Monday, August 4, 2008

Thoughts on Cato University Lecture III: "Understanding the Economics of Free Markets" by Peter van Doren

Sonic the Hedgehog was always one of my favorite video game series. I especially enjoyed saving all of the furry animals that had been captured and (depending on which game), turned into robot slaves by Doctor Robotnik.

But defeating mad scientists via Sonic's cannon-ball spin is only one of many approaches to securing animal welfare. People propose to legislate minimum living conditions for animals, or heavily tax meat and animals bred as pets. Private organizations, post videos exposing unsavory animal treatment practices, aiming to influence consumers directly. Or people can act like The Wisconsin Humane Society just did. According to NPR, they simply decided to raise cash and buy out what they consider a "puppy mill," in order to dismantle it. Because I viewed Peter van Doren's lecture, in which he described free markets and various approaches to dealing with social costs, I recognized the Humane Society's deal as Coase's Theorem put to work.

Van Doren (after teaching basic microeconomic principles, and explaining the problems that public goods present) compared the approach of Pigou and Coase toward "negative externalities" or the "social costs" of market transactions. Unlike stealing tangible objects, negative externalities spring up when one party does something with his own property that unavoidably and negatively effects another party. Banning such an action, due to its (possibly minimal) harm to other people would be economically damaging and completely impractical. It is also unfair to harm other people without their consent. So a compromise must be brokered.

A simple example of a negative externality is air pollution caused by power plants. Pigou believes that the person who causes the pollution (i.e. the power plant) should be required to pay all those effected by such pollution (the city) through a tax, calculated as the approximate cost of the inflicted damage. The government would impose such a tax, so there would be little room for negotiation among the various parties. All affected members of the community would become automatic partners in the deal.

In contrast, Coase believed, according to van Doren, that, clear-cut initial property and ownership rights would solve the problem, without a need for central calculation. For example, the initial rule would be "the power plant has an absolute right to pollute the air with sulfur oxides" or "the people own the right to breathe air completely clear of sulfur oxides." In Coase's view, whether the former or latter condition is chosen does not even matter. Whatever the initial rules of "the game," both parties will bargain with each other until they broker an agreement that is equally satisfactory.

Van Doren provides a few examples of Coasian successes, such as the case of the entire 221-resident town of Cheshire, Ohio, which agreed to a complete buyout by American Electric Power Company for $20 million. He mentioned the recent case of Florida's and environmental groups' purchase of U.S. sugar, which translates to more more land reclaimed for the Everglades. Van Doren, who is suspicious of the government's ability to determine the accurate Pigouvian costs, seems to consider himself a Coasian, and believes that "the initial distribution of entitlements itself does not alter the willingness of the parties to exchange the entitlements."

I find Coase's theorem intriguing, but I do have some concerns about it. (I'm sure Dr. van Doren has considered reasonable objections, and has excellent answers for them, all of which would be beyond my scope of knowledge). A summary of some of my concerns (I'm sure that they've been mentioned by many economists): 1) Poor people can't necessarily afford to "buy in" to the table. If they get no chips with which to negotiate, they ultimately get stuck with unfair externalities 2) It is virtually impossible to rally up all relevant parties, which makes the transaction costs are too cumbersome 3) If the "harmer" doesn't have a profit motive, then some negative effects (i.e. extinction of species) can occur, no matter how why high the "purchaser" bids.

Animal rights are, admittedly, a much trickier issue than air pollution. It is difficult to determine whether the "rights" belong to the humans upset by the alleged atrocities imposed on the animal, or belong to the the animal itself. If the latter, this would mean the animal activists actually have no right to negotiate the appropriate limits of animal cruelty. The law (appropriately, in my opinion) treats animals as pseudo-living beings/pseudo-property, and the deal with the Humane Society depicts animals in their "property" incarnation.

However, according to NPR's story, the breeder of Puppy Haven is ready to retire, while the animal rights organization hopes to shut down his whole operation, and deliver the animals to eager families. What results is a market-based exchange, based on clear, well-established private property laws and driven by personal interests and values. Somewhere in Chicago, 97-year-old Ronald Coase may be smiling.

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