David R. Henderson  

What Would Coase Say?

Resolving U.S. Indebtedness: ... Bagehot vs. Bernanke/Paulson...

Ronald Coase won the Nobel prize for, in part, what has become known as the Coase Theorem. According to this theorem, if people could bargain at low cost, there would be no problem of externalities and, indeed, the outcome would be the same no matter who had the rights. So, for example, if household A burns a fire that emits smoke and this smoke harms household B next door, then whether the smoke continues to be emitted doesn't depend on whether household A has the right to emit smoke or household B has the right to prevent it. Why? Let's say household A values burning at $100 and household B disvalues it, because of the smoke, at $120. Then, if household A has the right, household B, by paying more than $100 but less than $120, can persuade A not to burn. On the other hand, if household B has the right, A is not willing to pay more than $100 for permission to burn. At that price, B would say no.

Now to the messier reality. This last winter, our house smelled like an ashtray much of the time. Our neighbors upwind insisted on burning. We told them of the discomfort we felt and, while the lady of the household was sympathetic, the adult sons were not and, at one point, one of them got quite nasty when I tried to press the point. I even offered to pay $50 a month for every month they didn't burn. The lady of the household returned the check uncashed. You might say that I didn't offer enough. I sensed, though, that that wasn't it. (There's a lot more to say, but I don't want to tell too long a story.)

We had always had good relations with our neighbors except for some bumpy moments involving the adult sons over the years. Both my wife and I have trouble holding grudges: it takes emotional energy--as Milton Friedman once said, it makes you pay twice. So we decided that even though we weren't getting what we wanted, we would not hold a grudge.

One day, my wife made banana bread and took half of it next door. The lady of the house was delighted. Then we noticed something else: the frequency of the fires went from almost every day, which had been driving us wild, to about once a week or less. Shortly after, one of the sons, out mowing his lawn, waved and smiled at my wife as she was pulling out of the driveway. She was so shocked that she almost sideswiped our house. I thought we were on to something, so the next time I made my brownies full of chocolate chips, I took half of them over. A few days after that, one of the sons brought over some cantaloupes. Then about a month ago, I took over some brownies. Then Sunday evening, one of the sons brought over some home-grown tomatoes and onions. Summer in Pacific Grove, where I live, is almost as cold as winter. Yet they have hardly burned a fire at all.

Here's my prediction: no matter how cold it is this winter, they will burn their fire a lot less this winter than last winter.

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CATEGORIES: Property Rights

COMMENTS (20 to date)
Niklas Blanchard writes:

This is very interesting, and is something that I study in conjunction with alternative currency systems. Under my preferred narrative, your neighbors wished your relationship with them to remain informal and on a friendly basis -- and thus, refused to formalize it with the introduction of legal tender.

HOWEVER, in the spirit of reciprocal exchange, they are willing to barter using an alternative medium of exchange. Because the mechanics of the alternative "currency" differ from that of legal tender, it preserves, and even fosters the type of relationship that your neighbors desired.

Akshay writes:

The Coase theorem also requires property rights to be clearly defined. That aside, good work on the diplomacy.

Constant writes:

I'm not sure this specifically hits Coase, rather than hitting a much more general economic model that Coase along with most of the profession uses. Tyler Cowen, I think, would say that the refusal of the money would make a fine illustration for the next edition of his book "Discover Your Inner Economist."

From Amazon: "The key to tapping your Inner Economist, Cowen explains, is the ability to identify people's true incentives, which are usually more than money. Suppose you want your daughter to help out around the house by washing dishes. Should you pay her? Bad idea, Cowen warns."

Maybe Becker has found a way to subsume neighborliness (which is what you're talking about) under the general category of exchanges, where what you are exchanging is something much less specific than the specific items which are primarily symbolic in character (chocolate chip cookies having very little intrinsic value - their value is as a sign of something entirely different - a promise of neighborliness, one might say).

AD writes:

Interesting question. I think Coase would say: "If this is generally true, then I was wrong."

For transaction costs between you and your neighbor in any real sense is low. That means things other than transaction costs - like norms of "gift exchange" and other things from psychology and social anthropology - may mediate market exchanges (Polanyi is smiling, Coase probably not so much. This means that even if transaction costs (as in how difficult it is to actually make offers) is low, in many cases, one may not have the ability to find the appropriate form of compensating that would allow one to reach a mutually agreeable situation through voluntary exchange. For instance, I can't really bake. It would be costly for me to learn how to bake just to bribe my neighbor in a non-offensive fashion. And buying a cake to give it to them might also equally offend them if they were to find out.

Now, if we want to re-interpret "transaction costs" to involve subtleties of symbolic exchange, we really make the Coase theorem a tautology: that formal rights don't matter in all cases that they do not.

ajb writes:

Of course, Coase wanted to make the point originally that the zero TC version of the so-called Coase Theorem IS a tautology. He has emphasized that it was meant as a critique of the neoclassical simplifications of the profession. He thought that the real action came in understanding when bargaining was hard or costly and therefore under what conditions property rights really DID or didn't matter. He's explained this often but people cling to the Stigler version of the theorem. I think Coase would see this as definitely a case where psychology played a big role in hindering bargaining.

However, Vernon Smith might observe that this is usually a problem for smaller effects, whereas a more neoclassical exchange would be likely if the neighbors were causing you harm in the multi-thousand dollar range, especially if it were not part of the norm of "acceptable" behavior.

Nico D writes:

AD, I see what you call "the subtleties of symbolic exchange" as pretty clearly an example of transaction coasts. Aren't ones time and the effort it takes to know what will incentivise people costs? And, as they make an effective transaction more costly, don't they count as transaction costs?

I don't see how this makes the Coese theorem a truism, at least beyond the sense in which all theorems are truisms. There are cases where there's a stonger case for changing property rights than others. Isn't Coase useful for determining when a situation of externalities is more likely to be resolved without regulation or other legal changes?

I should say that I think libertarians are far too eager to appropriate Coase to say that externalities don't matter. Clearly they do in many cases. But there are some counteracting effects which suggest that, sometimes, we're probably OK letting voluntary transactions sort things out.

BlackSheep writes:

$50 isn't nearly enough to either fix the chimney or stand the cold. ;)

AD writes:

[Comment removed pending confirmation of email address. Email the webmaster@econlib.org to request restoring this comment. A valid email address is required to post comments on EconLog.--Econlib Ed.]

David writes:

Clearly the check was viewed as a payment with an intended result, but that was not the case with the banana bread; the banana bread was seen as a gift. If they took your money and burned anyway, you could ask for your money back. If they ate your bread, you could not ask for it back.

Giving a payment for a favor signals a business deal - an impersonal exchange. The gift, though, implies a personal exchange. You don't know for sure if the lady of the house next door bakes infrequently or poorly, but this was somehow helpful in persuading the sons. Perhaps Coase would say to read Vernon Smith?


Ben writes:

I wonder what the effect of their reading your blog would be

phineas writes:

From Amazon: "The key to tapping your Inner Economist, Cowen explains, is the ability to identify people's true incentives, which are usually more than money." I think Cowen is barking up the wrong tree here. Instead, it's better to jettison the economist mindset from most areas of life, because it completely fails to model human spirit (the big big thing in life).

Pacific Grove is a cool place to live.

happyjuggler0 writes:

How is this any different than offering a non-prostitute money for sex, vs offering her dinner in the implicit *hope*, but not necessarily expectation, of sex?

Grant writes:

If transaction costs are high, then it is more economically efficient to put up with the negative externalities than to bargain to reduce them. I don't see the problem here.

AD, all costs are subjective and in that sense symbolic. I don't think Coase ever meant to say that the only transaction costs that matter are monetary ones.

RBE writes:

AJB is right: Coase did not think that people normally bargained to solutions in the real world, where transaction costs were non-trivial. I expect he would be quite interested in this kind of example. But I'm not sure your neighbors will actually burn less this coming winter, unless you continue to invest in their friendship. What's the limit on that score?

The Coase Theorem is not Coase; it's Stigler.

Roger Koppl writes:

IMHO David nailed it. It's the two faces of Adam Smith as explained by Vernon Smith.

Here's that url once more:

Bill Mill writes:

Dan Ariely would call it a consequence of "social markets" versus "monetary markets", via his paper "Effort for Payment".

El Presidente writes:

First, I absolutely love PG, summer or winter. Why would anybody ruin the fog and sea air with smoke? I visit your town several times each year and the rest of the time I'm jealous. Good choice.

Second, could this mean that the Coase Theorem is invalid or that the preferred price was not monetary consideration but rather neighborly consideration? It would seem that they wanted trade more than surplus, that they wanted the act of exchange more than the value in exchange. Alternatively, perhaps their body temperature was elevated from all the desserts and they didn't want the additional heat of a fire. Who knows?

Neal Hockley writes:

Congratulations, you just discovered social cohesion. Now model a situation with increasing mobility, so that your neighbours change more frequently. See if burning frequency increases. When will libertarians understand that there is such a thing as society, its a social good, and providing people with property rights over it (controlling immigration) MIGHT be a good thing, and no danger to libertarianism

Mark Bahner writes:

Hi David,

I'm an environmental engineer, specializing in air pollution. If you wanted, and were willing to provide somewhat-detailed information, I could advise you on measures you and/or your neighbors could take to make your life better, even if they continued to provide much heat/ambience from their fires as they always have.

For example, even without detailed information, I can advise you that pellet fires cause much less air pollution than standard wood fires. Per this website, a pellet stove has particulate emissions that are 50 times less than older, non-EPA certified wood stoves.


“Pellet stoves are very efficient -- 75 percent to 90 percent overall efficiency -- and have a BTU output content four to five times higher than cord wood or wood chips. Pellet stoves also have very low particulate emissions; 50 times less than older, non-EPA certified wood stoves, and two to five times lower than more efficient, EPA-certified woodstoves.”

So if they switched to pellet fuel (which you could buy for them) that would help.

Also, there are indoor HEPA filters. If you bought one for almost every room in your house, the smoke (and presumably odor) levels would be much lower:


You have my email address. Send me an email if you'd like some advice.

Mark Bahner writes:

Removing http www's to get around spam filter...

[Self-advertising, repeated comment removed. Finding ploys to get around the spam filter is not going to endear yourself to us. Your original comment was okayed within a few hours. Your repeated postings to try to bypass that short delay of only a few hours has put you on our watch list.--Econlib Ed.]

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