THE PROBLEM OF SOCIAL COST
The Journal of LAW & ECONOMICS
R. H. COASE
University of Virginia
-----Presented by Qing YANG & Pei-Lin YOU
Who Is The Famous COASE?
Born December 29, 1910
Business Address
The University of Chicago Law School
1111 East 60th Street
Chicago, Illinois 60637
Telephone (773) 702-7342; Fax: (773) 702-0730
Professional-University
Clifton R. Musser Professor Emeritus of Economics, and
Senior Fellow in Law and Economics, University of Chicago
Law School, since 1982
Distinguished Professor (visiting) of Law and Economics,
University of Kansas,1991
Clifton R. Musser Professor of Economics, University of
Chicago Law School, 1971-81
Prof. of Economics, University of Chicago Law School, 196470
Professor, University of Virginia, 1958-64
Professor, University of Buffalo, 1951-58
Reader, London School of Economics, 1947-51
Lecturer, London School of Economics, 1938-47
Assistant Lecturer, LSE, 1935-38
Assistant Lecturer, University of Liverpool, 1934-35
Assistant Lecturer, Dundee School of Economics and
Commerce, 1932-34; Sir Ernest Cassel Travelling Scholar,
1931-32
Education
Kilburn Grammar School, 1923-1929
London School of Economics, 1929-1931
Degrees
University of London, B. Com. 1932, D.Sc. (Econ.) 1951
University of Cologne, Dr. Rer. Pol. h.c., 1988
Yale University, D. So. Sc., (honorary) 1989
Washington University in St. Louis, LL.D., (honorary)
1991
University of Dundee, Scotland, LL.D., (honorary) 1992
University of Buckingham, England, D.Sci, (honorary)
1995
Beloit College, D.H.L., (honorary) 1996
Universite de Paris-I, docteur, (honoris causa) 1996
Academic Honours
Distinguished Fellow, American Economic Association
Honorary Fellow, London School of Economics
Fellow, American Academy of Arts and Sciences
Corresponding Fellow, the British Academy
Membre Titulaire, The European Academy
Law and Economics Center Prize, University of Miami,
1980
D. Francis Bustin Prize, University of Chicago, 1988
Alfred Nobel Memorial Prize in Economic Sciences,
1991
Those actions of business firms which
have harmful effects on others!
•
Talk at Washington University in St. Louis, 1994, with Douglass North
The Problem to Be Examined
• The actions of business firms having harmful effects on others
– example : The smoking factory
• The divergence: the private & social product of the factory
– Pigou’s treatment in the Economics of Welfare
• Solution
– Making the owner liable for damages it caused
– Placing a tax
– Moving
• Coase’s answer (WHY?)
– inappropriate & not desirable
The Reciprocal NATURE of the Problem
•
•
If A harm B; then Restrain A ? ( Is it Right?)
The reciprocal nature of a problem:
– Avoid to harm B, will inflict harm on A
– Or A allowed harm B
•
Given different situation
– Costly v. costless; law & regulation; Public v. Private
•
Cases
– Confectioner & Doctor (Choice: Candy & Doctoring)
– Straying cattle & Neighbor’s crops ( Meats & Crops)
– Stigler’s instance ( The product pollute a stream & fish)
•
The problem has to be looked at in total and at the margin
The Pricing System with Liability for Damage
• When the damaging business has to pay for all damage caused and the
pricing system works smoothly (TRC=0, solved by market)
•
Cattle-raiser
Farmer (Total)
Marginal Damage
•
Number in herd
Annual Crop Loss
Crop Loss per Additional
•
1 (Steers)
1 (Tons)
1 (Tons)
•
2
3
2
•
3
6
3
•
4
10
4
• Basically, the costs of Fencing is $9 and the price of crop is $1; and the cattleraiser shall bear/entail the additional annual costs
• when erects the fence?
• Fencing or pay for the damaged crops directly ( cheaper?)
Liable for the Damage
• Do increase farmer’s planting if paying for all damage?
• (1)The value of the crop: $12;the cost of cultivating:$10,then net gain is $2
• If the cattle-raiser make a agreement with Farmer
– Damage crop $1, get $ 1 from cattle-raiser, net gain still is $2;
– Even If the value of meat greater than additional costs, damage costs
$3, net gain still is $2;
– ABANDONMENT OF CULTIVATION ( less than $3) (Decrease)
• (2) The value of the crop: $10;the cost of cultivating:$11,then net gain is $1,then maybe cattle-raiser lose $10 and famer lose $1.
• NOT Affecting the allocation of resources , but merely alter the
distribution of income and wealth as between cattle-raiser and famer
– “The cattle-raiser is liable for damage caused and the pricing system
works smoothly, the reduction in the value of production elsewhere
will be taken into account in computing the additional cost involved in
increasing the size of herd”
– Weighed between meat and fall value, Optimal allocation of resources
The Price System with no Liability for Damage
• Opposite payment (Avoiding the damage)
– Case is the Farmer pay up to $3 if cattle-raiser reduce herd to 2 steers;
then up to $5 for 1 steers, ……..abandoned.
– Of course, maximum payment could not exceed $9=the fencing cost
• In both cases $3 is part of the cost of adding the third steer( the same size
of herd liable/ nor liable for damage)
• So :
– “ it is necessary to know whether the damaging business is liable or
not for damage caused since without the establishment of this initial
delimitation of rights there can be no market transaction to transfer
and recombine them.
– But, the ultimate result is:“ independent of the legal position if the
pricing system is assumed to work without cost”
The Problem Illustrated Anew
• The wide variety of forms, four actual cases as below:
– Sturges V. Bridgman : a confectioner Vs a doctor ( built a consulting
room 8 years later), Noise and vibration prevented the doctor from
examining his patients by auscultation
– a legal action forcing the confectioner stopping his work (it needs the
legal system get involved in? case from China )
– Modify the arrangement: bargain between the parties, pay for
damage/build a separate wall ( depends on adding income v subtract
gain)
– The confectioner won the case: the doctor pay him to stop using
machinery
– So again
– “With costless market transactions, the decision of the courts
concerning liability for damage would be without effect on the
allocation of resource.
The Problem Illustrated Anew
• Cooke V. Forbes :
– The manufacture emitting fumes Vs blackish fibre matting
– But because the damage was accidental and occasional, that careful
precautions were taken and that there was no exceptional risk, an
injunction was refused
– Suggestions: The payment for damage would then become part of the cost
of production of sulphate ammonia
• Bryant V. Lefever
– Before 1867, plaintiff and defendant adjoining houses, no chimneys
smoking, the same height
– In 1867, defendant rebuilt it and caused the plaintiff’s chimneys to
smoke
– In a trial, the plaintiff was awarded damages of 40 p
– In the Appeals: the JUDGMENT WAS REVERSED
– The smoke nuisance was not caused by the man who erected the wall
but by the man who lit the fires
– Question : who caused the smoke nuisance? BOTH? Market
transactions
The Problem Illustrated Anew
• Bass V. Gregory :
– The plaintiffs: Jolly Anglers, the owners of a public house
– The defendant: the owner of cottages and a yard adjoining the Jolly Anglers
– The well was the ventilating shaft for the cellar, the air impregnated by the
brewing operations passed up the well and out into the open air, was
offensive to him( Jolly?)
– Argument: “is not what shall be done by whom but who has the legal right to
do what”
– Doctrine of lost grant: “that if a legal right is proved to have existed and been
exercised for a number of years the law ought to presume that it had a legal
origin”
– So the owner of the cottages and yard had to unstop the well and endure the
smell (The reasoning employed by the courts in determining legal rights will
often seem strange to an economist: lower/higher cost of beer &
worsened/improved amenities)
– Modify by transactions on the market the initial legal delimitation of rights
The cost of market transaction taken into account
• In a real world, operations are often extremely costly, so taking the initial
delimitation of rights and costs of carrying out market transactions as given.
• Choosing the appropriate social arrangement for dealing with the harmful
effects (Besides market)
– The firm is alternative answer to the problem (Economic organizations,
achieve the same result at less cost than, by administrative decision, No
bargaining)
– If the administrative costs too high to deal with the problem within a
single firm, an alternative solution is direct Government regulation( not
well handled by the market or the firm)
– Government has power.. Done at lower cost than a private organization
• The aim of this article is to indicate what economic approach to the
problem should be
The Legal Delimitation
of Rights & the
economic problem
•
The situation is quite
different when market
transactions are so costly
as to make it difficulty to
change the arrangement of
rights established by the
law
•
– The doctrine that the harmful effect
must be substantial before the court
will act is, ….. Some gain to offset the
harm.
•
•
•
MARKET TRC INCREASING,
RE-ARRANGEMENT LEGAL
RIGHTS DIFFUCULLY
Courts influence Economic actually
Webb V. Bird :Not a nuisance to build a
schoolhouse so near a windmill as to
obstruct currents of air and hinder the
working of the mill.
Sturges V. Bridgman: thinking of economic
consequences of alternative decisions
Adams V. Ursell: planning and zoning by the
judiciary (sometimes difficulties in applying
the criteria)
Andreae V. Selfridge and Company LTd: the
lower court awarded the hotel 4500 P
damages, then appeal , the upshot awarded
the damages were reduce to 1000P(not
always refer very clearly to the economic
problem, “ reasonable, common or ordinary
use
• Delimitation of rights in this
area also comes about because
of statutory enactments
•
The effect of much of legislation in
this area is to protect business from
the claims of those they have
harmed by their action.
•Halsbury’s laws of England
•Given of freedom from liability for
acts authorized
•Delta Air Corporation V. Kersey,
Kersey V. City of Atlanta
(authorized): aviation was a lawful
business affected with a public
interest and the construction of the
airport was authorized by statute
•” FOR NOISE & DUST,BUT LOW
FLYING?
• HOW ABOUT AUTHORISED DAMAGE?
• Another Aviation case: Smith V New
England Aircraft Co
• Publicly authorized &Publicly
operated
• Needs for government regulation:
blocked driveways & local people
influenced by passing
train( misapprehension: Balancing
gain/loss)
• But, Government may prefer to public
enterprise
• Absolute or conditional government
power may change as time goes
The Legal Delimitation of Rights and
the economic problem
Dealing with actions which have
harmful effects
The delimitation of rights is also
the result of statutory
enactments
Evidence of the reciprocal
nature of the problem
• Coase:
– Not only restraining
– Also considering the gain form
preventing the harm ＞ the loss
– Costs of rearranging the rights
established by the legal system, the
courts, in cases relating to nuisance ,
are, making a decision on the
economic problem and determining
how resources are to be employed.
– Danger: extensive government
intervention
PIGOU’S Treatment in “ The Economics of Welfare”
• Pigou’s Economics of Welfare
– Dealing with divergences between social and private net products (P1)
– discovering improvements in the existing arrangements determining
the use of resources (his answer is yes)
– NO refrain, namely “ Naturally” promote economic welfare for “Selfinterest” (market system)
– Then, NOT need sate action?
– But imperfections, then what additional state action is required?
• Coase ( Then Why?):
– Misapprehension: State action to correct this “ Natural” Situation
– Not Desirable: Compensate Damages
Britain case: Railway compensation
• In Britain, a railway does not normally have to compensate those who
suffer damage by fire caused by sparks form an engine
– State action to improve on “natural” tendencies(misapprehension)
– Forcing railways to compensate those whose woods are burnt(not
necessarily desirable)
• Coase :
– Considering the legal position ( need statutory authority to run)
– Compensation would be paid if NO government action(strange?)
– NOT need, for it would not matter whether the railway was liable
for damage caused by fires or not ( the same as straying cattle)
– Why ?
Britain case: Railway compensation in details
• Why desirable that the railway should be liable for the damage is wrong?
– If not liable for damage
• Comparing the damage to the net return of the land, 2 trains run
– If liable for damage
• No train run
1 train9(＄) 2 train(＄)
R
150
250
C
50
100
Damage
120
240
– How to make decision: considering the value of total production
If suppose crops yield is ＄160, and its opportunity costs is ＄150, then
the total value is 250-100-120-160+150=20 (Not Liable for
damages)(p33?)
– SO, NO compensation or Taxed
PIGOU’S Treatment in “ The Economics of Welfare”
• Why Pigovian analysis wrong ?
– Not noticing his analysis is dealing with an entirely different question
– Is not whether it is desirable to run an additional train
– But whether it is desirable to have a system in which the railway has to
compensate……. (legal delimitation right or economic problem)
– Private and social products? Taxed?
• Boulston’s case (example for law and economics are interrelated)
– The problem of legal liability for the actions of rabbits is part of the
general subject of liability for animals
– How to distinguish the harbourer of a rabbit with a tree planter?
• Understanding what Pigou really meant?
The Pigovian Tradition
• Challenge the inadequacy of Pigovian tradition:
– Both the analysis and the policy conclusions which it supports are
incorrect
• The approach to the problem is through an examination of the value of
physical production ( so fragmentary)
– The private product: the value of the additional product resulting from
a particular activity of a business
– The social products: Equals the private product minus the fall in the
value of production elsewhere for which no compensation is paid by
the business
• Solving the harmful effects (incorrect)
– Be Forced to Compensate those who suffer damage ( Not comparing
the total product obtainable with alternative social arrangements)
– Using taxes or bounties (case: factory emits the smoke, highly cost,
NOT identical as above), Reduction in production due to the tax base
on the damage ( how about based on the fall in the value of
production, then need more information)
A change of approach
•
Welfare economics & a change of approach (Shortage)
– To comparison of the value of production, as measured by the market ((
shall ) In broader terms, and the total effect of arrangements in all spheres
of life )
– Comparison between a state of laissez faire and some kind of ideal world
(better approximating the actual situation, or compare the new to original
one)
– a faulty concept of a factor of production: usually thought of as a physical
entity which the businessman acquires and uses instead of as right to
perform certain actions
•
So, the change shall regard for the total effect
– Social arrangements within individual decisions, the change lead to an
improvement or worsening;
– The costs involved in social arrangements & moving a new system
Conclusion
• Stepping stones on the way to an economic analysis of studying the law
– In the absence of Transaction Costs, Liability (Property rights) Rules do
not matter for Achieving efficient economic outcomes
– 1937, if TRC=0, the firm have no purpose in serving economic
efficiency
– 1960, if TRC=0, the law have no purpose in serving economic efficiency
– TRC: include search and information costs, Bargaining and decision
costs, policing and enforcement costs etc.
• The focus is on Those actions of business firms which have harmful
effects on others!
– factory and the smoke from which has harmful effects on those
occupying neighboring proprieties
Conclusion (continuous)
• With costless market transaction costs:
– The decision of the courts concerning liability of damage would be
without effect on the allocation of resource in terms of economic
efficiency
– A re-arrangement of legal rights would be made through the market
whenever this change would lead to an increase in the economic value
of production
• Take into account the economic costs:
– Such re-arrangement of propriety rights will only be undertaken when
the increase in the economic value of production is greater than
economic costs involved
• So
– If TRC=0: the allocation of resources remains the same;
– If TRC>0: the law plays a crucial role in determining how resources are
used
The Road Map of This Paper
The
Treatment
of PIGOU
smoking
factory
The problem to be examined:
The actions of firms having
harmful effects on others
The Reciprocal Nature of the
Problem? A&B situation
The Pricing System With
Liability for Damage TRC=0
Straying
cattle
The Legal delimitation
of Rights & The
Economic Problem
Pigou’s Treatemt in “ The
Economics of Welfare”
The Pricing System With NO
Liability for Damage TRC=0
The Pigovian Tradition
The Problem Illustrated Anew
The Cost of Market Transactions
Taken Into Account TRC>0
A Change of
Approach
Thank you for your attention!