pollute—and once again, the market would “decide” how much pollution members of society are willing to pay to prevent. (Remember, I’m just describing this idea, not endorsing it.)
Now, you might think that the level of pollution that society would decide on would depend on how “pollution rights” are distributed—that is, whether polluters are given the “right” to pollute, or potential victims are given the “right” to be pollution-free. But Coase’s theorem shows that, under ideal circumstances, the way that “rights” are assigned doesn’t actually affect the environmental outcome. Instead, for any given set of individual preferences and costs, a pollution market will always wind up allowing the same level of pollution, regardless of whether the polluters or the victims are assigned the “rights.”
And that’s why free-market environmentalists pay so much attention to Coase: his theorem suggests that, if you really want to figure out the “socially optimal” level of pollution—the exact level that free people are willing to tolerate, based on the actual costs and benefits of pollution control—all you need to do is create pollution rights, stand back, and let the market sort things out.
A long line of critics have conceded Coase his mathematical insights, but questioned their relevance. After all, the ideal conditions envisioned by Coase—with firmly enforced property rights, fluid markets, and zero transaction costs—are nearly impossible in practice.
But Hahnel and Sheeran go several steps farther, building the case that Coase’s theorem is even more deeply irrelevant than previous critics have allowed. Here’s the nickel version of their critique:
- Complete information is impossible: One of the key assumptions of Coase’s theorem is that all parties in a pollution market must be essentially omniscient, aware of all private individuals’ preferences to be pollution-free, as well as the costs of pollution control and the potential profits and losses for private firms. That kind of omniscience not only goes beyond what’s realistic, it even exceeds the assumptions of other areas of economics—which tend to assume that economic actors are merely “self-aware” rather than omniscient.
- Without complete information, Coase’s theorem breaks down: Coase’s math suggests that there’s a single “socially optimal” level of pollution that any set of free negotiations will achieve. But once participants in a pollution market start playing their cards close to their chest—say, by claiming that pollution controls will put them out of business—then all bets are off. All sorts of different pollution levels and prices could result from pollution negotiations, depending on how the market plays out under conditions of incomplete information. And that dashes all hopes for having market forces discover a single “socially optimal” level of pollution.
- Coasean negotiations aren’t markets: To achieve mathematical rigor, Coase simplified pollution negotiations to the simplest case: one polluter and one victim. But with just two parties, you don’t have a market at all! Instead, you’ve got a bilateral negotiation, also known as a “divide-the-pie” game. And with those kinds of games, many different price and pollution levels are possible, depending on the specifics of how the negotiations are conducted. Hahnel and Sheeran quote fellow economist Joseph Farrell to explain: “if bargaining and negotiation are perfect (that is, produ
ce perfect outcomes) then the outcomes are perfect. [But] actually, negotiation is far from perfect, even in the simplest situations.”
- Multiparty negotiations make things even more complicated: Standard discussions of the Coase theorem point out that multiparty negotiations can increase “transaction costs”—i.e., costs for running parallel negotiations, or for deciding which people are genuinely victims, and to what extent they’ve been harmed by pollution. But even more troublesome, multiple parties create a host of “tragedy of the commons” complications which make it nearly impossible to believe that market forces alone will arrive at the “socially optimum” level of pollution, with many firms or private individuals “free riding” on the more virtuous actions of their neighbors. Hahnel and Sheeran argue that multiparty problems are so severe that they can’t be simply explained away as higher transaction costs.
All told, Hahnel and Sheeran build a substantial case that Coase’s theorem has very little to do with the actual workings of real-world pollution markets. Absent other democratic institutions and meaningful oversight, “free” pollution markets quite likely would allow far more pollution than people actually want. And if you buy this line of reasoning, you have to demote the Coase theorem from one of the pillars of an entire world view to a quirky but not particularly relevant bit of theoretical math.
Now, I’m sure that a single paper won’t be enough to shake free-market environmentalists’ faith in their ideology. But for those who aren’t already committed to that faith, Hahnel and Sheeran give every reason to believe that free-market environmentalism is like so many other “isms”—beautiful and elegant on paper, but so divorced from reality that it offers very little to recommend itself in practice.
Photo courtesy of flickr user Steve Rhodes, distributed under a Creative Commons license.
Your description of the Coase theorem (or any of his work for that matter) as “mathematical” suggests that you haven’t ever read it. Check it out before you rely on an article critical of Coase for your understanding of Coase’s ideas. In reality, much of your argument could be rearranged to be critical of Pigou.
Shawn is correct. Coase’s theorem is not mathematical at all. Other economists have applied mathematics to the theorem but the in his paper “The Problem of Social Costs” there is no math. The Coase theorem is never utilized in the real world as the sole means to correct for an externality. It just provides a different way to view private and social benefits and costs, a way that doesn’t over rely on opportunity costs. In fact, in Coase’s paper, he does go on to discuss the presence of transaction costs and the role of government and the legal system. This whole thing is kind of a moot point.
to the author/editors:were y’all being funny using the photo of the “really, really, free market”?’cause the folks who put on those events want to bring back the gift economy and their “really, really…” events are more about the FREE than the Market part. just in case you didn’t realize it, they are a bunch of bike riding anti-capitalist anarchists swapping patches and giving away dumpstered food.http://www.reallyreallyfree.org/index.php?l=homehttp://www.infoshop.org/index.phpfrom the really really free website:About the RRFMBecause there is enough for everyoneBecause sharing is more fufilling than owningBecause corporations would rather see landfills overflow than anyone get anything for freeBecause scarcity is a myth constructed to keep us at the mercy of the economyBecause a sunny day outside is better than anything money can buyBecause “free trade” is a contradiction of termsBecause no one should have to do without food, shelter, entertainment, and communityBecause life should be a picnic, but it only will be if we make it happenHave you ever picked up something you found on the sidewalk? Or saved your neighbor from throwing away something useful?A Really Really Free Market is like a potluck for whatever you want to give or take away. Have you ever brought one dish to a potluck and gone away with a full belly and a balanced meal? Everybody brings something and goes away with more.We all have skills, ideas, objects, smiles, talents, friendship, excitement, discussions, and many other things to share. If we bring them all together at the Really Really Free Market, we can provide more balanced and full lives for everyone.As a community we have many more resources than we do as individuals. If we share our resources we won’t need to buy as many new ones. This uses fewer of the Earth’s resources, and fewer of our working hours, leaving us more time to devote to ourselves and our communities.Would we all work forty hours a week at one job if we didn’t feel we had to? What if instead we worked at improving our individual skills and talents and shared them with each other? We would all spend more time doing things we enjoyed.The Really Really Free Market is an attempt to put these ideas into practice for four hours every month.Please help us keep the Really Really Free Market a 100% FREE and non-commercial event. Once a month, let’s come together and forget about trading, bartering and money. Leave the business cards at home and remember the joy of giving for the sake of giving.Help us keep Dolores Park clean. If no one takes what you brought, please bring it home with you.
Yeah, johnthetreehugger—using that picture was supposed to be a joke. I went looking for a picture that said both “free market” and “super groovy”. That was the best match.
What do you mean? You cite Hahnel and Sheeran who show that markets can’t internalize external cost—but label the post “Free-market environmentalism isn’t an oxymoron”. I think it clearly is. Yes—tradable quotas work , but that’s because a “social planner” /”benevolent dictator” is determining the hard limit (which the market, according to Coase, should be able to find by itself). The “market” part in tradable quotas isn’t about finding the optimal level of externalities, but simply to divide the spoils.
In a recent blog post, Sightline’s Clark Williams-Derry recently commented on my article, “Misinterpreting the Coase Theorem” published in the Journal of Economic Issues. Since our hope when we wrote the article was to stimulate discussion about what the Coase theorem does and does not say, and what a careful examination of the theorem does and does not suggest about the likelihood of achieving efficient pollution levels through voluntary negotiations between pollution victims and polluters even if property rights are clarified, we are pleased that Williams-Derry’s piece has sparked a great deal of response. For the most part Mr. Williams-Derry summarized and interpreted our article well. However, we did we not write his blog, nor were we shown a copy before it was posted. His words are entirely his own. And while Mr. William-Derry conveyed the substance of our argument accurately, in our opinion he did misrepresent what Coase wrote in some regards.For example, Williams-Derry states that “Coase proved mathematically that, with a system of guaranteed pollution property rights and under ideal “free-market” conditions, society as a whole would get exactly the amount of pollution that its members want—no more and no less.”. He then goes on to criticize the Coase theorem as an example of over reliance on theory and mathematics by the economics profession in general.We, of course, are quite aware that Coase did not use any mathematics in his argument, and did not claim to have “proved” any “theorem.” While some economists can be rightfully accused of over reliance on formal theory and mathematics at the expense of common sense reasoning, Coase is actually not among them. As a matter of fact, early in our article we argued that this was a case where more formal mathematical modeling might have been useful to avoid the kinds of misinterpretations that have flourished. To quote ourselves: “The confused history of misinterpretations of what is called the Coase ‘theorem’ demonstrates why formal modeling, where assumptions are stated rigorously and conclusions are derived as theorems, can sometimes be useful.” Moreover, we were very clear in our article that while many others have misconstrued Coasian negotiations as a “free market” process, Coase was fully aware that there was no market involved, and therefore did not assume “ideal ‘free market’ conditions” as Williams-Derry states. Since he is not a professional economist it is not surprising that Mr. Williams —Derry is not thoroughly familiar with Coase’s work , and has confused what Coase said with how some of his followers have misinterpreted him. We believe we have been quite careful in this regard in what we published. But Mr. Williams-Derry did summarize our main findings well enough to warn the general public that the implications of the so-called Coase “theorem” are quite different from how they are usually portrayed, and we thank him for doing so.Robin Hahnel Portland State University
Ok, I apparently made a hash of this one—a lesson to me to think more carefully before I hit the “publish” button. To recap at least two of my errors:1) As one commenter correctly suggested, I never read Coase in the original, just treatments of his theory by others. As it turns out, the word “theorem” is a misnomer: Coase himself apparently didn’t make much of a mathematical argument at all. So every time I talk about Coase’s “mathematical rigor” and so forth, I’m wrong.2) According to stand up economist (and stand up guy) Yoram Bauman, who contacted me via email, Coase’s work does not imply that pollution negotiations will always tend towards a single amount of pollution, regardless of how pollution rights are distributed at the outset. Instead, Coase concludes that Coasian pollution negotiations will always result in a “Pareto efficient” amount of pollution. This means that pollution negotiations could in theory wind up with number of different outcomes; but in any end state of the pollution negotiations there’s no transaction that could make someone better off without also making someone else worse off.I take full responsibility for these errors, and apologize to our readers for propagating misinformation.
Erik -I think we agree! I may have not have expressed myself clearly enough, though. My point is just that it’s possible to be sincere about environmental protection and also sincere about free market principles. But in this case, that sincerity doesn’t count for much. Still, I suppose a “free market environmentalist” could be ok with some other democratic process for setting levels of pollution or resource extraction, while letting markets determine the specifics. After all, I’ve read an awful lot of praise from FME quarters for transferable fish quotas—even though in the fishing rights systems that I know about there’s a regulatory body, rather than a market, that figures out the allowable catch each year.
Robin Hahnel is right—you (and even more so, I) shouldn’t confuse the “Coase theorem” with Coase own position. Yoram Bauman is also right (even if Coase own example gave a specific point, and as far as I remember he never mentioned that it would deviate as long as we had zero transaction costs). However, I think it would be wrong to imply that this consideration/specification has any prominent role in the environmental economics literature (other than possible a fun trivia). The default assumption is that the payment you have to present as a compensation to the rights owner, only amount to a small part of your total income. The only subfield of (mainstream) economics where you would expect this distinction to actually play any role is within general equilibrium theory and welfare economics.Fish quotas is great (or could be—they currently create a lot of problem in e.g. west Africa).Markets is a great way to allocate those (or could be—se above)But—markets won ´t find the appropriate amount of externalities (which is what the Coase theorem is about).I.e.: I ´m not saying that environmental regulators shouldn’t use the market. The market is often a great way to organize and allocate things. I ´m saying that the Coase theorem is false and that there aren’t any reasons to think that the market would find the socially preferable level of externalities (even if you’re a nutcase neoliberal who believes in linear utility in consumption).
Erik – I totally agree with your i.e.I don’t doubt that the bulk of the environmental economics literature ignores idealized Coasean negotiations as a means of choosing a socially optimal level of externalities. But the only reason that I brought up the idea at all is that I’ve heard and read Coasean rhapsodies from libertarian-leaning policy wonks: just assign property rights and get out of the way. The Property and Environment Research Center website is full of this talk: I googled this pretty quickly, for example:http://www.perc.org/articles/article163.php“[For] environmental markets to emerge, government regulators must get out of the way…government agents must help to define and enforce property rights just as they do in other markets. When property rights to water quality are defined clearly, when the rights can be defended in court, and when the rights can be bought and sold among water quality users, the miracle of the market can deliver environmental quality at lower cost.” That makes sense if and only if Coasean negotiations necessarily produce “good” results. But if zero-transaction-cost negotiations tend to produce MORE pollution than people want—for example, because of collective action problems and information limits—then, well, I gotta say something.