PIGOU AND COASE The art of political economy

A.C. PIGOU

EXTERNALITIES An externality is a cost or benefit of a transaction falling on people not party to the transaction.

NEGATIVE EXTERNALITY Social costs are higher than private costs:

NEGATIVE EXTERNALITY “Pigovian” solution is to tax the activity:

POSITIVE EXTERNALITY Social benefits are greater than private benefits:

POSITIVE EXTERNALITY “Pigovian” remedy is a subsidy:

THE SCIENCE OF ECONOMICS VERSUS THE ART OF POLITICAL ECONOMY “it is not enough to know that a form and degree of [government intervention] can be conceived, which, if carried through effectively, would benefit the community.” “We have further to inquire how far, in particular country in which we are interested and the particular time that concerns us, the government is qualified to select the right form and degree of State action and to carry it through effectively.”

POTENTIAL PROBLEMS WITH STATE ACTION For a government, we must worry about “the intellectual competence of the persons who constitute it, the efficacy of the organization through which their decisions are executed, their personal integrity in the face of bribery and blackmail, their freedom from domination by a privileged class, [and] their ability to resist the pressure of powerful interests or of uninstructed opinion.”

THE SCIENCE OF ECONOMICS VERSUS THE ART OF POLITICAL ECONOMY “The results of the political process thus will likely be skewed, in that the efforts of the state are ‘most likely to be invoked successfully by the strong’” — Steve Medema, discussing Pigou

PUBLIC CHOICE CONCERNS Concentrated benefits and dispersed costs mean those getting the benefits will work hard to preserve them.

REGULATORY CAPTURE “Regulatory capture is a form of political corruption that occurs when a regulatory agency, created to act in the public interest, instead advances the commercial or special concerns of interest groups that dominate the industry or sector it is charged with regulating.” — Wikipedia

RONALD COASE

THE FEDERAL COMMUNICATIONS COMMISSION Frequency was assigned by fiat. Coase asked: Why not create property rights in frequency?

THE "COASE THEOREM" “What Coase proposed in 1959 was that as long as property rights in these frequencies were well defined, it ultimately did not matter if adjacent radio stations interfered with each other by broadcasting in the same frequency band. Furthermore, it did not matter to whom the property rights were granted. His reasoning was that the station able to reap the higher economic gain from broadcasting would have an incentive to pay the other station not to interfere. In the absence of transaction costs, both stations would strike a mutually advantageous deal. It would not matter which station had the initial right to broadcast; eventually, the right to broadcast would end up with the party that was able to put it to the most highly valued use. Of course, the parties themselves would care who was granted the rights initially because this allocation would impact their wealth, but the end result of who broadcasts would not change because the parties would trade to the outcome that was overall most efficient.” — Wikipedia

THE "COASE THEOREM" Cost of wandering cattle # CATTLE CROP DAMAGE MARGINAL DAMAGE

COASE IN THE REAL WORLD In the real world, transaction costs are never zero.

COASE IN THE REAL WORLD Four possible ways of handling externality: 1) Negotiate on the market 2) Bring all relevant property inside one firm 3) Direct government regulation 4) Do nothing: sometimes the cure is worse than the disease!

COASE IN THE REAL WORLD “Coase insisted that one cannot properly assess the merits of the regulatory option without considering… administrative costs, political pressures, the lack of any sort of competitive check, and incomplete information, including the lack precise measures of benefit and cost as well as information about producer and consumer preferences.” — Steve Medema discussing Coase

COASE IN THE REAL WORLD “Coase was arguing that there are multiple options for dealing with harmful effects, that none of them is optimal, and that there is no single, obvious solution to problems of external effects” — Steve Medema discussing Coase

COASE IN THE REAL WORLD “Coase rejected both the optimal markets and optimal government approaches… arguing that… policy-making involves ‘choosing between social arrangements which are all more or less failures.’” — Steve Medema discussing Coase