Free Essay on Economics of Regulation and the Coase Theorem

Published: 2022-03-24
Free Essay on Economics of Regulation and the Coase Theorem
Type of paper:  Essay
Categories:  Economics
Pages: 8
Wordcount: 1966 words
17 min read

Externalities are one of the major reasons that governments have to intervene in the markets, to ensure that negative externalities are avoided, and goods that have positive externalities are cheaper. However, the Coase theorem explains that there is a way of eliminating the need for government intervention. Government intervention has been criticized for interventions in the markets because they lack all the information that is needed to effectively achieve the desired outcomes. This means that leaving the market forces to play their roles is the best way of ensuring that there are no externalities. The Coase theorem explains that all that is needed is ensuring that there are property rights for the producers in the economy (Frank, 2011). One producer can have all the rights, or the rights would have to be shared among the various producers in the economy, and it is possible to trade the property rights.

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The Coase theorem is based on the view that there should be no transaction costs, such that it is possible for the producers who pollute to negotiate without incurring costs and reach agreements. This means that the individuals with the rights will be willing to trade their pollution rights so that they can get some financial compensation (Frank, 2011). An example is farmers who do fishing in a river can get some compensation from companies producing goods and pollute the river killing the fish. They will accept the compensation up to a certain level. The producers of goods, on the other hand, will be willing to give compensation up to a point where the value of what they produce is equal to the amount that they pay as compensation to the property right owners. This can lead to both the farmers and the companies in the industries arriving at equilibrium without the need for the government intervention (Coase, 1988).

It should be noted that even if the property rights were given all rights to pollute the river was given to the company that produce goods and pollute the river, they would be willing to trade their rights, reduce production and allow the farmers produce fish. The farmers would be willing to pay the company up to the point where the value of the fish in the market is equal to the cost that they incur in buying the rights from the companies that own the property rights to the river (Frank, 2011).

As per the Coase theorem, the government would have no reason to intervene as the market forces will lead to the production of the optimal output in an economy. In the example given, it would be possible for the society to accept a given level of fish as output, and the industrial goods. The society needs both of these goods and are thus willing to accept a given level of pollution, rather than have zero level of pollution and no goods and services from the various producers in an economy (Coase, 1988). In such a case, the socially acceptable level of production, and optimal quantities of goods and services in the economy would be available for the members of the society.

In this case, government intervention in any way would lead to undesirable results. First, it would mean government expenditure and people in the society would have to pay more taxes to fund the government activity. This would be undesirable considering that it is possible to have socially acceptable levels of pollution without having to tax the members of the society (Coase, 1988).

There is a great problem when the government intervenes because it lacks the needed data to determine the socially acceptable levels of pollution for all the stakeholders in the society. The government cannot tell the pollution levels that would lead to optimal levels of the fish production, industrial goods production while also maintaining a reasonable level of environmental degradation that does not make the members of the society worse off. Without the important data that is necessary in making decisions, the Coase theorem implies that the government intervention would lead to a shortage of some goods in the market, and very low levels of pollution or the opposite would be the case (Congdon, Kling, & Mullainathan, 2011). This is where the supply of goods would be excess in the market, and the levels of pollution would be too high to the society such that although the goods in the market are readily available and even at lower prices, their welfare is interfered with as they would suffer from various diseases due to diseases would make the society worse off. This would be a reason for the government to leave the market forces to shape production (Coase, 1988).

Additionally, government intervention in negotiations would also be of negative impact to the intended purpose. The reasoning is that when the government influences negotiations or even provides a platform for the same, then it means additional costs to the negotiation process. The parties would have to include the negotiation costs to their production activities, and this would mean that though equilibrium is reached, the high costs would mean less output in an economy and also more pollution and high prices for the output (Congdon, Kling, & Mullainathan, 2011). It is thus undesirable to intervene even in the negotiation process.

The Coase theorem thus concludes that the government should do nothing in the market to address any externalities that may be experienced. It just needs to give property rights to the parties, and allow for negotiations to take place so that companies can choose the extent to which they are to produce and meet the demands in the market (Parisi, 2017). The trade of the rights would lead to the society accepting a certain level of production while ensuring that the pollution level (externality) remains within the acceptable levels. In such a case, the various producers would have been compelled to internalize their externality.

There are limitations of the Coase theorem that would always necessitate the intervention by the government. This is mainly associated with the assumptions that the theory makes. First, it assumes that there are only two stakeholders in the economy so that they can trade the property rights between themselves. This is not practical in the real world situation. The fact is there are very many stakeholders in the economy (Congdon, Kling, & Mullainathan, 2011).

In the example given, there is the assumption that there is one farmer and one industry producing goods. The truth is that there may be many farmers who are depending on the river, and there are many companies producing goods in the same industry and even in the different industries but in the same economy. As such, bringing the so many stakeholders on the same table to negotiate would not be possible. There would be a conflict of interests and the decisions that the property right owners may not be based on the desire to achieve the best outcomes for the economy. There may be externalities that are not accounted for (Congdon, Kling, & Mullainathan, 2011). The sale of property rights, in this case, would be intended to make the highest profits from the sale, and not on the need to eliminate externalities and produce a desirable output.

The Coase theorem is based on the need to allocate the property rights to some stakeholders who will then be willing to trade the rights with the other stakeholders in the economy. The theorem does not come up with a clear way of allocating the property rights such as rights to pollute a river or the right of clean air. This means that the government would be needed to assess the value of the property rights so as to allocate a fair value for the property rights, and also ensure that the value is reviewed from time to time. Doing this would help arrive at an optimal level of pollution (Parisi, 2017). Considering that the Coase theorem is against the government intervention, then it leaves a lot to be determined in regard to the process of allocating the property rights. The fact is that such allocation of property rights would lead to some transaction costs and this would be against the assumptions of the Coase theorem (Coase, 1988).

When there is property rights laws, there is no assurance that the stakeholders in the economy will implement the laws are per requirements. If there is a certain level of pollution that is allowed by the government, it is not obvious that the companies in the economy will pollute as per their rights. It is possible for some stakeholders to violate the property rights and without government intervention, then it would become difficult to ensure that the rights are respected (Parisi, 2017). When there are negotiations and an agreement is agreed on between the property right owner and the other stakeholder buying the rights, there would be a need to have a party that is responsible for ensuring that the agreement is implemented accordingly so that production goes on without externalities. The government would be required to oversee the implementation of the agreement (Congdon, Kling, & Mullainathan, 2011). As such, the intervention introduces new costs, and the Coase theorem in such a case would not be working.

The ownership of property rights would be the reason for the creation of natural monopolies in the economy, which are inefficient. This is because property rights especially for one specific party would mean that companies would deny other companies the rights to produce by not selling them any of such rights. As such, they would have the exclusive rights to produce and pollute the property that they pollute such as rivers (Parisi, 2017). They would also sell such property rights at exorbitant prices so that they can discourage them from producing. As such, the economy would end up having low production levels and high prices for goods because of the high prices that are charged for the property rights. This would be undesirable for the economy, and this requires that the government intervenes effectively (Congdon, Kling, & Mullainathan, 2011).

It is thus clear that the Coase theorem has weaknesses that warrant state intervention in the markets. There are various other alternatives available to fill the gaps created by the weaknesses in the Coase theorem. The first option is to impose a pollution tax so that every company that pollutes pays tax depending on the quantities of pollution. The more a company pollutes, the more tax they have to pay. Since the tax adds to the cost of production for companies so that they lower their production levels and reduces the levels of pollution (Friedman, 2000). As a result, desirable levels of pollution are arrived at, and the government can vary the tax rates to arrive at the desired levels of pollution. This is a better alternative as compared to the Coase theorem because the tax collected can be used to clean the pollutants in the water bodies and in the atmosphere.

For the Coase theorem, trading of property rights benefits the individual property right owners, and this does not create funds for the purpose of cleaning the environment. This means that pollution tax is a better alternative to what the Coase theorem recommends. While it introduces some costs in the economy, it leads to better results since the society benefits from tax revenue considering that the society members suffer from pollution by companies (Friedman, 2000).

The other alternative is having a quotas system which allows various polluters to produce up to certain levels of pollution. This would mean that there are many companies in the industry that are allowed to pollute. The government would just determine the acceptable level of pollution that makes it possible to meet the needs of the consumers in the society, and then ensures the producers are given a quota to pollute. The impact would be that the pollution level would...

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