Thursday, May 04, 2006

As if Coase's 1960 piece never exists

"It doesn't have to be complicated. Estimate the monetary cost of the negative externalities associated with gasoline use, set the appropriate tax, and then do nothing else. The market price then sends the correct signal to investors about how to take advantage of new opportunities in alternative energy."

No, no, no, I did not take this passage straight out from Pigou's "Economics of Welfare." It is from a post written by economist Andrew Samwick at his blog, read more here.

Frankly, I am shocked by the fact more than 40 years after publication of "The Problem of Social Costs", there are still economists out there who buy into the whole Pigovian taxation approach in dealing with "externalities."

But does the term externality have any economic meaning at all?

Back in the 1970, Professor Steven Cheung wrote in "The Structure of a Contract and a Theory of Non-exclusive Resource", Journal of Law and Economics:

"The process of arriving at a useful concept of analysis is not only slow andpainful, but may also go astray and attain nothing useful. Someone begins withone example or observation, followed by a theory which is intuitively plausible.A theoretical term associated with a vague concept is coined. Examples of aseemingly different type emerge, which call for another theory. The process goeson. As examples and theories continue to accumulate, the different categoriesunder the same heading of analysis serve only to confuse and each associatedtheory becomes ad hoc. Such has been the fate of the concept of ‘externality.'"

That still rings true today!


Andrew Samwick said...

I appreciate the comment. My re-reading of Coase's article suggests 4 elements to his critique of Pigou:

1) Pigou presumes that government involvement would be the natural means of adjudication for externalities.

2) Pigou presumes that the natural remedy involves taxing or discouraging the one who commits the act, failing to appropriately acknowledge the reciprocal nature of the relationship.

3) There are new problems that enter the dispute if the proceeds of the tax are paid directly to the harmed party. These problems look like moral hazard--the harmed party now seeks to maximize his eligibility for these payments.

4) The preoccupation with a tax on the amount of damage done by one party ignores alternative technologies that might exist and be available to the other party to lessen the total damage incurred. Perhaps I could restate this as saying that Coase is criticizing the partial equilibrium nature of the way economists discuss Pigouvian taxes.

Okay, (1) and (2) are classic Coase. But even Coase acknowledges that the appropriate solution depends on the relative costs of implementation. He's attacking what he perceives to be the prevailing wisdom that it is the government solution. I wasn't explicit about this, but it's hard for me to see the privately negotiated solution as relevant in dealing with the negative externalities (say, pollution and propping up non-democratic regimes).

(3) and (4) are errors of omission that are frequently made. I'm grateful for the prompt to re-read Coase's article, so that I am more aware of them in the future. But in my post, I did not suggest direct compensation of harmed parties, and I am not convinced that there are as yet viable alternative abatement technologies that would be relevant here.

So I would be happy to see your alternative proposal in the spirit of Coase rather than Pigou.

snowball said...

Professor Samwick, you can ignore this guy. He is totally a blind follower of Coasian or Cheungian economics. Perhaps he is also strongly influenced by one of his teachers, a PhD drop-out in HK who leads a junk magazine in HK. That guy is only good at writing rhetorical article. Same here as I only see superficial and empty comments all the time.

If he ever rereads Coase's classic, he will realize that Coase himself did not say that Pigouvian tax is not the answer. He said on the other hand that without investigating the cost and benefit, government intervention is not necessarily a solution to market failure.

It seems to me that to these guys including his so called teacher I mentioned above, free market has become dogma. This is not what you as a REAL economist should bother too much with.