Seminar 2

Seminar 2: Ronald Coase & Guido Calabresi
Just a bit before Richard Posner’s book came out, there were two other seminal papers published that I think take Law and Economics in a slightly different direction. Ronald Coase’s paper is one of the most cited articles ever, so we use this session to explore why it has proven so influential. I think it is also helpful to think about how the approach provided by these two scholars is slightly different from that suggested by Becker and Posner.

Reading

Coase ‘The Problem of Social Cost’ (1960) 3 Journal of Law and Economics 1

Calabresi & Melamed ‘Property Rules, Liability Rules, and Inalienability: One View of the Cathedral’ (1972) 85 Harvard Law Review 1089.

Further Reading

Cooter ‘The Cost of Coase’ (1982) XI Journal of Legal Studies 1

Ellickson ‘Of Coase and Cattle: Dispute Resolution Among Neighbors in Shasta County’(1986) 38 Stanford Law Review 623

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4 comments on “Seminar 2

  1. Irina Domurath says:

    Coase’s standpoint emanates from an orthodox approach to law and economics and the assumption that social costs derive from a reciprocal situation and, thus, can be negotiated. In his article on the “Problem of social cost” he argues that legal disputes will be resolved in the same way with regard to the efficient allocation of resources through law and regulation (liability for damages) as through negotiation of the involved parties (no liability for damages, freedom of contract). The reason for that is, he claims, that in the case of liability there are no transaction costs as they are involved in negotiation, which in the latter case would cancel out the effective allocation of resources. He concludes that government regulation does not necessarily lead to more desirable results.

    In contrast, Calabresi/Melamed acknowledge the problem of different strengths and powers in the negotiation process, which can prompt the need for state intervention and the designing of property, liability, and inalienability rules, each protecting entitlements in different ways. However, using the polluter-resident-example they design a framework for approaching the protection of entitlements, namely the possibility of continuing pollution unless the resident pays compensation to the polluter for stopping the pollution. This rule acknowledges, so the claim, the value assigned to clean air and pollution by the polluter and the resident and even leads to economic efficiency and distribution of wealth in a situation where there the cheapest cost-avoider may be unknown.

    One point is worth pointing out, if I understood the approaches correctly: Even though Calabresi/Melamed take account of power constellations in bargaining processes, they do not seem to go much beyond the “negotiation rationale” of the orthodox approach to law and economics either, since their approach is in the end also based on a negotiation process between the polluter and the resident on the amount of the damages to be paid. In that situation, the unequal distribution of bargaining power might just as well realize as in Coase’s model. From an economic point of view, their approach seems questionable as it is based on the less widespread Pareto optimality.

  2. Marios Iacovides says:

    Both papers discuss what they consider is often overlooked in discussions of externalities and harmful effects caused on others, namely that one needs to calculate not only what the damage caused to the third party is, but also what it would cost the damaging party not to do the harm. Putting this into the equation changes the perspective and makes possible a fourth option for dealing with the problem of externalities beyond the three classic ones, ie. Paying for the externality by being liable for damages caused to those injured, paying a tax or excluding the damage (by for example relocating). The fourth possibility is that the injured party might want (or be called upon) to pay the injurer for the latter to stop inflicting the injury. If I understand correctly, these four possibilities described by Coase coincide roughly with Calabresi’s and Melamed’s four rules (Rule one: enjoin nuisance, rule two: nuisance damages, rule three: no nuisance, rule four: reverse who has to pay in order to improve the situation).

    From the point of view of economic efficiency, the result will be the same irrespective of whether the person causing the entity has to pay damages or not. I accept this, although it sounded a bit counterintuitive from the outset, I understood the economic logic behind it. Nevertheless, even if the cost is the same, I find it hard to decouple from the whole consideration notions of justice (as I perceive it), and say that it is immaterial who should bear the cost of the externality. I also find it hard to accept that, as a matter of causation, both parties in such situations are liable for the damage caused (Coase p. 13).

    From an economic point of view, the legal doctrines may be ‘as relevant as the colour of the judge’s eyes’ for solving the ‘economic’ problem (Coase, p. 15). Yet, when faced with the legal problem, in a concrete case, before a court, even though one may, unconsciously and inexplicitly, take into account the economic aspects of the questions at issue when interpreting legal terms and applying legal tests (Coase p. 22), the legal doctrines is what we have to work with. That, I guess, is the other view of the cathedral.

  3. Tim says:

    One of the conclusions I draw from the Coase paper is that transaction costs exist and therefore bargaining does not always lead to an efficient outcome, so that a government should step in and regulate, thereby assigning rights to certain actors. Such assignment of rights would then minimize transaction costs and help transactions to take place. See the example of the amount of toxic substances that may be discharged – given the technicality and complexity, neighboring private households would never be able to agree with a factory upon the maximum nuisance that could be accepted. So one could derive from this that the law is there to facilitate transactions where one of the parties to it is not well-enough informed. However, this seems to collide somewhat with the proposition that law is supposed to protect the weaker party in a relationship; see e.g. consumer protection law. In the example of a private household vs. a factory, it is easy to see that the factory would be the stronger one. One could say that information equals power, but on the other hand, I wonder whether this is a sound method to distribute rights/entitlements. Calabresi seems to be more nuanced in this respect, as he refers to economic efficiency, distributional goals and “other justice reasons”.

    Even though not directly, the Calabresi paper mentions an issue that relates to last week’s discussion in the framework of Becker’s Crime and Punishment’s paper. Becker argued that the most efficient way to punish violations of law is a fine, but Calabresi mentions that being the holder of an entitlement can also depend on the capacity to pay a price for an entitlement (cf p. 1095). It is true that Becker talks about criminal offences and that Calabresi seems to be more focused on rights enshrined in private law. Nevertheless, suppose making noise (being the example in the Calabresi paper) can be considered as a criminal offence, this would mean that an offender can buy itself an entitlement, the victim thus “sells” its integrity, meaning that rich people could afford to violate laws more than poor people (cf. last week’s discussion). It was more or less agreed upon that is not in line with our understanding of justice – cf. the point made of determining the fine for speeding according to the income of the violator. However, suppose we agree to sanction criminal behavior with a prison sentence, why would we give all offenders the same prison sanction? Offenders making EUR 3,000 a month are much heavier sanctioned then people making EUR 1,000 a month – at least in terms of revenue.

    Directive 2011/7/EU on combating late payment in commercial transactions provides that Member States should enact legislation that, in essence, entitles suppliers to interests that de-incentivizes late payments by purchasers. Both private as public purchasers are envisaged. Reading the Calabresi paper, however, made me question whether this is economically sound, especially in situations where a private purchaser turns out to be a bad payer.
    Member State X transposed the said directive by applying an interest rate of 10%. Supplier A supplies goods for an amount of 1000 EUR and is entitled to 1000 EUR. Suppose purchaser B cannot pay this amount right away, but needs an unforeseen term of 30 days to pay, implying a legally prescribed additional cost of 8,21 EUR – unless parties did not agree otherwise. Thus, supplier A has an entitlement which has been violated by purchaser B, and which is de facto sanctioned with a liability rule, the interest being the price established by an institution outside the supplier-purchaser framework. However, liability rules – offering in economic terms more or less a possibility for expropriation – are an instrument to overcome the impossibility to establish an efficient outcome or deal with the obstacle to establish the value of a transfer of entitlement before such transfer actually occurs. Protection of an entitlement by property rules should prevail however, as this guarantees an (efficient) outcome that is deemed to be satisfactory to both parties.
    Why enacting such legislation? The directive sums up a number of reasons, the most important being supplier protection avoiding suppliers to go bankrupt because of late payment. However, this seems to be rather one-sided as purchasers can go bankrupt as well because of stringent payment rules. Based on the Calabresi paper, I do not see an economic justification for such rules. Supplier and purchaser can agree upon how to meet the payment obligations in a way that is beneficial to both, implying that supplier and purchaser should be able to bargain over the price of a violation of the supplier’s property right. It is true that parties can agree in a contract not to apply or to derive from that law, but this hardly seems to be a counter-argument as a supplier may not have an incentive to bargain when he is protected that well by the law.

  4. Argyri says:

    Although I agree with Irina’s closing point on Coase, that he concludes that government regulation does not necessarily lead to more desirable results, I understood his argument a little bit different: Coase starts with the assumption that in the ideal (but unrealistic case – see p. 15) of zero transaction costs and well defined property rights, the market is able to deliver the socially optimal amount of an externality without outside intervention.
    Absent the transaction costs, parties will negotiate and end up with an efficient allocation of resources.
    Given that in reality transaction costs are inevitable, I think that he still recognises the need for regulation, but emphasising that the regulator must take account of the costs of his intervention and thus minimise it to necessary. In other words, regulator is not free of the burden to justify his decision economically, thus taking account of the ‘total effect’ of his social arrangements, comparing harm and utility of an act.

    My question is whether every act’s utility is objective or (easily) measured. For example, while I could follow the economic balancing in most cases cited and described in the article, I found the Adams v. Ursell case (Fish and Chips case, p.21) very puzzling. How is utility to be measured in this case for each side?
    I found Calabresi’s and Melamed’s article more helpful here. The distinction between property rules, liability rules and inalienable rules to protect entitlements (p. 1092) can perhaps be used here to argue for example that a “good neighbourhood” is -‘inalienably’ – equally, but not superiorly protected by law when it comes to nuisances. Otherwise, given the asymmetry of bargaining power in a negotiation process absent any regulatory intervention, in cases similar to Adams v. Ursell, I think that the market solution would be that the poor neighbourhoods would always end up suffering more nuisances.

    And while, according to Coase, in a transaction-cost free environment, resources and rights will end up in the hands of those who value them most, still I think that the theory is to a point circular as the ones who have the most bargaining power from the beginning will likely be the ones able to ‘value’ resources more and thus recourses will tend to return to them. The wealth effect introduces an element of circularity into the theory by suggesting that, all other things being equal, the one who values something most is the person who already posses whatever is at stake, thus introducing a bias in favour of the status quo.

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