The Environmental Turn

The earliest responses to Coase’s analysis in “The Problem of Social Cost” were largely affirming, though this affirmation centered on the negotiation result rather than the larger message of the paper - his call for a comparative institutional approach to economic policy issues.

In formulating the Coase theorem as he did, Stigler seems to have been intentionally drawing a parallel to the First Fundamental Theorem of Welfare Economics, which asserts the optimality of competitive equilib­rium under certain conditions - one of which is the absence of external effects. The Coase theorem, then, suggests that externalities are not inevit­ably an impediment to optimality. Given the slight literature on the theory of externalities extant, Stigler’s rendering is sensible. The focus of the limited discussion of externalities in the period since Pigou penned The Economics of Welfare (1920) had been on ascertaining the effect of exter­nalities on competitive equilibrium and the reasons for the resulting inefficiencies (Medema 2019).7 And, indeed, this was the basic frame through which Coase’s result was viewed for the first decade following its publication. With a couple of prominent exceptions (Wellisz 1964; Mishan 1967b), it was generally accepted that negotiation could, under the as­sumed conditions, result in the maximization of the value output, though commentators typically stressed that this was not relevant to the problem under consideration in the paper at hand owing to the prevalence of transaction costs.

In the 1970s, however, the tide began to turn, and to turn sharply. The Coase theorem was assailed seemingly from every side and on a variety of grounds, theoretical and otherwise. The argument here is that it is the “otherwise” that provided much of the impetus for the controversy, in­cluding the theoretical part of it. Specifically, the Coase theorem's logic and implications - both real and perceived - for policy struck a chord, and on at least two fronts.

First, the Coase theorem and its implications for externality policy intersected, externally, with an increased societal concern about the effects of large-scale pollution and, internally, with the related genesis of the field of environmental economics (Medema 2014). In the process, the tradition­al externality-related concern with the efficiency of market outcomes became enmeshed with, and at times gave way to, non-welfarist consider­ations driven by attitudes toward pollution and what should be done about it. Second, the Coase theorem became a, and perhaps the, bedrock principle of the emerging economic analysis of law (e.g., Calabresi 1970; Posner 1973). Here, its implications intersected with traditional behavioral norms and perceptions of justice, offending the sensibilities of both legal scholars and economists. Given the subject matter of this paper and the fact that the great majority of these concerns were raised by lawyers rather than econo­mists, we will not treat this literature directly. But as there are common threads of argument across these two fronts, we will at times make note of the legal-economic commentary.^[88]

The association of externalities with pollution is a long one. Though, as noted above, the externality literature prior to the late 1950s is extremely thin, such discussions as we do see regularly invoke pollution - typically a factory dumping waste into a stream - to illustrate the problem. Even so, the focus of the analysis, post-Pigou, was not on devising mechanisms to restrain the polluter's activity, or on remedies generally.

When economists began to take up the analysis of environmental prob­lems in the latter half of the 1950s, they did so via the theory of externalities handed down from Pigou and, as the field developed over the next two decades, the Pigovian approach became entrenched as the dominant para­digm. The focus was on Pigovian tax and regulatory remedies (with some attention to subsidies), all justified based upon the standard welfare prescriptions of orthodox economics - that pollution led to divergences from the marginal conditions for an optimum, divergences that could be effectively eliminated via Pigovian instruments.

Despite this Pigovian emphasis, the Coase theorem was slowly becoming a staple of the externalities literature. As we move through the 1960s, we find Coase’s result discussed more and more in theoretical treatments of the subject, as well as in applied discussions of externalities and the policies available for dealing with them. Even so, there was no groundswell of support in the literature for negotiated solutions to externality problems. Instead, as noted above, we find Coase’s result mentioned, but quickly pushed to one side in favor of Pigovian remedies on the grounds that transaction costs preclude the operation of the theorem’s mechanics.

The explosion of literature on the economics of the environment in the 1970s, however, brought a radical change to the nature and tone of the discussion. Suddenly, the Coase theorem was perceived as a threat to the proper analysis of and policy formation with respect to externalities and, in particular, the problem of large-scale pollution. Though Coase (1960, p. 18) himself had specifically noted that the negotiation result could not be expected to apply to such situations, a substantial body of theorem criticism emerged suggesting that many economists took seriously the notion that the Coase theorem offered a means for dealing with pollution externalities.

If the goal of externality policy is to generate efficient outcomes - and this had been the theme in the literature for some four decades - economic theory provided no reason to prefer Pigovian instruments to Coase theorem solutions. Each assured efficient outcomes under idealized conditions but could promise no more than that. To get at the hostility to the theorem, then, we must look to other considerations. Two such considerations emerge from the environmental economics literature of the 1970s: a concern with fair­ness, or equity, in the allocation of the costs associated with reducing pollution damage and a view of the environment as an end in itself.

9.3.1 Equity, Fairness, and the Rejection of Reciprocity

In what is typically regarded as the first major statement of a neoclassical economic approach to the environment, Allen Kneese, writing in The Economics of Regional Water Quality Management (1964), put Coase’s negotiation result front and center in the environmental discussion.^[89] Kneese devoted several pages to Coase’s result and accepted the theoretical validity of both the efficiency and invariance claims. Having gone this far, however, he suggested that, in the case of a firm whose pollution damages fishing stocks, “on equity grounds it might be considered justifiable to compensate the fisherman for his loss of fish,” as opposed to having the fisherman pay the polluter to induce a reduction in or the elimination of pollution emissions (1964, p. 44). Kneese’s concern that equity matters in the determination of who is made to bear the costs related to environmen­tal harms would echo time and again in the discussions of the Coase theorem within the environmental economics literature. The underlying message here, implicit in Kneese’s argument but a recurrent theme in the environmental Coase theorem literature through the 1970s, was that there are “injurers” and “victims,” and it would be unfair to require “victims” to bribe polluters to reduce their emissions.

The strongest voice on this front was LSE welfare economist E. J. Mishan, who wrote extensively on welfare economics in general and externalities in particular during the 1960s and 1970s.^{[90] [91] His views, ex­pressed across a range of books and articles - including his 1971 Journal of Economic Literature (JE:) survey of externality theory (1971b) and The Costs of Economic Growth (1967a), written for a broader public - received wide exposure. Though his initial reaction to Coase’s negotiation result was largely affirming (Mishan 1965), his attitude toward it changed as exter­nality theory increasingly became synonymous with pollution control in the late 1960s and early 1970s. Mishan’s concern for ethical issues on this front comes through forcefully already in The Costs of Economic Growth, but the connection to the Coase theorem was driven home in his 1971 JEL survey, where, in the course of analyzing the Coase theorem’s invariance claim, he took pains to emphasize that while the claims of competing resource users in situations of externality “are indeed Pareto symmetric,” they “may not be ethically symmetric” - that there is something ethically wrong with an assignment of rights under which the victim pays (Mishan 1971b, p. 24).11 As Baumol (1972, p. 309) put it, under this line of reason­ing, “the murder victim too, is then always an accessory to the crime.”}

While Mishan was concerned about the potential distributional conse­quences of Coasean bargains - in other words, that the poor may be harmed for the benefit of the wealthy through pollution - he placed greater emphasis on “the inequity per se of a law that countenances the inflicting of a wide range of damages on others without effective means of redress.” Absent a set of sanctions against those who would “trespass on the citizen's amenity,” he believed that “existing institutions lend themselves inadvert­ently to a process of blackmail in so far as they place the burden of reaching agreement on the person or group whose interests have been damaged” (1967b, p.

The message that emerges here is that holding “victims” liable is simply wrong, or, as Mishan put it in 1967, contrary to “social justice” (1967a, p. 68). These arguments represent a clear-cut rejection of the reciprocal view of externalities laid out by Coase in “The Problem of Social Cost.”¹² Indeed, given this reciprocity - which we find emphasized not just in Coase, but in, for example, Hohfeld (1913) and Commons (1924) - the very rhetoric of “polluter”/“injurer” and “victim” speaks to the non- welfarist underpinnings implicit in economists' discussions of these issues. One prominent illustration of this, and of the problematic nature of such assertions, can be found in Mishan's argument for the priority of rights of non-smokers, made on the grounds that “the freedom to breath fresh air does not, of itself, reduce the welfare of others.” In like manner, he said, “the freedom desired by members of the public to live in clean and quiet surroundings,” as against having noisy vehicles or polluting factories operating nearby “does not, of itself, reduce the welfare of others” (1971b, p. 25). But these statements are patently false; freedom for the non­smoker reduces the welfare of the smoker and the freedom of the residents

these (e.g., Mishan 1967a, pp. 60-61), though Common (1988), in contrast, later argued that this conventional story of wealthy polluters and poor victims may well not be true in certain instances. Problems associated with the long-term nature of certain forms of environmental degradation, too, were raised in this context, with the argument being that the interests of future generations are not likely to be sufficiently taken into account in Coasean negotiations carried out by members of the present generation and that govern­mental solutions were more likely to be framed with these intergenerational issues in mind (Mishan 1971b, pp. 24-26).

¹² Interestingly, others, including some not favorably disposed to the Coase theorem as a mechanism for dealing with externality problems, suggested that alerting economists to the reciprocal nature of externalities was one of the major contributions of Coase's article. This is a theme that Samuels, for one, emphasized repeatedly. See, e.g., Samuels (1974). to enjoy amenity reduces the welfare of owners of the automobiles and of the plant, as well as the plant’s employees and the customers, both of which groups are impacted by the higher costs of production associated with costly pollution abatement activities.^[92]

The centrality of these fairness considerations in the literature and the seriousness with which they were taken by scholars in the field is further evidenced in the fact that they were given prominent play in the textbook literature of the period.^[93] Lloyd Reynolds (1973, p. 214), for example, instances a situation where “A chemical plant dumps wastes into a river which kill the fish in a lake located downstream, thereby depriving would- be fishermen on the lake of a pleasant recreation.” Reynolds pointed out that the fishermen could band together and bribe the plant to reduce emissions sufficiently to make the lake safe for the fish. “But on second thought,” he continued, “this doesn’t seem very fair. Why shouldn’t the company pay the fishermen for the damage inflicted on them, instead of the other way round?” It was not simply about efficiency, then, and even when it was about efficiency there was concern for how that efficiency was to be achieved.

It is worth noting that not all of those who raised the issue of fairness came down on this side of the fence. Tony Chisholm, Cliff Walsh, and Geoffrey Brennan (1974), for example, struck a rather different tone, contesting the standard dichotomy between wicked polluters and virtuous victims. Like Coase, they argued that the problem is inherently reciprocal: “The truth of the matter is that all consumers contribute to pollution by the very act of consumption; firms pollute, not because they derive fiendish delight from doing so, but because the individual consumers of their products pay them to do so” (p. 4). The argument, of course, is that if consumers, too, are a cause of the pollution, it becomes reasonable to consider the option of making them bear some amount of the cost. This, however, was very much a minority view.

9.3.2 The Environment as an End

The second major emphasis in the non-welfarist attacks on the Coase theorem was the view that environmental preservation is an end in itself

and that the Coase theorem works as a threat to the achievement of this end. This emphasis manifested itself in a strong “pro-abatement” tone that was found in so much of the environmental economics literature during this period - a view that pollution levels must be reduced “to levels that are considered to be tolerable” (Baumol 1972, p. 307).

The perception of potentially cataclysmic effects from pollution was a driving force behind the writings of two of the theorem's staunchest critics during this period. Warren Samuels, writing in 1972, argued that other criticisms of the Coase theorem were “dwarf[ed]” by

the fact that such externalities as water and air pollution may threaten the very basis and operation of civilization both in individual industrialized nations and on the planet as a whole. We may be dealing not with the subtle marginal conditions of a maximizing equilibrium, but the even more subtle total conditions of survival, a bounded consumption set, as it were, for the entire species. The threatened wreckage is far more than welfare economics. (1972[1981, p. 67])

H. H. Liebhafsky (1973, p. 676) struck a similar chord in his essay for the Natural Resources Journal's Coase theorem symposium:

We are all tenants for life of the environment and our possession is rightful. The environment is an essential part of the inheritance, and uncontrolled pollution constitutes a destruction or improper deterioration of that inheritance. Those who may from time to time be in a position to make use of governmental power to preserve the inheritance stand as trustees.

The question of the Coase theorem's applicability is front and center here, underpinned by the belief that leaving things to the market will almost certainly result in significant environmental degradation owing to the failure of the Coase theorem to work its magic in the real world (e.g., Samuels 1974, p. 22).

As Randall pointed out, those who saw the Coase theorem as relevant for dealing with environmental issues made one of two arguments. The first, grounded in the notion of allocative neutrality, was that there is no reason to move away from a system where polluters are not liable, since a change in the assignment of liability would have no allocative impact in any event (Randall 1974, p. 38). Randall referred to the doctrine of allocative neutral­ity as “the clincher” to the Coasean approach and argued that “its demise,” owing to the various critiques of the theorem, was “disastrous to the laissez-faire people” (p. 53). As both Samuels (1974) and Randall (1975) noted, it makes the policy significance of the Coase theorem the exact opposite of what those disposed to market solutions assert - property rights assignments, in reality, affect both allocation (including pollution levels) and distribution, as well as “the whole range of macroeconomic variables” (Randall (1975), p. 739).^[94]

The second argument made by Coase theorem supporters, most forcefully stated by Demsetz (1964; 1968), was that transaction costs are simply another form of cost, like production costs, and that exchange which exhausts all gains from trade, net of transaction costs, is Pareto optimal. The conclusion drawn from this was that externalities are efficiently intern­alized through the market if transaction costs are the only factor precluding further exchange. As such, it was argued, government intervention to internalize the externality is unnecessary and even efficiency-diminishing. Randall (1972a, pp. 176-177) summarized this position as follows: “[W]hen a market for an external economy does not exist it should not exist, since the benefits from such a market clearly cannot exceed the costs of its operation. The absence of an observable market is itself a market solution.”

It goes almost without saying that both of these “Coasean” positions would be anathema to those who believed that pollution should be reduced from its existing levels. As Mishan put the case in his Journal of Economic Literature essay, “Rationalizing the status quo in this way brings the econo­mist perilously close to defending it” (1971b, p. 17), and the status quo was viewed by many as wholly objectionable. The clear sentiment that emerges from the writings of the theorem's strongest critics is that the market should not be the sole arbiter of rights over resources such as air and water.

The objection here is not to the use of Coase-theorem-type legal rules of liability or property-rights solutions per se - that is to non-Pigovian (tax/ regulatory) remedies - but to the notion that failing to directly restrict the activities of polluters will lead to unacceptable levels of environmental degradation.^[95] Randall (1974, p. 54) even went so far as to ask whether one can adopt the Coasean invariance position “without appearing bla­tantly anti-environment” (Randall 1972b, p. 47; 1971, p. 867) and Dick (1976, p. 194) made the achievement of “higher levels of environmental quality” (Randall) or “environmental gains” (Dick) a goal and advocated polluter liability on that basis, though both were willing to countenance the possibility of market arrangements that allow polluters to purchase the right to pollute.^[96] Mishan's case for “amenity rights,” referenced above, similarly was grounded in his view that they would “promote... a rise in standards of environment generally” by reducing activity levels or promot­ing abatement or, if necessary and feasible, the compensation of victims (Mishan 1967a, pp. 71-73). Daniel Bromley (1978, p. 57), for his part, took a still stronger position, going so far as to suggest that it may be best to rule out the possibility of market transactions in certain situations, asserting that a rule of inalienability “would seem most appropriate” for externality situations that are “detrimental to human health or to long-run ecological integrity.”

In short, there can be no question that the Coasean approach was perceived - by environmental economists and others - as a real threat to the long-accepted status of the Pigovian tradition, an approach that guar­anteed reductions in pollution emissions from market-generated levels and did so in a way that imposed costs on emitters rather than “victims.” Mishan made this explicit, characterizing what he labeled a “consensus” on the Coase theorem (1971b, pp. 16-17) as the launching point for “an iconoclastic movement to edge the master [Pigou] from his niche in the hall of fame” (1974, p. 1288n.1),^[97] the blame for which he laid squarely at the feet of Coase and, to a lesser extent, Buchanan and Stubblebine (1962). In adopting such a stance, however, economists put themselves at odds with “politicians, administrators, and the general public,” as this latter group, in Randall’s view, “seems to have more faith in systems of stand­ards” to achieve the desired level of pollution reduction (1972a, p. 176).^[98]

9.4