Monday, February 04, 2002

Pollution and the Environment II- The Coase is Clear One of the nice things about blogdom is that you learn a lot as you go. In critiquing part I, Econ student and anarchocapitalist James Haney pointed me to the work of Ronald Coase, the 1991 Nobel Economics laureate. As I noted this morning, my education on externalities somehow missed Coase, and once I got over the mild sting of being "showed up" by an (very kind) undergrad, I did some reading. This David Friedman piece on Coase is a good starter for a more in-depth look at the issue. There are three ways to regulate externalities. One way is to regulate the pollution, mandating a level of pollutant that cannot be exceeded. A second way is for the government to levy a fee for each unit of pollution, called Pigouvian taxes in the literature. The third option was introduced by Coase in a 1960 article, "The Problem of Social Cost"- give someone either the right to not be polluted or the right to pollute and allow people to trade those rights. The basic thrust of his argument is "Coase's Theorem"

Regardless of the specific initial assignment of property rights, in market equilibrium the final outcome will be efficient- provided that the initial legal assignment is well defined and that transactions involving exchange rights are costless.

Instead of government fixing the price of pollution, which may not be optimal, assigns rights to pollute (or rights to cleanness) and allow the market to decide what a fair price is. An early stab at a Coasian market is the trading of sulfur dioxide (SO2) rights. This system allows plants with efficient ways to reduce SO2 emissions to trade their rights to plants that have a harder time reducing emissions, thus (in theory) allowing pollution to be cut efficiently. It's an imperfect start, as EPA regulations make the market murky and the cost-plus nature of establishing utility rates discourage cost savings, but the basic idea has proved workable. CO2 trading was placed into the (thankfully-departed) Protocol of the Elders of Kyoto to make cost-effective reductions in "greenhouse gasses." A Coasian market avoids all-or-nothing solutions, such as shutting down a plant, to meet goals-the plant can buy the rights to pollute from the offended parties and if the cost is too high, they'll find ways to avoid the pollution. This strategy will run into fire from some circle who would consider a clean environment priceless and will be offended at the idea of being bought off by the polluters. It would be a major political trick to set up a system where a certain amount of pollution is acceptable. The public will have to be educated and convinced of the merits of a system to establish and sell rights to pollute. Smart environmentalists can use Coasian markets to their advantage; the SO2 system allows environmentalists to buy rights and take them out of the system. The trick to a Coasian market is to have well-defined rights and to have low exchange costs. One of the problems with the SO2 market is that the government sets the overall pollution level, which can change from year to year, thus making the value of cutting pollution over time problematic. A coherent system of establishing rights and prices for such rights has yet to be established. Also, exchange costs are high if lawsuits are needed to establish damages to be paid; an unholy alliance of trial lawyers and environmentalist will try and stop more efficient pollution rights markets from developing. Setting up such a system will be hard, but worthwhile. The media will not be helpful and liberals will try and twist the plan beyond recognition. However, people who want to lower pollution in an efficient manner can be won over to a Coasian framework. The next step is to figure out what items to target for a Coasian solution and selling it as an alternative to more-intrusive government solutions.

Comments: Post a Comment

This page is powered by Blogger. Isn't yours?