Getting Environmental Regulation Right

Tuesday, September 10, 2013

The recent death of Ronald Coase has given rise to an outpouring of praise about his contributions to the field of economics and his influence on the complex world of institutional politics. In my interactions with Coase, he was always cautious and diffident about social prescriptions—the very opposite of an ideologue. He never engaged in overt political activity and he had little patience for political opportunists who turned his ideas to ends that his own cautious intellect did not support. He never proselytized like Milton Friedman, but was an understated and consistent critic of big government.

Illustration by Barbara Kelley

Sadly, in death, Coase is being swept into today’s overheated political vortex, most notably in a graceless column written by John Cassidy of the New Yorker. The column, “Ronald Coase and the Misuse of Economics,” castigates conservative intellectuals for using Coase’s insights to promote a slavish adherence to market solutions when it comes to the environment, leading, in Cassidy’s view, to “a conservative counter-revolution that turned the United States (and many other countries) into a coarser, less regulated, and less equitable direction.”

Cassidy’s uninformed and overwrought criticism cries out for a response.

Let’s start with the simple question of influence. Coase’s seminal intellectual contribution was his 1960 article, “The Problem of Social Cost,” which is apolitical. It has proved so influential over the last 50-plus years because it offers a coherent approach to environmental harms of use to liberals and conservatives alike.

Coase is taught regularly not only in environmental law courses, but also in courses like contracts, torts, property, and corporations. He is without question the most influential economist for lawyers who work on understanding property rights, liability rules, and, yes, government regulation. His work stresses the importance of transaction costs in dealing with social organization.

Two Parties, Zero Transaction Costs

Coase’s initial question asked how to treat pollution and similar externalities in a world with zero-transaction costs. His now paradigmatic case involved harmful interactions between a farmer and a rancher who are locked together in a land use dispute. In this two-person setting, Coase notes that if transaction costs are zero, then the assignment of rights and liabilities will not matter for determining the production levels of either crops (from the farmer) or meat (from the rancher).

Let the right be assigned to the farmer to keep the rancher off his land. If the rancher can make greater use of that resource, he will pay the farmer something to use his land. If not, no bargain will take place. Reverse the original entitlements, and the farmer will buy back the exclusive right if the land is more valuable for producing crops than for producing meat. If it is not, the entitlement will stay with the rancher. The original right assignment determines the relative wealth of the two parties, not the ultimate pattern of production.

Coase knew that his zero-transaction costs assumption was fanciful at best, so the second part of his analysis asked how property rights should be assigned when transactions costs are high. In the two-party situation, he rightly cautioned against assuming the rancher should be solely responsible for all precautions against harms from the joint interaction of two activities. In particular, many cases call for a joint care solution, so that the rancher reduces the size of his herd, while the farmer puts a less sturdy fence around his land. Some “victim precaution” helps lead to an efficient solution that maximizes the total value of crops and meat—a counterintuitive result that cuts against the environmental mantra of a “polluter pays” policy.

Many Parties, High Transaction Costs

One striking implication of Coase’s zero-transaction costs assumption is that it also works for cases with more than two parties. With zero transaction costs, all parties can resolve their differences instantaneously, so that all the right allocative decisions are made, as Cassidy himself acknowledges. The focus on the rancher and the farmer, however, can conceal the hard social problem, which is how to set up a property rights regime for a large population. That decision really matters in a positive-transaction costs world, because it is highly unlikely that voluntary transactions could correct any inefficiencies built into the original allocation.

It is just for this reason that the dominant choice of an initial position gravitates to a traditional system of private property and personal autonomy that gives one owner (or a small number of co-owners) the exclusive right to the possession and use of any given resource. Those rights in turn impose the correlative duty on all others to refrain from using or damaging that resource. This rule of mutual and reciprocal forbearance offers huge transaction costs gains that set up a round of voluntary exchanges among two or more parties.

In the initial position, everyone knows where he or she stands relative to everyone else; these rights remain stable as overall populations shrink or expand. And this regime works well regardless of the wealth or tastes of the many people governed by it. The next generation of Coasean defenders gravitated to this system for its social advantages, not to provide unwitting assistance to “right-wing groups” who “were doing the bidding of big business,” or to judges who were duped into thinking that they were doing good by “scrapping environmental regulations, and removing other restrictions on odious business behavior,” as Cassidy claims.

How then does Coase’s logic apply to environmental issues? As a first cut, it offers strong legal protection through both damages and injunctions against pollution that invades land, air, and/or water, both public and private. Those invasions can often be controlled by private lawsuits for major injuries concentrated in a few individuals.

But as early as 1536, the English court recognized that although private rights of action were appropriate for parties that suffer “special injury,” an administrative remedy had to be invoked to undo the nuisance, lest it cause widespread (if low level) harms to large numbers of other individuals. That mixture of private and public remedies remains, I believe, the best broad-based approach today to minimize in good Coasean fashion the enforcement costs needed to protect the initial entitlement.

This claim, however, must also be sensitive to Coase’s insight that it may be unwise to drive pollution to zero in a high transaction-costs world. A principle of “live-and-let-live” for low-level nuisances was clearly articulated in 1860 by Baron George Bramwell in Bamford v. Turnley. It also applies with equal force to modern environmental regulation. Cassidy foolishly assumes that undermining the enforcement of environmental laws is the big problem. But, as Coase reminds us, the risk of over-enforcement cannot be ruled out of bounds either. The question is how to strike the right balance.

Trading Emissions

Unfortunately, Cassidy peremptorily concludes that “there is seldom any reason to suppose that letting the market deal with externalities will produce a good outcome.” But he is going after a straw man. The right objective in this case is to find the right mix of regulation and markets to maximize the social gain from any given unit of pollution. And on this issue, it has been the so-called big business conservatives who have honed in on the right solution.

The correct environmental approach seeks to maximize the amount of useful output for any given unit of pollution. A very critical administrative law case, Chevron U.S.A. v. National Resources Defense Council, involves the use of a plant-wide “bubble” to control pollution. The program, championed by the Reagan administration, allowed any given plant to switch its production from one activity to another so long as it did not increase the total level of pollution, without having to first get an expensive and time consuming government permit. The program makes good sense from the Coasean point of view, as the increase in production comes at low transaction costs, without creating additional losses for others.

The bubble program is of course limited to pollution from a single source, and cannot organize trades of emission rights across plants, which should be encouraged so long as the buyer does not increase pollution beyond the seller’s level. The state sets the target, while markets increase useful output for the stated level of pollution.

The system also allows environmental groups to buy pollution permits, which they can retire or resell as they wish. But no direct regulation can reduce pollution to zero and hope to maintain a viable economy, so informed collective guesses are needed to determine the collective levels. Cassidy is so intent on denouncing conservatives that he never once addresses how widely accepted concrete proposals use government regulation to set up private markets.

Wetlands and Habitat Protection

Coase’s work is not only relevant to pollution, but also to burning issues such as wetland or habitat preservation. Here too markets usefully allow private bodies to purchase and protect sensitive environmental sites. Knowing that their resources are scarce, these organizations in their private dealings never demand a total cessation of output.

The Audubon Society allows for oil and gas drilling on its Louisiana land, accepting lower royalties in exchange for higher levels of protection for its sensitive properties. Increasingly, however, these trades rarely take place, as the same environmental groups now push for total moratoria on all development activities in a classic version of overprotection.

The same issue of government overreaching is evident in the common practice today of environmental agencies imposing onerous conditions on parties who wish to develop their land, unrelated to the actual or potential common law nuisances that these parties might create.

The issue, which received an erratic response in Koontz v. St. John’s Water Management District (2013), shows how these exaction programs lead to inferior environmental outcomes relative to the simple expedient of having the government impose general taxes on the public at-large to finance its own environmental improvement program. Exactions impose real inequities by insisting that new developers bear the brunt of general improvements enjoyed equally by others. In so doing, local governments hold landowners hostage by imposing an exaction that requires an owner to fork over a huge portion of his gains from development.

Yet since the government never commits its own resources to the project, no one knows whether its proposed improvements are cost-effective. Exactions create immense bargaining difficulties of the sort that Coase feared by forever tying up good projects in litigation or negotiations. Forcing the government to compensate from public funds avoids the bargaining hassles and leads to the selection of the right properties for wetland or habitat protection.

The takeaway from this discussion is that much of the serious environmental debate does not choose between markets and regulation. Rather, it asks what kinds of government regulations are likely to produce the right social results. Sometimes condemnation is superior to direct regulation. Sometimes it is not. Coase was right to be leery of adventurous regulatory programs that can misfire.

Cassidy’s crude effort to debunk property rights advocates is oblivious to the risks of his own doctrinaire approach to environmental issues. The strongest defenders of nineteenth-century laissez-faire had no wish to run roughshod over environmental interests. Indeed, like Baron Bramwell, they developed with great sophistication the common law backdrop that is still essential for the environment’s proper protection. Writers like John Cassidy seem fundamentally unable to get off their high horses to examine how various schemes of regulation actually work. If he had done so, he might not have portrayed Coase as the unwitting pawn of some pro-business conspiracy.