Coase’s legacy in law and economics

In writing ‘The problem of social cost’, Coase intended to correct a consoli­dated error of the Pigouvian interpretative tradition. From the vantage point of over 30 years, Coase does not appear to show any sign of repentance.

Coase formulates a rigorous argument in support of his severe conclusions. His point is that, in addition to the relative difficulty of gathering the neces­sary information for an effective use of the Pigouvian taxes,¹²¹ this type of approach lacks symmetry in addressing the problem of externalities. Accord­ing to Coase, economists in the Pigouvian tradition fail to consider the possible reciprocity of the effects of individual choices.¹²² By labelling one agent as injurer and the other as victim, the Pigouvian tradition presumes an initial allocation of rights.¹²³ In such a manner, this approach falls into a serious methodological error.¹²⁴ By taxing the generator of the externality in a measure corresponding to the difference between the private cost and the social cost of his own activity, Pigou’s followers fail to consider the effects of potential victims’ behaviour.

The example I used to illustrate my argument was that of a factory whose smoke would cause damage of $100 per annum but in which a smoke-prevention device could be installed for $90. Since emitting smoke would involve the owner of the factory in paying taxes of $100, he would install the smoke-prevention device, thereby saving $10 per annum. Nevertheless the situation may not be optimal. Assume that those who would suffer the damage could avoid it by taking steps which would cost $40 per annum. In this case, if there were no tax and the factory emitted the smoke, the value of production would be greater by $50 per annum ($90 minus $40).¹²⁵

Coase renders his reasoning even more convincing by taking into considera­tion the choices of new individuals who locate their residence in that area, without considering the potential increase in the costs imposed on the indus­trial activity. Through these arguments, Coase’s analysis demonstrates the incapacity of the Pigouvian approach to consider the interdependence of the harmful effects generated by individual choices.

These are, in truth, complex questions which have engaged a whole gen­eration of economists and policy makers. The two approaches - sound in their respective analyses - must be evaluated in light of the specific circum­stances. Lawyers and policy makers will have to be particularly attentive to the respective assumptions of each tradition, weighing the relative strengths of each remedy in the treatment of the complex situations they encounter. In considering the Pigouvian and Coasean traditions, one can no longer think of two directly opposed theories, in which the first identifies the solution with the choice of the optimal parameters for the fiscal imposition, while the other maintains that, in the long run, all externalities will be cured in the market.

The issue for the jurist is of a broader scope. It deals with the unstable relationship between private and public remedies in the pursuance of social goals. The jurist may have limited opportunity to enter actively into this debate, but he/she should always treasure Coase’s intuition in reappraising familiar legal issues.