A Coasean view

Ronald Coase has consistently argued with respect to the special case of externalities that such externalities merely reflect the existence of incompat­ible uses of the same resources by different agents.

By way of example, consider a coal-based electricity generation plant located in a valley close to a river from which it can take cold water for its cooling tower, re-emitting the water partly into the river and partly into the air. Assume further that, beyond the warming effect, there is no further contamina­tion of the water which is being reintroduced into the local ecological system. In addition, electricity generation, by burning coal, leads to potentially toxic fumes which can be reduced to safe levels by building large smokestacks and thereby distributing the substance over a large area. The local economy in the ecological system is further assumed to consist of agriculture-based produc­tion: for the sake of simplicity we assume wine growing on the slopes of the mountains surrounding the river and fishery in the river.

From a physical point of view, there is emission of fumes into the air, which can be spread over a large area so as to avoid safety problems: there will be some warming of the water and a certain amount of (clean) steam being released into the air. A combination of a warmer river and steam in the air are likely to lead to the formation of mist which inhibits exposure of the grapes to the sun.

On the basis of these assumptions, let us look at the externalities in ques­tion from a Coasean point of view. The intra-system externalities crucially depend on the number of different uses we allow to be made of the ecosys­tem. We have incompatibilities between the power plant and the wine-growing industry, between the power plant and the fishing industry, but no incompati­bility between wine growing and fishing - small wonder, since they have probably coexisted for a long period of time with well-established property rights governing the use of the river and the surrounding mountain slopes. The negative effects from warming of the river can probably be contained on the part of the fishing industry if there is certainty about the temperature of the water and fish used to higher temperatures can be bred and harvested in that stretch of the river. That would imply, however, that the inflow of colder water will now have to be regarded as a negative externality from the point of view of using the river for warmer water fish. Hence any arrangement be­tween the fishing industry and the power plant would have to involve guarantees and compensation schemes with respect to the temperature of the river. Both the right to breed and harvest fish and the right to emit warm water would have to be curtailed so as to make the two uses of the river compatible. Fishermen would not be allowed to breed and harvest those species of fish that are particularly vulnerable to large fluctuations in water temperature, and in particular vulnerable to excessively low levels of water temperature, be­cause that is most difficult for the power plant to control during the spring season when the ice is melting in the mountains.

With respect to the relationship between the power plant and the wine­growing industry, the formation of mist is crucial, which implies that, under those weather conditions when mist has a crucial influence (in particular during the early autumn when sun exposure is necessary for the grapes to ripen and mist can lead to contamination by insects and diseases) the two uses of wine growing and cooling with river water have to be reconciled. Hence a contractual arrangement needs to be designed that governs the ejection of steam during these sensitive periods: alternative forms of cool­ing or additional forms of recooling the steam before re-emitting it into the river or ejecting it into the air may have to be considered, the timing of ejection or re-emission may also be crucial during the day, as, for instance, the formation of late afternoon mist on sunny days is unlikely. Again a partitioning of property rights with respect to the water use, including the possibility of mist formation and with particular emphasis on that possibil­ity during crucial periods of growth and harvest, will in all likelihood allow for the internalization of the externality through an effective definition of property rights.

The analysis has, so far, been substantially facilitated by limiting the number of alternative and partly incompatible uses of the common resource (the valley with the river) for the three different purposes of energy genera­tion, wine growing and fishing. In addition, the plant emits potentially toxic fumes, which, however, become toxic only if additional sources of emission exist outside the system. Obviously, here a different ecological regime needs to be defined for that particular resource use, which is independent from the other resource uses. It is here that the principle of subsidiarity has to be invoked (see Backhaus, 1995).

With respect to the relationship between the power plant and the fishermen, again the management of the ejection and re-emission of the cooling sub­stance is crucial. Interestingly, here at times a larger inflow of warm water into the river may be required in order to protect the fishing stock from a sudden drop in water temperature. As obviously the pattern of breeding and harvesting fish can largely contain the cost of sudden temperature drops, and during the winter different fish can populate the river from those during the summer, the requirement may only involve relatively small peak periods and, in this case, require the re-emission of uncooled water into the river. Again a large water reservoir and the ability to use and manage different forms of cooling will be required for this approach to be successful. Very similar to the first case, the cost of operation will again largely be affected by the timing of the decisions, and, when the decisions can be taken at the time of design and construction of the plant, the costs will in all likelihood be much lower than if later alterations of plant design, process of production or management need to be implemented.