Matthew Mandel

I recently had occasion to read Coase’s “The Problem of Social Cost”. Coase’s really radical idea in the paper is the economic symmetry of responsibility in property disputes. According to Coase, when two people’s preferences collide, each is equally responsible for the suboptimal outcome. The chocolate gets in the peanut butter just as much as the peanut butter gets in the chocolate.

Or as Coase puts it

Judges have to decide on legal liability but this should not confuse economists about the nature of the economic problem involved. In the case of the cattle and the crops, it is true that there would be no crop damage without the cattle. It is equally true that there would be no crop damage without the crops… If we are to discuss the problem in terms of causation, both parties cause the damage. If we are to attain an optimum allocation of resources, it is therefore desirable that both parties should take the harmful effect (the nuisance) into account in deciding on their course of action. It is one of the beauties of a smoothly operating pricing system that, as has already been explained, the fall in the value of production due to the harmful effect would be a cost for both parties.

(emphasis added)

The process for determining how to maximize the utility between the two is blind to who was “responsible” for the situation. By planting crops that could be trampled, the farmer either accepts the risk of trampling or deprives another of their ability to herd cows in the area, and there’s no economic reason to treat the preference for crops or cows as more fundamental. Each has their own set of preferences, and the conflict between them is a problem for both. This is an unintuitive frame of the situation, or at least one that conflicts with our typical moral intuitions (which usually look for a good guy and a bad guy), but it’s critical for Coase’s solution. According to Coase, if the parties with conflicting preferences don’t have high barriers to transacting, they will optimally resolve the conflict. And the optimal resolution isn’t a moralizing one – how could you expect the cow herder or farmer to acknowledge the other vocation as more important or the other’s rights as primary. Instead, the solution invokes Solomonic wisdom: if it’s easy for the parties to transact, the one with more to lose because of the conflict will use a portion of their expected profits to pay the other to relent. This might look funny, if not unjust, like a town paying a factory to not pollute. But, even such an arrangement would make the factory “feel” the cost of polluting by forcing it to forgo the “profits” the town would have paid for it not to pollute. And Coase further points out that though this kind of bargain will result in the optimal outcome and the internalization of the cost of the externality, other procedures (which may be preferable for reasons of justice or anything else) could replicate the same optimal outcome with different intermediate steps.

Though I haven’t read many of the great papers of economics, I’ve been pleasantly surprised a few times at how brain teaser-like they are. Economics is more grounded in real world concepts than pure math, for example, but also sketches elegant models that kind of click into place once you see the thrust of the argument like a good math proof does. Coase’s paper is no exception, and I’ve had some fun googling “site:marginalrevolution.com coase” and playing with examples of Coase’s theorem in action.